Hydro praying for rain

There was more than a hint of Donald Rumsfeld’s maxim of ‘known unknowns’ when new Chairman Grant Every-Burns spoke of challenges facing Hydro Tasmania:

“The corporation is impacted by the well understood uncertainty around carbon pricing, renewable targets and rainfall variability. We are able to predict with certainty that the Hydro will be impacted for some years into the future.”

Hydro Tasmania appeared before a House of Assembly committee two weeks ago.

Scrutiny hearings often produce more heat than light, but amongst the wearisome adversarial exchanges was some useful information.

Hydro’s profits have now disappeared along with the carbon price.

Hydro was able to able to maximise production during the two years of carbon pricing achieving profits of $480 million almost all of which was remitted to the State government. The 30% of power in excess of local needs was exported to the mainland.

Hydro also benefited, to a lesser extent, from Renewable Energy Certificates (RECs).

These are granted to renewable energy producers for electricity generated from new renewable sources since the start of the scheme in 2001 and for electricity generated from the then existing renewable sources above a base line figure.

Power retailers are required to buy a certain number of RECs each year as stipulated by the Australian government.

Income from RECs depends on their market price and the renewable energy target RET set by government, and also the power generated above the base line figure which in Hydro’s case was boosted by the carbon tax.

The RET target is now under threat from the Abbott government. There is local tri-partisan support for keeping the current RET target.

Hopefully Senator Lambie can be persuaded to come on board. She reportedly considers the RET a tax on Tasmania, whereas the reality is that Tasmania via Hydro receives about 14% of REC revenue Australia wide yet Tasmanians consume only 5% of national electricity and the large industrial consumers are largely exempt from RET requirements.

The third matter of concern for Hydro has also been imposed from outside. The previous government paid too much for the Tamar Valley gas-fired power station when it was only one-third built before handing it to Aurora Energy to manage. Aurora picked the wrong path, tried to compete as a base load generator, contracted for more gas than needed under take or pay arrangements and tried to get rid of the excess by entering into loss making contracts.

The government forced Hydro to take on the Tamar Valley power station as Aurora was being prepared for changes in the retail market, possibly even a sale of all or part.

It was a hospital hand pass. Hydro had to write down the value of the asset by over $200 million, record a liability of over $100 million representing the estimated cost of the dud deals arranged by Aurora and take on unwelcomed debt of $205 million.

Expected losses from the dud deals were recorded in the 2013 accounts. Hydro essentially confirmed the losses will be about $45 million over the next six years.

The fourth area of concern, this time created by Hydro and raised by Greens leader Kim Booth, is the possible losses from wind farms, particularly the recently constructed facility at Musselroe Bay.

Both Musselroe Bay and the earlier Woolnorth wind farms are now owned separately from other Hydro assets. Chinese interests own 75% and Hydro 25%.

The wind farms sell power to Hydro. Power purchase agreements were needed in order to establish a price Shenhua were prepared to pay for their 75% share.

Hydro was trying to reduce debt (this is even before being lumbered with extra debt from Aurora) and entered into power purchase agreements to achieve a better sale price of the wind farm assets at the risk of incurring losses each year pursuant to those agreements.

Mr Booth quoting from an internal Hydro planning document revealed estimated losses from the Musselroe Bay power purchase agreement total $98 million over the next six years. This wasn’t denied by Hydro, adding if the price of RECs rises then the losses reduce.

There is a lot riding on the retention of the RET scheme.

The fifth significant issue impacting Hydro’s future is Basslink. The Liberals in opposition hinted at building a second link. Whilst the engineering aspects may be reasonably certain, future demand for electricity is anything but assured, especially given overall demand has fallen over the last few years.

The shadow over the plan however is who will build and how Hydro will be charged.

Once considered antithetical to the free market, price regulation is rife in the electricity industry, in part to protect consumers but also helpful to the rent seekers on the other side of the counter who like guaranteed income streams.

The current Basslink is not regulated. Hydro pays a facility fee which is linked in part to market interest rates. As a risk mitigation strategy Hydro entered into a separate agreement known as a swap agreement to fix the interest rate at about 8%. Given that rates have since halved the swap agreement is costing $36 million per year, in addition to the facility fee of $75 million.

Hydro appears to prefer a agreement where prices are regulated and increases more easily passed to customers.

But just how a regulated interconnector would operate alongside an unregulated one is another of life’s known unknowns.

Not so the level of borrowings, which at 30^th June 2014 stood at $859 million. Reducing this figure will harder as the government plans a special dividend of $75 million in three years time.

Under repeated questioning Minister Groom was unable to say how this would be achieved leaving the impression it was only included in the forward estimates so the government could fulfil its election promise to produce a better bottom line.

Selling Hydro is sometimes suggested.

Now is not the time for fancy prices, given the uncertain future and the fact that some of the income streams have already been hijacked by outsiders via power purchase and swap agreements

Let’s hope it keeps raining.

(Published in The Mercury 17th December 2014)