An unoriginal end to NSW's gentrader experiment

The NSW government has finally cleaned up one of the very messy and contrived arrangements its predecessor entered into when it partly privatised its electricity assets.

Origin Energy announced today that it had executed an agreement to acquire Eraring Energy for a net payment of $50 million and agreed to a cancellation of a coal supply agreement that will see the NSW government make a $300 million payment to Origin.

The deal, which gives Origin the net cash infusion of $250 million, is a rational undoing of a complex and quite artificial set of arrangements the former Labor government put in place to privatise the electricity sector without appearing to privatise its generators because of the political problems that would cause it with its union base.

In Origin’s case, it bought two state-owned energy retailers for $2.3 billion and entered what were termed 'gentrader' arrangements that were effectively long-term lease arrangements over the output of Eraring, which continued to be owned by the state.

The state, however, didn’t own its own coal deposits to supply the generator and wasn’t able at the time (in the midst of the resources boom) to secure supply at a reasonable cost. Under the deal Origin was supposedly responsible for its own supply but the government arranged for a 17-year contract, starting in 2015, for up to five million tonnes from a state-owned but undeveloped coal project, Cobbora Coal.

At the time the logical analysis of the deal was that the government had effectively inflated the value of the gentrader contracts (TruEnergy, now Energy Australia, entered a similar arrangement) by guaranteeing them access to coal at lower-than-market prices. That appears to have been borne out by today’s deal with Origin.

Origin paid $950 million for the gentrader contract which, after taking into account inventories at the point of the sale as well as the value in Eraring’s hedge book, reduced the net proceeds to $867 million.

With payments to Origin for capacity upgrades that have seen the plant’s capacity increase from about 660 megawatts to 720 megawatts, the notional residual value of what was effectively a pre-payment by Origin for the plant’s output was about $609 million.

By stumping up an extra $50 million Origin’s overall payment for Eraring is therefore about $659 million.

That left the coal contract with the still-undeveloped Cobbora coal project. In today’s environment, with coal mines closing and others losing money it doesn’t make sense to develop another low-quality coal resource, particularly as Centennial Coal has deposits that are adjacent to Eraring.

Origin and the government have cancelled the Cobbora contract – at a cost to the government of $300 million – and Origin has entered a shorter term contract, to run from 2015 to 2022, with Centennial.

The deals mean that Eraring has finally been cleanly privatised, the government has avoided having to develop Cobbora, Origin gets a net $250 million knocked off its original purchase price to reflect the reality that it will have a greater exposure to the coal price in future because the contract with Centennial is for only about half the term of the Cobbora contract. It will also have more flexibility in terms of the plant’s output, greater optionality within its own generation portfolio and energy trading business and should be able to manage it to drive greater efficiency.

It was always inevitable that at some point the politically compromised and overly-complicated gentrader contracts would be replaced by a more conventional private ownership model for NSW’s power stations and logical that the most likely buyers would be those on the other side of those contracts, which is what has now occurred.

It is a sensible outcome for both NSW taxpayers and Origin.