Energy Companies to Provide the Impetus for Australian Corporate Bond Market
Updated: May 2, 2018
Written by Michael McAlary and Geoff Watkins
The lack of depth in the domestic corporate bond market has been the subject of much discussion and research. Different studies have advocated a range of steps aimed at creating the right business and taxation environment for a liquid corporate bond market. Ironically, it may be the regulatory activities of the Australian Energy Regulator (AER) and Economic Regulation Authority of Western Australia (ERAWA) that provide the necessary extra incentive beyond any steps that Federal Treasury takes that help in building a deep and sustainable corporate bond market.
Regulated energy networks in Australia are in a special situation compared to other infrastructure or industrial corporates. The AER and ERAWA have provided a revenue allowance for a regulated energy company’s cost of debt. This allowance is determined by the interest rate on corporate debt, so a regulated energy company is in a position to minimise interest rate risk in a way not available to other corporates. In the past this allowance was a rough approximation to their actual financing cost; however with the new regulations there can be a much closer matching of cost and revenue.
Now the revenue allowance is based on gradual annual measurements of the 10-year bond rate for broad BBB rated AUD debt, whereas in the past it was set once every five years at the rate current at that time. Over the next 10 years there will be a transitioning to these new measurements, so the practicalities are just beginning to impact the profit (or loss) of energy companies.
The shift of regulatory calculations comes at an interesting time in debt market conditions. Over the past few years the network companies have regularly been seen raising significant amounts from bilateral or syndicated bank loans, which are typically 3-year to 5-year terms. With banks globally being flush of cash and long term bond investors harder to find, the preference for bank debt was not surprising. In this new banking regulatory world the cost/risk trade-off has shifted. Now the network companies need more 10-year debt to minimise their risk. New capital costs and bank risk practices are unlikely to see the banks prepared to offer 10-year loans to the network companies. On the other hand, higher charges for risk and capital costs on cross currency swaps is making foreign currency bond markets, including the regularly-tapped US Private Placement market, more expensive in final AUD terms.
With the collapse in energy asset prices and energy supply outstripping demand, the new energy network regulatory regime and new banking regulations should result in network companies more keenly seeking to remove interest rate risk. The natural place for energy companies to turn for debt management issuances will be the long-term domestic bond market. A strong and viable local corporate bond market is a necessary element of a diverse international financial services sector and this is an outcome that the Federal government, business, financial services practitioners and investors are seeking.
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