Australia’s power sector is in jeopardy: Gottliebsen

This is one of the most frightening comments I have ever written for Business Spectator. Three months after Alan Kohler, Steve Bartholomeusz and myself first met with representatives of most of the power players in Australia – but particularly connected to Victorian power generation – we again met under the ‘Chatham House Rule’ to discuss what would happen if the carbon trading legislation was passed in its present form today.

Three months ago they were apprehensive, now as disaster looms they are ringing the alarm bells.

In the room there was total agreement with the Morgan Stanley and KPMG reports (Morgan Stanley and KPMG were not in attendance), which state that the current legislation would have an $8 billion adverse impact on four Latrobe Valley power generators which is offset by $2 billion in current credits – a net enterprise value reduction of $6 billion.

Within a week of the current proposed legislation being passed, the boards of each of the companies that own the Latrobe generators will meet with their auditors on whether the companies’ debt covenants have been broken. Almost certainly a majority, if not all the boards, will decide to appoint official administrators.

That would not stop power being generated, but would have two dramatic effects. First, given that all the electricity protection legislation is state based, it would be rendered useless because the official administrators work under the Commonwealth Act. Second, retailers like Origin and AGL, plus a string of smaller retailers, have long-term contracts and hedge agreements with the generators which would have no legal validly once the administrators were appointed.

It is highly unlikely that the international and local banks who are owed about $5 billion by the generating companies would want to contract forward so they will sell all their power on a spot basis. That means long-term, fixed-price arrangements that any of the retailers have made with commercial organisations would be high risk because they would no longer be protected by supply agreements with the generators. Accordingly, once administrators were appointed to the Latrobe Valley generating companies, retailers like Origin and AGL will need to set out their long-term vulnerability to the ASX. Some analysts are becoming concerned.

Talking to the bankers in the room it seems that if they are forced to appoint administrators, while their administrators will only sell on a spot basis, they will not do anything to reduce output.

However, they are about recouping their loans, so they will cut back on long-term maintenance. In South Australia earlier this month a power break down sent the spot price for electricity from the long-term contract price of around $45 a per megawatt hour to $10,000 per megawatt hour for about two hours.

Once hedge contracts and long-term arrangements are not in place then a break-down in the Latrobe Valley could see the spot price go very high with huge losses to retailers who can’t pass on the cost. And as long-term maintenance is run down the power interruptions will become more and more prevalent with enormous cost to industry. Victoria will suck as much power as it can from NSW but the line connecting the two states has limited capacity so Victorian industry will bear the brunt although it will affect the whole nation. NSW and Queensland use black coal which does not emit as much carbon but they will still be affected. However, the stations are owned by the Government so they will not go broke and long-term contracts are not jeopardised.

The Victorian Government has received the KPMG report which spells out exactly what will happen. The Victorian Government has explained to the Federal Government what will happen but the level of understanding in Canberra is very poor and they have not yet grasped the implications.

John Brumby has not gone public apparently because he hopes that either the legislation will not be passed or it will be passed in a way that minimises the danger to Victorian electricity supply. But if it looks like being passed in its present form, he has to choose between raising the alarm and minimising his own electoral damage or ‘copping it sweet’ and receiving his full measures of federal money in many other areas.

As always there is a simple answer. As Alan Kohler explains, instead of going bananas and jeopardising everyone, we should close the Hazelwood and Yallourn stations over, say, 10 years and take the offer by Hong Kong-based global power generating group China Light & Power (CLP) to spend about $2 billion on a gas-fired generator (CLP owns TRUenergy which owns the Yallourn power station). But that’s too simple for Canberra instead they are played high stakes which could see massive damage to Australian industry.

And if the Hong Kong offer – which depends on sufficient carbon credits being given over 10 years – is not accepted then the governments will have to fund the power stations themselves because private capital will be too damaged, and India and China and the rest of Asia are offering wonderful deals to attract scarce capital.

This article first appeared on Business Spectator.