Government proposes a qualified commitment to underwrite new renewable energy projects

The recent change of leadership at the Federal Government level and subsequent abandonment of the National Energy Guarantee has thrown new focus on the ACCC’s Report on Retail Electricity Pricing[1] issued in June this year. 

The Federal Government says it “is implementing a number of key recommendations from the ACCC inquiry,”[2] and has also foreshadowed a Royal Commission into electricity prices.[3]

The ACCC made 56 recommendations which, if implemented, would result in substantial structural and regulatory change to the National Energy Market (NEM). Whilst the recommendations need to be considered as a whole, there is one area which has recently received attention from the Federal Government and key industry participants, namely the proposal that the Federal Government provide financial support for new renewable energy projects.

As the NEM is an energy-only bidding market, an adequate level of competition is required to deliver efficient prices. The ACCC Report states efficient prices are being prevented due to insufficient competition in the NEM. It says that the increase in prices of wholesale energy over the past two years is due to multiple factors including the tightening of supply conditions after the closure of several large generators. Whilst a persistent increase in prices should generally lead to an investment response, to the extent that investment from new parties is not forthcoming the ACCC concludes that this may be due to barriers preventing entry by smaller investors.

After highlighting this issue as a key failing of the NEM, the ACCC proposed a government program to help increase competition by improving access to finance for new large-scale projects.

Generally, large-scale energy projects require project developers to source significant upfront investment when entering the market. Typically a project developer will source support from current or prospective customers through a power purchase, or offtake, agreement (PPA).

These agreements enable a project developer to sell their future output from the project at a fixed price over an extended period of time to customers. Without a commitment from customers to purchase their future energy production at the commencement of the project (usually for a 10-year period), developers cannot secure financing.

THE ISSUE: BARRIERS TO MARKET ENTRY

The Report found that a number of large-scale energy projects were never able to get off the ground because they could not obtain funding from private sector banks. As new developers hoping to enter the market have found it difficult to either secure a PPA or offtake agreement for more than a five-year period, finance has been refused on the basis that the developer is not able to demonstrate significant customer commitment (eg 10 years or more).

Whilst many major electricity retailers have no difficulty obtaining investment or funding to develop new low-cost sources of generation, some customers with significant electricity requirements have been unable to sponsor these types of resources due to the risk associated with future pricing of energy, specifically beyond the five-year life of a project. The consequence is that large industrial and manufacturing customers have been precluded from gaining access to the independent low-cost electricity in the market and prices for consumers remain high.

The ACCC says that these circumstances have resulted in a market failure.

GOVERNMENT OFFTAKE PROGRAM

The ACCC has recommended that the Government offer its support to certain projects.

Recommendation 4 proposed the Government create a program under which it will enter into low fixed-price energy offset agreements for the later years of a project with new market players. Government support would be targeted at the period in which it is usually challenging to secure a commercial customer, that is, the six-15 year period of the project. The amount offered by the Government under the PPA would be significantly lower than market value, although set at a level which will enable developers access to financing.

The ACCC argues that this will increase competition as the low price offered under the PPA will encourage the sale of energy to alternative commercial customers at a higher price. This in turn will allow the existing PPA with government to exist only as a fall-back option, while still allowing financing at the commencement of the project.

To ensure the program fosters competition and does not merely provide an advantage to existing market players the recommendation specifies certain parameters for project eligibility. Specifically, it was proposed that to obtain support, the project must:

• have at least three customers committed to acquire energy for at least the first five years;
• not involve existing retail or wholesale market participants with a significant market share (eg 10% or more of any NEM region);
• be sufficiently capable of serving a large number of customers; and
• be able to provide a firm product so it is reliable for the needs of corporate and industrial customers.

The ACCC proposed the program be open for at least four years and should be reviewed for its effectiveness prior to completion. Where there are no successful applicants during the program’s life then it will end without any further obligation on government.

FEDERAL GOVERNMENT’S RESPONSE

In October the Federal Government released a Consultation Paper on Underwriting New Generation Investments.[4]

The proposal set out in the Paper differs from the ACCC’s proposal in several ways.

First, underwriting support would cover both firm[5] and firmed[6] generation.

Second, it would apply to greenfields and brownfields projects and to extensions of existing projects.

Third, the ACCC’s suggestion that support be in the form of an offtake contract for a specified period following the initial phase of project delivery, has been expanded. The Government has specified additional detail around the type of offtake agreement which could be used (eg a contract for difference or a cap and collar contract) but has also suggested some other forms of support, including a government loan or capacity payments.

Following consultation, the Government proposes issuing initial program guidelines and an expression of interest process to invite applications for nominated projects. Updated program guidelines will be released in January 2019 along with finalised assessment criteria following which an RFP process will be undertaken. The first phase of support will commence from 1 July 2019.

Analysis 

The ACCC’s view is that its program would:

1. enable customers to access low-cost generation which should translate to lower electricity prices; and
2. increase competition across the generation sector by accelerating new and independent generation.

Two additional eligibility criteria set out in the Government’s guidelines, namely reliability and the expansion to brownfield or expansion projects means that coal and gas fired generation projects would be entitled to apply. This deviates from the ACCC’s stated objective that competition be increased by supporting new, and low-cost generation.

A further issue arises in the inherent structure of the Government’s proposal. The ACCC’s program envisaged ‘customer-led’ underwriting. That is, Government support might be sought at the point in time where it became apparent that whilst the project had a demand side business case (eg customers) the project could not proceed due to the inability to obtain sufficient finance (due to, for example the shorter tenure of the negotiated PPA). In other words, the project is ready to proceed but needs ‘back end’ support to commence.

The Government’s proposal will enable applications from all sorts of projects including those who do not necessarily have firm arrangements with customers.[7] The risk of this kind of government-led intervention in planning is market distortion and a ‘chilling’ effect on investment.[8]

Other concerns which have been raised include:

1. the short time frame for consideration of proposals;
2. the short time frame for finalisation of the guidelines;
3. the risk that the program will impact on innovation which is developing in the PPA market;[9]
4. interference in a market with enough existing and planned generation capacity;
5. the risk associated with a government taking on a power infrastructure planning function; and
6. failure to demonstrate a need for the taxpayer to underwrite new generation (either in the short time frame proposed, or at all)[10].

Another concern raised is the restriction proposed by the ACCC that support not be given to generators with more than 10% market share in any NEM region appears to have been removed, although this concern might be addressed by the criteria that a proponent demonstrate that a project would otherwise be unable to proceed without government underwriting (and also the criterion relating to market share at page 7 of the Paper).

Finally, it has been suggested that the process should not be run as an RFP (with, presumably separate consideration of each project) but as a reverse auction, using the model applied in Victoria and ACT, to ensure lowest cost exposure to the Commonwealth and taxpayers.[11]

In light of the NEG’s failure, whilst it may be important for Government to be seen to be taking steps in relation to energy policy, these steps should only be taken after an appropriate period of consultation and consideration. This would enable the proposed underwriting mechanism to be designed in a way that provides additional protection against an adverse outcome.

It remains to be seen how the Government will respond to the submissions from industry and peak bodes, and whether this will result in a redesign of the timing, structure or approach of the proposed program.

This article was co-authored by Jane Hider.