Power
Purchase Agreements have been used to assist developers of renewable energy
projects. These notes explain how Hydro Tasmania and Aurora Energy
account for these agreements and how accounting standards allow much of the relevant
detail to escape the reporting net.
Included also
is a closer look at how Hydro’s sale of a majority share in its windfarms was
only possible due to a generous Power Purchase Agreement by Hydro effectively guaranteeing
to pay the purchaser’s debt over the term of the agreement.
Finally there’s a note outlining how the assumption of sunk costs are used by renewable energy promoters to give a rosy view of individual projects. For instance, a windfarm developer needn’t consider the costs of Marinus because it’s a sunk cost however large. A recent article is cited describing how sunk cost trickery understates the costs of renewable energy projects.
Onerous contracts
Hydro Tasmania (HT) disclosed the value of its
onerous contracts in Note 17 of its 2022 Annual Report. Onerous contracts are
included as ‘Other provisions’ as per the cut and paste below from page 57.
Readers will note the figures
are for both the Parent Entity (HT) and for the Consolidated Entity (HT plus
its subsidiaries which in this instance means AETV which is the Tamar Valley
gas power station transferred from Aurora Energy in 2013).
We can be reasonably certain the
onerous contract in HTs books (the parent entity) of $100.7 million relates to the
LGCs with Woolnorth Windfarm Holdings P/L (which includes Musselroe) and with
Granville Harbour. The additional onerous contract in the books of the
Consolidated Group (of $42.6million being $143.3 million less $100.7 million) almost certainly
relates to the gas pipeline deal with AETV.
The reduction in the value of
onerous windfarm contracts of $139 million in the 21/22 year reflects the movements
in LGC prices in the futures markets. The reduction in value for the year is
included with ‘Fair value gains’ in the P&L of $145 million (from page 40 of the
2022 Annual Report). At 30th June 2022 the future expected stream of
payment to the 2x windfarm operators had a present value of $100.7 million. In
nominal terms the level of payments will be much higher, $150 million say over the
period until 2030, but the stream is recorded in the balance sheet with a lump
sum present value of $100.7 million.
In any year the level of
payments to the windfarm operator depends on LGC prices, whether they are more
or less than the contracted price. In 22/23, the reduction in the value of
onerous contracts implied there was a reduction in the difference between the
market and the contract price for LGCs. Page 101 indicates what it cost HT in
2021/22:
Fortunately, the cash outlay to Granville Harbour for LGCs in the 2022 years was only $1.6 million. It must be noted that HT, by
recording its liability to Granville Harbour as a CSO, is indicating that it
doesn’t regard it as a commercial arrangement that it willingly signed up for,
rather an obligation that was imposed on it by the shareholder minister.
Payments to WWFs were not
separately mentioned in the Annual Report.
Overall, we know the value of
onerous contracts fell by $139 million mostly as a result of revaluation, with only
a small amount due to the actual payment made. In the previous year things were
the complete opposite. Not only were payments made but the future value of
expected payments rose, as can be seen, to $239.9 million at 30th June
2021.
How much will be paid in the
future depends entirely on how LGC market prices differ from the contract
prices.
Power Purchase Agreements PPAs
usually cover not only the LGCs but the electricity itself. The LGC deal is a
financial instrument and movements are recorded as just described. On the other
hand, the liability for a top up payment of wholesale electricity proceeds
doesn’t arise till the electricity is sold into the market. The
exact liability is not known until that occurs so it doesn’t appear as a
liability because it's paid almost immediately.
Hence there is nothing in HTs
financials to indicate future possible top up payments expected when PPA
electricity contract prices exceed spot prices. Accounting standards often
produce anomalies. The different treatment of LGC top ups versus electricity
price top ups is one such anomaly.
Before the current rises in
wholesale prices HT was almost certainly subsidising the 2x windfarms’
electricity prices. In the last year payments may have gone in the other
direction. We know from WWFs publicly released financials this was the case. In
2021 HT paid WWF a subsidy of $24 million just for electricity because spot prices
were so low.
But we don’t know what happens
with Granville Harbour because HT refuse to divulge any details about the PPA.
Cattle Hill is analogous to
Granville in some respects, although the government entity is Aurora Energy and
Aurora Energy doesn’t list it as a CSO.
This is from p93 of Aurora’s
Annual Report for 2021/22:
The liability for the onerous
contract with Cattle Hill at the end of
the 2022 years was only $6.8 million having reduced significantly during the 21/22
year due to rises in future LGC prices. It’s not just movement in current LGC
prices, rather how the prices for future LGCs, say 2026 LGCs and 2027 and
beyond, which determine the overall value of LGC contracts in the 2022
financials.
But again we don’t know how that
part of the PPA covering wholesale electricity markets impacted Aurora, what it
cost them in 2021/22 to make top up payments. Or maybe it received payments from
Cattle Hill? We just don’t know.
Why does Hydro Tasmania, a renewable energy
generator, buy LGCs? These certificates are created by generators of
electricity and sold to energy retailers who have an obligation to buy them. HT includes under Other financial assets (Note
11 in the 2022 Annual Report) includes unsold LGCs, described as ‘environmental
energy products’. At 30th June 2022 HT had $59 million worth of unsold
LGCs.
Maybe it makes sense for Aurora as a retailer to do
a deal with Cattle Hill. It buys LGCs which are then handed over and cancelled
by the Regulator as required. At 30th June 2022 it only had $3 million worth of LGCs (included under Inventory in Note C2 of the 2022 Annual Report.)
At best we know only a fraction of the story, and
that is the value of the onerous contracts that relates to LGCs. They are
recorded in financial statements because they’re financial instruments and
accounting standards require them to be treated that way.
But the other half of a PPA relates to a contract
for wholesale electricity. When payments for wholesale electricity pursuant to
a PPA are made, they are lumped with all other purchases and hence a breakup is
impossible. In addition, accounting standards don’t require future liabilities
to be recognised. A liability only arises for accounting purposes when the
electricity has been produced. So even though we might be able to make a
reasonable guess about what a future liability might be, accounting standards
don’t require it and hence HT doesn’t divulge it.
HT and the WWF deal[1]
HT transferred Woolnorth and Musselroe windfarms to
WWF together with a large amount of debt. At that stage HT owned all the shares
in WWF. It then sold a 75% interest to Shenhua, a Chinese government owned
entity in two tranches, $88 million in 2011 and $90 million in 2013 totalling
$178 million approximately. It retained a 25% interest worth just under $60 million.
Essentially the assets were transferred to WWF at cost so there were no gains
on disposal.
Currently in HT books its 25% interest is worth $58 million at 30th June 2022 as per Note 7 in the 2022 financial statements:
HT’s 25% share
of WWF was worth $60 million in 2013. Little has changed, although it has
received some income over the years.
However, if
one were to deduct the value of the onerous contract for WWF’s LGCs, not to
mention the undisclosed contingent liability for future wholesale electricity
price top-ups, HT’s 25 % share of WWF is probably negative.
The PPAs
which the Chinese insisted before agreeing to the deal to buy 75% of WWF, effectively
guarantees the payment of WWFs debt by HT. Back in 2012/13 WWF had debt of $420 million. By
2030 WWF’s existing debt will likely all be paid, thanks in no small part to
the generous PPA.
That
pre-empts the question, why didn’t HT hang on to WWF instead of guaranteeing
the Chinese government to take it over? The answer to that requires a closer look at
HT financials. The WWF divestment occurred at roughly the same time as HT was
about to be burdened with $205 million of debt when the Labor government forced
it to take over AETV, the Tamar Valley gas power station, which HT had to write
down by $335 million when it took over ownership on 1st June 2013.
The
movement in HT’s debt from 2011 to 2013 can be seen in the following table:
|
HT borrowings 2011/12 to 2012/13 $ '000 |
||
|
2011/12 |
2012/13 |
|
|
Opening balance |
$969,876 |
$850,600 |
|
Changes as per cash flow statement |
$27,999 |
-$155,600 |
|
Add AETV borrowings |
$0 |
$205,000 |
|
Less WWF borrowings transferred |
$147,275 |
$0 |
|
Closing balance |
$850,600 |
$900,000 |
In the 2012
year when HT received the first tranche of $88 million from Shenhua, whilst it
managed to transfer $147 million of debt to WWF, it had to use the first tranche as
well as borrow another $28 million to finish building Musselroe, which it did before
transferring Musselroe to WWF and receiving the second tranche of $90 million from
Shenhua in 2013.
HT was able
to reduce its existing debt by $155.6 million in 2013 due in part to the $90 million second
tranche. But 2013 was also one of HT’s best ever years being one of the 2x
carbon tax years. Over the 2 years HT’s debt only reduced by $70 million.
The LGC
scheme is part of government incentives to encourage 33,000 MW of new renewable
energy. Eligible projects had to register by 2020, although they were given
time to become operational. The scheme ends in 2030. New wind farms proposed
after 2020 are not able to generate LGCs and therefore PPAs will probably only
cover electricity prices.
Sunk cost
trickery
Sunk costs
are costs that have been incurred and can’t be recovered and which are ignored
when making investment decisions.
It’s a
familiar occurrence when looking at the economics of investment projects.
Projects are unbundled into let’s say, 2x sub-projects. Each assumes the other
is proceeding and treats the other’s costs as sunk costs. That way each sub-
project might look ok, but had they been treated as one project a different
result may well have eventuated.
Promoters of electricity generation and transmission projects are notorious for using sunk cost assumptions to make their individual projects stack up. A recent
article summarised the use of sunk cost trickery in the renewables space. [2] The
conclusions are pasted below:
If people
are unsure, Marinus on one hand, and windfarms and Battery of Nation on the
other hand, are classic cases where sunk cost assumptions are used. Most
readers are unaware of the built in trickery.
Most people
are also unaware that Basslink was based on similar shaky foundations. Basslink
was being assessed in the early 2000’s at the same time as the gas pipeline
interconnector received the go-ahead. Deputy Premier Lennon at the time was an
unashamed supporter of both. From Hydro’s viewpoint electricity from gas had
the potential to compete in the same markets. On the other hand, electricity
from subsidised gas had the potential to generate more on-island electricity.
The final Basslink business case agreed to by Hydro’s Board in November 2002
assumed 2,000 GWh of electricity from gas would be produced each year, allowing
Tasmania to become a net exporter thus reaping the arbitrage advantages thereby
justifying the building of Basslink. It never eventuated. Tasmania has been a
net importer in most years. It’s been a costly lesson, which current policy
makers and politicians are only too willing to ignore.
[1]
For
a more detailed discussion of PPAs and
WWF see Tasfintalk: Marinus and the case for more Tasmanian wind
farms
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