Is the market, that wasn't broken, now dead?

Thirty years ago the Australian energy companies were vertically integrated Government owned monopolies. In the early 1990’s Jeff Kennett and Alan Stockdale in Victoria led a charge to customer facing reform and privatisation that transformed the market, despite subsequent sales being more about Government coffers than reform. The SA distribution price hike to double the value of the poles and wires business is a distant but painful memory.

Governments spent most of this time adding and subsidising market impacting measures. Queensland’s Gas Certificates to get a Gas station built preceded the REC’s, NGAC’s, VEEP’s and others. The retail sector has more regulations and requirements than one could poke a stick at.

These subsidies have transformed the market. New assets’ value is related to the detail of the subsidy scheme, with little return from or incentives for reliable energy production, the hallmark of the sector’s contribution to an industrial democracy.  The subsidy structure has emphasised energy production, therefore windfarms are located in areas uncorrelated with demand, rooftop solar schemes maximise energy production not capacity correlated with demand, and now solar farms will bloom in the landscape farming Government dollars not crops.   Installed generation capacity has increased many times faster than demand, and with the vast bulk of the new generation dependant on capital subsidies for viability and dispatching at zero bid price.

In the midst of this stygian muddle South Australia had a storm that damaged its infrastructure and, due to the protection systems on the wind farms that dominate SA’s supply, caused a whole-of-state system shutdown.

As is well known, this has occurred as State Governments have adopted anti-gas drilling policies that have choked traditional and non-traditional supply sources, especially from what should be cheap plentiful onshore gas fields. As they did this, Australia developed enormous LPG export terminals hoovering up gas to fill Take or Pay contracts, sending domestic gas prices soaring.

The Result.

Commercial generators are pricing in massive uncertainty for industrial and domestic markets. Gas markets are short, so gas prices are equally high. The combination means Industrial customers facing unprecedented high energy prices (and querying the reliability of the product they are getting).

The only thing darker and more distressing was the precarious state of politics, so that politicians have felt isolated and apprehensive. As a result they adopt their crisis mode:

  • promise to fix things (irrespective of whether they have the power or wit to do so.)
  • spend large licks of money on the same things other Governments are spending money on (less risk of standing out)
  • regulate and pass laws to stop the things that are happening from happening. (To a person with a hammer, every problem is a nail)

Is the market dead?

This note started with the Government owned monopolies. The only thing worse than our current situation is to contemplate if this was all happening without the counter balance of the variety of private entities actually delivering power to the economy and arguing what should and could happen, rather than a set of bureaucrats & ministers free to add cost & complexity at whim.

I think Energy Companies, widely defined, will have a very rough ride in the next 10 years. The market will however re-emerge.

Governments will

  • Continue to subsidize specific asset types irrespective of their impact on reliable supply.
  • Directly invest in assets that will smash the market pricing.
  • Mandate company actions that destroy private value
  • Regulate retail prices

Nothing lasts forever, this too will pass. Then what?

Subsidised New Generation.

Governments will continue to subsidize specific asset types irrespective of their impact on reliable supply. The hand wringing time has passed, there are too many rent seekers and zealots who will scream if the tap is turned off. There will therefore be zero priced energy sloshing around in the middle of the day when it is bright & windy, for the foreseeable future. This is the most significant change to energy market pricing since the introduction of coal stations that couldn’t be turned down overnight. That led to energy sloshing around overnight and low off-peak pricing. Over the next 3- 5 years the high-priced power (and capital return for generation assets) will be overnight – NOT during the peak. What risks will remain in peak hours? Big change. How will it affect your Company – portfolio mix, product pricing, asset management and asset procurement?

Since residential load will switch from the high volume/high volatility being in the high price period to the high price period being a period of low volume and volatility will we see the nirvana of real fixed price residential energy products? Too bad about the resi’s that invested in solar to avoid peak pricing, tho.

Direct Investment.

The SA Government, for example, is building a suite of assets including a gas power station and batteries. Too much of the conceptual work will be done by a non–commercial bureaucracy and too quickly. Batteries, for example, will be the Desalination Plants of the late 2010’s, every State Government will build one, as quickly as possible and as big as possible. The rush will happen and the Governments will be left with a suite of assets that will lose money hand over fist – even without the peak-off-peak pricing switch above. 10 years from now Governments will sell the assets to market entities for the same reason they privatised in the first place. How do the Companies make that sale happen sooner?

Mandated Actions.

The Prime Minister asked AGL to sell Liddell. Politicians are like the really big kid in the primary playground and always get their own way. If they can’t beat you at marbles they just take them. What should AGL do? In my opinion – sell. Wrap the asset up in the old-style vesting contracts, sweep all the value back to AGL and sell it. Governments are worried about their survival; the reaction may be worse than the sale.

Regulated Prices.

There is a very long history of Governments (and bureaucrats) knowing better than the markets on price. Governments will re-regulate. Unfortunately for the customer, it is more profitable to deliver to a regulated market than an unregulated one. The larger Companies, will not resist re-regulation too fiercely, even with the ugly kid in the playground metaphor above.

Two comments:

  • The stock market will get very jittery. Analysts and investors get very nervous when Governments play with the value chain, and are likely to take a very negative view of the risks in the sector. This could significantly reduce the value of these Companies.
  • At some point, the penny will drop that customers are better off in an unregulated market. Until then, regulation will leave niches for smaller entities to take profitable customers from the larger companies by cherry picking, data mining and a casual approach to the regulations. How do regulatory systems add value to a Company, and how does your regulatory advocacy work? It should be warning the political system that regulated markets are not customer centric. Will it?

Do you have the people in place to lead these changes?

 

This article was originally posted on LinkedIn here.


About our Guest Author

AndrewBonwick

Andrew Bonwick is am one of 7 Partners at Fish & Nankivell, an executive recruitment firm providing executive search and advertised recruitment services.Andrew has a long experience in the energy sector, including being CEO of Australian Energy Ltd (trading as Power Direct Pty Ltd), one of the first new entrant retailers in the electricity sector.

You can find Andrew on LinkedIn here.

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One response to “Is the market, that wasn't broken, now dead?”

  1. observa says:

    If not dead then dying or perhaps at best every man for himself- http://www.weeklytimesnow.com.au/agribusiness/dairy/dairy-farmers-go-offgrid-as-power-prices-surge/news-story/3f3b42124b2adef064da266255d03af7

    Well the SA Govt have set the example rushing out the diesel gennys, albeit with a unicorn Tesla battery to divert attention away from the obvious.

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