Is it the government’s job to make the energy sector less risky?
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- Jul 9, 2019 4:45 am GMT
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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.