Henry Ergas: the CEFC Labor/Green folly in the extreme

Professor Henry Ergas – the CEFC simply has to go.

The Clean Energy Finance Corporation is the brainchild of the Green-Labor alliance that left the Australian taxpayer as the unwilling underwriters of highly speculative wind power ventures that conventional banks won’t touch with a barge pole.

The CEFC is an outfit living on borrowed time – the Coalition have sworn that it’ll be scrapped as soon as they get the numbers needed in the Senate – which means July.

The true cost and risk of CEFC lending has been grossly understated by the CEFC which means taxpayer exposure is even greater than might be reasonably justified. Here’s the Australian’s Henry Ergas on just what that exposure might be.

Never mind the sentiment, the maths is all wrong
The Australian
Henry Ergas
31 March 2014

THERE is no passion, said Georges Clemenceau, like that of a functionary for his function. He must have had the Clean Energy Finance Corporation in mind, as it battles the Coalition’s election commitment to abolish it.

Faced with those efforts, voters may wonder about the propriety of public funds being used to sabotage the policies they so recently endorsed. After all, the CEFC was not set up to advise on climate policies but to implement the legislation Labor and the Greens had put in place. That its board and management have chosen to divert taxpayers’ money into a campaign to prolong their existence seems unbecoming. But the CEFC believes it ­answers to a higher calling. Indeed, CEFC chairwoman Jillian Broadbent argues its claims are so compelling that Tony Abbott should shred his pledge to end the $10 billion program.

Those claims are certainly startling. Apparently, each dollar invested in the CEFC not only more than pays for itself financially but reduces emissions to boot. The Climate Change Authority estimates it could cost up to $65 a tonne in 2020 to reduce domestic emissions. The CEFC, however, says the emissions reductions it achieves cost a negative $2.40: that is, taxpayers get both a unit of abatement and a cheque for $2.40.

That is not a free lunch, it’s a free feast. But during a campaign, Henry Adams reminded us, the air is full of speeches and vice versa. And although the air in this case may be emissions free, the CEFC’s campaign is no exception to Adams’ rule.

Unfortunately, unpicking the CEFC’s “hot air for nothing’’ analysis is like chewing on a wet sponge: much spillage, scant nourishment. But donning the green eyeshades throws up errors and omissions so numerous one scarcely knows where to start. In essence, the CEFC borrows at the government bond rate, say 3.5 to 4 per cent, and lends at slightly above 7 per cent to abatement-­related projects that, in ­theory, would otherwise struggle to find funding on reasonable terms.

The CEFC treats the government bond rate as its cost of funds; assumes it will secure the cash flows associated with its interest charge and with repayment of the principal, minus a modest provision for bad loans; and claims the margin between those as a profit to taxpayers. That profit it compares to the alleged emissions reductions, yielding the “negative cost’’ per tonne abated that is at the heart of its case.

But each and every step in this analysis is incorrect. For starters, when taxpayers issue public debt to invest in risky projects, the burden they incur is not just the 4 per cent at which they borrow, but the higher taxes they will have to pay to cover potential losses. Properly measured, that burden turns out to rarely be any lower than the cost at which the project could borrow commercially: which is why schemes such as those the state banks of Victoria and South Australia devised, in which government debt funded low-interest loans to uncertain private ventures, have proven so ruinous.

As a result, the CEFC simply errs when it treats the commonwealth bond rate as the cost to the community of the funds it employs. To make matters worse, however, it treats its own loans as being close to a sure thing. Yet even a small probability of default means the effective expected return is well below the headline interest rate.

For example, if the probability of default is 15 per cent, the average interest rate required to actually achieve a 7 per cent return is 26 per cent; in that case, a 7 per cent headline rate, far from yielding taxpayers the 3 per cent margin the CEFC claims, results in a 13 per cent loss.

To all that the CEFC then adds the sin of double counting. In ­effect, the only reason the previous government allowed the CEFC funding at the bond rate was the potential benefit in terms of abatement. In other words, even it recognised those funds were being loaned at a loss, but offset that loss against the social value of the emissions reductions. Yet the CEFC contends that loss is a profit and then trumpets the abatement as if it were a further gain on top of that.

Not that it is easy to accept the CEFC’s claimed emissions reductions. Its major wind farms ­already existed; excluding those, it is difficult to believe its other projects could provide anywhere near the abatement it asserts.

Nor could anyone readily ­accept the claim that those other projects would not otherwise have proceeded: on the scant information available, they yielded cost savings so vast (with internal rates of return exceeding 100 per cent) that even the beneficiaries should have happily underwritten them.

But those beneficiaries would, of course, have been even happier shifting the costs on to taxpayers, with the extraordinarily high implied subsidy rates on the CEFC’s projects making their celebrations all the merrier. On highly plausible assumptions, those subsidy rates are in the order of 60 per cent. And for its wind farms, which have also benefited from myriad other sources of public support, they imply the private owners obtained a total of $75 in taxpayer funding for each $25 of their own money, while pocketing the entirety of the profits.

No wonder the CEFC has a backlog of applicants, which it proudly points to. And no wonder those applicants have touted so loudly on its behalf: the cheaper the crook, the gaudier the patter. But far from attesting to its merits, they highlight the folly of the undertaking and of the Labor-Greens pact from which it sprang. That pact is now a bad memory; no matter how well intentioned its board may be, it’s high time the CEFC joined it.
The Australian

Not a bad little dissection of the CEFC and its sterling efforts to self-justify (hardly ever a sound basis for justification, but always worth a try).

Where Henry could have gone further was to have a look at the fact that the developer/applicants for tax payer underwritten “loans” from the CEFC are treating it as the lender of last resort simply because they cannot secure Power Purchase Agreements (PPAs) with retailers. If they have a PPA they’ll get financed by banks and won’t need to hit the CEFC.

Reputable banks were willing to lend to Infigen, Pac Hydro & Co while they were signing PPAs, because that agreement provides a guaranteed stream of cash in future (it incorporates the net present value of a future stream of electricity sales and, much more importantly, REC income).

The PPA itself was, therefore, viewed by commercial lenders as a reasonable form of security for credit extended to the developer holding the PPA.

But, as newly signed up PPAs are now as rare as the Tasmanian Tiger, Infigen, Pac Hydro and their “chancer” mates have nothing of meaningful value to offer the banks.

The only thing they hold is a “licence” to enter some poor sucker’s land in order to stick up their fans, and a dodgy planning consent – neither of which are worth the paper they are written on.

These desperados now appear prepared to run operations without PPAs, selling into the spot market and relying on RECs to make a margin. Wind power output usually hits its straps at night-time – when demand plummets – and the dispatch price heads toward negative territory. The overnight collapse doesn’t bother operators with PPAs – they’re guaranteed a minimum price from their retail customer of between $90-110 per MW/h, so clean up anyway.

But it’s a whole different shooting match without a PPA – the operator is punting on the value of the REC to make a margin – with RECs battling to top $30 that’s a mighty big punt. Of course, with their CEFC loans underwritten by us, it’s a bet their clearly willing to take – at our ultimate expense.

The other territory Henry could have explored is the financial performance of outfits like Acciona (its Spanish parent in diabolical trouble back home – see our post here) and Infigen aka Babcock and Brown.

Hands up who’s ready to send their hard earned coin to Infigen – the crowd that backed up a $55 million loss in the year ended 30 June 2012 with an $80 million loss in the last financial year?

“High risk” is a term that sits perfectly in a sentence with words such as “lending” and “Infigen” and “Babcock and Brown” – RISK of a kind that the CEFC is all too quick to assume on the Australian taxpayer’s behalf.

The other massive RISK that Henry overlooked is the kind that’s staring investors operators and developers in the face – and that’s the regulatory kind.

The RET review will not leave the current mandatory target unscathed and – once the target is cut or scrapped – the REC price is bound to fall, if not collapse.

The Coalition’s Direct Action policy is also aimed at achieving least-cost CO2 abatement using Carbon Capture Units (CCUs) – to be issued on audited proof of the abatement of 1 tonne of CO2. At the minute the boys in Greg Hunt’s office are working out how to consolidate the REC into the CCU in order to simplify the system, bring about the cheapest possible abatement and ensure that no rewards are made unless there’s proof of abatement. All of which puts the entire basis for the wind industry – the REC – under a very large cloud.

A revenue model built on the current mandatory target, which in turn determines the REC price, the risk of an immediate revenue collapse for an operator hoping to punt power without a PPA is just around the corner. Moreover, those hoping to eventually sign a PPA with a retailer can kiss that goodbye. Retailers might be greedy, but they aren’t stupid – none of them want to be left holding a pile of worthless RECs after the RET review.

The fact that all that risk is being bundled up by the CEFC on our behalf is bad enough – that the CEFC seeks to ignore the true degree of risk and make wild (and unsubstantiated) claims about returns is audacity and hubris in the extreme.

In July the new Senate takes its place and looks likely to give the Coalition the support needed to scrap the CEFC. In STT’s view, that can’t come soon enough.

The CEFC’s Oliver Yates and Jillian Broadbent.
On a mission to justify risking a fat pile of taxpayer’s cash.