This provocative suggestion came from the Grattan Institute, which says writedowns of the value of network assets is inevitable. The only question is who should pay: shareholders, taxpayers, or consumers?
This week I was having a conversation with a leading utilities analyst and raised the question of electricity network valuations, and whether these needed to be written down, as we suggested in May and on several occasions since, including in a report on the massive grid investment in Queensland.
“I don’t think it has even entered their dreams, let alone their thoughts,” came the response. It’s one of the legacies of a regulated monopoly – there is an absolute conviction that the revenue model is holeproof. If one customers doesn’t pay, then the bill simply gets spread over to the remaining clients. There is another reason too, because state governments still want to sell their networks, and even private networks are trying to attract the attention of international groups, as is the case at SP Ausnet.
But a new report by the Grattan Institute suggests that situation is untenable over the long term, and network operators, policy makers and network owners, which in many states mean the governments, should be getting their thoughts around the issue of network valuations. According to Tony Wood, Grattan’s energy program director, grid writedowns are all but inevitable. The only question is – who should pay.
The Grattan report – Shock to the System, dealing with falling energy demand – goes through all the reasons why network costs are such an issue – and RenewEconomy believes they are the single biggest issue facing the electricity market today – along with the rapidly declining cost of solar and the emergence of storage. It is an issue that has implications for generators (indeed they are the ones most likely to put pressure on the networks to act, because they are being forced into their own write-downs), retailers, consumers, and governments.
Network owners, the report says, have simply invested too much money in oversizing the networks – a situation that is obvious now that demand is falling, due to a combination of more efficient appliances, energy conservation, rooftop solar and declining industrial use. Even if not a single extra dollar was spent on new grid upgrades and expansion, there is still a massive bill to pay – on regulated returns based around a high cost of capital for investments already made.
As it turns out, some new investment in networks is unavoidable. New houses are built, new lines are needed, older ones need replacing, and even with all the recent investment Australia has been left with a largely dumb grid – that will need upgrading to cope with “smart technologies”, the new bi-directional flow of energy and high levels of solar PV.
That, though, can be managed through some careful thinking about tariffs, and the elimination of deliberate and accidental cross-subsidies (such as the added cost on the network of new air conditioners).
What is more problematic is what to do about the sunk investment. Networks expect to get returns on the $45 billion they have just spent for several more decades, let alone previous investments.
The problem is that the combination of high network costs and falling technology costs for solar – and presumably energy storage – is making it attractive for consumers to either produce their own electricity, or even contemplate leaving the grid, as the CSIRO Future Grid Forum suggested last week.
This, in turn, means extra costs for those remaining – made worse by the closures of large energy users such as Kurri Kurri, and possibly Holden – accelerating a vicious circle that provides yet more incentive for people to find alternatives. The electricity industry calls this the “death spiral.”
“We are in a bit of a nasty place and we’ve got to get out of it,” Wood says. “When you dig yourself into a hole, the best thing to do is to stop digging. Then you work out how to get out.
“You can’t avoid the question and hope it will go away. And there are only so many options.”
The Grattan report says that low network costs will help to keep electricity prices low and improve the competitiveness of electricity supplied through power networks against technologies that could allow consumers to bypass the network.
This is how it describes the problem:
“Making tariffs reflective of the cost of peak demand would provide the right pricing signals for consumers to change their electricity consumption. However, these measures may not be enough.
“The amount consumers are charged for using Australia’s regulated power networks is a reflection of the cost of previous investments. At present, consumers have no choice but to pay for these assets. But in future they may have the means to do so.
A better alternative would involve writing down the value of network assets. This would mean recognising the need for networks to compete with non-network alternatives and reducing the value of the regulated asset base accordingly.
If this were to occur, governments would need to decide who would pay for the asset write-downs. This is not a simple decision, and one that could be faced on multiple occasions in a range of jurisdictions ‑ consumption and peak demand are likely to continue to fall, and with them the value of the network assets.
The cost of asset write-downs will be borne by one of three players:
Consumers, already paying for overvalued networks through high electricity tariffs, could pay even more. In the first instance, they would pay through higher prices. If prices reached unsustainable levels, customers disconnecting from the network could also be forced to pay substantial disconnection charges. This would cover the cost of network assets that may be made redundant as a result of a large number of disconnections, but such charges would be likely to be highly unpopular.
Private owners of network businesses in South Australia and Victoria could be forced to write down the value of their regulated assets. Existing regulatory frameworks do not envision this prospect, and the risk is not reflected in the rates of return paid to the businesses. Such write-downs could be seen as a real sovereign risk and deter future investment in Australian infrastructure. It could also greatly increase the price that would have to be paid to attract investors.
Governments that own network businesses in New South Wales, Queensland, Tasmania and Western Australia could be forced to write down the value of their regulated assets. In Victoria and South Australia governments could pay compensation to privately owned businesses. In both cases, taxpayers would bear the cost.
Actually, Wood says he is not really serious about charging consumers to leave the grid, although such ideas do raise the issue of whether there was an “implicit contract” between the network operator and the consumer. And there are precedents in some areas where consumers are required to pay for the available of utility services (water, sewage) whether they use them or not.
The one saviour for the grid operators could be the electric vehicle, as we have also suggested. While it might be some time away, the arrival of the cost competitive EV is probably going to correspond with the arrival of cost competitive battery storage. This, says Grattan, could be the ‘game changer’ for Australia’s power system, because it would reverse the recent decline in demand and increase the consumption of electricity across the economy.
“The key issue is whether the batteries that power EVs could be charged at times when the network experiences high levels of demand from users. If EVs were charged in off-peak periods, like the middle of the night, they could materially increase the total amount of electricity that could be delivered through the network without creating a need to build more infrastructure. This would allow the cost of building the network to be spread across a larger volume of sales, and help to bring down power prices.”
Battery charging systems could also be programmed to stop charging batteries when electricity demand was high, or even to feed power back into the network. In some cases, this could reduce the need to expand the electricity network to cope with high usage periods, which could help to lower power prices.
That seems a reasonable proposition. You buy some solar panels, and the network operator throws in an EV to encourage you to stay on the grid. Problem solved!