Ian Verrender in the Sydney Morning Herald recently wrote of Victoria’s two oldest power stations that they were bought by their owners “when the issue of climate change was well known”. Though he made that remark in the middle of a longer article focused on different issues, the point is important. The winners of Australia’s power station privatisation auctions all knew they might someday face a carbon price. And the losers knew it too. It’s one of the reasons they lost.
Since some appear to doubt this – for instance, commenter Patrick in this Ken Parish post – it should be made clear.
Patrick argued: “Anyone in 1996 who seriously envisaged carbon trading/caps/etc would have been considered delusional. Can you remember how long ago 1996 was?”
In fact, 1996 was not that long ago in the climate change debate, which is more than 30 years old. Dr Sinclair was teaching my Year 10 science class about the greenhouse effect back in 1979; the first substantial federal political discussion of a carbon tax occurred in 1990. The prospect of a carbon tax or trading scheme was very real by the time the Victorian electricity assets came up for sale in the mid-1990s. And the prospect of a carbon tax was particularly real for the community of people trying to figure out what a brown coal power station was worth. The conversations I had with keen potential buyers (or more often, their investment bankers) at the time could be summed up like this: “Carbon pricing will come. One day. But there’s plenty of money to be made before that happens.”
Now step back a bit and take a careful look at the potential buyers who made it to the final stages of the Victorian power auction. They were by definition the biggest optimists about the industry’s prospects. They could see the greatest opportunities, and had the greatest myopia about the risks. Fifteen years later, what I remember most is their intense optimism. In contrast, people who were worried about carbon pricing couldn’t justify the sort of prices that were being talked about, kept their wallets in their pockets, and didn’t even bother flying to Melbourne.
The Victorian power station buyers were delusional. I don’t mean that in a bad way. Successful asset buyers have to be delusional: you bet billions of dollars that the bad stuff won’t happen and the good stuff will. It takes nerve. The uncertainties of betting that much of people’s superannuation money would turn most people into a nervous wreck.
Anyway, one of the Victorian power station buyers’ delusions was that carbon pricing would not arrive – or at least, not until after they’d made plenty of money.
(A bigger delusion was that the $40/MWh electricity price forecast in a McKinsey study paid for by the assets’ seller would turn out to be correct. If McKinsey had been right, the original buyers really could have made a nice profit on the deal by now. Whoops.)
The huge challenge that asset buyers confront is called the winner’s curse. It’s a known issue in auctions with incomplete information. The curse is often a problem in utility privatisations, because the profits of utilities are politically sensitive and government policies change. The same curse pops up all the time in business, though often the incomplete information is about a question like “does this oil field I bought from that nice multinational oil giant actually have any economically extractable oil in it?” If you’re particularly foolish, like that Perth bloke who bought the late Kerry Packer’s TV stations, the winner’s curse will send you broke.
I’m pretty sure I wrote something in The Age in the mid-1990s noting that if and when carbon pricing did come in, the Victorian power station purchasers would scream their heads off. I think I also noted that paying any attention to their screaming would be unfair to the losers of the Victorian asset sales process. That still seems a fair observation today.
The real problem for Australia is that we need a smooth transition to a carbon price, and power stations are lumpy assets. Ross Garnaut is trying to solve this, but it’s not easy.
The not-real problem is that power station owners need to be compensated for all the losses in the value of their assets. They don’t. The buyers were grown-ups, and they knew what they were getting into. They knew about carbon pricing and the winner’s curse and they hoped like hell they had guessed right. Bad luck, fellas.