FEBRUARY 2023 – ISSUE 12
The Energy Market
The Unintended Consequences of Government Intervention
How should investors assess
market intervention by governments?
It’s a perennial challenge as governments strive for a balance between the growth and competition offered by free markets and the social and environmental outcomes desired by society.
Federal government price caps, imposed on east coast gas and coal markets late last year, have put the issue firmly back in the national discourse.
The details of the price cap policy are simple enough, and the government’s intent is commendable — there’s no argument from us that high energy prices crimp economic activity.
But history shows this kind of intervention simply does not work.
For twelve months, anyone entering a new wholesale gas supply contract must not charge more than $12 a gigajoule, compared to the $20-plus price available on spot markets. For coal, the cap is $125 a tonne compared to $350/tonne available on the open market. Following the twelve-month cap, an ongoing requirement to provide ‘reasonable prices’ will cover contracting behaviour.
History shows that price caps limit market efficiency by reducing the incentives for companies to invest and increase supply, ultimately leading to suboptimal outcomes.
In fact, by slowing investment in the energy sector, the price caps are likely to drive prices higher.
This counterintuitive outcome is due to producers reassessing their investment plans under the new regime.
BHP and Woodside have already flagged that an immediate reduction in profit margins for energy producers is materially impacting the profitability and potential future life of their existing operations.
In our view, it is unlikely that any new investment will be sanctioned until producers have long-term visibility over the policy framework. Capital invested in gas and coal production facilities and export infrastructure is significant and made over a very long-term time horizon of 20-plus years. Still, the government’s new regulations have only been in place for twelve months.
This does not mean investment will not return.
Even if maintained, the current price caps allow for an adequate return on capital.
Investment is also likely to be incentivised by the sunset nature of the coal and gas industry, where producers must invest in their existing project pipeline or risk losing any remaining value in their undeveloped asset bases as customers move away from purchasing fossil fuels.
Nonetheless, the important thing for investors to understand is that it is not the level of the price cap itself that is the issue — it is the uncertainty created by the potential for new price caps and further intervention.
These are complex issues that require careful consideration.
At Platypus Asset Management, we agree with the intention of lowering energy prices for consumers.
The consequences of these policies however must be carefully weighed to ensure that they do not negatively impact the longer-term future of the energy industry.
It is our strong view that key enablers for new investment into the sector and, in turn, lower prices for consumers will be long-term fiscal stable with a more supportive regulatory backdrop. An alternative and more desirable path to cheaper energy would be to fast-tracking permits to incentivise new investment.
For investors, this is not an abstract issue. The uncertainty faced by energy producers is also faced by equity investors — and Platypus is cognisant of the predicament for both.
“History shows that price caps limit market efficiency by reducing the incentives for companies to invest and increase supply, ultimately leading to suboptimal outcomes.”
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