web viewfrom word version] craig mickle. partner. table of contents. 1.executive summary1. ......

Financial and Commercial Analysis – Second Tasmanian InterconnectorDepartment of the Environment and Energy

22 December 2016

NOTICE

Ernst & Young (“EY or “we”) was engaged on the instructions of the Department of Industry, Innovation and Science1 (“the Department”) on behalf of the Tasmanian Energy Taskforce to undertake commercial and financial analysis in relation to a second, Tasmanian energy interconnector in accordance with our contract dated 21 September 2016.

The results of Ernst & Young’s work, including the assumptions and qualifications made in preparing the report, are set out in Ernst & Young's report dated 22 December 2016 ("Report"). The Report should be read in its entirety including the applicable scope of the work and any limitations. A reference to the Report includes any part of the Report. No further work has been undertaken by Ernst & Young since the date of the Report to update it.

Ernst & Young has prepared the Report for the benefit of the State and Federal Governments, and has considered only the interests of the potential viability of a second cross interconnector between Tasmania and Victoria. Ernst & Young has not been engaged to act, and has not acted, as advisor to any other party. Accordingly, Ernst & Young makes no representations as to the appropriateness, accuracy or completeness of the Report for any other party's purposes.

No reliance may be placed upon the Report or any of its contents by any recipient of the Report for any purpose and any party receiving a copy of the Report must make and rely on their own enquiries in relation to the issues to which the Report relates, the contents of the Report and all matters arising from or relating to or in any way connected with the Report or its contents.

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1 The energy function from the Department of Industry, Innovation and Science has been transferred to the Department of the Environment and Energy. For the avoidance of doubt, EY has used the original engagement department for this notice.

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22 December 2016

Department of the Environment and Energy Canberra, ACT, 2600

Financial and Commercial Analysis – Second Tasmanian Interconnector

To Whom it may concern,

In accordance with work order dated 21 September 2016, pursuant to agreement with the Tasmanian Energy Taskforce to undertake commercial and financial analysis in relation to a second, Tasmanian energy interconnector (“Agreement”), Ernst & Young (“we” or “EY”) has been engaged by the Department of Industry, Innovation and Science (“you”, “the Department” or the “Client”) on behalf of the Tasmanian Energy Taskforce to provide financial and commercial analysis in relation to the suitable commercial and delivery models (the “Services”) in relation to a proposed second Tasmanian interconnector (the "Project").

The enclosed report (the “Report”) sets out the outcomes of our work. You should read the Report in its entirety. A reference to the report includes any part of the Report.

Purpose of our Report and restrictions on its usePlease refer to a copy of the Agreement for the restrictions relating to the use of our Report. We understand that the deliverable by EY will be used for the purpose of assisting the Department in its investigation into the relative merits of a proposed second Tasmania to Victoria interconnector, and in particular the potential commercial and delivery model(s) in which a proposed interconnector could operate, should a decision be made to proceed to delivery of the project (the “Purpose”).

This Report was prepared on the specific instructions of the Department solely for the Purpose and should not be used or relied upon for any other purpose.

This Report and its contents may not be quoted, referred to or shown to any other parties except as provided in the Agreement. We accept no responsibility or liability to any person other than to the Department or to such party to whom we have agreed in writing to accept a duty of care in respect of this Report, and accordingly if such other persons choose to rely upon any of the contents of this Report they do so at their own risk. Third parties seeking a copy of this Report will require permission from EY, and will be required to sign an access letter in the format agreed to between EY and the Department.

Nature and scope of our workThe scope of our work, including the basis and limitations, are detailed in our Agreement and in this Report.

Our work commenced on 21 September 2016 and was completed on 22 December 2016. Therefore, our Report does not take account of events or circumstances arising after 22 December 2016 and we have no responsibility to update the Report for such events or circumstances.


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LimitationsThe outputs and advice provided within the report considers a number of combinations of input assumptions relating to future conditions, which may not necessarily represent actual or most likely future conditions. Additionally, the modelling outputs that have been utilised within this report are sourced from work conducted separately by EY and can be found within the “Market dispatch cost benefit modelling of a second Bass Strait Interconnector – Report” which is also subject to similar restrictions in use and limitations. The outputs inherently requires assumptions about future behaviours and market interactions, which may result in forecasts that deviate from future conditions. There will usually be differences between estimated and actual results, because events and circumstances frequently do not occur as expected, and those differences may be material. We take no responsibility for the achievement of projected outcomes, if any.

We highlight that our analysis and Report do not constitute investment advice or a recommendation to you on a future course of action. We provide no assurance that the scenarios we have modelled will be accepted by any relevant authority or third party.

Our conclusions are based, in part, on the assumptions stated and on information provided by the Department during the course of the engagement. The commercial and financial analysis are contingent on the collection of assumptions as agreed with the Department and no consideration of other market events, announcements or other changing circumstances are reflected in this Report. Neither Ernst & Young nor any member or employee thereof undertakes responsibility in any way whatsoever to any person in respect of errors in this Report arising from incorrect information provided by the Department.In the preparation of this Report we have considered and relied upon information from a range of sources believed after due enquiry to be reliable and accurate. We have no reason to believe that any information supplied to us, or obtained from public sources, was false or that any material information has been withheld from us.

We do not imply and it should not be construed that we have verified any of the information provided to us, or that our enquiries could have identified any matter that a more extensive examination might disclose. However, we have evaluated the information provided to us by the Department as well as other parties through enquiry, analysis and review and nothing has come to our attention to indicate the information provided was materially misstated or would not afford reasonable grounds upon which to base our Report.

This letter should be read in conjunction with our Report, which is attached.

Thank you for the opportunity to work on this project for you. Should you wish to discuss any aspect of this Report, please do not hesitate to contact Craig Mickle via email at [email protected].

Yours sincerely

[signature removed from word version]

Craig MicklePartner


Table of Contents1. Executive Summary.......................................................................................................1

1.1 Key Findings............................................................................................................21.2 Detailed Findings.....................................................................................................31.3 Relationship to the EY Market Dispatch Cost Benefit Modelling...............................7

2. Background...................................................................................................................92.1 Overview..................................................................................................................92.2 Basslink...................................................................................................................92.3 Scope of Work........................................................................................................102.4 Approach to Assessment........................................................................................102.5 Structure of this Report..........................................................................................11

3. Commercial Analysis...................................................................................................123.1 Overview of Commercial Model analysis................................................................123.2 Qualitative and Quantitative Analysis....................................................................143.3 Detailed results – Base Case..................................................................................193.4 Detailed Results – Alternative Cases......................................................................233.5 Detailed results – Hybrid models...........................................................................293.6 Conclusion – Commercial Analysis.........................................................................31

4. Procurement Models....................................................................................................334.1 Procurement considerations..................................................................................334.2 Ownership structure – 1 Owner vs 2 Owner...........................................................344.3 Procurement Model Options...................................................................................354.4 Procurement Summary..........................................................................................36

5. Validation....................................................................................................................375.1 Market Sounding Participants................................................................................375.2 Case Study Validation............................................................................................38

Department of the Environment and EnergyFinancial and Commercial Analysis – Second Tasmanian Interconnector EY i

1. Executive SummaryIn April 2016, the Australian and Tasmanian governments established a joint feasibility study (the Study) into whether a second Tasmanian interconnector could improve Tasmania’s energy security and facilitate large scale renewable energy investment. The Study is investigating the benefits of a second high voltage direct current (HVDC) interconnector (the Project, 2IC), construction of which would increase transfer capacity of electricity between Tasmania and Victoria.

EY have been engaged to undertake two separate tasks, firstly, market modelling to evaluate the costs and benefits of a second interconnector (“Market dispatch cost benefit modelling of a second Bass Strait interconnector Report – 22nd December 2016”) and secondly, to provide Commercial and Financial analysis in respect of the second interconnector (“this Report” or “Financial and Commercial Analysis – Second Tasmanian Interconnector – 22nd December 2016”). This Report provides the findings that result from our analysis in respect to the assessment of commercial models for the second interconnector, ranging from fully regulated to fully merchant options.

The report “Market dispatch cost benefit modelling of a second Bass Strait interconnector” presents the market modelling assessment of the merits of a second interconnector.

The market modelling (“Market cost benefit modelling of a second Bass Strait interconnector Report – 22nd December 2016”) is best used to form a view on the merits of having a second interconnector. The commercial and financial analysis (Financial and Commercial Analysis – Second Tasmanian Interconnector – 22nd December 2016”) is best used to form a view on whether a private party might be willing to fund a second interconnector.

The purpose of this Report is to consider and analyse the commercial and financial impact of various options to deliver the second interconnector. The analysis is a desktop study and preliminary in nature, consistent with the conceptual stage of the Project’s development. A range of hypothetical commercial operating models have been assessed on a qualitative and quantitative basis to capture the full scope of potential options.

The commercial operating models considered range from fully regulated, partly regulated, fully market and partly market exposed. For the purposes of the analysis, it is assumed that the 2IC (and Basslink where relevant) could attain the relevant status and, if required, existing commercial arrangements could be modified.

► A second interconnector could be developed under the following models:

► A regulated transmission asset with the contribution of costs evaluated under a RIT-T type process, with revenues determined through the Australian Energy Regulator (AER)’s typical process

► A Market Network Service Provider (“MNSP or merchant interconnector”), whereby all revenues are determined by the ability of the operators to profit from arbitrage opportunities that exist between Tasmania and Victoria. The profit, and ultimately the viability of the interconnector, is the responsibility of the operator.

This Report also considers variations of these commercial models, such as Basslink operating as an MNSP with the 2IC operating as a regulated asset and vice versa. With MNSP interconnectors being exposed to considerable revenue volatility that could negatively impact commercial viability, the report also considers two hybrid models. The partially regulated and partially merchant models involve some risk sharing between governments, consumers and the private sector in order to improve the viability of the Project:

Department of the Environment and EnergyFinancial and Commercial Analysis – Second Tasmanian Interconnector EY 1

► Partially Regulated Assets – defined as assets that earn a fixed return with revenues over and above the viability line shared between the owner of the interconnector and the Government. These are becoming increasingly popular in Europe and are typically called Cap and Collar or Cap and Floor Models

► Partially Merchant Assets – defined as assets that operate outside of regulation, i.e. the interconnectors generate their own revenue stream, but still requires some form of government assistance in order to support the viability of the commercial model.

Please note all prices in this report refer to real June 2016 dollars unless otherwise labelled. The net present values are discounted to 2016-17.

1.1 Key FindingsAssessing the commercial structures that may be used to develop the Project raises substantial commercial complexities due to the interactions that the operation of the assets would have on each other.2 This means that the second interconnector cannot be viewed in isolation of Basslink.

These complexities are not limited to either a merchant or regulated approach. A more merchant approach to the development of the Project exacerbates these complexities because of the implications for the existing owners of Basslink, and those that derive value from its use. A more regulated approach to the development of the Project reduces these complexities, but does not remove them entirely, as any inconsistency in the status of the two interconnector’s risks creating material distortions.

These complexities mean that:

► A merchant 2IC is unlikely to be commercially viable without harmonising the commercial arrangements in regard to Basslink and providing some level of funding support. The model is therefore likely to favour joint ownership

► A regulated 2IC is likely to be commercially viable, assuming it could attain that status, but would also require some harmonisation of the commercial arrangements in regard to Basslink. Regulation could however achieve that this without joint ownership.

The advantages of the regulated approach should, however, not be surprising given that the Project is being driven primarily by objectives that are broader than the commercial opportunities for arbitrage. In determining the appropriate commercial and delivery model for a second interconnector, clear consideration needs to be given to the reasons for its development, as that will have the greatest bearing on the most appropriate delivery model.

2 We have not had access to the BSA between BassLink and HydroTas as part of this work and are only aware of its broad commercial terms. We also do not have visibility of the restrictions on HydroTas’s bidding behaviour. We understand, however, that Basslink in essence currently operates as a quasi-regulated asset (i.e. bids in at zero and HydroTas’s bidding behaviour is constrained).


1.2 Detailed FindingsTable 1 contains a summary of the various models assessed, with some initial commentary on their commercial viability.

Table 1: Model SummaryCommercial Model Key Features Viability

Base Case – 134.► Basslink – MNSP► 2IC - MNSP

1. Basslink operates as a pure MNSP (no availability charge is earnt)

2. 2IC enters the market as an MNSP asset

3. Unless there is a single owner for both interconnectors would compete for flow to ensure efficient use of the assets

► Model only likely to be practical in scenarios where HydroTas can participate as owner, who would then be incentivised to ensure its viability

► Some form of guaranteed revenues likely to be required as the market risks are considered too great for typical investors

Base Case – 2.► Basslink – MNSP► 2IC - MNSP

1. Basslink remains a MNSP whilst earning an availability charge (mimics current operations)

2. 2IC enters the market as an MNSP3. Commercial restrictions in the

Basslink Services Agreement between HydroTas and Basslink Pty Ltd (BPL) limit 2IC operating as overflow cable only (only utilised when Basslink is at capacity)

► Similar to above, models are only viable with ongoing revenue support

► No true MNSP’s are currently operating in the Australian landscape

Alternative Case 1.► Basslink – MNSP► 2IC – Regulated

1. Basslink remains MNSP (with availability charge)

2. 2IC meets RIT-T to become a regulated asset

3. 2ICs’ regulated revenue determined by Regulator

► Model provides support for 2IC at the expense of Basslink

► Pure MNSP operations for Basslink would negatively impact its viability (currently earns an availability charge)

Alternative Case 2.► Basslink –

Regulated► 2IC – MNSP

1. Basslink becomes a regulated asset with regulated revenues

2. 2IC to operate a MNSP

► Similarly to Alternative Case 2, Basslink regulation will further support its operations

► 2IC would not be viable without HydroTas’s support

Alternative Case 3.

► Basslink – Regulated

► 2IC – Regulated

1. Basslink becomes a regulated asset with regulated revenues

2. 2IC regulated, revenue determined by Regulator

► Regulated models provide some level of surety in regards to revenue which will support the viability and delivery of a second interconnector

3 In the market modelling report, this is the “MNSP Base Case”4 In the market modelling report, this is similar to the operational assumptions of Base Case unregulated interconnector. Importantly, the market modelling assumes that both interconnectors act co-operatively such that the bidding of the two interconnectors maximises the total revenue of the interconnectors. However, from a commercial perspective, this would only be the case where the interconnector is owned by the same owner. Further, this Report does not include consideration any of the market benefits, as these are unable to be captured by the asset owner to generate commercial returns. See Section 1.3 for discussion of the relationship to the market modelling


Commercial Model Key Features Viability

Hybrid Case 1.

► Basslink – Partially Unregulated

► 2IC – Partially Unregulated

1. Both Interconnectors are partially unregulated (MNSP), with an availability charge

2. Government provides partial upfront grant, lowering capital costs and therefore ongoing impact on consumers.

► As this model is in essence an MNSP structure with some level of government support in the form of grants, the revenue required to remain viable would be lower than pure MNSP options

► Still requires the support of HydroTas to remain viable

Hybrid Case 2.

► Basslink – Partially Regulated

► 2IC – Partially Regulated

1. Both Interconnectors are partially regulated

2. Both Interconnectors are supported by a partial transmission charge (Floor)

3. Both Interconnectors earn 25% of the arbitrage revenues

► Partially regulated models have the potential to provide some regulated revenues and exposure to market risks

► Model would be appealing to investors, though none are in operation in Australia and would require government policy shift

Finding 1: Basslink must be considered in the delivery of 2IC. ► Both Basslink and 2IC connect Tasmania to the rest of the NEM, which creates the

potential for competing bidding behavior between the two links in an unconstrained market.

► 2IC can operate with reduced transmission losses, which means it can bid more competitively than Basslink, in an unconstrained world.

► The position and approach adopted by Hydro Tasmania (HydroTas) in its bidding behavior would be crucial.

This means that the optimal commercial model for the 2IC to be procured may not produce the optimal outcome overall for other key stakeholders.

Finding 2: Commercial structures and operational assumptions that impact bidding behavior are critical to the delivery models assessment.► The BSA sets out the commercial arrangements between Basslink and HydroTas. We

understand that the commercial structure consists of an availability charge for capacity, plus a variable payment linked to electricity flows.

► In the event that the majority of flows are transmitted through 2IC, Basslink would still be paid its availability payment at a minimum subject to maintaining minimum availability requirements, but may not receive its variable payments.

► To the extent that competition restrictions exist in the BSA (for example Basslink has dispatch priority over 2IC), this may materially impact the ability of 2IC to generate revenue to cover its capital repayments.

Finding 3: Commercial models which expose the asset owners to revenue risk have the potential to impact the ongoing commercial viability of Basslink and 2IC► Operating model options that have both links acting as MNSPs and separate ownership,

expose the asset owners to considerable revenue and asset stranding risk. Without operational restrictions, sub-optimal market outcomes may eventuate:

► Either very low competitive pricing which creates financial stress for the asset owners; or


► Pricing is maintained at artificially high levels due to the pricing power a duopoly might possess.

► MNSP models actively encourage profit maximisation at the expense of the other interconnector. With the new interconnector able to deliver lower transmission losses, though newer design capability and improved technology, the newer interconnector could garner a majority of the energy flows, which will further isolate Basslink’s ability to generate a rate of return that would support its ongoing operation and viability.

► MNSP models with a high degree of revenue risk expose asset owners to significant volatility in forecast revenue. For an interconnector which captures benefits from the price differential between Tasmania and Victoria, this revenue is expected to be challenging for financiers to forecast and ultimately raise debt against.

► MNSP options are expected to attract a risk premium by financiers to compensate for this risk, and result in much lower gearing (the proportion of debt to debt plus equity) compared to models with more stable and secure cashflows.

► The bidding behaviour (and strong market position) of HydroTas may impact the ability of financiers to take a long term view on the ability to secure revenues to repay investors.

Finding 4: A form of the regulated asset model for 2IC could be expected to minimise financing costs and creates more options for how the Project can operate alongside BasslinkRegardless of whether Basslink remains a MNSP, or is regulated, delivery of 2IC under a regulated asset model is likely to have advantages because:► This would reflect the underlying reasons why the 2IC would be built (i.e. not to provide

additional capacity that can pay for itself by operating as an MNSP in the short term). It would also reflect the difficulties that the MNSP model has previously encountered in Australia.

► Fully regulated models for 2IC and Basslink on balance offer the greatest level of benefits to electricity consumers and also to the owners of the interconnectors. It would however impact negatively on private generators, which may expose consumers to higher costs over the longer term.

► It effectively encourages the higher utilisation of the second interconnector as it will benefit from reduced transmission losses being newer technology and design which could undermine the viability of Basslink (if it remains a MNSP), whilst simultaneously impacting the energy security benefits of dual interconnectors.

► Enables a broader range of benefits to be delivered to consumers through regulated asset framework and can be structured so government and other beneficiaries can contribute funding to the link.

► Regulated assets owner takes the risk on changes of regulated returns made by the AER on a five (or more) year basis.

However, under this model, regulation would be required to provide the incentives to encourage efficient maintenance of the assets.

Finding 5: There may be potential to refine the regulated asset model to enable other beneficiaries of the Project to contribute to the funding of the Project► Government may consider funding a proportion of the capital costs through providing

an upfront grant to the Project delivery company. We expect that this would reduce the Regulated Asset Base (RAB) that the regulated return would be based upon and mean that taxpayers rather than electricity consumers bear part of the cost.


► A cap and floor model, similar to what has been implemented by Ofgem in the UK could also provide incentives for efficiency.

► Further investigation would need to be undertaken into variants of regulation that could meet these objectives.

Finding 6: While revenue modelling indicates that a fully merchant MNSP model has the potential to be feasible, the risk premium for the transfer of revenue risk is unlikely to be considered feasible by the financing market► Indicative modelling of MNSP revenues show considerably higher net present values

than its regulated counterparts, over the project life for 2IC.

► MNSP models with a high degree of revenue risk expose asset owners to significant volatility in forecast revenue. For an interconnector which captures benefits from the price differential between Tasmania and Victoria, this revenue is expected to be challenging for financiers to forecast and ultimately raise debt against.

► The cost of equity finance for a fully unregulated link likely to be high (15-20+%) given high volatility of cash flows.

► Currently Basslink is the only MNSP in Australia. DirectLink and MurrayLink interconnectors were constructed as MNSPs with merchant revenue exposure, but subsequently applied to the AER to receive regulated status as ‘competing’ regulated interconnects were built or expanded.

► Market sounding of financiers and energy asset owners confirms this finding.

Finding 7: The introduction of 2IC may impact the commercial viability of Basslink, which may require the asset owners to consider their options in relation to the commercial model and ownership structureThe EY electricity market modelling report indicates that Basslink is forecast to be impacted with the introduction of 2IC. The reduced profitability of Basslink may result in the asset owners:► Considering applying to the AER for regulated asset status

► Considering a sales process for the asset

► Seeking to renegotiate terms with HydroTas

► If it is assumed that Government does not have any levers to compel Basslink to become regulated or modify its commercial model, this would represent a key risk to the delivery of 2IC.

Finding 8: A single owner for 2IC and Basslink is preferred on balance, unless both assets are regulated


► Under the MNSP model a single owner is likely to be the only viable model. This is also likely to be true if only one asset is regulated unless other constraints are imposed.

► Separate asset owners is only likely to be viable if both assets are regulated.

Finding 9: An initial assessment indicates limited ability for a MNSP to capture revenue benefits other than the difference in pool prices► There is currently limited scope for third party revenues from other renewable energy

generators.

► Whilst there are strong wind sites in Tasmania which may result in differences in capacity factors between new Tasmanian wind farms (when compared to the marginal project in Victoria), the additional transmission costs associated with paying to reserve capacity to supply power to the mainland (e.g. under a Power Purchase Agreement) is unlikely to make these projects feasible.


Finding 10: Procurement model analysis indicate a contestable regulated model (applied for projects with significant capital costs) would enable competitive bids for construction, operations and ownership of the asset► The regulated asset model is market tested, and competitive for transmission assets.

► It could be expected to deliver the Project at a low cost of capital.

► We understand that only 3 HVDC suppliers are capable to meet the technical specifications globally, which may impact the competitiveness of the procurement.

► The existing DNSP arrangements in Tasmania and Victoria would be expected to continue for the procurement of requirement network connection infrastructure for new generation and connection to the existing grid.

Finding 11: Where a MNSP with a capacity charge is preferred, a Build Own Operate Transfer (“BOOT”) delivery model represents a viable delivery model► BOOT transfers majority of construction, maintenance, operations and ownership to the

private sector.

► Bidders would compete on what their minimum availability charge is to deliver and operate the asset over the project life.

► Maintains strong incentives for the asset owner to ensure the asset is available and maintain and maintain and operate the asset to reduce transmission losses.

1.3 Relationship to the EY Market Dispatch Cost Benefit Modelling

EY have been engaged to undertake market modelling (“Market cost benefit modelling of a second Bass Strait interconnector – 22nd December 2016”) and to provide commercial and financial analysis in respect of the second interconnector.

This Report provides commercial and financial insights in respect to the assessment of commercial operating models for the second interconnector, ranging from fully regulated to fully merchant options. This Report considers these alternative options in our analysis to form a view on the ability of the private sector to fund the second interconnector under a range of commercial models, not limited to regulated or MNSP only cases.

The market modelling report (“Market cost benefit modelling of a second Bass Strait interconnector Report – 22nd December 2016”) presents the market modelling outcomes of the merits of a second interconnector under fully regulated and MNSP cases only. This report (“Commercial and Financial Analysis – Second Tasmanian Interconnector – 22nd December 2016”), takes the outcomes and data from the market modelling MNSP case only and applies the data in alternative ways in order to consider the range of commercial operating models that may deliver a second interconnector (please see Section 3 for greater detail).

The market modelling under the regulated asset case examine the merits of a second interconnector largely by examining the NEM wide market benefits it would provide (such as lower production costs or deferred capital costs). The modelling conducted as part of the “Market cost benefit modelling of a second Bass Strait interconnector Report – 22nd December 2016” is intended to consider the potential for the second interconnector to be classified as a regulated asset by meeting the requirements of the Regulatory Investment Test for Transmission (RIT-T).

For the MNSP option, the electricity market modelling report considers the market revenues that might be expected to flow to the owner of the second interconnector, and also the


financial impact on other relevant parties in Tasmania: Basslink, Hydro Tasmania and energy consumers in Tasmania.


The impact of a second interconnector on these parties is heavily dependent on the arbitrage opportunities to be exploited and the operating behaviour of the second interconnector. Although market benefits may result from the operation of the MNSP, these benefits do not form the basis of the viability of the asset, as the second interconnector asset owner is unable to capture these benefits as project revenues. Rather, the viability of the MNSP is formed by an expectation of revenues derived from arbitrage benefits between Tasmania and Victoria with appropriate consideration of the range of market and regulatory risks associated with the asset.

The choice of whether one is superior to the other is a function of a broader view about the risks associated with wholesale market exposure and the viability of having competition in the provision of interconnectors. This Report does not consider the financial impact of the range of operating models explored on other market participants such as Hydro Tasmania (HydroTas) and Tasmanian electricity consumers.

This Report uses the same underlying data as the market modelling for the MNSP cases. The financial modelling however examines the merits of a second interconnector separately from any market benefits, and as such attempts to determine the private benefits it would provide (i.e. those that can be captured by and accrue to the owner of the asset). Under the regulated model, those private benefits are largely divorced from the operation of the asset and the market benefits it delivers because private benefits flow indirectly through the regulated returns as determined by the Australian Energy Regulator. Under the pure merchant model, however, those private benefits are largely a function of the owner’s ability to exploit arbitrage, and are therefore largely dependent on wholesale market conditions. Furthermore, the private benefits depend on the extent to which to the owner of the second interconnector can capture these when there is another interconnector (and associated commercial arrangements) that influence the extent to which this possible.

The operating assumptions of Basslink and the second interconnector in the MNSP Base case provided as part of the Market Modelling (see “Market cost benefit modelling of a second Bass Strait interconnector Report – 22nd December 2016”) is similar to the operating assumptions of the two interconnectors in the commercial and financial analysis Base Case 1 scenario. Alternative operating models such as converting Basslink to a regulated interconnector while operating the second interconnector as an MNSP have not been modelled in the market modelling.

This Report considers these alternative options in our analysis to form a view on the ability of the private sector to fund the second interconnector under a range of commercial models, not limited to regulated or MNSP only cases. Simplifying assumptions were made to illustrate the potential financial impacts and ability of the private sector to fund the second interconnector for the range of commercial models. Where these commercial model alternatives are worthy of further investigation, additional electricity market modelling of these alternatives at the next phase of project development is suggested.


2. Background

2.1 OverviewIn April 2016, the Australian and Tasmanian governments established a joint feasibility study (the Study) into whether a second Tasmanian interconnector could improve Tasmania’s energy security and facilitate renewable energy investment. The Study is investigating the benefits of a second high voltage direct current (HVDC) interconnector (the Project, 2IC), construction of which would increase transfer capacity of electricity between Tasmania and Victoria.

2.2 BasslinkBasslink is the incumbent Tasmania to Victoria high-voltage transmission line (interconnector) that operates between George Town in Tasmania and Loy Yang in the Latrobe Valley area in Victoria. It was commissioned in early 2006 after Tasmania joined the NEM. It is owned by the publicly listed Keppel Infrastructure Trust (SGX: A7RU), and is the only unregulated interconnector in the NEM. Basslink is the world’s second longest subsea electricity interconnector, with a nominal capacity to export 594 MW from Tasmania to Victoria, and import 478 MW. It cost $874 million.

When the development of Basslink was endorsed by the then Labor Government in 1998, they set out several goals and strategic objectives for the construction of the interconnector including:

► Improve the security of electricity supply and reduce the exposure to drought conditions in Tasmania

► Provide Tasmania with access to electricity prices determined competitively in the NEM

► Provide a means by which electricity generated in Tasmania can be sold into the NEM and provide a new source of peak generating capacity in the NEM.

Basslink generates revenue in a similar way to generators in the NEM; by bidding into the spot market its capacity to deliver energy, with the returns determined by the price difference and the energy flows between Victoria and Tasmania. In 2002, HydroTas signed the Basslink Services Agreement (BSA), in effect agreeing to lease the cable over 25 years and pay a facility fee. The BSA is for an operational period of 25 years, with an option to extend the term for a further 15 years.

The BSA allows the owners of Basslink to swap that market-based revenue for an agreed fixed facility fee, plus performance-related payments. The agreement also gives HydroTas the rights to control the way in which Basslink bids its interconnector capacity, either flowing in or flowing out of Tasmania. Graph 1 is indicative of how Basslink is supported by the availability payment vs. the potential return that could be generated through pricing differential.


Graph 1: Basslink Revenue Stream

0

50

100

150

200

250

BassLink BassLink MNSP revenues

$ m

illion

s

2.3 Scope of WorkThe report that follows cover four (4) main topic areas to assist in making a determination on the preferred commercial operating model(s) and procurement model(s) that could best support delivery of the Project. The four (4) areas of focus are as follows:

► Assess the range of Revenue/ Business Models via a qualitative assessment and consideration based on the operating models already in existence in the electricity markets (Regulated, Non-Regulated, and/ or combinations of both)

► Run a series financial analyses on each of the model(s) determined above

► Assess the financial viability of each model(s)

► Determine the range of delivery models available

► Assess the suitability of each model(s) to deliver a second interconnector

► Validate findings through market soundings.

The report is intended to be utilised in the financial and commercial sections of the final feasibility Study report being prepared by the Tasmanian Energy Taskforce.

The Report uses the price forecasts for MNSPs from the EY electricity market modelling in this report to inform the quantum of arbitrage benefits may be able to capture by the asset owner of 2IC.

2.4 Approach to AssessmentThe report follows the four (4) steps that are outlined below in Figure 1. It follows a structured process on each of the three (3) key work streams to enable Step 4 (listed below) to occur. This approach is based upon Infrastructure Australia’s National Infrastructure Procurement Guidelines.

Figure 1: 4 Steps to determine the Procurement Model.


STEP 1:Data Gathering

STEP 2:Operational

Model Analysis

STEP 4:Validation

STEP 3:Delivery Model

Analysis

►Objectives►Risks►Unique project

Characteristics►Agency & Market

capability

►Consider the suitability of

►Regulated Models►MNSP Models►Hybrid Models

►What precedent exists for the project?

►What does the market think?

►Which model best achieves the requirements and objectives whilst reducing risk?

The focus of each of the four steps of our approach are discussed below in greater detail.

The Report considers:

► Commercial operating models (e.g. Fully regulated, partly regulated, fully market and partly market exposed) “the Commercial Operating Models”

► Procurement models (e.g. Design & Construct, Build Own Operate Maintain, State build then transfer to private sector upon operations). These procurement models also include a range of private and public sector funding options “the Procurement Models”

► Underlying operational scenarios which will draw on the market modelling work stream (e.g. growth in Tasmanian wind energy generation, Victorian coal fired generator retirement), and which may materially impact on the revenue profile of the asset, particularly over the longer term.

The report enabled each of these combinations (Figure 2) to be assessed against the revenue scenarios from the EY electricity market modelling report in a bespoke financial model, in order to generate a range of quantitative outcomes that inform the financial and commercial outcomes.

Figure 2: Procurement Models and Commercial Models combinations that are possible outcomes for the Project


2.5 Structure of this ReportThis report is structured as follows:

► Section 3: undertakes the qualitative and quantitative analysis of the commercial operating models considered in this Report

► Section 4: undertakes a qualitative analysis of the delivery model and ownership options available

► Section 5: validates the preliminary findings of sections 3 & 4, summarising the key findings of the market sounding exercise and outlines case studies for the delivery of interconnectors


3. Commercial Analysis

3.1 Overview of Commercial Model analysisThis section:

► Identifies a range commercial models available to the Project

► Undertakes a qualitative assessment of the potential feasibility of these options. Under each option, the commercial structure that may make each option feasible from a financing perspective is undertaken taking into consideration keys risks, and revenue

► Undertakes a series of qualitative financial analyses on each of the identified commercial models in order to create a holistic overview of the options available to government to pursue the development of a second interconnector

► Assumes that Basslink and 2IC are able to meet the RIT-T.

3.1.1 Commercial Model OptionsTable 2 summarises the key features of commercial models under which the two interconnectors could potentially operate and variation between them. These commercial models are assessed against a fixed criteria that will help to determine the most appropriate operating model.

Table 2: Commercial Model VariationsCommercial Model Key FeaturesBase Case – 1► Basslink – MNSP► 2IC - MNSP

► Basslink operates as a pure MNSP (no availability charge is earnt)

► 2IC enters the market as an MNSP asset► Unless there is a single owner for both interconnectors

would compete for flow to ensure efficient use of the assets

Base Case – 2► Basslink – MNSP► 2IC - MNSP

► Basslink remains a MNSP whilst earning an availability charge (mimics current operations)

► 2IC enters the market as an MNSP► Commercial restrictions in the Basslink Services

Agreement between HydroTas and Basslink Pty Ltd (BPL) limit 2IC operating as overflow cable only (only utilised when Basslink is at capacity)

Alternative Case 1► Basslink – MNSP► 2IC – Regulated

► Basslink remains MNSP (with availability charge)► 2IC meets RIT-T to become a regulated asset► 2ICs’ regulated revenue determined by Regulator

Alternative Case 2► Basslink – Regulated► 2IC – MNSP

► Basslink becomes a regulated asset with regulated revenues

► 2IC to operate a MNSP

Alternative Case 3► Basslink – Regulated► IC – Regulated

► Basslink becomes a regulated asset with regulated revenues

► 2IC regulated, revenue determined by Regulator

Hybrid Case 1

► Basslink – Partially Unregulated

► IC – Partially Unregulated

► Both Interconnectors are partially unregulated (MNSP), with an availability charge

► Government provides partial upfront grant, lowering capital costs and therefore ongoing impact on consumers.


Commercial Model Key FeaturesHybrid Case 2► Basslink – Partially

Regulated► 2IC – Partially Regulated

► Both Interconnectors are partially regulated► Both Interconnectors are supported by a partial

transmission charge (Floor)► Both Interconnectors earn 25% of the arbitrage revenues

3.1.2 Qualitative CriteriaTable 3 includes the six main assessment criteria that have been used to assess the various business models listed in Table 2. It includes a summary explanation of its importance and the critical issues that need to be addressed.

Table 3: Assessment Criteria

Criteria Explanation Importance Rationale for weightingOperational

Risk TransferWhich business model provides the greatest level of effective risk transfer of second interconnector?

High

The ability to appropriately manage and transfer risk to the private sector is a key differentiator between the models.

It is of high importance due to demand and price risks of the asset, and technology and construction risk of delivering an undersea cable

Operational Utilisation/ Incentives

Which business model(s) encourage the greatest level of interconnector utilisation/ operational efficiency?

Medium

The ability to ensure a high level of utilisation/ encourage the efficient use of the interconnector is deemed as medium importance.

Energy Security

Do any of the potential business models improve or hinder the energy security benefits that an additional interconnector could provide?

Medium

An operational second interconnector is important factor in ensuring energy security for Tasmania and therefore has a medium rating. With dual interconnectors potentially available should 2IC be developed, it has slightly lower importance than if it was a stand alone connection.

Financial

Financing Costs

Which business model offers the lowest financing costs? Low

The cost of financing in relation to other criterion is of less importance than the ability to actually secure funding.

Suitability for Funding

Which business model is bankable?

MediumThe ability for the commercial model to be bankable is of medium importance in a high level assessment. The models need to be able to support debt funding in the absence of investor appetite for pure


Criteria Explanation Importance Rationale for weighting

market risk.

Market Appetite

Is there market appetite for the business model? High

The commercial model selection will ultimately determine both the type of investor and appetite for the asset in the long run. In the absence of full government funding, this is a critical criteria which justifies its high rating.

A short overview of the assessment scoring can be seen below.

Assessment Scoring:

To facilitate the qualitative assessment of the options against each criterion, the following rating system was adopted:

Table 4: Options Assessment ScoringRating Number Description 3 Option is extremely effective in satisfying the requirements of

the criterion. 2 Option is effective in satisfying the requirements of the criterion. 1 Option just satisfies the requirements of the criterion. 0 Option is ineffective in satisfying the requirements of the

criterion. -1 Option is extremely ineffective in satisfying the requirements of

the criterion.

Each score and rank is then be weighted by multiplying the ‘Assessment Score’ by the ‘Importance’ rating. The importance rating attracts the following weightings: High = 3, Medium = 2 and Low = 1.

The assessment criterion above was selected and weightings agreed in conjunction with the Department. The assessment criteria are representative of the key considerations that need to be addressed when assessing the benefits and risks of possible commercial and delivery models.

Throughout the financial analysis and market sounding process, the calculations and feedback tended to ultimately focus on which model would provide the most bankable revenue profile, whilst still providing an avenue to attract the required level of funding to deliver the 2IC.

3.2 Qualitative and Quantitative Analysis3.2.1 Quantitative Assumptions and financial modelling

approachEY developed a cashflow model to enable the quantitative assessment of the commercial models. In the first instance, for the MNSP models the projected electricity flow profiles


(provided as part of the Market Dispatch Cost Benefit Modelling), are utilised to determine a revenue profile for each of the MNSP models. Secondly, the capital costs and ongoing operating costs then flow through the financial model to calculate the likely profitability and free cash flows. This enables a determination of the value of the 2IC generated cash flows has to potential investors. Thirdly, the cash flows are then assessed against some high level project financing criteria (internally generated internal rates of return, debt service coverage ratios, positive Net Present Values) in order to quantify the ability of each MNSP model to attract or sustain investment.

In regards to the regulated models, we have modelled a high level regulated asset financial model structure to calculate the future cost impacts. The regulated models are not reliant upon market generated revenues for their viability, therefore the financial model considers the costs of delivering the project (capital costs, ongoing operating costs, required investment returns) to calculate the ongoing annual payment that would be required to sustain the 2IC. These are the quasi cash flows the project could theoretically generate under a regulated environment, which have value to investors, and in a similar manner to the MNSP models, are then assessed against the high level project financing criteria (internally generated internal rates of return, debt service coverage ratios, positive Net Present Values) to determine their attractiveness to investors.


Table 5 contains the operating assumptions that were used within the quantitative analysis.5

Please note, the report is not assessing the suitability of these assumptions as they have been either provided by third parties (Tasmanian Energy Taskforce) or are indicative of typical market financing terms that EY, in its experience, deem suitable for this type of analysis. All assumptions should not be relied upon outside of this report and would need to be independently verified in a competitive process. EY takes no responsibility to the accuracy of these figures.

Financial revenue and cost outcomes in the Report are in 2016 dollars unless otherwise labelled.

Table 5: Assessment Criteria

Assumption Input

2IC Capital Cost A$930 million (June 2015 $)

2IC Operating Costs A$16.7 million annually (June 2015 $)

2IC Construction Period 6 Years beginning 2020

2IC Operational State Date 2026

Inflation (CPI) 2.0% p.a.

Cost of Equity Funding 15.0% p.a. (post tax nominal)

Cost of Debt Funding 5.03% p.a. (post tax nominal)

Capital Structure (Gearing) 75% debt ; 25% equity

Loan Term 20 YearsDebt Service Coverage Ratio (“DSCR Target”) >1.5x

Discounting base date The net present values are discounted back to 2016 terms.6

Discount ratesTwo scenarios are presented: 7% nominal and 10% nominal discount rates7

Source: Tasmanian Energy Taskforce, EY assumptions.

5 It should be noted that the same cost of capital assumptions are used for all commercial models. This is a major simplifying assumption (given they entail different risks) but ensures consistency with the market modelling. The implications of weakening that assumption is discussed when presenting the results.6 The electricity market modelling report discounts its real prices forecasts to 2026/27 terms7 The electricity market modelling report applies 7% and 10% real discount rates to real cashflows, where this Report converts revenues and cost to nominal terms, and applies nominal discount rates


3.2.2 Qualitative Summary Table 6 shows that the results of the qualitative commercial models assessment. The MNSP scenario (Base Case 1) generates the greatest risk transfer and utilisation, though this comes at the expense of funding suitability, whereas the dual regulated scenario (Alternative Case 3) offers the greatest suitability for funding, though this comes at the expense of risk transfer and utilisation of the second interconnector.

Table 6: Qualitative Score SummaryCriteria Importance Base Case 189 Base Case 2 Alt. Case 1 Alt. Case 2 Alt. Case 3 Hybrid Case 1 Hybrid Case 2

Both MNSP’sBoth MNSP’s – Commercial Restrictions

on 2IC

Basslink MNSP, 2IC Regulated

Basslink Regulated, 2IC

MNSPBoth

RegulatedPartially

MNSPPartially

Regulated

Risk Transfer High Operational Utilisation Medium

Energy Security Medium Suitability for

Funding Low

Financing Costs Medium

Market Appetite High

Score 10 8 12 7 12 8 14Weighted Score 23 19 24 24 24 16 29

The Hybrid Case 2 model ranks highest as it takes the best parts of the regulated model (a minimum transmission charge to support funding), whilst transferring some MNSP revenue risk exposure to incentivise asset utilisation and enable higher investor returns. The ability of this model to generate further returns (over and above the transmission charge) provides an additional benefit of incentivising asset owners to ensure the link is utilised, as they are able to share a portion of the arbitrage revenues that they otherwise wouldn’t in a traditional regulated model.

8 In the market modelling report, this is known as the “MNSP Base Case”9 In the market modelling report, this is similar to the operational assumptions of MNSP Base Case. Importantly, the market modelling assumes that both interconnectors act co-operatively such that the bidding of the two interconnectors maximises the total revenue of the interconnectors. However, from a commercial perspective, this would only be the case where the interconnector is owned by the same owner. Further, this Report does not include consideration any of the market benefits, as these are unable to be captured by the asset owner to generate commercial returns. See Section 1.3 for discussion of the relationship to the market modelling


3.2.3 Quantitative Summary – 40 YearsTable 7 below highlights both the profitability of each commercial model over 40 years. It is important to note that the modelled outcomes are based upon hypothetical market scenarios that were produced by the EY electricity market modelling team on behalf of the Tasmanian Taskforce.

Table 7: Modelled Scenario Summary – 40 yearsInvestor Suitability SummaryScenario (NPV 2016 terms) Base Case 1 Base Case 2 Alternative

Case 1Alternative

Case 2Alternative

Case 3 Hybrid Case 1 Hybrid Case 2

Description Both MNSP’sBoth MNSP’s –

Commercial Restrictions on

2IC



MNSPBoth

Regulated Partially MNSP Partially Regulated

NPV (2016) of Interconnector Revenues @ 7% ($m) – 2IC 1,662 598 1,152 1,662 1,152 662 1,314NPV (2016) of Interconnector Revenues @ 7% ($m) – Basslink 598 1,013 1,013 791 791 - -NPV (2016) of Interconnector Revenues @ 10% ($m) – 2IC 827 304 619 827 619 353 695NPV (2016) of Interconnector Revenues @ 10% ($m) – Basslink

304 515 515 407 407 - -

Project IRR 12.7% 3.9% 9.9% 12.7% 9.9% 9.9% 11.2%Equity IRR 18.2% 1.7% 15.0% 18.2% 15.0% 15.0% 18.1%Cash flow sufficient to support debt repayments Yes No Yes Yes Yes Yes Yes2IC financeable No No Yes No Yes No Yes

Notes

Market revenues are seen as “risky” and

unlikely to be able to be fully transferred to

the private sector. Will be

difficult to finance as pure MNSP without price support.

Similar to Base Case 1, MNSP

based revenues are unlikely to attract funding

due to the riskiness of cash

flows. Poor utilisation of 2IC,

and consequential low returns.

As 2IC would have the benefit

of regulated revenues, will increase the likelihood of attracting funding to deliver the

project at a low cost of capital.


based revenues are unlikely to

attract reasonable

funding levels due to the

riskiness of cash flows.


of regulated revenues, will increase the likelihood of attracting funding to deliver the

project at a low cost of capital



attract reasonable

funding due to the riskiness of

cash flows.

As 2IC would have the benefit of regulated, or minimum cash flow payments, will increase the

likelihood of attracting funding to deliver the

project

The net present values are discounted to 2016 terms using nominal post tax discount rates of 7% and 10% respectively. Note that for Base Case 1, the NPV of Interconnector Revenues are different to MNSP Base Case 1 in the electricity market modeling due to different discount rate assumptions as set out in Table 4. The differences in assumptions are appropriate as the discounting is undertaken for different purposes, and variances have been reconciled.


3.2.4 Quantitative Outputs Summary – 50 YearsTable 8 contains the same scenarios and outputs as the summary table above, with adjustments made to consider the outputs over a 50 year operational period.

Table 8: Modelled Scenario Summary – 50 YearInvestor Suitability SummaryScenario Base Case 1 Base Case 2 Alternative

Case 1Alternative

Case 2Alternative

Case 3 Hybrid Case 1 Hybrid Case 2

Description Both MNSP’sBoth MNSP’s –

Commercial Restrictions on

2IC



MNSPBoth Regulated Partially MNSP Partially

Regulated

NPV (2016) of Interconnector Revenues @ 7% ($m) – 2IC 1,745 616 1,211 1,745 1,211 697 1,380NPV (2016) of Interconnector Revenues @ 7% ($m) – Basslink 616 1,073 1,073 843 843 - -NPV (2016) of Interconnector Revenues @ 10 ($m) – 2IC** 845 308 635 845 635 363 712NPV (2016) of Interconnector Revenues @ 10 ($m) – Basslink 308 528 528 418 418 - -Project IRR 12.7% 4.0% 10.0% 12.7% 10.0% 10.0% 11.3%Equity IRR 18.0% 2.1% 15.0% 18.0% 15.0% 15.0% 18.1%Cash flow sufficient to support debt repayments Yes No Yes Yes Yes Yes Yes2IC financeable No No Yes No Yes No Yes

Notes

Market Revenues are

seen as “risky” and

unlikely to be able to be

fully transferred to

the private sector. Will be

difficult to finance as pure MNSP

without price support.


based revenues are unlikely to attract funding

due to the riskiness of cash

flows. Poor utilisation of 2IC,

and consequential

low returns


of regulated revenues, will increase the likelihood of attracting

funding to deliver the project at a

low cost of capital.



attract reasonable

funding levels due to the

riskiness of cash flows.


of regulated revenues, will increase the likelihood of attracting

funding to deliver the project at a

low cost of capital



attract reasonable

funding due to the riskiness of

cash flows.

As 2IC would have the benefit of regulated, or minimum cash flow payments, will increase the

likelihood of attracting

funding to deliver the project


3.3 Detailed results – Base Case3.3.1 Base Case 1 – Both MNSP’s - QualitativeTo consider Base Case 1 from a qualitative perspective, the operating assumptions for each commercial model is compared against the criteria, to provide the key takeaways provided in Table 9.

Table 9: Key Takeaways – Base Case 1

Criteria Key Takeaway Rating

Risk Transfer► MNSP assets provide the greatest transfer of risk

from the interconnectors, particularly for demand and price risks.

Operational Utilisation

► Both interconnectors will be encouraged to operate at the highest level of utilisation as they are directly competing against each other for energy flows, unless they are operated by the same asset owner.

Energy Security► Whilst dual interconnectors offer greater energy

security, this is offset by the potential impacts on viability as both interconnects compete for flow, forcing down profitability and sustainability.

Suitability of Funding

► With limited capability to accurately forecast future wholesale energy prices there is no guarantee that the price differential will be great enough to profit from the arbitrage and underpin revenues that support funding.

Financing Costs

► As financing is so heavily reliant upon arbitrage which will be an unreliable cash flow, financiers will see this commercial model as presenting them with the highest levels of risk and therefore pricing will represent the riskiness of the investment.

Market Appetite► Without reliable market data, revenue remains

relatively uncertain which will impact investor confidence and finance ability.

In Base Case 1 both interconnectors operate as MNSP’s (no availability charges or other forms of revenue support) that are attempting to profit from any price differential that may exist on either side of the interconnector in order to generate their revenue. This model encourages the high utilisation of the interconnectors (as flow equals the potential ability to generate returns) though reliability of funding needs to be addressed.

The financeability of this commercial model is the key limitation. As MNSP generated revenues are forecast to be highly volatile and reliant upon the electricity generator (HydroTas) to help ensure there are price differentials to take advantage of, this model is expected to struggle to attract reasonable levels of funding and is not regarded as a viable commercial model.

The revenue impact and uncertainty of MNSP operating models is illustrated in sensitivity analysis of the second interconnector revenues when the mainland market is oversupplied. The electricity market modelling report (section 6.2.2) estimates that revenue falls by approximately 40% in an oversupplied market compared to MNSP Base Case 1. This outcome has a material impact on commercial viability.

Department of the Environment and EnergyFinancial and Commercial Analysis – Second Tasmanian Interconnector

3.3.2 Base Case 1 – Quantitative AnalysisGraph 2 below shows annual revenue for 2IC and Basslink, with the 2IC being a newly designed interconnector, in a market environment where 2IC competes against Basslink for energy flows. Due to the lower loss factors of 2IC, 2IC would garner a significant portion of the potential revenue that could be earned through arbitrage, which is consistent with the qualitative assessment.

Graph 2: Revenue scenarios under Base Case 1 – MNSP’s

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BassLink 2IC 40y operating period

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3.3.3 Key Modelling ResultsTable 10 below shows that based upon the assumptions used in the modelling, that the outcomes generated are indicative of a project with strong financial metrics. The NPV’s are high, the Project and Equity IRR’s are also high. When considering the figures in isolation, it would seemingly support a high gearing ratio (Debt to Equity), all of which are attractive to investors.

Table 10: Financial modelling results for the MNSP Commercial ModelBase Case 1 – Dual MNSP

Scenario Outputs40y operations 50y operations

MNSP NPV (2016) @7% ($m)2IC 1,662 1,745Basslink 598 616MNSP NPV (2016) @10% ($m)2IC 827 845Basslink 304 308Other 2IC financial metricsProject IRR 12.7% 12.7%Equity IRR 18.2% 18.0%Debt Fundable Yes YesFinanceable No No

Whilst this commercial model seemingly provides all the required outcomes of a fundable project, when overlaid with the issues raised in the qualitative assessment, namely, the unreliability of market generated cash flows, along with the encouraged interconnector competition, this model is actually unlikely to be fundable, nor desirable by energy infrastructure investors. This is further evidenced by the fact that no true MNSP interconnectors are in operation in Australia.


We note the market modelling assumes that both interconnectors act co-operatively such that the bidding of the two interconnectors maximises the total revenue of the interconnectors. However, from a commercial perspective, this would only be the case where the interconnector is owned by the same owner. The financial outcomes above reflect MNSP outcomes where both assets are owned by single party. We note that electricity market modelling suggests if Hydro Tasmania was the owner of its current assets and the two interconnectors and bid to maximise its total wholesale revenue, in most trading intervals it would derive maximum benefit from being able to export energy (i.e. bidding close to zero).

► In order for this model to be viable, HydroTas would need to have greater capacity to operate the interconnector (as a participating owner).

► Alternatively HydroTas would need to enter into offtake contracts with the interconnector owner to ensure they have consistent access to electricity flows at discounts to the prevailing market prices in order to generate revenues.

3.3.4 Base Case 2 – Both MNSP’s – Commercial Restrictions on 2IC -QuantitativeBase Case 2 varies slightly operationally from Base Case 1 in one key area, specifically, putting a constraint on the second interconnector’s ability to access energy flows. This model is assumed to have a commercial restriction in place in the Basslink BSA that ensures Basslink receives a majority of flow from HydroTas, with the second interconnector operating as a pure MNSP.

Table 11: Key Takeaways – Base Case 2


Risk Transfer

► MNSP assets provide the greatest transfer of risk from the interconnectors, particularly for demand and price risks.

► Ongoing support and partial risk transfer to underwrite the revenues required to service any form of financing.


► 2IC will operate essentially as an overflow cable only as it’s no longer in competition for the initial 500MW which is the capped capacity of Basslink in this modelling.

Energy Security► Model restricts the capability of 2IC to support itself if

overflows are limited which could negatively impact energy security, as its viability is critical to keeping the asset operational.


► Funding will be difficult to secure unless guarantees for a minimum flow level is achieved which could support funding.

Financing Costs ► Expect financing costs (if funding can be supported) to be expensive if no availability payment is made.

Market Appetite► Guarantees would need to be provided at least for

“minimum” flow access to ensure some level of revenue can be generated if the intent is to encourage non-government funding sources.


In a similar outcome to Base Case 1, all the scores with the exception of Risk Transfer are low. In a commercial model that is unable to provide some certainty of revenues or support for flows through the 2IC, this model is unlikely to attract sufficient funding from investors to meet capital repayments. Any form of commercial restriction on 2IC from accessing a fair amount of flow from HydroTas significantly impacts its profitability. This model also limits the efficient use of 2IC (as there is no incentive for Basslink to change its operating efficiencies to better utilise 2IC).3.3.5 Base Case 2 – Quantitative AnalysisWith Base Case 2 placing commercial restrictions on the availability of energy flows for the second interconnector, Basslink is now the major beneficiary of the arbitrage revenue (Graph 3) able to be generated in this scenario. Whilst 2IC would typically garner a majority of the flow due to its ability to provide lower losses to HydroTas, this benefit is not able to be realised.

Graph 3: Revenue scenarios under Base Case 2 – Commercial Restrictions

0

50

100

150

200

250

300

350

Basslink 2IC 40y operating period

$ m

illion

s

3.3.6 Key Modelling ResultsSimilarly to the previous case Table 12 below contains the outputs generated from the financial analysis. The NPV for 2IC is less than Base Case 1, and the project and equity IRR would not meet most investors’ minimum criteria. This is compounded by the fact that this model is not able to support a significant level of gearing that would be required to deliver the second interconnector.

Table 12: Financial modelling results for the Base Case 2 - Commercial RestrictionsBase Case 2 – Dual MNSP with Commercial Restrictions


MNSP NPV (2016) @7% ($m)2IC 598 616Basslink 1,013 1,073MNSP NPV (2016) @10% ($m)2IC 304 308Basslink 515 528Other 2IC financial metricsProject IRR 3.9% 4.0%Equity IRR 1.7% 2.1%Debt Fundable No NoFinanceable No No


If the second interconnector is unable to garner a fair portion of energy transfers from HydroTas, it will be severely restricted in its ability to generate revenue. The “riskiness” of the revenue profile, means like Base Case 1, this model is unlikely to be financeable.

► The inability of the model to support adequate gearing levels and provide minimum market returns for investors, coupled with the fact that revenue is still generated via arbitrage opportunities (and therefore out of the control of the interconnector owner), also means this model is unlikely to be commercially viable.

3.4 Detailed Results – Alternative Cases3.4.1 Alternative Case 1 – Basslink MNSP, 2IC Regulated -

QualitativeAlternative Case 1 is a commercial model where Basslink remains an MNSP (and earning an availability charge), and the second interconnector enters the market as a regulated asset. This model assumes no commercial restrictions are in place and that the assets will be utilised by HydroTas as they are required.

Table 13: Key Takeaways – Alternative Case 1Criteria Key Takeaway RatingRisk Transfer ► Third party revenue risk not transferred to the private

sector asset owner of 2IC.


► 2IC is only seeking to earn a return on its capital invested and cover operating costs, meaning it could potentially offer lower access costs to the NEM, increase operational utilisation and ensure minimal costs are passed on to electricity consumers as they don’t pay an arbitrage premium.

► However, asset owners are not financially incentivised to optimally maintain and operate the infrastructure (other than through the regulated asset’s minimum requirements).

Energy Security► Dual interconnectors will increase energy security for

Tasmanians purely through the addition of a secondary line that can operate viably as a backup should one or the other line be unavailable.


► Increases the level of funding suitability through reliable cash flows to service investor funding

Financing Costs► With 2IC having reliable and consistent cash flows

then financing costs would be expected to be competitive with other recent regulated asset sales processes.

Market Appetite

► From a pure investment perspective, if guarantees can’t be provided on returns generated through arbitrage that could consistently be exploited, then a regulated scenario will drive market appetite as investors will have greater insight into the expected returns which will increase the desire for the asset.


This model has considerable advantages over the pure MNSP models previously assessed due to the increased financeability of regulated revenues, which could lead to improved outcomes in relation to the bankability of this model as this offers a considerably lower risk profile for investors.

3.4.2 Alternative Case 1 – Quantitative AnalysisThe cashflow profile of this model visually is different from the previous models. As can be seen Graph 4 below, Basslink’s revenues are directly linked to its ability to generate returns via arbitrage opportunities which is evidenced by the volatile line, whilst 2IC earns a consistent regulated return, hence almost no variation in the revenue profile.

Graph 4: Alternative case 1 – Basslink MNSP, 2IC Regulated

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2026

2028

2030

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2042

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2050

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2068

2070

2072

2074

2076

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150

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250

300

350

Basslink 2IC 40y operating period

$ m

illion

s

3.4.3 Key Modelling ResultsWhen considering this model with the Base Case options, the outputs in Table 14 indicate that whilst the NPV’s may be somewhat lower, they are still strong outcomes, enhanced by the ability of this commercial model to generate equity IRR’s of approximately 10% (expected to be sufficient for a regulated asset) and is capable of supporting a high gearing ratio. This model is supported by regulated revenues for 2IC (limited only to what is required to repay debt, cover operating costs and applicable depreciation).

Table 14: Financial modelling results for Alternative case 1 – Basslink MNSP, 2IC Regulated

Alternative Case 1 – Basslink MNSP, 2IC Regulated


MNSP / regulated NPV (2016) @7% ($m)2IC 1,152 1,211Basslink 1,013 1,073MNSP / regulated NPV (2016) @10% ($m)2IC 619 635Basslink 515 528Other 2IC financial metricsProject IRR 9.9% 10.0%Equity IRR 15.0% 15.0%Debt Fundable Yes YesFinanceable Yes Yes


The biggest issue this model faces is it exposes BassLink to market generated returns which will ultimately impact its ability to generate market linked returns above the availability charge.► BassLink would need to be able to enter into offtake contracts in order to ensure

access to electricity flow and provide a consistent revenue stream. ► With HydroTas being responsible for ensuring base load domestic supply to

Tasmania first and foremost, MNSP’s are unlikely to be commercially viable due to their inability to control demand flow from HydroTas.

This commercial model provides superior outcomes for 2IC when considering the benefits of regulation on the projects ability to support debt and deliver long term viability. For 2IC, this model would likely be financeable by both debt and equity investors.

3.4.4 Alternative Case 2 – Basslink Regulated, 2IC MNSP - Qualitative

Alternative Case 2 is a variation on the Alternative Case 1.

Table 15: Key Takeaways – Alternative Case 2Criteria Key Takeaway Rating

Risk Transfer

► Delivers a greater level of risk transfer over the Alternative Case 1, though with Basslink becoming regulated, there needs to be comfort that this is a sustainable outcome for 2IC to ensure its viability given the transfer of demand and pricing risk and enable effective risk transfer.

Operational Utilisation► Encourages greater competition that will benefit energy

consumers at the expense of profits for the interconnectors.

Energy Security► With 2IC being MNSP, the commercial viability risks

increase which could negatively impact energy security should the asset be vulnerable to failure through limited revenues.


► With cash flows from the 2IC being directly impacted by the ability of the asset to generate revenue through arbitrage (needs to compete with Basslink’s to impact on pricing to secure flow), reliability of cash flows becomes a concern.

Financing Costs► As the asset is subject to inconsistent cash flows being

generated, expected riskiness will increase and therefore this is expected to be represented in an increase in funding costs.

Market Appetite► With limited certainty into the expected cash flows of

the asset and no firm guarantee of energy flows along the link, the market will have less appetite for this structure.

In this model, Basslink would operate as a regulated asset (earns a regulated transmission charge), whereas 2IC would operate as a pure MNSP. The model assumes no restrictions of flows between either of the interconnectors, as 2IC is expected to compete against the regulated Basslink for flows. This model encourages 2IC to bid, at a minimum, the same equivalent value that it would cost HydroTas to use Basslink.

As previously explored in prior models, with 2IC expected to generate revenues from market arbitrage opportunities and the high levels of risk associated with that revenue profile, it scores low in regards to the finance criteria and therefore is an assessed as an unsuitable model to support the delivery of a second interconnector.


3.4.5 Alternative Case 2 – Quantitative AnalysisIn a similar structure to the Alternative Case 1, though in this instance revenue for Basslink is regulated, whilst 2IC operates as an MNSP. In Graph 5 below, it should be clear that Basslink’s revenues are relatively consistent, with 2IC being directly exposed to market generated returns, which on face value look considerably higher than a regulated return.

Graph 5: Alternative case 2 – Basslink Regulated, 2IC MNSP

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3.4.6 Key Modelling ResultsThe key outputs in Table 16 are similar to the outcomes generated in Base Case 1, specifically when looking at the NPV’s, Project and Equity IRR’s. This commercial model could also theoretically support high gearing levels, though as 2IC is back to generating arbitrage revenues.

Table 16: Financial modelling results for the MNSP Commercial ModelAlternative Case 2 – Basslink Regulated, 2IC MNSP


MNSP / regulated NPV (2016) @7% ($m)2IC 1,662 1,745Basslink 791 843MNSP / regulated NPV (2016) @10% ($m)2IC 827 845Basslink 407 418Other 2IC financial metricsProject IRR 12.7% 12.7%Equity IRR 18.2% 18.0%Debt Fundable Yes YesFinanceable No No

Similarly to Base Case 1, this commercial model provides a significant NPV along with strong project and equity IRR’s. As 2IC’s revenue is again MNSP based, due to the riskiness of cash flows, this model is unlikely to be financeable.


► Though in a similar outcome to Base Case 1 (high NPV’s), this model still relies upon HydroTas supporting the 2IC by providing access to electricity flows at a discount to the prevailing markets at the time in order for the interconnector to generate revenue.

► Without some form of offtake agreement (from HydroTas) or HydroTas participating in some form of ownership structure in 2IC to support it commercially, this model is unlikely to be commercially viable due to the inability of 2IC to generate consistent returns to repay lenders.

3.4.7 Alternative Case 3 – Both Regulated - QuantitativeThe next case considered is a scenario where both Basslink and the second interconnector are operating in regulated commercial models.

Table 17: Key Takeaways – Alternative Case 3


Risk Transfer► Limited revenue risk transfer to asset owners (as

above) as both assets are regulated and not exposed to demand and price risks.


► HydroTas would be free to operate both links as they wish with limited commercial implications.

► However, asset owners are not financially incentivised to optimally maintain and operate the infrastructure (other than through the regulated asset’s minimum requirements).

Energy Security

► Regulated revenues for both interconnectors improves energy security for Tasmania as regulation will underpin the viability of both interconnects, meaning the likelihood of both assets being unavailable would be low.


► Regulated returns on the 2IC will provide a higher level of funding when compared to MNSP’s as cash flows are pre-determined and could be more easily financed.

Financing Costs► With 2IC having reliable cash flows, as long as

they can comfortably meet funding covenants then financing costs would be expected to be competitive with other forms of funding.

Market Appetite► For 2IC to have meet the RIT-T requirements, the

asset will be generating a return to cover funding, returns on funding and operating costs, meaning an increased interest in the assets.

In this instance, neither Basslink nor the second interconnector have viability concerns at the same level as MNSP models as their revenues are determined by the regulator. From a financing perspective, this commercial model structure meets the requirements that most investors would be looking for, namely low risk, bankable revenue profiles, though the tradeoff is risk transfer and utilisation are relatively low.


3.4.8 Alternative Case 3 – Qualitative AnalysisAt the opposite end of risk transfer spectrum to the Base Case options, this commercial model option provides an ongoing regulated return for both Basslink and 2IC. As Graph 6 shows the revenue lines for both interconnectors are stable, only increasing overtime in line with any inflationary impacts.

Graph 6: Alternative case 3 – Basslink and 2IC Regulated

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3.4.9 Key Modelling ResultsTable 18 shows that this commercial model provides improved outcomes in most areas, though as expected the NPV’s and Project IRR’s are not as strong as you would expect to see in outright MNSP operations. The significant benefit of this model though is the regulated revenues that could support the ongoing viability of the interconnectors.

Table 18: Financial modelling results Basslink and 2IC RegulatedAlternative Case 3 – Basslink and 2IC Regulated


Regulated NPV (2016) @7% ($m)2IC 1,152 1,211Basslink 791 843Regulated NPV (2016) @10% ($m)2IC 619 635Basslink 407 418Other 2IC financial metricsProject IRR 9.9% 10.0%Equity IRR 15.0% 15.0%Debt Fundable Yes YesFinanceable Yes Yes

The dual regulated commercial model is able to support a level of funding, and internal rates of return that will attract investors to support the development of a second interconnector. For 2IC, this model would likely be financeable by both debt and equity investors at a relatively low cost of capital.


► The dual regulated commercial model is able to support a level of funding, and internal rates of return that will attract investors to support the development of a second interconnector.

► This model does not address the higher loss factors that Basslink suffers from and may ultimately lead to reduced operational viability as HydroTas by default would want to select the second interconnector for transmission due to lower losses.

► Depending on total flows across both interconnectors may force Basslink to operate as an overflow cable only.

3.5 Detailed results – Hybrid models3.5.1 Hybrid Model 1 - Partially Merchant Commercial

ModelIn contrast to the partially regulated model, a partially merchant model functions in a fundamentally different way. The regulated version attempts to create additional value for investors by creating a floor and providing the opportunity to share in some upside, whereas the merchant version is designed to lower the level of return required to remain viable through some form of government assistance. For example, a government grant towards the capital costs required to deliver a second interconnector, instantly lowers the level of revenues that would need to be generated by the interconnector in order to sustain the viability of this model.

Graph 7: Partially Merchant Commercial Model – Reduction in Transmission Charge

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3.5.2 Key Modelling ResultsWhen compared to the partially regulated model results above, Table 19 highlights that the NPV’s, project and equity IRR’s in this model are lower. On face value the model can also sustain high levels of gearing, though this imposes a higher cost on consumers as the interconnector is still operating in profit maximising mode. As we discuss above, models that ultimately requires market generated returns to recover capital is unlikely to be viable and fundable.


Table 19: Financial Modeling Results - Partially MerchantPartially Merchant ModelScenario Outputs

40y operations 50y operations2IC – NPV(2016) @7% ($m) 662 6972IC - NPV (2016) @10% ($m) 353 363Project IRR 9.9% 10.0%Equity IRR 15.0% 15.0%Debt Fundable Yes YesFinanceable No No


► The interesting take away from this model, is that in a market that could consistently return strong market driven revenues, this would offer considerable appeal over a pure MNSP commercial model by covering the asset owners repayment of capital.

► As the asset would still operates as a MNSP, this model is unlikely to be funded without considerable revenue generation support from HydroTas.

3.5.3 Hybrid Model 2 - Partially Regulated Commercial Model

A partially regulated commercial model is one in which at a minimum, the asset is able to generate a regulated return in order to cover debt, operating and associated deprecation costs that to underpin the viability of the interconnector, whilst still offering the owner of the interconnector an ability to generate some market returns, though the partial sharing of any arbitrage revenue that could be realised.

These commercial models are increasingly popular in Europe and are known as Cap and Floor Models. They earn revenue through the payment of a capacity charge, which is set at a minimum amount of revenue that the interconnector can earn. This means that, if an interconnector does not receive enough revenue from its own operations, its revenue will be ‘topped up’ to the floor level.

The top up payment, in this instance would come from HydroTas, which in turn will recover that sum from transmission charges applied to all users of the NEM. This model also passes on the viability of the interconnector to consumers, who are essentially underwriting the revenue risk to pay for the investment. In circumstances where the interconnector’s revenue exceeds a pre-determined cap, the interconnector will transfer the excess revenue to HydroTas, which in turn will reduce the transmission charges for consumers.

Graph 8: Partially Regulated Commercial Model – Capped Upside (25%)

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3.5.4 Key Modelling ResultsWhen considering Table 20 against the variations of the models already analysed above, it should be clear as to the benefits this type of model provides.

Table 20: Financial Modeling Results - Partially Regulated Partially Regulated Model


2IC – NPV(2016) @7% ($m) 1,314 1,3802IC - NPV (2016) @10% ($m) 695 712Project IRR 11.2% 11.3%Equity IRR 18.1% 18.1%Debt Fundable Yes YesFinanceable Yes Yes

With the benefit of “minimum” ongoing payments due to the floor function of this model, it would likely attract funding should this type of commercial structure become available in Australia.

► The benefits of this model comes in the form of capped higher returns for investors over a traditional regulated model, which will encourage greater investment, whilst providing lower costs to consumers as they are only exposed to a capped upside rather than what may otherwise could occur under MNSP type models.

► For this model to be considered in the Australian context, it would require a significant policy shift to supporting this type of commercial structure, though it does offer improved viability over MNSP models and increased attractiveness for investors over a pure regulated model.

3.6 Conclusion – Commercial AnalysisIn a simplistic view, it would easy to take the key outputs from the qualitative and quantitative analysis and draw conclusions that MNSP scenarios are profitable and would encourage the highest level of investor interest, whilst regulated assets may offer lower costs to consumers and are potentially more suitable to debt funding. The reality is that determining the appropriate commercial model is considerably more difficult.

With MNSP’s (at a high level) offering greater levels of returns, the level of market exposed risk is considerable. To generate their revenue the interconnect would need to rely upon HydroTas making electricity available to the interconnector at a level that is consistently lower than mainland prices so that the asset owner can profit off the price differential to sustain the connection or generate substantial revenues through ancillary services.

The fact that the price differential is very difficult to forecast outright, and that HydroTas is not operating with the profitability of the interconnector in mind, mean the potential revenue streams are highly volatile and difficult to predict.

On the other hand, regulated models by nature are considerably more fundable than MNSP’s purely due to their revenue profile being pre-determined through regulation. Whilst regulating assets provide cost of funding benefits when compared to MNSP’s, they may not always encourage the most efficient use of the assets, nor generate the levels of returns that some investors may require due to the reduction in risk profiles.


The key to the selection of the preferred commercial model is directly related to the outcome that government is seeking in relation to the second interconnector. If the overarching goal is to ensure energy security and to open further renewable generation options within Tasmania then forms of regulated models should support this goal as they can operate without the need to be in profit maximising mode as their return is already determined.

Alternatively, if the goal is to deliver a second interconnector that encourages the greatest level of third party investment in a competitive environment with little concern given to their viability or risk profiles, then MNSP models that offer exposure for asset owners to generate greater returns than regulated models would be preferred, assuming that these revenue streams are consistently available and are attractive for investors considering their risk profile.

In light of these two extremes, the advantages of the hybrid models, and in particular the partially regulated model, looks to offer the benefits of regulation for investors (i.e. lower risk profiles) whilst offering some of the MNSP benefits (i.e. efficient asset operation and potential to share in increased revenues). As with all options, the pros and cons of the range of commercial models are considerable and cannot be considered in isolation.

The analysis indicates that for a second interconnector to be delivered in the current environment, it will more than likely, at least initially need to be supported by some level of regulated return or availability type charge, similar to Basslink or the Cap and Floor models in operation in Europe, in order to attract funding and provide a viable commercial model.


4. Procurement Models

4.1 Procurement considerationsThis section focuses on the range of procurement model options for 2IC. Figure 3 below identifies the considerations which need to be addressed prior to any procurement model decisions. As can be seen, operating models (Section 4) are typically the starting point, before considering the impact of ownership structure which then help form the decision process around procurement model choices.

Figure 3: Decision flow

4.2 Ownership structure – 1 Owner vs 2 OwnerAs section 4 considers the range of commercial models, the next steps in the process is to overlay those decisions with the impact that the ownership structure may have on procurement options. Table 21 contains the range of ownership structures available depending on the number of potential asset owners of both interconnectors.

Table 21: Ownership structures

Ownership Ownership structuresOne Owner (Basslink and 2IC)

State-owned (S) Existing operator (E) New Operator (N)

Two Owners(Basslink / 2IC) S / E E / S S / N N / S E / N N / E

In broad terms, under a one-owner model, interface risks are reduced, commercial complexity is reduced and the flexibility and adaptability in how the asset is operated is increased given the single-ownership and governance structure.


In addition, by controlling both Basslink and 2IC, loss-minimising operational practices can be undertaken by the owner to improve the utilisation of both assets in an efficient manner which may also deliver improved energy security outcomes.

The market modelling under Base Case 1 where both assets are MNSPs assumes that both interconnectors act co-operatively such that the bidding of the two interconnectors maximises the total revenue of the interconnectors. However, from a commercial perspective, this would only be the case where the interconnector is owned by the same owner. Operating model options that have both links exposed to revenue risks (MNSP’s) and have separate ownership structures may impact the commercial viability of the assets. Without regulatory restrictions, sub-optimal market outcomes may eventuate such as:

► Low competitive pricing which creates financial stress for the asset owners

► Pricing is maintained at artificially high levels due to the pricing power of the duopoly

Conversely, under a two-owner model, benefits may include increased price competitiveness, increased opportunity for innovation as well as a diversification of risk through separated ownership and governance structures.

With Basslink being a privately owned MNSP, the Government presumably has minimal levers to compel Basslink to become a regulated asset or consider a change to its commercial model. This represents a key risk to the delivery of 2IC. It is also important to consider that an option to extend the BSA in 2031 for another 15 years exists, though it is unknown at this stage if that option will be executed.

Should Basslink find itself in a less than ideal operating scenario, the options available include:

► Considering applying to the AER for regulated asset status

► Considering a sales process for the asset

► Seeking to renegotiate terms with HydroTas

4.3 Procurement Model OptionsTable 22 below sets out the key procurement models available for this type of asset. In undertaking this assessment, each model has been evaluated against their ability to meet the project objectives. There are a variety of revenue models which might influence the desirability of each approach. The potential delivery models for 2IC, and their relative advantages and disadvantages include:

Table 22: Procurement model optionsProcurement Method Description Advantages Disadvantages

Design & Construct (D&C) and transfer to private sector

Under a D&C and transfer approach, Government would procure the design and construction of 2IC with the D&C provider transferring ownership back to Government / current operator following completion.

► Price certainty and value for money (depending on structure of commercial models)

► Time (to market and to completion)

► Risk management► Flexibility to change


Procurement Method Description Advantages Disadvantages

Design, Build and Maintain (“DBM”)

Under a design, build and maintain model, Government would contract a private entity to design, build and maintain the asset, with operational responsibilities retained by Government.


► Risk management

► Price certainty and value for money

► Flexibility to change

PPP / Build Own Operate Transfer (BOOT)

Under a PPP / BOOT model, a private operator would be contracted to design, build, operate and maintain 2IC, with Government providing revenue to the operator under an availability payment

► Risk management► Price certainty and

value for money


► Flexibility to change

4.4 Procurement SummaryA contestable regulated model (applied for projects with significant capital costs) is likely to enable competitive bids for construction, operations and ownership of the asset

► The regulated asset model is market tested, and competitive for transmission assets

► It could be expected to be delivered with relatively a low cost of capital

► With only 3 HVDC suppliers capable of meeting the technical specifications globally, concern needs to be given to the impact this may have on the competitiveness of the procurement model

► The existing DNSP arrangements in Tasmania and Victoria would be expected to continue for the procurement of required network connection infrastructure for new generation and connection to the existing grid

Should an MNSP commercial model with a capacity charge be the preferred choice, a Build Own Operate Transfer (“BOOT”) delivery model should deliver an optimal outcome


► BOOT transfers majority of construction, maintenance, operations and ownership to the private sector.

► Bidders would compete on what their minimum Capacity Charge is to deliver and operate the asset over the project life

► Maintains strong incentives for the asset owner to ensure the asset is available and maintain and maintain and operate the asset to reduce transmission losses.

► Much like the commercial model analysis, procurement decisions cannot be considered in isolation. Ideal procurement outcomes are a derivative of both the government’s goals and objectives of the second interconnector.

► This analysis also highlights the importance of the level of the need to consider the implication of the one vs. two ownership structure may also have on the procurement and long term viability of two interconnectors.


5. Validation

5.1 Market Sounding ParticipantsAs part of this report, EY undertook a series of market soundings in order to validate the key outcomes for each series of analysis on the various commercial models contained in section 3.

The various market participants included were:

► HydroTas► Clean Energy Finance Corporation► APA Group► Macquarie Bank► AusNet Services► HRL Morrison.

Each participant provided considerable insights into the commercial models, which are summarised in the following sections. The views expressed below are EY’s key takeaways from those discussions and it should not be concluded that they reflect the views on any particular party consulted with.

A widely held view was that clarity in relation to the key objectives for considering a 2IC is a critical prerequisite to making an assessment on the appropriate commercial delivery model. Some provided insights (and expressed strong views in both directions) into why a second interconnect might be required and whether there may be other ways of meeting those objectives. Our focus is however on how the Project might be best delivered, if a decision was taken to proceed with it.

5.1.1 MNSP ValidationIn line with the outcomes of the analysis in section 3, the general feedback from the market participants was that whilst HydroTas continues to operate outside of the ownership structure of the interconnector in Tasmania, MNSP type models (and their variations) are unlikely to be commercially viable.

The market traditionally aims to seek out investment opportunities that contain a risk profile that can be managed in order to generate revenues. As HydroTas isn’t currently operating (nor is it envisaged that this will change) with the viability of the interconnector in mind, for outright asset investors this presents too greater risk. Market participants are unable to manage their market exposure as HydroTas dictates the access to flow and the price that interconnectors must pay.

HydroTas would need to shift its operating position in order to be able to provide greater opportunity for the 2IC interconnector owner to share some of the arbitrage revenue (preferably through an offtake contact with the asset owners) which enables consistent revenue generation to be achieved, underpinning the investment and viability of a second interconnector.

5.1.2 Regulated ValidationIn a similar outcome to the conclusions from section 3, the market participants were in general agreement that when compared to the alternative market exposed commercial models, some form of regulated model structures, or alternatively models that also include minimum payments (transmission charges, availability fees or floor supports) that ensure the ongoing viability of the interconnector are significant risk exposure improvements over outright MNSPs.


The market was quick to point out that the current RIT-T is a challenging test to be met and that 2IC may have trouble meeting the requirements to become regulated. It was the markets’ suggestion that alternatively, should the interconnect not meet the regulation test, then “quasi” regulation in the form of ongoing payments (much like Basslink’s availability charge or the Cap and Floor Model in operation in Europe) could be viable variations to consider.

Given the choice between an MNSP model that has terms dictated by HydroTas versus a regulated commercial model that has an almost guaranteed revenue stream, it was clear that the market believed that in the current environment, regulated structures would provide superior outcomes, if the objective is to deliver a second interconnector.

It was also noted, however, that a considerable re-working of the regulatory arrangements might be required if the second interconnect was to achieve regulated status.

5.2 Case Study Validation5.2.1 Terranora Case StudyTerranora (formerly known as Directlink) is an electricity network asset that spans 63km between Mullumbimby and Bungalora in New South Wales. The interconnector was constructed with the aim of addressing the power shortage in South Queensland, and surplus capacities in New South Wales.

The interconnector has a nominal capacity of 180MW and is owned by a joint venture (JV) between Emmlink Pty Ltd (a wholly owned subsidiary of Country Energy) and HQI Australia Ltd Partnership. The asset was commissioned in December 1999 and started operations in April 2000. At a construction cost of US$70 million, Directlink was the first time that transmission systems of New South Wales and Queensland were linked.

Directlink was originally built to operate as an MNSP market network, trading between the NSW and Queensland region. This meant that the asset earned its revenues based on the spot price differential between the New South Wales and Queensland electricity regions.

However in early 2004, the JV submitted an application to the AER requesting to convert the asset from a market network service to a regulated network service. This stance was taken as the MNSP operation was proving to be unprofitable as the asset was consistently underperforming due to operational issues. In order to support the NEM and provide greater surety in regards to its viability, DirectLink applied to achieve regulated status.

Following the decision to reclassify the asset as a prescribed transmission service (and thereby receiving regulated revenue), the AER determined the Regulatory Asset Base and Maximum Allowed Revenues for the nominal 10 year period.

5.2.2 Murraylink Case StudyMurraylink is an interconnector that provides a corridor for the flow of electricity between the South Australian and Victorian regions of the NEM. The interconnector covers 176 km from Red Cliffs in Victoria to Berri in South Australia and has a limit of 200MW capacity. The interconnector is the world’s longest underground power transmission system and cost in excess of $175 million.

The asset was commissioned in 2002 by Murraylink Transmission (TransÉnergie Australia), a subsidiary of TransÉnergie (the transmission division of Hydro-Québec, Canada). It is now owned by Energy Infrastructure Investments consortium and operated by the APA Group. In early 2013, the Murraylink applied to be treated as regulated asset and agreed adopt 5 year regulatory control period (commencing 1 July 2013 and concluding 30 June 2018).


In a similar vein to Directlink, Murraylink was having considerable issues remaining viable operating as an MNSP and therefore sought to become regulated. Whilst there was considerable concern within government at the time as they “believed the asset owners were prepared to take market risk and therefore should not be supported by the South Australian consumers” the regulator believed that the considerable benefits offered by the interconnector to the overall NEM was worth supporting via regulation.

5.2.3 International PrecedentsIn order to support the ongoing development of electricity interconnectors in the United Kingdom (UK) and mainland Europe, a commercial model is emerging that is designed to underpin the viability of interconnects. In a joint project between National Grid Plc and Elia Group (Belgian) called the Nemo Link, subsea and underground cables are being connected to each country, allowing the flow of electricity between them to occur as demand requires.

In order to ensure the viability of the interconnectors and guarantee security of electricity supply, the interconnectors are being delivered using Cap and Floor commercial models. The floor is the minimum amount of revenue that an electricity interconnector can earn. If an interconnector does not earn enough revenue from its operations, its revenue will be topped up to a minimum ‘floor’ payment (funds transferred from the system operator, which is then recovered from transmission charges applied to all users of the electricity transmission system).

The cap is the maximum amount of revenue for an electricity interconnector. Should an interconnector’s revenue exceed the cap, the interconnector then transfer’s excess revenues back to the system operator, which is used to reduce transmission charges. The cap on revenues provides benefits in return for their exposure in managing the floor price. For the interconnectors, it supports an investment route to underpin viability.

Figure 4: NEMO Link Project: European Cap and Floor Interconnectors

The cap and floor model is designed to encourage greater investment into electricity interconnectors as they are structured to strike a balance between commercial incentives and risk mitigation to enable predictable revenue streams to support development.


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