How 'non-delivery' haunts Greg Hunt

The history of abatement auctions is chequered at best. If industry again fails to deliver, Greg Hunt will have little time left to salvage emissions targets.

A key challenge facing those poor bureaucrats tasked with trying to make something half workable out of the government's Direct Action policy is how to deal with winning bidders failing to deliver promised amounts of abatement. 

The thing is that an emissions abatement auction scheme will have to determine in advance, often many years in advance, who it should pay to provide abatement and how much it should pay them. 

Now people sell things via auctions all the time, so why is this a big deal?

The difference is that usually in auctions you are buying a product or service that already exists and the auction is tightly constrained in the products being auctioned. You bid for a house, you have a handful of bidders and at the end of it you typically settle the deal in 90 days and never need to speak to one another again.

But with the government’s abatement purchasing auction they’ll be contracting with a vast array of industries – from power generation, to metal refining to piggeries – for those businesses to deliver often complex projects that take years to develop, and the company may never have done such a project before. And the government doesn’t just need a handful of abatement projects, they need lots and lots of them to meet their 2020 emissions reduction target – and they need them delivered quickly. Plus, for these abatement projects to be viable they’ll need the government to enter into at least a 10-year contract to buy the abatement.

So this isn’t quite as simple as eBay.

If past government greenhouse abatement projects are anything to go by we can typically expect around half the winning bidders will never deliver their projects, or deliver them many years late. Now these programs involve tendering and, thankfully, Environment Minister Greg Hunt has chosen a more streamlined auctioning approach and will only hand over money as abatement is delivered, rather than via grants given upfront as the project is constructed. This is a major improvement.

But auction schemes can also have problems with winning bidders failing to deliver, especially when projects are novel and complex to execute. The Indian Solar Mission auction to acquire 470 megawatts of solar thermal power provides an ominous lesson in this regard. 

In the the Solar Mission auction, whoever offered the lowest price per MWh of power and payment would only be provided by the government per MWh delivered to the grid – there would be no cash given before the project generated power. This should have worked well, deterring proponents who lacked the capability to deliver functioning solar thermal projects as they wouldn’t make any return on their investment unless they were confident they could deliver a fully functioning plant.

The auction was held in 2010 and, on first appearances, delivered an astounding result – the seven selected projects pledged to sell power at an average of $US197 a megawatt-hour. That’s 43 per cent below the global average of $US344, according to data compiled by Bloomberg. But in 2013 only one 50 MW project has been built and it was 20 per cent over budget.

Another Indian project, Reliance Power’s 100 MW plant using the Australian linear Fresnel technology, was about five months behind its deadline, encountering problems with water pipeline supply. According to a Bloomberg report, the remainder were stalled by rising costs and technical setbacks, according to Tarun Kapoor, joint secretary at the Ministry of New and Renewable Energy. All winning bidders have encountered myriad unforeseen difficulties and challenges which suggest that even if they deliver, with the benefit of hindsight they wouldn’t have bid such low power prices.

Now in fairness to the program, it's still doing better than Australia’s Solar Flagship scheme launched in 2008 and which is still yet to finalise selection of its second project, even though it is supporting the far more straightforward solar PV technology. But the story behind this program illustrates that the success of an auction can be highly illusory.

What’s important to recognise is that Hunt lacks that most precious of commodities – time. Large scale abatement projects have gestation times (other than small-scale energy efficiency) in the realm of two years and often more. 

The government in its first two years, of 2014 and 2015, may think everything is all in hand, contracting for plenty of abatement projects all at bargain-basement prices. Then, by 2016 and 2017, it could find they are like sand, seeping through their fingers as proponents find their cost estimates too optimistic, or it taking longer than they thought, or that they have problems with customers, or suppliers, or the exchange rate changes, or the price of vital input or output changes, and so on.

By 2017 they could realise the auctioning scheme is failing, but that they only have another three years left until 2020. Considering that abatement projects take two years to develop, in reality they would have only one year left to make up for a large shortfall in the abatement required to meet emissions reduction targets.

The public servants assigned to designing the abatement auction scheme will therefore need to think long and hard about how to ensure the winning bidders deliver on their promises, while not scaring away too many capable abatement providers.

This is the first article in a two-part series. The second part, 'Fixing the abatement black hole', is available here.

InvestSMART FORUM: Come and meet the team

We're loading up the van and going on tour from April to June, with events on the NSW central & north coast, the QLD mid-north coast and in Perth, Adelaide, Melbourne, Sydney and Canberra. Come and meet the team and take home simple strategies that you can use to build an investment portfolio to weather any storm. Book your spot here.

Want access to our latest research and new buy ideas?

Start a free 15 day trial and gain access to our research, recommendations and market-beating model portfolios.

Sign up for free

Related Articles