The Cost of Power - Part 2 The Tasmanian Experience

Part 1 examined the development of the NEM (National Energy Market) from a national perspective.

In Tasmania, three utilities were created from the disaggregation of the old Hydro Electric Corporation (HEC).  Hydro Tasmania was to be responsible for power generation, Transend for high voltages transmission, and Aurora for distribution (poles and wires) and retail sales. An arbitrary distribution concerning the allocation of the old HEC debt landed Hydro with over $1000m, and Aurora around $350m.  Transend was debt-free.

The later addition of the Basslink cable has connected us with the mainland and enabled full participation in the NEM.

Hydro generates most of its power from water, and unlike thermal generators, can adapt to rapid changes in demand in quick order.  As long as the water is there, Hydro can be a significant player in the NEM.  Even through the drought, when water storages were low, Hydro was still able to provide power into the grid and pay its loan guarantee fee to the State.

Hydro derives its income from NEM market sales, arbitrage over Basslink, and its consulting business, Entura.  It also has a successful and growing retail business on the mainland called Momentum, servicing a niche market for clean energy.

For some years, especially during the drought years, the interest payments on the debt allocation significantly constrained Hydro’s operations, including essential maintenance of its generating assets.  In 2008, the government shifted some $220m of debt over to Transend, enabling Hydro to operate more efficiently.  The advent of the “carbon” tax will be of competitive advantage to Hydro, essentially by making its coal-fired competitors less competitive.  A great opportunity for its Momentum business.  

First and foremost, Hydro is a business.  It competes in a national market, and the price it charges for its power is determined by the market, and a regulatory oversight ensures it provides power at market prices.  It provides major customers with bulk power under 24/7 take-or-pay contracts, and, although disbelieved by some, is charging commercial prices for that power. 

To me, Hydro has been an outstanding success story.  It has managed our water resource well, it has developed a successful wind-farm business, it has adapted to changing circumstances, it has become a successful trader in a national market, its business model of being a renewable energy business has provided it with competitive advantage, and its consulting arm is recognised throughout the world bringing renown to Tasmania. And it provides substantial dividends to the State.  

Transend had the good fortune of starting its life debt-free.  As a monopoly business it is tightly regulated, and its opportunities to value-add are limited.    Transend’s revenue is derived from a revenue reset mechanism, whereby the price charged relates to the value of the assets under management.  The higher the asset value, the more it is paid.  In other words, it is in Transend’s interests to have high-value assets, as distinct from appropriate assets.  It has in the past followed an extraordinary risk-averse strategy, with little evidence of business rigour. Compare the increase in its charge rate (71%) against the CPI (21%) since 2003.  And staff numbers from 50 to over 300.  Maybe the reset mechanism needs a reset.

Government should also seriously consider transferring the poles and wires business from Aurora to Transend.  Bringing the regulated monopoly power delivery businesses together is a natural fit and could deliver synergies and cost savings resulting in cheaper power prices.

A new Chairman and CEO must deliver more commercial rigour to Transend’s operations.  In fact, Government must insist on it.

Aurora is responsible for the distribution and retail sales of power.  It buys power on the open (wholesale) market, which has significant price fluctuations, but needs to sell power at fixed prices.  It must therefore embark on a sound risk management profile in order to remain viable.  At the same time, it is at the cutting edge of our concern about power prices.  However, demands for concessional rates are in fact community service obligations that should be paid for by government.  In other words, Aurora should be allowed to run as a commercial business and pay a dividend to the State, which then determines how that money should be spent.

Government gifted Aurora an onerous legacy in the Tamar Valley Power Station.  A new gas-fired station, it was half-built when its owners went broke.  The government  purchased it, paying far too much for a distressed asset, then handed it to Aurora to complete the build.  To its credit, the task was completed on time and on budget.  However the station was an expensive construct, and the debt still needs to be serviced.  Furthermore, Aurora then “negotiated” an onerous take-or-pay gas supply contract, which has made the station an absurdly expensive operation to run.

More concerning is the approach the company has taken to its computerization program. It is common knowledge that there was a $50 m overrun implementing new billing software.  A disaster, true blue.  The reasons given were “we underestimated the task”.  Maybe we have overestimated the skill of its senior management. And no further action has been taken – where is the accountability? 

The Aurora business model is in need of some review.  By its actions, it is obvious that Aurora is still searching for its niche.  Is it a “poles and wires” business, a retailer, a generator, and to what extent should it be a national trader? All important questions.

Some folk remain critical of these entities – if a government business makes money it is at our expense, if they are losing money we have to subsidise them, again at our expense. Whichever way we look at it we lose.  In my view, this is not the correct approach.

Throughout this article I have endeavoured to paint a picture that these utilities need to be run as businesses.  The NEM has caused our utilities to be businesses.  They may be owned by government, but they are commercial entities operating in a competitive national market, and need to be given the freedom to do so.  Performance is a matter for their Boards.  That is where the focus of their boards and management must lie.  Questions about performance are really questions about their governance. 

There is a regulatory oversight to ensure they operate in a fair and proper manner, but at the end of the day their task is to return a profit and pay a dividend to the State. The role of government should be limited to its relationship with the Boards.  And no more.  It is then up to the government to determine how that dividend should be spent. 

Hopefully the review will come to the same conclusions.