Escalating Capital Requirements

This article has been prepared as one part of a more general summary of the Opportunities & Threats to energy users in Australia’s National Electricity Market (NEM).

Note that my focus is primarily towards large Commercial & Industrial (C&I) energy users – such as those who would be eligible for membership of the Energy User’s Association of Australia (EUAA) – however the concerns would be generally valid for all types of energy user, including small businesses (such as ours) and “mums and dads at home”.

I’ve split this analysis into a growing number of parts to enhance readability (i.e. so you can focus on what you’re interested in).  It’s also helping me to put this analysis together progressively (in between by normal job)!

The general post is linked here, for your reference.

Everywhere you look there is a different number quoted for the amount of capital that needs to be invested over the coming decade (or 3, or 5) to keep the lights on for Australia’s growing population and economy.

These numbers depend on many assumptions – such as about the remnant life in existing assets, the rate at which new technologies will become available (and proceed down a cost-curve), and the extent to which government policies are introduced (or strengthened) to support lower carbon-emissions and/or renewables.

A.  Comparison of numbers in the public domain

When I have some more time, I will add in further details here…

No matter what number you look at, though, they are all very large.

It was a presentation by Paul Simshauser (at AGL Energy) at the EUAA Annual Conference in Sydney last year that reinforced this significance to me.

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B.  Previous discussion

Stephen Hurn touched on this in his summary of the event at the time.

C.  Additional Insights

I would like to add a few additional points that were particularly important to me:

1) Comparative Scale

Paul pointed out that the Electricity Supply Industry (in Australia, as well as elsewhere) is the 3rd largest sector requiring capital funding in the coming years (after the governments themselves, and the banks).

This has been the case for many years, and is one of the reasons why electricity supply has sometimes been seen to be the responsibilities of governments in some areas around the world

2) Impact of the GFC

We posted some analysis back in July 2009 about the impact we’d seen the impact of the GFC on electricity demand in the NEM.

Paul pointed out that GFC had (at the time of the conference, which was October 2009) added a premium of 6% on typical (i.e. BBB) corporate funding, over and above the rate that an AAA-rated government could obtain funding for capital projects.

This, Paul had noted, had significantly raised the weighted average cost of capital (WACC) used by project developers as the hurdle rate for considering new developments.

(a)  This increase contrasted with the experience through much of the decade preceding, where WACC had previously been slowly declining.

(b)  Hence, the jump in WACC had combined with steadily increasing capital costs to have a compounding effect on new entrant costs for generation.

(c)  At the recent EPMU (9 months later), Rohan Zauner from SKM noted how the spread had steadily reduced since that time, but had still not returned to the pre-GFC levels that were almost negligible in comparison.

3) Capacity Utilisation

Paul quoted the results of modelling he had performed to conclude that the NEM had now reached a point (having soaked up much of its spare capacity) whereby its reserve plant margin was “about right” – meaning that (because of ongoing demand growth), major generation development would be required in the coming years.

I believe that the point Paul was implying in his presentation was that major investment will be soon required in base-load generating capacity, which is something that the NEM has not yet had to deliver in large volume.

Most of the capacity installed in the NEM over the past 10 years has been lower capital cost peaking plant.  The (higher capital cost) base load plant will require more policy certainty to be supported, from an investment point of view.

This will be a major challenge for the NEM, given ongoing policy uncertainties (about carbon, transmission connections, and  other things).

Paul quoted a figure of $32b required for generation capacity through until 2020 under the 20% MRET + ETS scenario.

4) Questioning our collective “Smarts”

Perhaps Paul’s most telling inference (to my mind) was that the world had been (largely) taken by surprise by the GFC, and yet it seemed that relatively few people were considering where all the funding would come from for a massive expansion in the capacity in electricity supply industries – not only in Australia, but also in other countries around the world.

To ensure Australia’s new capacity needs can be funded, Australia’s energy policies need to be such that it remains an attractive destination in which to invest.

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