The New South Wales parliament passed legislation on 30 May 2012 enabling the sale to the private sector of the remaining government-owned generation assets, including sites with planning approval for future generation.

The sale initiative is driven by a desire of the NSW Government to fund infrastructure projects, with proceeds committed to the ‘Restart NSW Fund’ dedicated to a to-do list of major infrastructure investments. It also marks another twist in the 16 year tale of the State’s attempts to sell the assets, which has created unusual investment signals.

The enabling legislation gives the Treasurer broad powers to undertake corporate restructures and bundle assets within the present state-owned corporations prior to effecting a sale. This evidences a willingness to tailor the asset package in response to market soundings and its commercial and legal advice.

The sale timetable, however, occurs at a tricky time. TRUenergy (already a major player in NSW generation) recently put on hold its proposed share market listing because of market uncertainty. There is also serious medium-term uncertainty about future pricing of the key input (coal) and output (power) of the generation businesses. The success and viability of a sale will hinge on a Scoping Study due to be released in late October and prepared by Goldman Sachs, who were appointed as lead financial advisor in early July.

This article sets out some of the many challenges the Scoping Study will need to confront in order to get the assets to market.

GenTraders

A unique feature of the NSW power sector is the generation trading agreements (GTAs) which state-owned Eraring Energy and Delta Electricity have entered with Origin and TRUenergy respectively.

Under a GTA, the generator (or ‘Owner’) operates and maintains its power station to meet fixed availability targets. The GenTrader assumes responsibility for the supply of fuel and is entitled to the entire output of the station. The GenTrader pays availability charges to the Owner and is entitled to liquidated damages in the event that availability targets are not met.

The ‘GenTrader model’ came about as the former Labor government’s ‘Plan B’ because it could be implemented without legislative amendment, following the collapse of parliamentary support for the Iemma government’s proposed privatisation program in 2009.

The GTA power stations form part of the package the government intends to sell, but if that is to be achieved the position of Origin and TRU needs to be addressed to create a competitive process.

Each GenTrader would have significant advantage over a competitor interested in acquiring the power station the subject of a GTA given their familiarity with the assets and ability to identify and minimise potential risks. The GenTraders also have leverage through a tax ruling condition in the GTAs which is still unsatisfied.

This potentially shrinks the market of interested parties, however the stability of revenue represented by the GTA, as well as the opportunity to earn incentives by driving efficiency reforms at the stations, could still appeal to parties.

Non-GTA Assets

Delta’s ‘non-GTA’ power station located on the Central Coast – Vales Point (1320 MW) (the other coastal power station, Munmorah, is now being decommissioned), and the two Macquarie Generation power stations – Bayswater (2640 MW) and Liddell (2000MW), would appear to be an easier sell.

The sheer size of Macquarie Generation may be problematic – it has close to 30% of National Electricity Market (NEM) share. ACCC Chairman Rod Sims devoted a large part of a speech to CEDA on 14 June to this topic, pointing to its ability to effectively set the market price at peak times and stating plainly that ‘restructuring MacGen into separate portfolios, rather than selling it as a single entity, will limit the exercise of market power in NSW in the future’.

Although the Bayswater and Liddell units are operated separately, most of MacGen’s supporting infrastructure, including coal conveyor belts, and many of its major contracts with suppliers and customers, are effectively ‘shared’ between the two stations. Splitting the assets would involve some complex legal and logistical work, similar to that undertaken for the shared infrastructure of Victoria’s Latrobe Valley generators.

Furthermore for a portfolio of its size, we understand MacGen’s load is largely uncontracted (or that existing hedge contracts are in place on a rolling basis for short terms), leaving an acquirer with a large exposure to the NEM pool price. This may be an issue of concern to overseas investors and banks with limited NEM experience.

Fuel

Parallel to the sale of the generation assets, the government is also seeking to sell or lease the Cobbora coal mine and associated infrastructure development and has appointed Citigroup to develop a Scoping Study on the sale of these assets. An asset of this scale and value certainly merits an independent review, however the outcomes of the two Scoping Studies will need to gel as a satisfactory position on Cobbora coal supply is central to the economics of the generation businesses.

The Cobbora project originated in state-sponsored exploration activity in the early 2000s, the rights to which were handed over to an unincorporated joint venture of the three major State-owned generation businesses and are now held by a State-owned holding company. It is anticipated that Cobbora will produce at least 12 megatonnes of thermal coal per annum from 2015.

Cobbora has entered supply agreements with the 3 state owned generators at prices based on the government’s cost of funds and expected operating costs in deals designed to protect those businesses (and by extension all electricity users) from the high international coal price.

Citigroup has been asked to consider whether the existing coal supply terms with the generators should be restructured prior to sale, against the background of consideration as to how much product a private owner of the mine should be allowed to export or sell on the open domestic market. It may be relevant to build in some responsiveness to the international coal price, or to the NSW generators’ actual level of reliance on Cobbora coal.

This analysis presents just some of the commercial dilemmas confronting the government, leaving aside the obvious uncertainty created by the introduction of a carbon price (which could either be floating or repealed within three years) or the issue of employment conditions for power station employees.

While it seems to be a sticky road ahead, it is worth bearing in mind that it is rare for 7000MW of operational capacity to come on the market (or c.10,000 MW if the GTA assets are counted) and that the NEM, notwithstanding its price volatility, is one of the most developed, transparent and sophisticated wholesale exchanges in the world. The legal and economic pitfalls will exercise the minds of bidders and their advisors alike over the coming months.

We think this presents an opportunity for bidders who can offer innovative and creative approaches to the possible structuring of the sale, or the management of residual risks.