*Pic: This incredibly stark photo illustrates Hydro’s problem … Taken March 5 by Isla MacGregor of Lake Burbury. Part of the flooded Crotty settlement is now exposed and water levels are down to just over 6 metres … and the forecasts for rain are not rosy …

The Basslink cable outage will have far-reaching effects on the finances of the State Government.

Working out how to generate enough electricity for our needs is the easy bit. Finding enough dollars to help Hydro Tasmania survive is harder.

If Hydro was a private company a Voluntary Administrator would have been appointed by now as there is no certainty it would have been able to trade its way out of current difficulties.

With borrowings of $850 million-plus Basslink liabilities of $860 million at latest reporting date, private lenders would be reluctant to lend assistance.

The reason for the cable fault has not been determined, the repair time is a guess based on experiences with other sub-sea cable problems, and once repaired, whether it will meet original design specifications is highly problematical.

In such circumstances the voluntary administrator checks the situation and talks to creditors, lenders and shareholders about the way forward. In essence that is what Minister Groom is now doing.

The dim light at the end of the electricity supply tunnel gives hope that we might find enough power to continue come what may. Next is the search for the necessary funds to sustain Hydro. We can dispense with talk about profits and returns to government. Neither is likely in the short term. The question is whether Hydro can generate enough cash from operations to cover its annual capex bill of $100 million needed to upgrade dams and generating plant.

The latest year 2014/15 saw net operating cash at only $25 million. Before returns to government it would have been $105 million.

Hydro doesn’t disclose the breakup of revenue, but the Auditor-General was more forthcoming in his 2014/15 report. Revenue from renewable energy certificates (RECs) was $151 million. This has been the pattern for the past few years. It wasn’t the carbon tax effect on wholesale prices that contributed most to Hydro’s bottom line. It was REC revenue. There are few expenses associated with RECs. Without them net-operating cash would have been negative in 2014/15.

No cash for annual capital improvements presents a problem. The shortage of cash in 2014/15 was overcome by a $205 million transfusion from Tas Networks, but that’s not an option available every year.

For each MWh above the base level a generator earns one REC. Users buy RECs to satisfy mandatory renewable energy targets. The number bought depends on the amount of electricity bought/used. Once used a REC is surrendered and has no further value. A base level is set for each power station. The combined base level across all Hydro stations is about 8600 GWh determined by the level of generation at the time the renewable energy scheme started. One GWh above the base level will earn 1000 RECs.

Calendar years are used for RECs. Even when Hydro’s annual output on a financial year basis has been less than the base level, Hydro has been able to generate REC income by shifting generation from one calendar year to another and between power stations without affecting generation totals for that financial year. That’s one great advantage of hydro as an energy source, provided there’s enough water.

With average rainfall and judicious use of Basslink it would have been possible for Hydro to generate a steady stream of RECs over the next few years. There will be a shortage of RECs in the next few years from existing hydro given the drought and also because new renewable projects have been slow to resume after the Abbott interregnum.

A supply shortage means REC prices are higher. For Hydro, RECs were the beacon on the hill. The light has now been extinguished. The cable outage means the prospects of REC income for the next few years will be considerably less.

It is unlikely Hydro will generate much more than base level amounts in the next few years from its hydro stations as dam levels are restored.

If Basslink is not restored Hydro will forgo the opportunity to buy and sell electricity and profit by doing so using import and export price differences.

If the link is not fixed Hydro will no longer have to pay the monthly facility fee but the chances are it will need to pay the liability which attaches to the side deal with Macquarie Bank designed to share the interest rate risk inherent in the variable facility fee. Because interest rates have fallen Hydro has to pay Macquarie Bank each year. This year the payment is expected to be $40 million. The deal won’t expire until 2031 unless paid out early.

The amount needed for early release at this stage is about $300 million which may not be the highest priority as alternative energy sources will need to be developed.

If Basslink is restored it will be a struggle for Hydro without REC revenue to which it has become accustomed. The amount required to service borrowings and Basslink liabilities is uncomfortably high.

The government can easily provide more funds to Hydro as Tascorp, the government’s borrowing arm, always borrows far more than it needs to on-lend to its clients, principally Hydro and Tas Networks. Tascorp always ensures it has plenty of cash available to repay loans rather than run the refinance risk of suddenly having to borrow at a high rate.

The problem with giving Hydro more funds is that interest will be a burden and principle repayment a distant hope. The conservative attitude of Tascorp stands in stark contrast to the imprudent deal with Macquarie Bank entered into by Hydro when Basslink was at the approval stage.

Successive state governments have been far more reliant on their businesses than they care to admit. The businesses as a whole have had better operating cash flows and have helped sustain the general government.

This is about to change.

By all means talk up the state’s prospects but ignoring its inherent vulnerabilities is foolhardy.

*John Lawrence is an economist who lives on Tasmania’s North-West Coast. He is a blogger at tasfintalk.blogspot.com , where you can find this article

John Lawrences’s Collected Articles are HERE … including forensic analysis of Forestry Tasmania’s solvency …

Published also in Mercury HERE

TT MEDIA HERE where there are permanent links to what the Pollies say …

The parlous state of Lake Gordon, ABC HERE

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