Hydro's Basslink problems

Hydro Tasmania doesn’t own Basslink, but is burdened with most of the costs.

Given what Hydro has outlaid for Basslink fees and associated finance since it became operational 10 years ago it could own it outright had it chosen to develop it from the very beginning.

Instead, at last balance date it still owed $864 million.

That Basslink Pty Ltd will have to fund the costs to repair the broken cable is about the only saving grace in the whole episode.

When Basslink was on the drawing board estimated construction costs were $500 million. The final figure was $875 million.

Hydro signed the Basslink Services Agreement in 2002. It agreed, in effect, to lease the cable over a 25 year period and pay a facility fee. Basslink started operating in April 2006.

In return for the fee Hydro gained access to the National Electricity Market (NEM). Furthermore any net revenue from inter-regional sales, whether from selling cheaper mainland power here, or selling our electricity at a higher price in Victoria, would be paid to Hydro Tasmania.

Hydro first accounted for the value of future inter-regional revenue in 2006. It reckoned it was worth $150 million. 

At the same time Hydro recorded the value of its Basslink obligations at $900 million.

The difference between the value of the liability and the only measurable asset was $750 million.

Accountants need to keep things in balance so they simply marked up the value of Hydro’s generation assets by $750 million.

This was the increased value due to the other expected benefits of Basslink, set out in the business case considered by the Hydro board in 2002, which included, so we were told, other trading opportunities, operational efficiencies and hydrological security.

But having massively marked down assets in 2005, the 2006 upward revision only took assets back to 2004 values. With an extra $900 million in liabilities on the balance sheet, Hydro’s net worth halved from the 2004 figure of $2 billion.

Jump forward nine years to June 2015 and the value of Basslink liabilities at $864 million showed little change.

The facility fee is complicated and fluctuates with changing interest rates. Hydro in its wisdom decided to enter into a separate agreement, known as a swap agreement, with a financier believed to be Macquarie Bank, to fix the fee at the prevailing interest rate.

Hydro only owes $521 million to Basslink in respect of the facility fee, but it has a further liability to Macquarie of $343 million for the swap agreement because interest rates have halved.  Both amounts cover a 25 year term from 2006. The amount of $864 million is the total estimated Basslink liability in today’s dollars.

For an asset costing $875 million that’s a lot of money, although a security deposit of $50 million paid by Hydro effectively means only $814 million is owing.

In short, Hydro agreed to swap its Tasmania only operation for mainland exposure by paying a facility fee to Basslink, and then swapped the variable rate fee for a fixed rate fee.

Despite outlays of $1 billion the amount owing on the whole deal is virtually what it was at the start.

All this at a time when asset values are about to fall, revenue is under threat from new technology such as battery storage, and Basslink has failed to deliver on one of the critical reasons for its creation, lowering hydrological risks.

All electricity generated by Hydro is sold in the NEM, covering the eastern seaboard and South Australia. There is no product differentiation. Electricity is the same wherever and however it is produced.

Generators like Hydro pool all their electricity into the NEM. NEM is a virtual market, it doesn’t have a location. Large users buy direct from NEM as do retailers like Aurora Energy. Both pay Tas Networks to transmit power. Aurora Energy also pays Tas Networks to distribute power to all its retail customers. Basslink as a network provider also participates in the NEM selling mainland power to Tassie and vice versa. Hydro gets the benefit of these sales as part of its agreement with Basslink. Large users and Aurora Energy have contracts with Hydro so if the NEM price is above the contracted price with Hydro, Hydro will reimburse them. If the NEM price is below the contracted price, they will reimburse Hydro.

With Basslink down, Hydro misses out on the effects of cheaper mainland power. Instead it has to pay more to fire up the Tamar Valley gas generators.

Once the cable is fixed Hydro will be importing lots of power in an effort to restore dam levels. This may well mean extra outlays for Hydro depending on NEM prices at the time compared to the contracted prices with users.

As well as revenue from electricity sales Hydro also receives income from renewable energy certificates (RECs). When Hydro generates electricity above a certain baseline figure, it earns RECs which are then sold to users, Aurora Energy for instance, to satisfy the Federal government’s mandatory renewable energy scheme.

Recently, roughly 25% of Hydro’s revenue has been from RECs.

The beauty of RECs when sold is it all goes to the bottom line. There are few selling costs.

The drought plus the recovery period whilst dam levels are restored will mean REC revenue will take an awful battering.

It’s easy to be critical with hindsight. However the simple fact is that Hydro addressed one of the risks, that of rising interest rates, by locking into a fee swap arrangement, which so far has cost, in actual and future expected outlays, close to $600 million, whilst not addressing the cost of a prolonged shutdown of Basslink coinciding with a drought, which could easily lead to cash and balance sheet losses of at least the same.

Ouch, that’s a $1.2 billion hit to Hydro.

It shouldn’t be overlooked that even though Hydro doesn’t own Basslink, it still owes $800 million for a right of use, which has just plummeted in value.

(Published in The Mercury 10th Feb 2016)