Hydro's Basslink problems: Part 3

This is the third blog in a series on Basslink and includes further detail on the Basslink agreements, how Basslink fees payable by Hydro are calculated, and other comments on Basslink’s performance during the first six years by the Electricity Supply Industry Expert Panel in its March 2012 report (available from the dpac site).

The Report is 800 pages long and covers the entire Tasmanian electricity industry. The following is a cut and paste from Part A of Volume 2 covering Basslink.

The operation of Basslink is governed by two main contracts, the Basslink Operations Agreement (BOA) and the Basslink Service Agreement (BSA). The two agreements are, however, independent of each other and the performance obligations in both are different.

Basslink Operations Agreement

The BOA is the contractual mechanism between the State of Tasmania and the operators of Basslink, the primary focus of which is ensuring that an interconnector is available to the State for a period of 40 years. Thee BOA has no financial incentives or penalties relating to the link’s performance.

The principal features of the BOA are:

·       a minimum availability of 97 per cent, and a performance target of 97.5 per cent (excluding force majeure events), assessed on a rolling 12 month basis and taking into account unavailability due to both planned and unplanned outages. The final business case for Basslink assumed availability of 97 per cent and allowed for 50 hours a year of unplanned outages ;

·       a cable failure frequency not exceeding once in ten years;

·       a maximum of five unplanned interruptions to transfers across Basslink per annum(excluding interruptions that last for less than 500 milliseconds); and

·       a maximum repair time per cable failure of two months (not including failures caused by force majeure events).

Under the BOA, sub-standard performance can also have potentially significant consequences for the operators of the link. Details of these arrangements were not disclosed by the Expert Panel for reasons of commercial confidentiality.

Basslink Services Agreement

The BSA, on the other hand, which is the agreement between Hydro Tasmania and Basslink establishing the rights and obligations of both parties with respect to the operation of Basslink, includes a number of financial incentives relating to the link’s performance, in terms of its availability.

The principal features of the BSA are:

·       a minimum availability of 97 per cent, assessed on a calendar year basis, along with financial penalties for BPL if the interconnector’s availability is below that level;

·       a financial incentive to the operator of the link if the cable is 100 per cent available during the Victorian summer (see Incentive availability payments); and

·       a commercial risk sharing mechanism that distributes the financial consequences of changes in the arbitrage opportunities made available through Basslink, which has the effect of incentivising the operator to ensure the link is 100 per cent available during times of high Victorian spot market volatility (see Commercial risk sharing payments).

(The Panel Report discusses variations in the BFF. No mention where a prolonged outage may lead to additional costs to Hydro notwithstanding the BFF may be waived for the period of the outage.)

Availability

There have, however, been periods when the availability of the link has been below the levels set out in the BOA and BSA, although only the link’s performance against the standard in the BSA has had financial ramifications in terms of the cost of the link to Hydro Tasmania.

This was particularly the case in calendar year 2008, when Basslink’s availability was below the 97 per cent required under the BSA, at 94.7 per cent (see Figure 5), resulting in a reduced Basslink Facility Fee (BFF). It is noted that despite the deterioration in availability that occurred in 2008, the total amount of energy transmitted in calendar year 2008 was higher than in either 2007 or 2009, even though availability in both those years was above the BSA standard.

Hydro contends that the reduced capacity to ‘import’ electricity associated with the link’s diminished availability in 2008 also had significant operational and financial impacts for its business, outcomes which were exacerbated by drought conditions that saw Hydro’s water storages drop to 16.5 per cent of capacity in June 2008.

As with any interconnector, particularly monopole links (like Basslink) that lack the redundancy provided by a second HVDC (high voltage direct current) cable, Basslink’s availability has been affected by planned and unplanned outages, although scheduled outages typically have less impact on the performance of the power system in question than unscheduled outages, because they are usually undertaken during periods of reduced system load or when a reduction in availability can be tolerated.

There were three comparatively ‘major’ unplanned outages noted by the Expert Panel (NB before the latest outage). To put those outages in context, the unplanned outage that began on 31 December 2007 lasted eight days and the unscheduled outage that occurred in July 2008 lasted nine days, as did the outage in April 2010.

The most significant planned outage occurred in October 2009, as part of a biennial preventative maintenance program, and lasted for four days.

Aside from the immediate impact that unscheduled outages have on Hydro’s capacity to trade electricity, under the terms agreed to as part of the System Protection Scheme (SPS), unplanned interruptions that have occurred while electricity has been flowing southward into Tasmania and triggered the shedding of major industrial load under the SPS have, on a number of occasions, continued to constrain flows over Basslink into Tasmania – even after the operation of the link has been restored.

This is because the arrangements put in place with some of the major industrial customers which are willing to interrupt production in order to protect Tasmania’s electricity grid have, in the past, included provisions which prevented them being called upon to do so within a period after their most recent load shedding event.

This arrangement meant that the level of load shedding available under the SPS could potentially be reduced, sometimes for weeks, following an outage of Basslink when ‘importing’ energy, constraining the link’s capacity to deliver energy into Tasmania and impacting on the value of Basslink to Hydro. The impact of this constraint would be greatest when the restriction on southward flows coincided with periods of high demand in Tasmania and low prices in Victoria. The Panel understood that re-negotiation of the terms under which some industrial entities participate in the SPS had reduced the limitations on further load shedding following an SPS trigger.

The physical performance of Basslink impacts both on the ongoing cost of Basslink to Hydro and the revenue earned by Basslink which accrues to Hydro.

Breakup of Hydro’s Basslink costs

·       Basslink Facility Fee (BFF)

The BFF is paid by Hydro Tasmania to Basslink in exchange for the rights to the variable inter-regional revenues accruing to Basslink through the NEM arrangements. While the BFF is indexed, the level of indexation is such that the fee declines in real terms over the life of the BSA. It is the largest of Hydro’s Basslink related costs.

·       Commercial risk sharing payments

These payments are paid either by Hydro to Basslink or vice versa, depending on the value of arbitrage opportunities presented by price volatility in the Victorian spot market. The risk sharing payments are highly variable and can have a material impact on the cost of Basslink to Hydro, with BFF able to vary within a 40 per cent range.

Basslink is rewarded with an increased fee when the arbitrage value provided by the link is high, provided the interconnector is fully available during periods of high Victorian prices. Conversely, those same arrangements substantially reduce the BFF if the link is not fully available during these high priced periods, or if the arbitrage value is low. The potential impacts on the BFF are material to both Hydro and Basslink, in that the fee can be varied within a 40 per cent range under the risk sharing arrangements.

The commercial risk sharing arrangements have resulted in Hydro paying an increased BFF in only one of the link’s first six years of operation (calendar year 2007). In that year, the price volatility in the Victorian spot market was such that Hydro made additional payments equivalent to 25 per cent of the BFF for that year, the maximum amount payable under the terms of the BSA. This reflects that the arbitrage value available to Hydro was high, providing it with the financial capacity to fund the additional payments.

Cumulatively, however, to the end of September 2011 Hydro has been a net beneficiary from the risk sharing arrangements in the BSA since it commenced delivering energy in 2006.

·       Incentive Availability payments

Incentive availability payments are paid to Basslink by Hydro depending on the availability of Basslink at certain times of the year and at predefined Victorian spot market prices that may provide Hydro with arbitrage opportunities. The amount of the payment made in any given year is variable, and is based on interconnector availability and spot market prices during the Victorian summer peak period. Incentive availability payments are relatively small compared to the facility fee (around 2 per cent).

·       Insurance costs

Hydro funds the costs of marine insurance for Basslink. Owing to the particular features of the insurance market at the time of financial close, which was enduring a period of instability in the wake of the terrorist attacks on New York City in September 2001, it was agreed that operational insurance costs above those already factored into the BFF would be paid as an ongoing operational cost pass through. The costs of insurance are variable but relatively minor in the context of the BFF (in the order of 2-4 per cent).

·       Financial costs (the BFF fee swap)

Paid by Hydro to hedge against adverse interest rate and foreign exchange movements from when construction started back in 2002.

These can be significant relative to the BFF (e.g. in one year over the period 2005-06 to 2010-11, hedge costs were equivalent to around 43 per cent of the facility fee).