Australia: Privatisation of electricity networks, New South Wales, Australia

Introduction

In June 2014, the State Government in New South Wales (NSW) announced that it intends to privatise the NSW electricity networks. This briefing note sets out the likely structure of the privatisation and identifies some key issues.

The NSW electricity networks are currently 100% state-owned and comprise:

TransGrid, an electricity transmission operator with a regulated asset base of AUD 6.1 billion that is expected to realise AUD 845 million in annual revenue next financial year. TransGrid owns roughly 14,000 km of transmission lines in NSW and transmits 71 GWh of electricity per annum over those lines.

Networks NSW, which comprises the following three electricity distribution businesses with a common CEO and common senior management:

• AusGrid, an electricity distributor supplying 1.6 million retail electricity consumers in the Sydney, Central Coast, Hunter and Newcastle regions of NSW. AusGrid has a regulated asset base of AUD 14.6 billion across its distribution assets that is expected to realise some AUD 2.21 billion in revenue in the 2014/15 financial year. AusGrid owns roughly 42,000 km of distribution lines and is capable of meeting peak demand of 5,149 MW;
• Endeavour Energy, an electricity distributor supplying 883,000 retail electricity consumers in western Sydney and the Illawarra regions of NSW. Endeavour has a regulated asset base of AUD 5.6 billion across its distribution assets that is expected to realise some AUD 949 million billion in revenue in the 2014/15 financial year. Endeavour owns roughly 34,500 km of distribution lines and is capable of meeting peak demand of 3,236 MW; and
• Essential Energy, an electricity distributor supplying 803,000 retail customers in regional NSW. Essential has a regulated asset base of AUD 6.9 billion across its distribution assets that is expected to realise some AUD 1.29 billion in revenue in the 2014/15 financial year. Essential owns roughly 191,000 km of distribution lines and is capable of meeting peak demand of 2,185 MW.

However, the Government has indicated that it does not intend to privatise Essential Energy.

The role of electricity networks in the NEM

Electricity networks transport power from generators to customers. Transmission networks (e.g., TransGrid) transport power over long distances at high voltages, linking generators to distribution load centres. Distribution networks (e.g., Networks NSW) then reticulate electricity from the transmission network through urban and regional areas at lower voltages to provide electricity to customers.

In Australia, the National Electricity Market (NEM) is a wholesale market comprising some 300 generators that collectively sell some 200 TWh of electricity annually in eastern and southern Australia. The principal customers of those generators are energy retailers. The energy retailers bundle electricity with network services for sale to some 9.3 million residential, commercial and industrial energy users. The NEM covers six Australian jurisdictions — Queensland, NSW, the Australian Capital Territory, Victoria, South Australia and Tasmania.

Electricity is carried within the geographic area of the NEM via five State-based transmission networks, physically linked by cross-border interconnectors and servicing 13 distribution networks. In geographic span, the NEM is one of the world's longest continuous AC systems, covering a distance of some 4,500 kilometres.

Because energy networks are capital intensive and incur declining average costs as output increases, network services in a particular geographic area can be most efficiently provided by a single supplier, leading to a natural monopoly industry structure. Within the NEM, each transmission and distribution network has a monopoly in its particular geographic area. As such, the electricity networks in the NEM are regulated under Australia's National Electricity Law to manage the risk of monopoly pricing and to encourage efficient investment in infrastructure. The National Electricity Law is explained later in this briefing note.

Political context to the privatisation

A number of other States in Australia privatised their electricity assets at an early stage, commencing with Victoria's privatisation of the Loy Yang B power station in 1992. However, the privatisation of electricity assets in NSW was politically controversial for the NSW Labor Party in its role in Government over the 16 year period from 1995 to 2011. A number of proposals for NSW electricity privatisation did not proceed during that period, including under Premier Bob Carr in 1997 and Premier Morris Iemma in 2008.

Ultimately, a first phase of privatisation was initiated by Premier Kristina Keneally in NSW in 2008. The first phase involved the sale of NSW electricity retail businesses, development sites and electricity generation output contracts (known as the "GenTrader" contracts). The Government realised AUD 5.3 billion in sale proceeds.

With a change in NSW Government to a Liberal/National Coalition in March 2011, Premier Barry O'Farell initiated a second phase of privatisation. The second phase involved the sale of the electricity generation businesses. As at June 2014, aspects of this sale are still occurring, including a successful application for authorisation by AGL Energy to the Australian Competition Tribunal to acquire Macquarie Generation.

In May 2012, the NSW Government announced that as part of its policy to put downward pressure on electricity prices a common chairman, board and CEO would be appointed to the State's electricity distribution network businesses from 1 July 2012. As a result Ausgrid, Endeavour Energy and Essential Energy were aggregated to form Networks NSW in a move viewed as a prelude to privatisation.

On 10 June 2014, Premiere Mike Baird announced the third phase of privatisation, the subject of this briefing note, as part of a 'Rebuild NSW' policy that the Liberal/National Coalition will take to the 2015 State election. Given political concerns, an outright sale of the electricity networks is not contemplated. Instead, the privatisation will occur via the sale of 99 year 'partial leases'. The Government will maintain ownership of 100% of Essential Energy and will also maintain an average ownership of 51% across all four electricity networks.

Timing for the privatisation

Importantly, Premier Mike Baird has announced the privatisation of the electricity networks in the form of a policy commitment that he will take to the next NSW State election scheduled for 28 March 2015. The formal process for the privatisation will therefore not commence unless and until the Liberal/National Coalition is returned as the NSW Government on that date.

As at June 2014, the Labor Party has indicated that it will not proceed with the privatisation if it wins the NSW State election in March 2015.

Notwithstanding that the privatisation is contingent on the election, the NSW Government is currently undertaking preparatory work for the privatisation, including the appointment of financial and legal advisors. The preparatory work will likely involve the completion of a scoping study and an initial vendor due diligence. The scoping study is likely to make a series of recommendations regarding the structuring of the privatisation and implementing legislation.

We expect the scoping study to be provided to the NSW Government in late 2014.

Transaction structure – ownership permutations

As at June 2014, the structure for the transaction has not been determined. We have speculated below on some possible structuring options.

Importantly, the NSW Government has announced that it intends to maintain an overall 51% ownership level across all four electricity businesses, including maintaining 100% ownership of Essential Energy. The NSW Government has not yet identified how it will apply the 51% ownership threshold in practice. Some public statements, for example, refer to the ownership level as "51% of total electricity network assets".

Given that Ausgrid is the most valuable business, the Government may prefer to privatise a full 100% of that business under a 99 year lease in order to maximise the privatisation proceeds. Similar reasoning may result in a structure in which different proportions of TransGrid and Endeavour Energy are privatised.

Assuming that this 51% ownership threshold is interpreted as a simple average across the four businesses (or across three businesses if any two businesses are merged), this could lead to various ownership permutations. The following table sets out three possible examples:

Other more creative solutions could be adopted, including the 100% privatisation of a merged distributor comprising both Ausgrid and Endeavour Energy. If the 51% level were interpreted as a weighted average across the regulated asset base of the businesses, other permutations would be possible (although weighting by the regulated asset base would reduce the extent of privatisation).

Transaction structure – treatment of a 99 year 'partial lease'

The NSW Government has indicated that the privatisation of the electricity networks will occur by way of a 99 year 'partial lease'. A similar 99 year lease structure was used for the recent port privatisations in NSW. A 200 year lease structure was used for the privatisation of the ETSA Utilities electricity distribution network in South Australia (SA).

If a combination of the approaches used in the NSW port privatisations and the ETSA privatisation were adopted, the following steps would occur:

• First, the NSW Government would enact implementing legislation, potentially modelled in part on the Electricity Corporations (Restructuring and Disposal) Act 1999 of SA. This legislation would amend relevant NSW State legislation to facilitate and authorise the privatisation as well as effecting any changes necessary to implement the transaction and desired post-privatisation framework.
• Second, the relevant assets to be privatised would be transferred into a State-owned Ministerial holding corporation (HoldCo), a State entity established by the implementing legislation to hold the network assets to be leased to the private sector. In SA, the HoldCo is known as the "Distribution Lessor Corporation".
• Third, a Project Company would be created to enter into a 99 year lease with HoldCo. The lease would provide HoldCo the rights to operate/use the relevant network assets andto retain the economic benefits of any charges it imposes, but would also impose a range of performance and compliance obligations. Holdco would retain no control of the day to day operation of the network assets in its role as lessor under the 99 year lease.
• Fourth, a separate 99 year lease may also be entered into with HoldCo by the Project Company for the lease of any associated land, but with HoldCo retaining freehold ownership. HoldCo would retain step-in rights and the ability to terminate both 99 year leases if the Project Company were to breach key obligations, but only following a predetermined 'cure period'.
• Fifth, existing key contracts would be assigned to the Project Company. Some employees would also transfer to the Project Company, supported by various Government commitments intended to preserve employee entitlements.

The privatisation could subsequently occur by the sale of the shares in the Project Company to an investor in the desired proportion, such as 100% or 49%. In this manner, investors would be offered a pre-packaged deal without any involvement in the negotiation of the 99 year lease. Any such sale could involve a trade sale or an initial public offering (IPO).

In the SA privatisation of ETSA, bidders were given three different alternatives. Bidders could acquire shares in the Project Company, as identified above. Alternatively, bidders could receive a novation of the pre-packaged 200 year leases and acquire the assets and liabilities of the Project Company. Alternatively, bidders could negotiate their own 200 year leases (to replace the pre-packaged 200 year leases) and acquire the assets and liabilities of the Project Company. In SA, the successful bidder opted for the third of these three alternatives.

The situation becomes more complex if less than 100% of a business is privatised. An investor in a partial privatisation at less than 100% would, in practical effect, be entering into an incorporated joint venture with the NSW Government. In Australia, one precedent for such a structure is the TransACT joint venture.

In a joint venture structure, investors may seek a shareholder agreement (or constitutional provisions) that addresses key governance issues for the Project Company, including appointment of executives and voting rights on the Board of Directors. A private investor at less than 50% may wish to secure de facto control. However, an IPO of a partial interest is also possible as demonstrated by the 'T1' privatisation of Telstra.

The Government has announced that the NSW Future Fund will hold 100% of the shares in Essential Energy. Presumably that Fund would also hold any other partial State shareholdings in electricity businesses.

Sale price

As at June 2014, the sale price for the privatisation is not yet known. The sale price will depend heavily on the ultimate structure adopted for the privatisation.

However, the NSW Government has indicated that it intends to realise at least AUD 13 billion in aggregate from the lease of NSW's electricity networks.

All of the sale proceeds are intended to be invested in new roads and other transport infrastructure projects in NSW. Assuming the Asset Recycling Fund Bill 2014 (Cth) is enacted, the NSW Government should also receive an amount of some AUD 2 billion as an incentive payment from the Commonwealth Government.

Conditions for the partial lease

In its 'Rebuilding NSW' policy for the 2015 State election, the Liberal/National Coalition has laid out strict conditions for the partial lease of the NSW electricity networks. These conditions are designed to promote the public interest and address community concerns.

The conditions already announced by the NSW Government include:

• all net proceeds from the privatisation will be invested in new productive infrastructure, through the Restart NSW Fund;
• electricity network prices will be discounted by 1% off forecast regulated prices until 2019;
• the jobs of permanent award employees will be protected, and treated consistently with previous transactions;
• the transaction will have no adverse impact on electricity reliability; and
• the regional presence of the network businesses will be maintained.

It is possible that further conditions could be announced if the privatisation were to become a major political issue in the context of the 2015 NSW State election.

Preliminary issues

A number of issues raised by the proposed privatisation are briefly summarised below, including:

• the extent to which any regulatory clearances may be required by bidders;
• the manner in which network companies are subject to price regulation;
• the impact of electricity demand on future cash flows; and
• the manner in which requirements for future investment in network infrastructure will be addressed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.