31 July 2014

Response to article in Australian Financial Review

AGL hit reveals myth of stable energy returns” – 31 July 2014

An interesting story appeared in the Australian Financial Review this week that we thought worthy of comment. The article starts by discussing AGL’s loss of carbon tax-related Government subsidies then drifts into questioning whether power generation is suitable for inclusion in the infrastructure asset class.

The factors cited as disqualifying power generation as infrastructure appear to relate to the nature of the risk being taken by owners rather than anything inherent in power generation assets themselves. 

ICG agrees that certain real assets, which provide a utility-like or public service, should not be classed as infrastructure if the asset itself is collateral or incidental to the services the business provides.  More likely such assets would qualify as property rather than infrastructure. Ports, airports, roads, electricity transmission assets etc are all specifically designed for the service they provide and are regarded as infrastructure by electricity investors.  Power generation assets are no different; they provide the same service as transmission and distribution assets, only in a different part of the supply chain.

Disqualifying assets from the infrastructure asset class because you are “taking on commodity pricing risk” could apply to many infrastructure assets, such as the recently acquired Port of Newcastle (which relies on the volume of coal exported and price-dependent).  And, if not having “monopoly revenues” is also a disqualifying factor then there are certainly other assets which would miss out such as Australia’s many unregulated gas pipelines.

As it happens, ICG has always sought and secured power generation assets which are not materially exposed to “commodity pricing risk”. We sell nothing to the National Electricity Market directly and all our assets have long-term, stable revenue contracts with a small number of large, highly creditworthy customers. It is also worth noting that the generation assets in which ICG has been successfully investing for well over a decade also have other risk mitigants such as fuel price stability. ICG has no “merchant” exposure as alluded to in the article.

I am not sure why Phil Garling would argue that long term “take or pay” contracts do not change the characteristics of the underlying business – clearly they do.  Or, at least, whatever that underlying business might be, it is not that in which investors are investing.

 If power generation investments have been marketed as infrastructure but performed instead with significant volatility, maybe the blame should lie with the original investment case and the risks adopted within it, rather than the definition of the asset class itself.