Uh-oh. Looks like civilisation as we know it comes to an end in 2015. That’s when, if we have an emissions trading scheme as currently designed, the large brown coal generators in the Latrobe Valley plunge into bankruptcy and the electricity supply — and all the mod cons we take for granted — can no longer be guaranteed.
TRUenergy CEO Richard McIndoe, whose company owns the Yallourn power station, does not say exactly how many days or weeks the generators can survive after receiving the last of the $3.9 billion in compensation from the federal government in 2015, but he does warn it is a “cliff’s edge”. Here’s hoping that they last at least until the end of September — it’d be too bad to miss out on the broadcast of the footy finals.
We’ve heard such stories before. Woodside, you may remember, spent much of last year telling people that the development of huge, multi-billion gas projects off the north-west coast of Australia, such as the Browse Basin, were threatened by the government’s ETS.
That claim went pretty much unchallenged and unquestioned until analysts at JP Morgan expressed astonishment that a carbon price would be more than a passing consideration for the project, which faced many other obstacles. No matter, Woodside’s lobbying was enough to scare the government into amending its carbon pollution reduction scheme so that Woodside could be compensated. Citi analysts estimated that compensation to be worth around 50c a share. Even if you take out 1c a share for lobbying fees and the celebrations afterwards, I guess Woodside could argue that efforts were entirely justified because it produced a good outcome for shareholders.
That’s why it’s worth being just a little bit sceptical about McIndoe’s apocalyptic vision, which is essentially a negotiating position. JP Morgan analysts said in a report after the release of the ETS that the impact on coal fired generators would be “relatively limited”. Fitch Rating noted that the compensation package significantly reduced the risk of asset write-downs in the sector.
Indeed, in the recent annual results of TRUenergy’s parent company, China Light & Power, which came out just over two weeks ago, nearly 10 pages are devoted to its Australian operations, in which it talks glowingly and enthusiastically about its plans for investment in renewable technologies, in solar, wind and geothermal, new gas-fired generators, preparation for the CPRS, and reducing the emissions intensity of Yallourn. It says the impact of the CPRS is mitigated by the compensation, but the overall effect is not quantifiable. Nothing so specific as the coal-fired generator’s impending bankruptcy, however.
To be sure, one of the big problems of the Latrobe valley generators is that many of them are hocked to the eyeballs in debt, the result of what Standard & Poor’s described in a recent report as “aggressive financing”. This gives them little room to manoeuvre. Little wonder that in their submissions to the government the generators wanted every single dollar invested in their facilities – equity and debt totalling some $12 billion — be compensated by the government under its ETS scheme.
Much of that debt needs to be renegotiated in coming years, and TRUenergy is first off the rank this August with a $650 million facility — albeit just lightly drawn — to be renegotiated, according to S&P, which incidentally describes as “inconceivable” the prospect that one of these generators would simply shut down operations. It would make McIndoe’s job in renegotiating the terms of that facility a lot easier if the ETS failed to come into being. It’s now more than likely he will get his wish.
So what are the alternatives? We’ve heard talk of carbon taxes and hybrid schemes, but an alternative route to cutting emissions might be along the lines of a submission to the government from International Power, the majority owner of the Hazelwood and Loy Yang B power stations — separately cited by Fitch and S&P as the most highly geared and vulnerable because they are stand alone facilities, although Loy Yang B does have an offtake agreement with the Victorian government to pass through ETS costs.
The submission, suggests the phased withdrawal of several brown and black coal installations. It reckons this could be done at $10 a tonne of carbon, about a third of the price of the CPRS, although there is not enough detail to explain exactly how it comes up with that estimate.
It is hailed by some as an example of the industry’s willingness to undergo a transformation to fit into a carbon lite regime. But is it? This proposal is again predicated on the power station’s owners being compensated for every last dollar of equity and debt invested, which in International Power’s case is more than $4 billion — and on the closure of the assets. I’m not sure what this says about the ability of carbon capture and storage to extend the life of such assets. Wasn’t that supposed to be the course to protect such large sunk investments? Perhaps not. There is nothing here about investment in new technologies. Some companies seem to prefer to take the money and go. Perhaps not so much transformation, as extraction.
And therein lies much of the problem of this debate. You can characterise it in many different ways, but it boils down to the fact that some choose to focus on the costs of the scheme and what they can extract from it as compensation, and others on the opportunities, and of the energy alternatives and benefits down the track.
AGL, part owner of the Loy Yang A brown coal station, recently held an international roadshow and didn’t make any mention that this asset was about to go bankrupt. One of the reasons is that AGL has invested heavily in renewables and created a diversified portfolio, positioning itself for the inevitable transformation. It estimates the uplift in value of its portfolio from an ETS — which grants Loy Yang A compensation of around $920 million, according to Credit Suisse — at around $300 million.
As S&P noted, those generators with diversity, significant financial flexibility and low cost operations, are best placed to prosper in a new regime — particularly those that acted early. TRUenergy is trying to catch up, hence the investments in geothermal and solar and the opening of the Talwarra gas plant that will help reduce its emissions intensity. McIndoe, more than anything, is playing for time.