The IPO market may be looking tricky for the first half of the year, but with privatisation of government-owned enterprises on the agenda in both Queensland and NSW once their state elections are out of the way, the prospects through the latter part of the year may have a significant impact on the sale prices.
Queensland is moving to sell off its power assets, while in NSW, the Baird government is expected to win electoral backing to sell its poles and wires at state election in March.
Robust financial markets later in the year could give the publicly owned infrastructure investors such as Spark and Duet the prospect of some additional firepower if they decide to participate, which may ensure greater competitive tension beyond just the likes of potential foreign bidders such as China Grid, which has already bought into the sector locally, or some of Canada’s pension fund managers.
But before the sales get under way, more fundamental is determining the value of the assets. And with the industry regulator finalising the latest price determination for the NSW network businesses, the outcome will have a clear impact on the prices offered for the assets to be sold.
In its draft determination for the NSW network businesses, the AER has slashed around $8 billion off the $24 billion sought in revenue for the regulatory period 2015-19, drawing howls of protest from the network companies Ausgrid, Essential and Endeavour Energy.
For the privately run network operators in Victoria, the pricing decision is of more than passing interest. Even though they are more efficient by most yardsticks than their NSW counterparts, they will be keenly focused on some aspects of the outcome – specifically interest rate assumptions along with issues surrounding forward demand and measures to cut future demand that will reduce future spending.
The NSW networks have taken aim at the headline cuts since, like any large organisation, it is difficult to quickly slash costs deeply, especially since a large part of the changes involve tackling outdated work practices of public sector unions that have had the upper hand in keeping management at bay.
Putting those issues to one side, one of the fundamental changes in the AER determination is the assumption about interest rates. The downturn in global financial markets with the collapse of Lehman Bros in 2008 kept the so-called weighted average cost of capital at a high 10 per cent in the last determination period; the world has changed significantly since, with interest rates now at record lows.
Even so, the regulator has opted for 7.15 per cent as the rate of return this time around, down from 10.02 per cent in the previous determination, which was fixed in 2008 and ran from 2009 to 2014.
However, in the UK, electricity sector regulator Ofgem, in its most recent pricing decision for its network operators, has chosen just 3.6 per cent. But given a gearing ratio of 65 per cent, this raises the figure to 4.8 per cent.
Clearly interest rates in the UK, and also Europe, are lower than in Australia. Still, with the prospect that rates will be lower for longer in Australia given the economic slowdown under way as the economy changes, moving on from the China-fired resources boom, the AER does appear to be unduly generous to the power companies in its interest rate assumption.
Some groups are lobbying for the AER to take a tougher stance here, since a lower interest rate assumption would slice electricity bills, while also hitting the value of the businesses.
A lower interest rate assumption here would also roll through to Victoria’s network companies when their prices are determined over the next few years, and would squeeze margins further at a time when the tougher regulatory approach now being adopted will weigh on their earnings outlook.
The NSW network businesses are already holding price rises at less than the rate of inflation, and the heavy cuts to spending that will result from the AER price determination will push charges down another notch.
It is easy to forget that just a few years back, the network companies were carrying out billion-dollar upgrades to ensure supplies could be met during the surge in “peak demand”, which ran for just a few hours in the middle of summer when, with industry in full swing, any hot weather would push up airconditioner demand, threatening to overwhelm supply systems.
The heavy – and sustained – subsidy received by the renewables industry has removed the need for much of this spending for now.
Even though the network companies are willing to pursue further operating efficiencies by seeking to reduce demand further at these peak times, the AER has ruled out including incentives to hasten the process as it awaits a deeper review of policy in this area by the industry’s overseer, the Australian Energy Markets Commission.
This is a missed opportunity, since it will mean it will not be until well into the next decade before policies are implemented in this area.
This story Administrator ready to work first appeared on Nanjing Night Net.