Why Macfarlane is dreamin'

As reported on Monday, the federal government appears to have realised that seeking to severely cut the Renewable Energy Target in the face of opposition from the Senate risks a dangerous political backlash. Instead, the Coalition would prefer to come to a negotiated settlement with Labor that removes the issue from political contention.

However, at this stage the Abbott Government is maintaining its political bravado.

Industry Minister Ian Macfarlane put on a brave face on Monday, suggesting that unless the renewables sector can get Labor to agree to a large cut in the target, consistent with relieving the large oversupply for incumbent coal generators, then it would be the renewables sector that loses out.  

Essentially, Macfarlane's presenting an ultimatum: 'if you don’t compromise and get Labor to back off from attacking us, there'll be no deal at all. You’ll be left in limbo without the regulatory certainty needed to support investment.'

Climate Spectator has been informed by a spokesperson for Labor’s shadow environment minister, Mark Butler, that the ALP has received no approach from Macfarlane to negotiate over the RET.

Butler explained that a precondition of any negotiation was that, “Abbott needs to completely disown the recommendations of the Warburton inquiry. This is the Prime Minister’s report, with the recommendations he wanted, and the onus is on him to respond before we move forward.”

Given Macfarlane has put nothing forward, one suspects he is trying to smoke out the renewables sector to make the first move.

Macfarlane’s hand is a strong one. While the sector may be protected from changes to the scheme in the Senate right now, the prospect of future changes is expected to kill the willingness of banks and equity financiers to fund projects, and power retailers to sign onto long-term contracts.

The belief is that the renewable energy sector may be popular but, in the end, they can’t afford to wait and are desperate to do a deal.

However, sources within the renewables industry are sounding a lot like a defiant Dale Kerrigan from The Castle: ‘Tell him he’s dreamin.’

In the end Macfarlane’s current position misreads the commercial imperatives facing the renewable energy businesses which mean they aren’t at all keen on exchanging regulatory certainty for a slashed target to cap their market share at 20 per cent.

Firstly the rooftop solar sector has no overriding imperative to do a deal urgently.

The financial support it receives via the small-scale Renewable Energy Target is provided upfront on installation of the solar system. This means there’s no need to worry about long-term bank financing or obtaining a power purchase agreement with a retailer. Provided the legislation and regulations remain as is, which the Senate has assured, it's business as usual for them. Judging from the latest polls, the next election will probably reduce the share of Senate seats held by the Coalition.

The pressure on utility-scale developers is far greater. However, they have concerns beyond just obtaining regulatory stability to support investment in new projects. They must also preserve the value of investments already made. 

Cutting the target almost in half under a 20 per cent market share scenario, would mean a significant drop in the future value of Renewable Energy Certificates, known as LGCs, relative to if the target remains in its current form. These LGCs make up at least half the revenue of large-scale renewable energy projects. ACIL Allen estimates a 25 per cent reduction in LGC prices in the near term and 20 per cent overall under the market share scenario. This would have a large negative impact on the value of developers' existing projects, possibly even breaching debt covenants which could then allow banks to take control of projects.  As can be appreciated, a number of renewable energy developers are desperate to avoid such a situation, as much as they crave the regulatory stability to build new projects.

By comparison, a Senate impasse which leads to no new projects means LGC prices will start to spike upwards as we get closer to the point at which supply falls short of the target (expected in 2017). So while no one wants such a situation, it at least isn’t too bad for existing projects.

In addition, a slashing of the target to 26TWh, from the current 41TWh, creates further risks that the industry is concerned about.

For some time now the LGC spot market has been stuck in the doldrums with little serious buyer interest. This is partly because of regulatory uncertainty but, more fundamentally, because power retailers are sitting on a large pool of certificates excess to their liability. This lack of buyer liquidity means prices are well below long-term fundamentals of supply and demand. A cut to the target could further exacerbate this short-term oversupply and unusually low LGC prices, further hurting the financial viability of existing projects.

In addition it could also harm the potential to develop new projects because it relieves the pressure on power retailers to sign onto power purchase agreements for new projects. Retailers don’t like being locked into holding large amounts of LGCs in excess of their compliance requirements which they may not need for a few years – it reduces their flexibility to respond to changes in the market, increases their risk and locks up capital. For retailers to be interested in contracting for new projects there’s a view that the market needs to face the prospect of a supply shortage within about two years or so.

Lastly, a number of the renewable energy companies operate in several countries with the Australian division having to compete for scarce capital. A slashed target will leave a much-diminished market, characterised by heightened risk. In an environment of multiple opportunities, Australia may just not be worth the effort. For the Australian subsidiary and its staff, they may face closure or rationalisation even if a 26TWh target provides the regulatory certainty to invest in new projects.

So it appears that Macfarlane and Hunt will have to do a lot more than bully and threaten if they want this political problem to go away.