Written in 2002 for CFO. Plus ca change…
Reform in the energy markets has resulted in upheaval and credit risk, writes Ed Charles
Since 1995 about 20 per cent of generating capacity, 26 per cent of transmission and 23 per cent of distribution and supply has moved into private hands. Now the companies that bought into the Australian energy market are moving out.
Sellers include US-based CMS Energy and NRG, which own 50 per cent and 25 per cent, respectively, in the Loy Yang 2000MW power station in Victoria, bought for a total of
$4.8 billion in 1997.
Market uncertainty has further been caused by the Council of Australian Governments’ Energy Market Review, which launched its issues paper calling for submissions in March this year. The first draft of the report was due to be published on November 15, just as CFO was going to press. According to insiders, Energy Minister Ian Mcfarlane wants the final report to be published by the year-end rather than the original deadline of February so that the Federal Government can push forward with reforms in 2003, prior to a 2004 general election.
Peter Dobney, national energy manager at Amcor, is concerned about the amount of consultation the review has had with the supply side of the industry and that, although evidence has been taken, there has been little feedback to the major users.
With a $122 million energy bill Dobney has many concerns, especially for the security of energy supply (see panel on opposite page).
Robert Booth, managing director of energy consultancy Bardak Energy Management
Services and a provider of evidence to the review, is a vocal critic of the current system and expects the COAG report to be “600 pages of absolute waffle.”
He claims the report has become the victim of warring tribes: bickering states and the Commonwealth.
In October rating agencies Standard & Poor’s and Moody’s Investors Service downgraded the outlook for energy companies. Moody’s said the change in outlook reflected its concern that TXU Australia – a key player in Australia – could come under pressure to repatriate funds to its ultimate parent, US-based TXU Corp.
S&P published its Australian Utilities Report Card, which noted that credit quality in the Australian utility sector throughout 2002 had continued to be heavily influenced by changes in ownership, with divestments by offshore parents with liquidity problems.
According to an S&P director, Ian Greer, most of the overseas companies that bought local power stations have had their assets on the market. NRG wants to sell its stake in Loy Yang; CMS has being trying to sell its stake, worth about $800 million, since 2000.
Says Greer: “Is there enough incentive for people to invest in new plant? I don’t think there is, because there is a lot of uncertainty over prices.”
His view is mirrored by major energy users such as CSR and Amcor.
Greer continues: “The worst case scenario for shareholders is that they lose their money. The worst case scenario for banks is that they end up owning a power station worth a lot less than they are owed.”
Loy Yang B, in the LaTrobe Valley, is probably exposed to the greatest credit risk in the market. Its owners want out yet they also need to refinance a $500 million slice of $3.5 billion of debt due in the first half of 2003.
Ten years ago the future seemed brighter. Power stations sold for top dollar, but now Victoria with South Australia have been left perilously short of generating capacity while NSW and Queensland each have overcapacity of about 20 per cent, similar to the prudent margins adhered to in Britain.
Loy Yang B, which also mines its own brown coal, can date its problems back to the fall in electricity prices that followed privatisation. Its exasperated owners are now considering a $2 billion equity offering to help pay off debt.
The electricity pool trading system, which has already been dropped by Britain and California, also presents a risk.
It has proved in Australia to be unstable and vulnerable to price manipulation.
According to Britain’s joint electricity and gas regulator, the Office of Gas and Electricity Markets (Ofgem), the country’s now abandoned trading system, similar to that still used in Australia, allows the abuse of market power.
“Under electricity trading, companies can use short-term market power to harm the
efficiency of the competitive market,” says the regulator. “Ofgem believes action to counter such abuse – generally reckoned to have contributed to the Californian energy crisis -is justified and needed.”
Since the new trading system was first mooted by the British Government in 1998, wholesale electricity prices have fallen by 40 per cent, according to Ofgem.
In the first year of the New Electricity Trading Arrangement (Neta) up to March 2002, wholesale electricity prices fell by 20 per cent.
Ten years ago the Business Council of Australia Energy called for effective competition in energy supply.
What it wanted for major users was electricity costing as little as practicable, price stability and predictability.
But as the Business Council noted in its evidence to COAG, there has been little success in creating real competition between generators, and this failure has been made worse by the weak links between the state electricity grids.
Indeed, a joint submission to the current energy review from Holden, Visy Paper,
OneSteel, WMC and BHP Billiton, questioned the benefits of energy reform. The companies said that the current trading system allows “gaming by generators when reserve margins are tight”.
Dr Booth is also critical of the casino-like nature of the electricity trading system.
Although prices initially fell in Australia to under $30 a MegaWatt/hour up to 1998 it was to the detriment of the system. Most major users believe the generators are now manipulating the market to recoup costs, causing large spikes in cost.
Booth says that prices have peaked at $9000 a MWh for a short time, compared with the current market price of $40 a MWh.
And where supply is short – Victoria and South Australia – costs are soaring. In 2001, South Australia saw a 45 per cent hike in industrial/commercial tariffs. Victoria will see a 30 to 35 per cent increase in domestic tariffs from early 2003.
The generators themselves face further financial risk from the insurance market. Terms for business interruption insurance have been revised up from 45 to 90 days before any payments will be made.
For companies with contracts to supply and a short market for electricity forecast this summer, some generators may be forced to pay high prices to meet their obligations.
S&P’s Greer says that it will take at least 18 months before any results are yielded from the COAG Energy Market, further increasing the risk in the market.
“Ultimately at the end of the day … the householder ends up paying,” he says.
Greer says that between buying a hedge from Loy Yang B in Victoria and Stanwell in Queensland, which is government owned, the credit risk is different.
He says that he would be reasonably happy with short-term contracts with Loy Yang B, but in the long term would be worried.
DISTRIBUTION AND RISK
Warren Saxelby, chief financial officer at CSR says that the best risk abatement the company has is the distribution of the group’s businesses over more than 600-odd sites. He says that most of the issues are handled by management within the individual businesses.
Saxelby reviews the procurement groups’ activities and has reviewed recent work on electricity contracts.
Paper manufacturer PaperlinX also diversifies its risk over many sites. According to CFO Darryl Abotomey: “PaperlinX generates a significant proportion of its own power. We have operations in three states so have a natural diversity.”
Simon Lillyman, general manager of procurement at CSR, is responsible for all the company’s energy costs of $41 million, consisting of $22 million for electricity and $19 million for gas. He says: “One of the biggest things that we find is that some of the infrastructure, especially in Victoria, is a bit on the old side.” If supply is broken for a fraction of a second it is a problem with the level of computerisation in plants.
CSR locked into long-term contracts – which have isolated the company from price spikes. Lillyman says that when it comes to long-term energy contracts, the retailers are becoming very risk averse, which has led to a quadrupling in the cost of contracts, albeit coming off a low base.
“Prices were too cheap,” he says.
SECURITY OF SUPPLY A PRIORITY
For most companies, security of supply at a fair cost is a priority. Amcor’s national energy manager Peter Dobney says: “Security of supply is the most important thing … Power outages cost more than the electricity bill.”
Darryl Abotomey, chief financial officer at PaperlinX, says that a risk free supply is ideal but probably impractical. “We feel the current situation for electricity is unstable, but are confident it will be resolved over the next few years between industry consolidation and linking of supply for example, [trans-Tasman power project] Basslink.”
At its California operations, Amcor has invested in back-up power because of the unreliable supply. In Victoria, one of the company’s plants had 12 outages in February and March earlier this year, costing more than $100,000. In his evidence to the review panel, Dobney said that the problems were “ongoing and are far from being resolved”.
His problems in Victoria are caused not by the generators or the National Electricity Market but by the regulation of the distributors and how they spend on maintenance of the power grid.
He says that while companies have incorporated more computers into their manufacturing, making the equipment sensitive to power surges and dips, the reliability of the electricity supply has not kept pace.
He believes that the electricity transmission and distribution businesses should be subject to the same commercial incentives as other businesses, in order to maintain secure supplies to customers.
Abotomey is philosophical about the problems and notes than even small reductions in costs and energy usage are good for consumers and the environment.
“There is clearly a balance between security of supply and price. We are not immune to competitive pressures, including cost. There is a fine balance,” he says.
“Absolute security would be cost prohibitive. And even if it wasn’t, no supplier could guarantee this, for example, [the supply of] gas with the Longford explosion. We look for a reasonable balance and we may suffer some downtime – that is the balance of risk and reward.”