Mediocre returns from Bulk Energy?

2025Q2

One interesting news report this quarter was media reports that AGL has decided to divest its 20% stake in Tilt Renewables.  Tilt Renewables is a developer and owner of renewable energy projects in Australia.   It was formed out of the combination of the Powering Australia Renewables Fund (PARF - a captive renewable energy asset owner created by AGL and funded by QIC/Future Fund) and Tilt Renewables.  Tilt Renewables was the specialist wind and solar developer and asset owner spun out of Trust Power and listed on the ASX/NZX.  Tilt was acquired by a Mercury – which took the NZ assets/projects and PARF – which acquired Tilt’s Australian assets/projects and development team.

Historically AGL has always liked to include Tilt’s development pipeline in its forward looking statements regarding its transition to renewables.

The mooted decision by AGL to exit Tilt is interesting and prompts the question why?  Why is AGL selling?  Presumably AGL thinks returns are higher on firming assets – eg batteries – than bulk energy – eg large wind and solar projects such as those owned by Tilt.   Industry participants often say that large retailers can contract for bulk energy with PPAs cheaper than owning and operating their own generation assets.

All of this somewhat echoes what we are seeing within superannuation/institutional investor circles.  For Australian superannuation fund investors there is a preference to invest in ‘platforms’ that combine development activities with asset ownership and operation.  The premise of these platforms are that by blending in development with more passive asset ownership it is possible to earn 1-2% higher returns.  There is also probably a bit of a fee disclosure game afoot – with platforms hiding asset management fees within the corporate operating budgets of the platforms and, hence, delivering a lower measured fee (despite development being an inherently much more management intensive activity).

All of this creates a bit of a paradox.  If all market participants think that bulk energy renewable assets offer unattractive risk adjusted returns, who is going to fund bulk energy projects and will this really prove to be true?  It’s a bit like the dynamic that the safest time to invest in markets is when all market participants think the world is about to end (or conversely, the most dangerous is when everybody is a bull).

Why does bulk energy matter? 

In simple terms, the energy transition has two components, bulk energy that is the MWh of generation to supply household and business energy needs and firming/storage, that is storing those MWh (or enough of them) to ensure that energy is available at the times of day and year that people need it (even when, to repeat the old trope, when the sun doesn’t shine and the wind doesn’t blow).

The fact of the matter is that the storage/firming side of the energy transition is actually going pretty well.  There is 8.7 GW of batteries under construction.   This is 146% of the 2022 AEMO ISP total forecast of the ulility scale battery requirement by 2030 (admittedly leading to AEMO to forecast an even larger utility scale battery build out in its 2024 ISP).  While in the longer term we will need new sources of long duration storage (8+ hours), for the next decade this can largely be provided by existing gas fired plant (operating as peakers, with relatively low utilisation rates and, hence, relatively small total emissions).

It is the bulk energy side of the transition that is really struggling.  Every component is costing more and taking longer.  

This makes success of the first two NSW renewable energy zones (REZs) and the CIS generation tenders critical. The Central West Orana REZ is expected to host 10 renewable projects including 3 GW of wind and 4.2 GW of solar and storage projects. At this stage the total capacity of the REZ is 7.5 GW with a maximum export capacity of 4.5 GW at any given time. A consortium of ACCIONA, Cobra and Endeavour Energy will begin construction works later this year with forecast completion by 2028. The New England REZ will be the second REZ in NSW which is planned to be delivered in two stages to provide a transfer capacity of 6 GW. Stage 1 will unlock 2.4 GW of transmission capacity by 2032, and Stage 2 will deliver an additional 3.6 GW by 2034 with an additional 2 GW of capacity to be added at a future date. Once fully operational, the combined capacity of the two REZs would be enough to replace the 8.2 GW of operating coal-fired power plants in NSW. However, the key complication may not be the build out of the REZs, but the projects that will be hosted within the REZs. Specifically, when will they be fully commissioned?

If AGL is selling its stake in Tilt, and Australian pension funds want to invest in development platforms rather than just operating assets, who is going to provide the capital to get the wind projects in the two NSW REZ’s and the broader CIS program built?  This is particularly apposite given that Liverpool Range – a key Tilt project – is a big part of the CWO REZ.

What are the implications:

• Risk that bulk energy build out is slower as projects struggle to reach financial close.

• Risk that projects need offer higher offtake prices (which would drive higher returns for bulk energy projects) in order to attract capital.   Note, this would potentially undermine the logic of AGL’s calculus that it is cheaper to be an offtaker than an asset owner.

• Risk that a slower build out of bulk energy results in higher average prices for bulk energy – less supply equals higher prices, all else equal.

• Risk that less bulk energy and fear of higher prices if coal plants are shut down, drives a slower path of coal shutdowns and, hence, puts Australia further behind the curve on the energy transition.  Decision to defer shutting Eraring in August 2027 which was principally driven by the potential impact on electricity prices (rather than reliability) – is a classic example (and could be repeated).

Within all of this, the Commonwealth Government’s Capacity Investment Scheme (CIS) is a key tool.  This is a mechanism for government to ‘take off the load’ in making projects bankable (which otherwise relies on long term PPA offtakes, typically from retailers) to absorb some of the revenue risk for project owners (and, hence, boost risk adjusted returns and help attract capital).   Infradebt hasn’t seen many CIS generation winners actually progress all the way to financial close so we're not in a position to judge where the trend on this matter is heading.

All this highlights Infradebt’s concern that large wind projects reaching financial close is a key bottleneck to solving the bulk energy part of the energy transition.  This warrants close attention.  The most important milestone is projects reaching financial close.  Once a project starts construction, while there can be delays, its output will hit the grid two to three years later.  There are 6.3GW of projects under construction – we need to see this pipeline grow or there will be a bulk energy shortfall.