Last week Pacific Hydro announced they will construct the 47 megawatts final stage of the Portland Wind Project. The size of the wind farm is nothing exceptional, but the way it is commercially structured is. This wind farm is one of very few constructed without a major energy retailer involved either as the owner, or as a 10 year-plus purchaser of the output.
Generally wind farms are developed with energy retailers involved. That’s because they substantially reduce the risk of the project by providing a fixed price for output, bypassing wholesale electricity and renewable energy certificate markets which can be extremely volatile.
Power prices can move from $30 per megawatt-hour to $12,000 in the space of minutes, and then back down again just as fast. If you happen to be generating power during a week-long heat-wave in Adelaide you can make more money than for the rest of the entire year. But if you miss out on such opportunities, it can be an extremely lean year. Also, we’ve seen the market for renewable energy certificates or LGCs halve in value within the space of 12 months in the past.
As you can imagine banks are quite fond of energy retailer power purchase agreements which remove this risk.
But electricity retailers haven’t been so keen on signing them.
When I caught up with Origin Energy's chief executive Grant King I put this question to him:
You’ve stated the 41,000 gigawatt-hour large scale renewable energy target is unrealistic and won’t be met or is highly unlikely to be achieved.
In light of such statements, can you understand why a number of renewable energy project developers are perplexed that Origin Energy isn’t more enthusiastic about entering into power purchase agreements with them?
His response was pretty emphatic:
So, I’m not puzzled that people would like us to put our balance sheet behind securing their income and us taking all the risk because people love to be in that position, but I’ve never heard any reason as to why we’d do that.
In the case of AGL they asked themselves several years ago, ‘why should we take on all the market risk while some other guy takes all the cream?’ So they got seriously into the renewable energy project development business.
Origin Energy and TRU/Energy Australia, on the other hand, have dabbled in doing projects themselves, but their hearts haven’t really been in it.
Which then leaves the question, if you are certain the target is unlikely to be met then you must also think either one of two things will happen:
- The price for renewable energy certificates or LGCs will rise from current spot prices of about $33-$35 to the tax-effective penalty of nearly $93; or
- The government will intervene to reduce the level of the target or otherwise not enforce the penalty.
My money is on number two.
But in our interview King adds a wrinkle to this debate.
He says that as a retailer Origin has been willing to enter into power purchase agreements to cover its household and small business customers.
However, he points out that, there is a mismatch between the level of actual price risk surrounding LGCs and the willingness of large business power consumers to pay a premium to obviate that risk. Large power consumers watch wholesale spot prices quite closely. They will sometimes bypass their retailer to purchase via the spot-market if they think they can get a better deal.
With the first stage of the Renewable Energy Target enacted by the Howard Government, retailers got burnt. They did the right thing signing power purchase agreements for enough projects to make sure the target was met. They paid something north of $40 per certificate, only to see spot prices plummet to $25 when the target was easily met and then exceeded.
Seeing these spot prices, a number of large consumers informed retailers they would take care of their own needs, rather than pay the price struck by retailers under power purchase agreements.
However, this can easily work in reverse too. If we don’t get cracking constructing projects, and the target remains the same, then these same customers could be paying the penalty price of nearly $93 per LGC in 2016.
The challenge for renewable energy project developers is whether they can make these large consumers recognise the risk they’re exposed to. Power purchase agreements direct with large consumers could allow developers to bypass retailers, while keeping the banks comfortable.
Climate Spectator put this issue to the chief executive of renewable energy developer Infigen, Miles George. He felt there was some way to go:
“I don’t think the market yet appreciates that ... because the big retailers are not underwriting contracts for new build (other than to protect their mass market customers)… the consequence is that commercial and industrial consumers are going to be exposed to rising LGC prices ... So there is a strong incentive for them to … enable the construction of new generation that’s going to supply LGCs for them.
We are talking to people about it and some are ahead of the curve… but they are pretty few in number.”
Pacific Hydro has decided to take a punt that market fundamentals will eventually prevail. It’s worth noting they’ve done this with $70 million in finance from the Clean Energy Finance Corporation. The CEFC’s mandate includes adopting the presumption that politicians don’t fiddle with the law of the land.
Will other financiers be quite so brave now the CEFC has been ordered to shut down?