This was written for a state government department a year or so ago. How can the state’s and the Federal government be so at odds on the environment and energy policy?
Enron changed everything. When the company, at the time the sixth
largest in the world, collapsed investor sentiment turned against the
seemingly copper-bottomed energy sector.
In the report A world of difference – strategic options for Australia’s
energy sector published by PricewaterhouseCoopers last November, the
consultancy noted that Enron had a massive impact on the perceptions of
risk in the energy sector with investors seeking stable cash flows
replacing high-risk high returns variety.
Last spring credit ratings agencies identified the risk in the energy
market related to the pending Council of Australian Government’s (COAG)
energy market review and major overseas companies, such as TXU,
focusing back on their home markets in the wake of Enron.
PwC energy group partner Derek Kidley says: “In the post Enron environment energy players are under significant scrutiny by the markets to ensure that they have robust balance sheets. That’s causing a number of players to consolidate their positions in their home markets.”
For years energy users have been calling for reform in Australia’s electricity and gas markets. And change was delivered for Christmas last year with the release of the COAG’s final report on the energy market review on 20 December.
Ironically, the publication of this report has again increased the risk of investing in energy at a time when the electricity distribution network is in need of an upgrade and generating capacity is running low.
Kidley says that the fact that the Parer review took place at all highlights that the existing energy market wasn’t that good. He notes that that uncertainty surrounding regulation, excessive government interference in energy markets and a lack of consistent national policy direction have all contributed to the problem.
Now it will take months, if not years, for the Parer recommendations to be adopted let alone implemented. This in the short term will stall investment in infrastructure. Kidley says: “Until the dust settles and we get a clearer picture which bits of the Parer review are likely to be adopted and which aren’t, you can certainly argue in the short term it has probably increased uncertainty and risk in the energy sector.”
He reckons that it will not be until mid 2003 before any clues emerge as to the final shape of the post Parer energy market. He says that inevitably there is disagreement between the states and the author as what should be implemented.
The federal government has a different agenda and wants to move implementation along with a strict timetable involving a general election in 2004. Energy Minister Ian McFarlane last year pushed for the Parer review to be published two months early in December because of this tight timetable.
Energy companies will welcome answers on issues such as whether there will be a national energy policy, what the new regulatory system will be, how the national electricity trading market will develop and when mandatory renewable energy targets will be replaced by emissions trading.
Kidley says: “There is one fundamental concern that the industry has that there isn’t a clear national energy policy. And there is a lot of uncertainty as to how the market may develop in Australia.”
Aside from the risks there are opportunities, particularly for local companies. PwC noted that while offshore owners focus on their problems at home, there is the opportunity for locally owned companies to expand. It says that Australia being a small market can only support two or three energy conglomerates, probably integrated across the energy chain. This would encompass gas production, power generation, distribution network, trading and retail.
When overseas companies bought privatised generating capacity in the mid 1990s they were hoping to be able to expand their businesses. The halting of privatisation, giving them little reason to hang on to their investments, thwarted expansion plans. Since 1995 about just 20 per cent of generating capacity, 26 per cent of transmission and 23 per cent of distribution ended up in private hands. The firm reckons that Australian energy companies should open their minds to joint ventures with overseas partners. This, it says, could lever overseas investors into energy companies in NSW and Queensland.
Kidley says that over the next year the focus will be in trying to manage the risks of the wholesale market. One of the main problems identified by PwC and Parer is the trading of electricity using financial instruments called derivatives which allow, for example, retailers in South Australia to buy electricity from Queensland. The derivatives provide a contract to deliver electricity but it can be swapped for energy from another market such as NSW, which would take delivery from Queensland.
One factor that has held back the use of derivatives is that Australia’s states have piecemeal distribution networks that aren’t very well connected to each other and don’t have the capacity to transfer very large amounts of power. One of the main Parer recommendations is to shore up and improve these connections. Until this takes place now institution will underwrite the market. Kidley. “There are still a number of concerns that risks are quite high.”
The nature of energy investments is changing. Companies can either build the most expensive large base load generating plant to satisfy day-to-day demand when spot electricity prices are low, or cheaper, quick to build gas-fired plants that would supply power when there are peaks in demand, which is when electricity prices are at their highest. “What we are seeing is that the trend in investment is more in peaking capacity rather than that base load,” says Kidley.
One of the Parer recommendations is a move to embedded generation, where it is decentralised to the local level in small plants. These plants are smaller and quicker to build and are cheap. They also take stress off the distribution network saving upgrades and maintenance. According to Kidley, these smaller investments will undermine the economics of building large stations that would have a 25-year lifecycle. He says: “Looking not at the next 12 months but the next 20 years then fuel cell technology and embedded generation technology could have a significant impact on the market.”