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Is it the government’s job to make the energy sector less risky?

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The art of government is always about balancing competing objectives. One of the more rewarding balancing acts in the near future will be deciding whether and how to manage energy risk. Recent developments ranging from technology change to public expectations are introducing new risks into the energy market. Because higher risk translates to higher costs, the question inevitably arises – should government play a role in reducing the risk of new energy investments?

Analyzing recent trends, the International Energy Agency recently said, “Whichever way you look, we are storing up risks for the future.” They pointed to disconcerting reductions in capital spending on conventional power facilities, combined with apparent under-investment in clean energy technology. Although each region is different, these are worrisome global trends. (See “Power sector got most investment worldwide” for a more complete report.)

As discussed in virtually every energy forum in recent years, the continual invention of cheaper and cleaner generation technology is creating challenges for any developer or investor working to raise long term funds for any project using current technology. Similarly, the advent of Distributed Energy Resources and micro-grids creates new risks for wholesale markets. Innovation itself creates risk as explored in the 2018 editorial “How innovation impacts the financing of new projects.” Add to this, the business risk associated with carbon policy, which has whipsawed from one approach to another as governments change. Other types of policy change can push up risk and costs. In one recent example, Hydro One shareholders were hit with a $100 million contractual penalty when a US regulator canceled a planned acquisition, saying that the risk of political intervention in Ontario was too high.

Suffice it to say that anyone in the power business is now assessing if not internalizing a wider range of risks than ever before. Risk premiums must be built into new power projects. This is a normal and necessary response by business. However, government may take a different perspective. Government may see those risk premiums as unnecessary additions to consumer costs, and possibly an area for policy action.

Should government take additional steps to reduce risk, consistent of course with respecting the integrity of market functions?

While experience has demonstrated that government is generally not well-positioned to make specific investment choices, it must inevitably make choices that determine investment conditions. In many cases over the years cautious government policy has stabilized investment conditions enough to increase supply or reduce costs or both. Arguably these public policies have reduced consumer costs without adversely affecting the market. Yet on the other hand, too much government intervention increases perceived risks, and may have the opposite effect.

Fortunately, government-led risk reduction is not an either/or question. Well-established government mechanisms from regulation to facilitating clusters of innovation to review of business plans will continue to reduce risk. The operative question of the day is more nuanced: Given the new risks that didn’t exist previously, should government take additional steps to reduce risk, consistent of course with respecting the integrity of market functions?

In historic terms we appear to be in the early stages of a shift towards energy supply projects that have shorter lead times and shorter amortization periods. This is an indicator of how markets are dealing privately with increasing risk. On the other hand, government has options that will reduce risk and cost, sometimes as aggressive as encouraging supply, and sometimes as subtle as systematically refraining from taking any action at all. Regulators can assist in developing and implementing appropriate risk reduction strategies in the interest of cost control.

Government may see these risk premiums as unnecessary additions to consumer costs, and possibly an area for policy action.

Energy planning is probably the most widely used means of reducing risk across the sector. Effective plans do not to be prescriptive or constrain private investment. When properly developed, multi-stakeholder energy plans can help to focus attention, clarify objectives, attract capital, assist with policy co-ordination, reduce duplicative efforts, and simplify later approval processes. This kind of risk reduction can lessen consumer costs significantly over time.

If governments can find further ways of reducing risk while preserving market functions, analysts like the IEA may be prepared to reconsider their warnings. It will be interesting to see where provincial governments across Canada, many of which are new, fiscally conservative, and responsible for provincial electricity policy, land on this question of how far to go in moderating risk in the power sector.

It’s not unreasonable to suggest that those policies that actually reduce overall costs should win out over time. Remaining silent or undecided means leaving money on the table. Taking action on the other hand, requires establishing a principled approach that could shape legacies and affect the leader in question for his or her entire political career. Important choices lie ahead.

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Note: This posting contains conjecture and opinion and should not be relied upon as definitive or used as a guide for any kind of investment decision. It contains the views of the author and may or may not reflect the views of APPrO or any APPrO members.

Jake Brooks's picture

Thank Jake for the Post!

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Discussions

Matt Chester's picture
Matt Chester on Jul 9, 2019 11:25 am GMT

This question is a compelling one, sure to get passionate reply from people with all different perspectives of the role of government. But I think the recent focus on the government on initiatives as agreed-upon as cybersecurity in the utility sector prove that there's widespread support for some level of government oversight and intervention-- given that most in the U.S. don't have choice when it comes to their power providers and given how catastrophic a widespread failure of energy systems has proven to be time and again across the world, the people should certainly be able to trust their government to step in and ensure some sort of risk management and mitigation when appropriate

Robert Borlick's picture
Robert Borlick on Jul 15, 2019 2:41 pm GMT

This lengthy article contains little substance.  Higher energy project risk is not necessarily bad if it forces the developers to be held responsible for the consequences of their actions.  

When the US restructured its wholesale electricity markets generation project risk went up but it was solely borne by the plant owners - not electricity consumers. Enen though this raised developers' cost of capital, consumers benefitted by not having to pay for resource planners' mistakes.  Ultimately, competition among the developers produced lower costs and more innovation.  

Have we forgotten the tens of billions in cancellation costs incurred from nuclear plant cancellations?  Electricity consumers, who played no role in the decisions to build those plants, paid for much of those cancellation costs.  That is no longer the case in most of the US.  

 

The Energy  Mix's picture
The Energy Mix on Jul 19, 2019 11:06 pm GMT

Jake, it's good to see you online, and an interesting lens for a transition that we know the grid will have to complete by 2050, both to fully meet the decarbonization target in the IPCC's 1.5°C pathways report, and to position Ontario to fully tap the business and job opportunities the transition will produce.

I hope this is in the back of your mind. But I didn't see you express any preference for de-risking technologies and strategies that are a part of the transition -- solar, wind, small hydro, battery storage, and ahead of them all, aggressive energy efficiency and conservation measures -- and doing the opposite, or at least remaining creatively silent, for the technologies that set us back. In Ontario, with coal out of the picture, the remaining concerns are the GHG intensity of natural gas, especially if it's fracked gas, and the sky-high cost of nuclear.

You're right that governments get themselves into political if not practical trouble when they're seen to be picking winners. But don't they do precisely that when they purposefully ignore well-known risks associated with energy options that they refuse to abandon for fear of the political fallout? I'm glad Robert referred to nuclear cost overruns, but while that's certainly Ontario's most flagrant example, I don't imagine it's the only one.

The other political risk that will increasingly confront governments of all stripes is the public reaction if they fail to put the existential risks of climate change at the centre of every decision. From the stranded asset risks associated with a rapid transition that  some producers can't or simply refuse to anticipate, to the physical risks of more frequent, severe weather, to the supply and demand changes that Ontario is already seeing, and much more...that's a layer of day-to-day reality that underlies the financial and planning risks you described in your post. It occurs to me that your framing might be a good way to present those realities to entities or decision-makers operating at a more abstract level, but the exercise will be moot if climate change in all its dimensions is not a central part of the picture.

(Hey, if you like, we could call it The Besserer Revisited Scenario. At least two of us would know what that meant. :) )

- Mitchell Beer

 

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