Tuesday, 16 September 2014

Hydro Tasmania's rivers dry up?

The recent Budget confirmed Hydro Tasmania’s uncertain future.

After the unprecedented financial success of the past two financial years 2012/13 and 2013/14, Hydro’s earnings are projected to plummet.

Returns to government lag profits by a year and hence payments from Hydro for the current year 2014/15 will be based on the record profits expected to be announced next month when Hydro releases its 2014 Annual Report.

But thereafter the future is bleaker.

Searching for revenue led the new government to increase dividends from government businesses to 90% of underlying profits after tax but unfortunately the budget papers reveal losses by Hydro in the forward estimates.

Nevertheless the government has pencilled in a special dividend of $75 million by Hydro in 2017/18 despite three years of losses. The government wishes to avoid borrowing at the time when its remaining cash reserves disappear, but lumbering a subsidiary with extra borrowing is just a smoke and mirrors ploy.

A capital restructure was promised by the last government. Everyone assumed that meant a capital injection not a further withdrawal.

At the recent state election the Liberals pledged to spend $2.5 million to look at a second Basslink and increase Hydro’s generation by 10 per cent, as if the thought hadn’t crossed the Board’s mind.

The virtual expression of no confidence in the Board of Hydro continued in the budget papers when the government undertook to “work with Hydro Tasmania to develop a strategy and operating model for the business to return it to profitability” so the special dividend can be paid.

Hydro had positioned itself for the future by selling down its interest in the Woolnorth and Musselroe Bay wind farms to 25% and using the proceeds to reduce debt to $700 million, before the previous government saddled it with another $205 million by transferring the Tamar Valley Power Station from Aurora Energy together with all associated liabilities.

The latter had behaved like a boy on a man’s errand showing inexperience in the generation business by biting off more than it could chew, leaving Hydro with no alternative but to take a massive hit to the bottom line when the asset was written down.

Fortunately asset write downs are ignored when calculating profits used to decide returns to government.

Not only did Hydro Tasmania have borrowings of $905 million, as at 30th June 2013, the Basslink agreements added an extra $920 million to liabilities.

The Basslink facility fee was designed to fluctuate with interest rates but Hydro decided to fix the fee via a separate agreement known as a swap agreement.

Of the annual Basslink outlays of $123 million, $47 million is the current annual cost of the swap agreement which fixed rates in 2006 at twice their current level, in effect, the fixing penalty.

Fixing rates for 25 years can be an expensive gambit when rates fall. The latest payout figure to exit the fixed rate agreement is $293 million. This forms part of the $920 million Basslink liability.

When Premier Rundle first proposed the Basslink interconnector in 1997, ball park cost estimates were $300 to $400 million.

The first firm estimate of $500 million soon blew out to $875 million following technical problems. Basslink now beneficially owned by the Singapore government completed the build at a reported cost of $1.2 billion and now charges an annual facility fee, currently $76 million, with another 17 years to run.

The swap agreement with Macquarie Bank is for a similar term and currently costs $47 million annually. The latter is an agreement too large to exit but increasingly too costly to bear.

Critically Hydro’s finance costs which include the interest on borrowings of $905 million plus the costs of the swap agreement, is now close to $100 million.

The Auditor General in his last report suggested interest cover of two times as a benchmark. In other words operating cash before finance costs needs to be greater than $200 million for comfort. That may be difficult on current settings.

Building a second interconnector might appear at first glance as a ready solution to Hydro’s profitability.

 But given the existing stretched nature of current finances, organising the ownership, financing and associated agreements will be an immense challenge particularly if paying the majority of proceeds to parties like the Singapore government and bankers at Martin Place is to be avoided.

 When service deliverers and financiers are first in line with guaranteed returns then why bother with full privatisation?

To be fair the Basslink proposal was first mooted when drought in Tasmania loomed as a large problem for Hydro.

The payment of the Basslink fee also entitles Hydro the right to share inter regional revenues which helps partially offset the liability of the annual fee.

But it was the ability to send power northwards which led to the large profits of the last two years following the introduction of the now aborted carbon price.

However it was not only the carbon price which assisted Hydro achieve a cost advantage over competitors.

So too did the Renewable Energy Target (RET) scheme which mandated a minimum amount of electricity be from renewable sources by 2020, and which is now being reviewed following a report by Tony Abbott’s handpicked climate sceptic, Dick Warburton.

The signs are that pragmatism may trump ideology and the RET may live to breathe another day. Without it projects such as the King Island wind farm will not proceed and Hydro will retreat to keeping the wolf from the door with existing assets of diminished value, at least in the short term.

Over time, Hydro’s fortunes have tracked the ebbs and flows of the Tasmanian economy. For a brief moment it appeared to be on the cusp of a profitable new era.

Let’s hope it doesn’t suffer the same fate as the goose which reportedly laid a golden egg.

(Published in The Mercury 16th September 2014)

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