Is it the government’s job to make the energy sector less risky?
The art of government is always about balancing between competing objectives. One of the balancing acts in the near future will be deciding whether and how to manage energy risk. Forces ranging from technology change to public expectations are introducing new risks into the energy market. Because higher risk translates to higher costs, the question inevitably arises – should government play a role in reducing the risk of new energy investments?
Analyzing recent trends, the International Energy Agency recently said, “Whichever way you look, we are storing up risks for the future.” They were referring to observed reductions in capital spending on conventional power facilities, combined with apparent under-investment in clean energy technology. Although each region is different, these are worrisome global trends. (See “Power sector got most investment worldwide,” elsewhere this issue in international news.)
As discussed in virtually every energy forum in recent years, the continual invention of cheaper and cleaner generation technology is challenging for any developer or investor who needs to raise long term funds for any project using current technology. Similarly, the advent of Distributed Energy Resources and micro-grids create new risks for wholesale markets. Innovation itself creates risk as explored in the 2018 editorial “How innovation impacts the financing of new projects.” Add to this, the business risk associated with carbon policy, which has whipsawed from one approach to another as governments change. Other types of policy change can push up risk and costs. For example, Hydro One shareholders recently endured a $100 million penalty when a US regulator cancelled a planned acquisition, saying that the risk of political intervention in Ontario was too high.
Suffice it to say that anyone in the power business is now assessing if not internalizing a wider range of risks than ever before. Risk premiums must be built into new power projects. This is a normal and necessary response by business. However, government may take a different perspective. It may see those risk premiums as unnecessary additions to consumer costs, and possibly an area for policy action.
While experience has demonstrated that government is generally not well equipped to make specific investment choices, it must inevitably make choices that determine investment conditions. There are some examples where government policy has stabilized investment conditions enough to increase supply or reduce costs or both. Arguably many of these public policies have reduced consumer costs without adversely affecting the market. Yet on the other hand, too much government intervention increases perceived risks, and may have the opposite effect.
Government-driven risk reduction is not an either/or question. Well-established government mechanisms, from regulation to facilitating clusters of innovation, to review of business plans, will continue to reduce risk. The operative question of the day is more nuanced: Given the new risks that didn’t exist previously, should government take additional steps to reduce risk, consistent of course with respecting the integrity of market functions?
In historic terms we appear to be in the early stages of a shift towards energy supply projects that have shorter lead times and shorter amortization periods. This is an indicator of how markets are dealing with increasing risk. Government does have options that will reduce risk and cost, sometimes as aggressive as encouraging supply, and sometimes as subtle as refraining from taking action. Regulators can assist in developing and implementing appropriate risk reduction strategies in the interest of cost control.
Comprehensive energy planning is widely used as a means of reducing risk. When properly developed, multi-stakeholder energy plans can help to focus attention, attract capital, assist with policy co-ordination, reduce duplicative efforts, and simplify later approval processes. Although planners must avoid being overly prescriptive, this kind of risk reduction can lessen costs significantly over time.
If governments can find further ways of reducing risk while preserving market functions, the IEA may be prepared to reconsider its warnings. It will be interesting to see where provincial governments across Canada, many of which are new, fiscally conservative, and responsible for provincial power policy, land on this question of how far to go in moderating risk in the power sector. Decisions may expose tension between conservative principles and populist tendencies. However it’s not unreasonable to suggest that those policies that actually reduce costs over time should win out. Remaining silent and undecided is literally leaving money on the table. Taking action on the other hand, requires establishing a principled approach that could shape legacies and affect the leader in question for his or her entire political career. Important choices lie ahead.
— Jake Brooks, Editor