A dim view of AGL's MacGen bid

The consumer watchdog can't have it both ways in its confusing assessment of AGL's proposed takeover of Macquarie Generation.

A reading of the statement of the issues that the Australian Competition and Consumer Commission has with AGL’s proposed acquisition of Macquarie Generation throws up some rather confusing logic.

The ACCC says in the statement of issues, published last week, that it considers the key areas of overlap between AGL and MacGen were in the supply of wholesale electricity and financial hedge contracts.

It also says that it understands that a retailer seeking to manage the price risk associated with its customer load in one region of the national electricity market (NEM) will rarely, if ever, enter into a hedge contract under which payments were calculated by reference to the spot price in a different region of the NEM. In other words, it believes a NSW retailer needs access to hedge contracts from NSW generators.

That tends to sideline any issues associated with AGL’s ownership of the Loy Yang A generator in Victoria – from the ACCC’s perspective the core issue is retail competition in the NSW electricity market and access to hedge contracts based on NSW spot prices to support that competition.

Within the NSW market, there are two existing vertically integrated generator/retailers. Origin Energy has generation assets that account for 26 per cent of the capacity in NSW and a retail market share of about 38 per cent. Energy Australia controls about 17 per cent of NSW generation capacity and about a third of the retail market.

The rationale for vertical integration is so that the companies can create a natural hedge by balancing their retail customers’ demand with their generation capacity, reducing their need for and exposure to financial hedges.

AGL, which has no generation assets in NSW, has a retail market share of about 16 per cent.

The ACCC said its preliminary view was that the proposed acquisition of MacGen by AGL was likely to substantially lessen competition in the retail supply of electricity in NSW.

It based that view on two factors. One was that there would be a significant reduction in the supply of hedge contracts because of a reduced volume of hedge contract trading if AGL’s retail load was supported with a natural hedge. This could, it said, increase the risk of spot price exposure for independent retailers and discourage their participation or increase their risk premia in forward hedge contracts.

The other was the increased ability and incentives for AGL to withhold competitively priced and customised hedge contracts to independent retailers that competed with its own retail arm.

The problem with the ACCC’s logic is that AGL doesn’t have any pre-existing generation capacity in NSW – it is an ‘’independent’’ retailer itself, indeed the largest independent retailer in NSW, albeit with less than half the retail market share of the two integrated ‘’gentraders’’. It has grown its retail electricity business organically in competition with Origin and Energy Australia.

The ACCC has already cleared a rival bidder for MacGen, ERM Power. ERM doesn’t have any generation assets in NSW either but has a fast-growing retail presence, albeit about a third of AGL’s retail base.

If the ACCC were correct in its assessment that NSW retailers can’t hedge their NSW price exposure from outside the state’s borders and ERM were successful with its bid for MacGen, wouldn’t it have the same incentive as AGL to use its natural hedge to grow its retail business faster – and to withhold hedge contracts from AGL?

As a dual-fuel and national energy retailer, AGL has the existing customer information and billing systems to be able to compete with Origin and Energy Australia and ought to have lower costs than an ERM or other second-tier retailer. It ought to be a stronger competitor on price – and has shown it can compete with Origin and Energy Australia, which acquired big retail businesses in NSW,  by growing its own NSW retail electricity customer base from scratch.

It is difficult to see, given the ACCC’s own assessment of the market for hedge contracts, the difference in competition policy terms between an ERM and an AGL other than their size, which arguably could make AGL the stronger retail competitor.

The ACCC stance – it cleared the ERM bid but has reservations about AGL -- would be easier to understand if it were opposed to any further vertical integration of the NSW market or if it saw AGL’s ownership of Loy Yang A as providing a hedge for its retail activities in NSW (although that would undermine the argument that NSW retailers can’t get access to hedge contracts from interstate generators).

ERM, with a market capitalisation of about $565 million, sees MacGen as a transformational opportunity to create a large-scale retail business in NSW. AGL sees it as an opportunity to create a natural hedge for an existing significant and growing retail exposure in NSW. Their strategic positions and ambitions aren’t that different, just their market share starting points.

The other interesting aspect of the competition policy framework is that demand for electricity within the NEM has been falling in recent years but supply has been increasing. This is a result of the renewable energy target, incentives for solar and new peaking capacity.

If NSW generators have significant excess capacity, it would seem reasonable to assume that there would be liquidity in the market for hedging contracts unless there were substantial and blatant anti-competitive behaviour by the integrated players.

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