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India’s Sysiphean task

Michael Mucci – 4 April 15

[Publisher’s Note: Michael West used to work for Murdoch having a humorous take on the markets in a column called Margin Call in the Australian. In the article Michael talks of hedging the risk of India going Solar. This is a form of insurance. If you insure against you house burning down, then there is a cost and if your house does not burn down all you have lost are the insurance payments; but if your house does burn down, at least you are covered. See his comment about India’s Energy Minister who “proposed a spectacular financial innovation: underwriting solar power purchase agreements (PPA) in $US terms, rather than rupees, and pooling the currency hedging risk at the central government level. It is brilliant.” As far as I can tell, he is talking about the risk of losses from the Indian rupee going up or down against the $US when all the loans are in American dollars. – Ian Curr, April 2015].

Further Comment from a contributor – Will Qld Labor back off and see the light and tell Adani to go jump or will they fall pressure to the AWU and CMFEU in the belief there are lots of jobs in the Galilee Basin – 27000 according to the Coal Co’s but far fewer according to the Aust Institute who have shown time and again that the coal industry exaggerate job numbers.

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India’s Sysiphean task

Michael West, Business columnist

It is both a masterstroke of international financing and yet another blow to thermal coal, a commodity whose price reeled another 10 per cent last month, rendering the biggest project in Australia, Adani’s Galilee Basin mine, even more speculative.

Ironically, the government of India, from where Adani hails, is to open its energy market to US dollar investment in solar. Hitherto, India has been effectively a closed capital market.

Some perspective: the Indian electricity grid is in financial and physical disrepair. Swamped with underutilised thermal power generation, a leaky distribution system and electricity utilities that are losing a combined $US11 billion a year, this makes Australia’s rickety National Electricity Market (NEM) look robust.

In contrast to his Australian cohort however, India’s Energy Minister Piyush Goyal has shown vision and flair. His task is to revamp the current network while delivering electricity to the more than 300 million people living beyond the reach of the grid; and it requires more than the odd tweak.

So it was that late last year, at a World Economic Forum panel discussion, Goyal spoke of the need for a “paradigm shift” in the Indian electricity system within five years.

He has made it clear that India cannot afford electricity generated by imported coal – it is not commercial – and that the Indian grid needs to be quickly diversified away from coal to ensure system diversity and energy security. Hence the push for 175 gigawatts of renewable energy generation. Goyal also sees distributed renewable energy as the solution to energy poverty for those off the grid.

This in itself is challenging enough, but Goyal faces other formidable constraints; not only can India ill afford to keep subsidising power, solar or otherwise, but any reform of the third largest electricity system in the world will adversely affect a multitude of communities, particularly when the government’s aim to grow real GDP at 8 per cent per annum demands enormous growth in electricity supply.

Faced with such a Sisyphean task, his latest move is a tour de force. This past week the former chartered accountant and banker proposed a spectacular financial innovation: underwriting solar power purchase agreements (PPA) in $US terms, rather than rupees, and pooling the currency hedging risk at the central government level. It is brilliant.

Central banks have been flooding financial markets for five years – there is virtually unlimited capital available from around the world to invest in low-risk long-term $US debt at 2.5 per cent (plus a credit margin). Trillions of dollars, literally. Yet almost none of this international capital is flowing into Indian financial institutions given the Indian capital markets are relatively closed to foreign capital and the banking sector is severely under-capitalised due to massive non-performing loans, many of which relate to the defective thermal power generation sector.

Says Tim Buckley, director of Institute of Energy Economics and Financial Analysis, access to this international capital is key to renewable energy affordability, particularly in India where installation costs are exceptionally low, economies of scale could be enormous, and demand at the right price is huge.

“The only constraint is that renewables have a high upfront capital cost,” he says. “So a $US solar PPA [power purchase agreement] backed by a central government guarantee and the currency hedging run centrally to give massive economies of financial scale, then your capital capacity constraint is solved; the cost of capital and cost of currency hedging are both dramatically reduced. 100 gigawatts of affordable clean solar energy by 2022 becomes a distinct probability.”

Policy stuck in past

The implications for seaborne thermal coal markets are clear. As in iron ore, Australia is ramping up its thermal production thanks to Adani’s Leviathan greenfields project in the Galilee at a time when prices are in freefall.

Notwithstanding the vast environmental damage to be wrought, Galilee is far from economic. According to Platts, the price of thermal coal dropped to $US56 a tonne last month, down another 10 per cent. With its low-quality coal, Galilee would need a price in excess of $US75 to be viable. The futures market has the stuff at $US56 in 2018.

Still, the new government of Queensland is pressing ahead, just like the old one and despite community opposition. It is especially bizarre in light of Adani’s need for $10 billion in project finance – interest costs of $600 million on a zero margin business.

Meanwhile, in China, which leads the world in hydro energy (already three times the capacity of the US), authorities announced a 20 per cent upgrade to the solar installation target. While coal consumption fell 2.9 per cent in China last year, hydro capacity ramped up 15 per cent.

The point is while Australia’s energy policy remains stubbornly last century, things are rapidly changing elsewhere. Energy prices have risen so high here that demand is falling and there is surplus capacity that needs to be shut down. Instead of encouraging renewables however, the government has cut the renewable energy target (RET) and is attempting to axe the profitable Clean Energy Finance Corporation (CEFC), the very body which could “do a Goyal” and finance big renewable projects with international capital near the government bond rate – and return profits to government to boot.

Renewables, with their high upfront costs, create more jobs than coal, and require far less capital once up and running, yet energy policy remains stubbornly 20th century.

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