Once bitten, twice shy of cable
John Lawrence
WITH all the talk about a second Basslink one would have expected to have a clear picture of the costs and benefits of the first interconnector.
Surely if you are buying another of the same, one of the determining factors would be how the first has performed? Has it worked as planned? The short answer is no. Basslink has been a costly voyage into the unknown.
It cost Basslink P/L $874 million to build the cable in 2006. Since then Hydro has paid $1.2 billion in fees and associated charges to use it.
Another $1.6 billion is expected to be paid before the contract expires in 2031, although Hydro does have an option to extend the deal for a further 15 years.
That’s an average of $110 million per year just for the use of the cable. Apart from major repair events, the cable is cheap for Basslink P/L to operate, roughly $15 million per year.
When Basslink P/L was selected as the preferred cable builder and a preliminary agreement signed in February 2000, the cost was estimated to be $500 million and the annual usage fee $40 million.
The final agreed cost almost three years later was $874 million, and the annual fee $57 million.
In addition, there were fees payable to Macquarie Bank for hedging costs.
While the final agreed cost for Basslink was being determined, Hydro could have walked away. But it had decided to proceed come hell or high water even though the final cost was a giant unknown.
In the interim it hedged interest rates and foreign exchange rates, which both affected the construction cost of the cable, and interest rates, which affected the facility fee once the cable started operating.
Hedging during the preconstruction stage was like credit betting. No money changed hands. By November 2002 when the cable cost and the facility fee were finally agreed, Hydro owed Macquarie Bank $150 million. Thereafter the only ongoing hedge was one to protect against rising interest rates causing rises in the facility fee.
Hydro pays the facility fee to Basslink P/L and the hedging fee to Macquarie.
In general, if one rises, the other will fall and vice versa. That’s the way ongoing hedges work. The combined figure is currently about $120 million per year.
The Auditor General, following a referral from the Ombudsman, wrote a report on Hydro hedges in 2009. He essentially found the hedging fell into the category of “it sounded like a good idea at the time”. He was more critical of Hydro’s lack of disclosure of the mounting losses.
It was not until 2006 that the hedging liability, as well as the facility fee liability, appeared in the financial statements. Before then there was only fleeting mention in the notes to accounts. In some years Hercules Poirot would have missed it.
The Auditor General satisfied himself the end justified the means. The outcomes projected in the business case were achieved, he said. A better outcome could have been achieved without hedging, he conceded.
Did the mounting hedging costs perversely act to keep Hydro at the table, to keep hiding the costs, hoping interest rates would increase to a level to justify the hedge bets, rather than walk away when costs kept rising and the project became marginal, with nothing to show but a huge amount payable to Macquarie Bank? Maybe if preliminary hedging costs were included in the business case, it would have been even more problematic?
If a business case is designed to justify a decision already made, there’s a greater chance of dodgy assumptions.
Hydro inflows have fallen short of historical averages used in the business case by 10 per cent over the past 15 years. The signs were clear back then that annual inflows were trending down.
An expert panel that reported to Government in 2012 about the Tasmanian electricity supply industry took a blinkered look at why Basslink was failing to live up to expectations and essentially concluded Hydro was a victim of circumstances, rather than due to errors of its own.
The panel said in its final report that Hydro hoped to make profits in the early years by running down water reserves. Yet the panel knew
there were no such reserves from 2001 on and should have categorically said so. Its 2011 discussion paper revealed the state of water storages from 1998 on. The business case could not have assumed a run down in dam storages. If it did, it was a sham.
The business case assumed Tasmania would be a net exporter of electricity, but this could only have come from gas. How it was to be possible to import gas through a pipeline, convert it to electricity and then send it back to Victoria via Basslink and consistently make money is yet to be explained.
Without electricity from gas there would be no net exports. And that is what happened. Tasmania has been a net importer of electricity.
The only significant way of making money from Basslink is for export prices to be much higher than import prices, enough to recoup the daunting annual costs. It happened in the carbon tax years but there were only two of them.
As the Auditor General recommended in 2009, there should be enhanced reporting, biannually to Parliament, whenever major projects such as Basslink, are undertaken.
The possibility of a second Basslink has led to a slew of consultants’ reports, with more to come. They don’t make easy reading and usually skewed to the technical side.
There’s a need to put some simple financial facts on the table about the costs and benefits of the cables.
There is no better place to start than by explaining, not simply justifying, how the current Basslink has worked, before we are faced with another deal largely hidden from view and which, if the mistakes of the first are replicated, will lead to suboptimal resource allocation and more pain for Tasmania. John Lawrence is a Tasmanian economist based on the NorthWest Coast.
Basslink has been a costly voyage into the unknown.