Monopoly Behaviour

The construction of a new solar farm or wind farm often requires augmentation of the transmission network to connect the generator to the grid. This might be a short length of new transmission line or the construction of new substation.

Historically this typically occurred by the new generator building the upgrade (or funding the grid operator to do so) and then gifting completed works to the grid operator. Under connection agreement the new generator will also pay for maintenance of the new works over life of the project via annual connection charge.

Infradebt has seen a new trend where the grid operator insists on building network upgrades itself and then recovering the capital cost of the upgrade through increased connection charges. This effectively converts the network upgrade from a capital cost to an operating cost. The effective interest rate of the annual charge is mid-single digits. That is, the grid company earns its WACC on the capital tied up in the upgrade works.

This all sounds fine so far. It involves shifting a capital cost from a relatively high cost of capital entity (the generator) to a relatively low cost of capital entity (the grid).

But the sting in the tail is that network company requires the generator to post a bank guarantee for the NPV of the annual connection charges. That is, the network company is effectively earning its WACC on a completely risk free bank guarantee backed ‘loan’ to the generator to undertake the upgrade works.

What’s completely galling about this, is that even if the generator offers to fund the upgrade works itself and gift then to the network company, the network company insists on this bank guarantee backed rentalised arrangement.

In Infradebt’s view this is an abuse of monopoly power plain and simple. The networks which do this are using their monopoly power to extract risk free profits out of generators. This pushes up the cost of new generation and, hence, electricity costs for consumers.

This should be called out for what it is. In our view, the AER should crack down on this. Individual generators are unlikely to complain – they are completely dependent on network companies for grid connection approvals – and so are in an extremely weak negotiating position.

There would be a range of ways of addressing this – one example would be to deduct from network company’s regulated asset base the amount of customer bank guarantees/deposits. That is, networks don’t get to earn their WACC on capital that is effectively provided by their customers.

© 2020 Infradebt