Finally some sense has been knocked into the operators of New South Wales’ gold-plated electricity transmission and distribution networks.
In draft rulings yesterday, the Australian Energy Regulator (AER), which oversees pricing of these monopoly services, told the four publicly owned businesses that own the state’s power poles and wires to cut their forecast revenues by almost a third over the next four years, in turn lowering customer electricity bills by 10%.
Given these networks are up for partial privatisation if the Coalition wins the March state election, there will be a hot debate about the impact that lower expected revenues, and therefore earnings, will have on the price investors are willing to pay for those businesses.
So far indications have been that the New South Wales government hopes to reap $13 billion from the sale of a 99-year leasehold interest in 49% of Ausgrid, Endeavour Energy and TransGrid, which UBS had valued at between $26 billion and $32 billion combined. One broking analyst told Fairfax Media yesterday the rulings would have “massive implications” for the likely sale proceeds to the state’s taxpayers and “will be reflected in lower asset prices”. Others are less sure.
What is certain is that electricity privatisation in NSW — and Queensland, assuming Premier Campbell Newman is re-elected — is going to make this week’s $6 billion Medibank float look like a walk in the park.
The combined enterprise value (equity plus debt) of the electricity assets to be put up for full or partial sale in NSW and Queensland is enormous, in the order of $70 billion. Setting aside the political sensitivity of selling off essential services, there is gnawing uncertainty over valuations amid arguably the most fundamental transformation of the energy business seen since the electricity grid was invented, with the emergence of true competition in the form of distributed generation such as rooftop solar.
Under the rules of the national electricity market, the AER decides how much money the networks can spend — both on capital and operational expenditure — and therefore how much they can charge customers, every four or five years.
The rules have recently changed after steep electricity price hikes over the last five years caused a consumer backlash, contributing to falling demand. By far the largest driver of higher power bills was increased expenditure by the network companies, particularly the publicly owned networks in NSW and Queensland, which were accused of over-spending so they could pass higher charges on to customers, in turn bolstering state revenues.
Yesterday’s AER draft determinations for the network businesses in NSW contain deep cuts — up to 60% in some cases — both to the amount that can be spent on network infrastructure (known as the regulated asset base) and operations, and to the rates of return the networks can make on their asset base.
Take Ausgrid, the largest network business in NSW, covering 1.6 million households from Sydney to the Hunter Valley, with a regulated asset base of more than $14 billion. In summary, Ausgrid wanted the AER to approve capital expenditure of $4.4 billion and operating expenditure of $2.9 billion. The AER has almost halved the allowable capital spend, to $2.5 billion, and cut the budget for operating costs to $1.8 billion. Not only that, it has proposed a 30% reduction in the rate of return Ausgrid can charge customers — lowering it from the 10% charged over the past four years to a little over 7%. This is a huge change: there is no bigger driver of network revenues, and therefore our electricity bills, than this allowable rate of return number. Ausgrid was hoping for more like 8%.
What impact will this have on the value of Ausgrid, and therefore the likely sale proceeds? In a note to clients yesterday UBS utilities analyst David Leitch crunched the numbers, estimating the company was worth between $15.5 billion and $18 billion assuming the draft ruling was implemented in full — which might not be easy to achieve, particularly on the operational side, where the regulator is asking Ausgrid to cut running costs back to 1999 levels, implying the loss of some 2000 jobs out of a workforce of 5500. That valuation is up to $2 billion less than the $17 billion to $18 billion value Leitch placed on Ausgrid a month ago, but the difference is not as great as might be first thought (partly due to use of a higher earnings multiple, which might be defensible, as investors might pay more for greater certainty).
It should be said, Leitch is an optimist about the future of the network businesses, viewing distributed generation as “more of an opportunity than a threat” and arguing “networks have captured a larger share of the electricity dollar over the past decade and investors expect they will keep it”. And some might argue UBS would say that, as one of two investment banks (the other is Deutsche) appointed to do a scoping study on privatisation for the NSW government. But even sceptics of the valuations have argued that investors could be prepared to pay more for the networks despite lower expected revenues, because the forecasts have greater certainty. In an October paper for the Public Interest Advocacy Centre, energy economist Bruce Mountain estimated the regulated asset base of the distribution businesses could be written down from $22 billion to $13 billion, assuming the NSW networks could deliver the same efficiencies as Victoria’s already privatised networks, but concluded:
“… a lower regulatory valuation need not translate into lower privatisation proceeds: the higher market valuation may compensate for all or more of the regulated asset base devaluation. Pre-privatisation RAB devaluations therefore may offer the potential for better outcomes for all parties.”