Australia’s clean energy history is a litany of mistakes, dashed hopes and failed plans. Even our successes, such as by far the highest level of household distributed energy in the developed world are derided by organisations like the Grattan Institute as being financial disasters.
At one moment in time, just after the first Rudd Government election, we seemed about to embrace a low carbon future. We had a strong renewable target, a carbon pricing/tax policy that had learnt from the mistakes of Europe, we were about to take advantage of world leading solar and wind resources and strong public support. And then it all fell apart.
Only a few now recall that as much as we like to blame the Coalition, it was actually the lack of support from the Greens that led to the initial carbon scheme proposal not passing the Upper House. And then Rudd abandoned his message and the public mood changed.
The Carbon tax, and tax is the right word, achieved nothing in the end. Large subsidies to a gross value of over $2 billion were handed out to the largest carbon emitters, such that profits increased during the period of the carbon tax.
Nothing symbolised the failure of policy and the difficulties of implementing sound economic policy, as supported by significant portions of the business community and by economists so much as the photo of the Environment Minister celebrating the carbon scheme’s repeal.
CEFC potentially the biggest player in the market
Still, out of the ashes some things survived and even prospered. Of those one of the most interesting, and potentially virile, is the Clean Energy Finance Corporation (CEFC).
The CEFC currently has $6 billion of available Government funding and this will increase to $10 billion by July 1, 2017. However the CEFC has currently invested only half the funds available to it, and most of those investments have been in debt.
The potential good news is that CEFC nearly $9 billion of funding – $4.8 billion today and a further $4 billion over the next two years for investment.
The CEFC currently makes a small profit (about $31m pretax in FY15 from $54m of interest and fee revenue)
As June 30, 2015 ,only $1.2 billion of investments were committed and typically this would be by way of a loan for solar PV or wind energy funding. The following four charts summarise the FY15 portfolio.
The CEFC’s function is to invest into renewables, energy efficiency and other emissions reducing technologies. The CEFC Act specifies that by 2018 50 per cent of the portfolio must be in renewables and the CEFC cannot invest in carbon capture and storage or nuclear.
Investment mandate and political issues
As the annual report states, “the investment mandate” [TIM] is the means by which the Government provides instructions as to how the CEFC can make investments, but it may not mandate a particular investment or be inconsistent with the CEFC ACT.
The current investment mandate requires the Board to adopt an average return over the portfolio of the Australian Government Bond Rate + 4-5% subject to in aggregate an acceptable but not excessive level of risk.
You don’t have to be Warren Buffet to appreciate that the bond rate + 5% is pretty much equal to the market cost of equity and not debt. The equity risk premium (the return over bonds the share market expects to receive based on what it has achieved in the past) is about 5-6%.
However what many don’t immediately realise is that this is a geared return. That is the equity market generally receives its return from investments in companies that also have debt in their capital structure. If invested in that way $10 billion of CEFC equity could support $20-$30 billion of gross investments.
The CEFC has no chance of earning the bond rate + 4-5% by investing in normal debt securities. It might get it by investing in “junk bonds” but losses would be high and in any event we don’t think there is that much clean energy junk bond available to invest in within Australia. Nor do we think most people want the CEFC investing in “junk”.
The most recent investment mandate included the new clause 13 which states in part
“…the Corporation must include a focus on supporting emerging and innovative renewable technologies and energy efficiency, such as large scale solar, storage associated with large and small-scale solar, offshore wind technologies, and energy efficiency technologies for cities and the built environment. This will in turn increase the uptake of emerging technologies such as large scale solar and energy efficiency…” Emphasis added
Palisade fund – a small step in the right direction
There are some signs that the CEFC is becoming more ambitious. We think this may reflect in part a “behind the scenes” push from the Govt to try and get some new solar and wind parks built. For instance as recently as yesterday the CEFC announced a $100 million equity commitment to a Palisade Investment Fund which will have around $500 m of equity in total and aims to have $1 billion of finance.
Although the RET is supposed to be a market based mechanism its clear the private sector doesn’t like the scheme much and market forces will not get the target achieved and the costs of non compliance will be borne by consumers. So Government support has to be rolled out one way or another.
But the CEFC will have to do so much more
Most estimates put the cost of getting to around 50% renewable energy in Australia at over $50 billion, that excludes the cost of the associated storage. The renewable energy has to be forced into a market that is already balanced and so it will have to force thermal supply out of the generation mix.
It’s difficult to earn big returns on equity in what’s a fiercely competitive market. There are likely to be more losers than winners. The CEFC by virtue of its balance sheet has the potential to be the single largest player in the sector. Certainly a far bigger role than its cautious steps to date would so far indicate.
David Leitch was a Utility Analyst for leading investment banks over the past 30 years. The views expressed are his own.
