More hot water for Origin Energy

There is irony in the timing of Origin Energy's revised earnings guidance, coming as it did on the same day that Martin Ferguson released the federal government's energy white paper. Origin's predicament highlights what a mess politicians are making of the energy markets.

Earlier this year Origin estimated that the cost of the Queensland Competition Authority's decision to freeze retail electricity prices, which it is appealing, would be about $60 million. Subsequently AGL said the QCA decision and a draft decision by the South Australian regulator to reduce prices would slice $45 million off current-year earnings and $60 million over a full year.

Yesterday Origin issued fresh guidance, lowering its previous expectation of steady earnings this year to a decline of five to 10 per cent. The reason? The interaction between two sets of regulatory decisions.
The Clean Energy Regulator, established by the federal government to oversee its carbon pricing policies, recently issued revised estimates for the cost of Small-scale Technology Certificates that retailers can recover in their pricing from January 1 next year.

The STCs are part of the government's Renewable Energy Target scheme. Industry participants with RET liabilities are required to purchase STCs and then surrender them to the regulator to demonstrate their compliance with the scheme but are allowed to cover the cost from customers.

The regulator revised its estimate of the costs to be recovered from 8 per cent to 19 per cent – it more than doubled the amount the companies could recover.

Unhappily for Origin and its peers, given that the revision came after the Queensland and South Australian regulators' decisions and a pricing decision by their New South Wales counterpart, there is no mechanism that would allow Origin to recover that increased amount – worth about $40 million to Origin – this financial year.

Origin wants a review of the RET scheme, saying it is needed because of the evidence that regulators and the industry are unable to forecast with accuracy the impact the Small-scale Renewable Energy Scheme is having on installation activity and costs that should be paid by customers.

It said the revised estimate meant the total costs that will ultimately be recovered from customers is about $1.4 billion, which is going to come as something of a shock to customers already experiencing soaring power bills. Given that the 2012 cost of the scheme of $1.79 billion is already locked in, that would mean the scheme will cost nearly $3.2 billion in two years.

Ad hoc and inconsistent energy pricing decisions motivated more by politics rather than economics are being overlaid onto the costs of the RET scheme (which doesn't reduce carbon abatement but increases the cost of abatement and distorts investment decisions) and are now being further complicated by the interaction between the detail of the RET and the state-based regulators' decisions and the inability of the federal regulator to forecast industry activity with any precision.

It's an absurd way to regulate a complicated and highly sensitive sector and one that is damaging to the industry participants.

The revised guidance hit the Origin share price quite hard today. Origin is going through something of a tough patch in terms of market sentiment.

Standard & Poor's recently announced it was reviewing its treatment of hybrid securities. Origin had received an equity credit of 100 per cent for the $680 million of hybrids it issued last year and that S&P announcement added to the market's concerns about its balance sheet, which centre on its ability to fund its 37.5 per cent share of the $23 billion Australian Pacific export LNG project at Gladstone in Queensland.

Origin's Grant King was forced to reiterate today that there were no plans or need for an equity raising – Origin shares have been effectively trading ‘'cum issue'' for some time – saying the company had sufficient funds to support both its share of APLNG's capital expenditures and its other businesses.

Origin has made it clear that it would like to sell down its APLNG stake to 30 per cent, which would both raise funds and reduce its funding requirement, but the market appears sceptical of its ability to find a buyer on acceptable terms. King has said Origin will only sell down its interest if the terms make sense.

The recent announcement from BG Group, which has its own export LNG project next to APLNG's, that China National Offshore Oil Corp had agreed to pay $US1.93 billion to lift its interest in the project, however, suggests that there is still an appetite among the projects' customers for both the gas and equity exposure to the LNG plants.

Despite its success in introducing partners and customers to the project – ConocoPhillips and China's Sinopec have equity stakes and Japan's Kansai Electric is a committed customer – and having demonstrated that it can monetise its leading position in coal seam gas resources by contracting to supply gas to the other projects, Origin gets little, if any, credit in its share price for its share of the project, which will start delivering gas in 2015.

To end the market's scepticism about its funding Origin will probably need to sell down the APLNG stake or accept that it will have to wait until closer to 2015 to demonstrate that it had the financial capacity to get through to those first shipments without raising more capital.

In the meantime, it has to deal with the incoherence and inconsistencies of federal and state energy regulation and the damage it is doing to its regulated energy businesses and those of its peers.