Time to write down the value of NSW networks

Bruce Mountain, 17 Oct 2014

Published by Business Spectator, http://www.businessspectator.com.au/article/2014/10/17/energy-markets/time-write-down-value-nsw-networks


“The NSW Government has committed to partially privatise, via leases, two of its three distribution network service providers and its transmission network service provider. There is still a long way to go and an election stands in the way. The last two privatisation attempts failed. Perhaps it’s third time lucky – the government seems determined, and so the proposals should be taken very seriously.

One of the critical elements of the sale – to all parties – will be the regulatory and market valuation of these businesses. Around two-thirds of the charge for network services depends on the regulator’s valuations. Electricity consumers would prefer a lower valuation. Buyers will also be interested in the regulator’s valuation since in Australia this has had a significant bearing on the amount investors will pay. Buyers would also prefer lower regulatory valuations as this reduces the regulatory risk of subsequent asset writedowns. The government’s interest in maximising sales proceeds should be obvious, and so they would prefer higher valuations.

Considering the conflicting interests and the high price NSW household consumers are currently paying for network services, the Public Interest Advocacy Centre asked us to examine the regulatory valuation at privatisation, and identify relevant issues.

The situation in NSW is striking. After the Victorian distributors were privatised 15 years ago, their regulatory valuation per connection was about a third that of the NSW distributors today. When the British distributors were privatised, the imputed regulatory valuation per connection at privatisation was one-seventh that of the NSW distributors today. In California – one of the most expensive states in the US to buy electricity – the privatised distributor asset values per capita are about one-tenth those in NSW.

In considering the extraordinary regulatory valuations in NSW, compared to those in Victoria and Britain, it is also helpful to be mindful that at the time of those privatisations the strength of the monopoly in electricity distribution was undisputed. Today, households in NSW can produce much of their own electricity from solar PV for less than the cost of distribution on the existing poles and wires, or equivalently less than half the price of grid-supplied electricity.

The rise of distributed generation, ever-greater consumption efficiency, industrial decline and consumers’ reaction to steep price rises, is resulting in sharply declining demand. The Australian Energy Market Operator now expects grid electricity sales in NSW this year to be about a quarter of what it thought they would be five years ago.

When the Victorian businesses were privatised, investors were willing to pay the government twice as much as the total regulatory valuation. These buyers were betting on an investor-friendly regulatory environment. In the event, they were not wrong. But will investors make the same bet now, considering asset valuations that are so much higher, a declining market and a monopoly that is fraying at the edges from rapidly increasing distributed generation?

Perhaps not. Can anything be done about it?

We estimate that households in NSW whose electricity is delivered by the two distributors that the government intends to sell, would now be paying around $200 to $300 less per year if they had spent capital, per connection, at the rate of the privatised Victorian distributors over the last 13 years.

Achieving this would mean a $9 billion asset writedown. Government would surely not give this a second thought, unless the buyers were willing to make up part or all of the shortfall through higher market valuations. Buyers might think this way: a lower regulatory valuation before investors buy-in reduces the risk of writedowns after they become owners. Even though regulated revenues would be lower after a writedown, they would be more secure and buyers may pay more for security.

A devaluation of the regulated asset base prior to privatisation may therefore offer better outcomes for consumers, retailers, the future owners and the current owner – the NSW Government. Further examination of these ideas may pay dividends for everyone. “