Business Opinion: The news that a second stake in Tynagh Energy may change hands before the Co Galway power station generates a single watt of electricity only confirms the view that its original owners hit something of a jackpot.
There was considerable surprise in November 2003 when it was announced that Tynagh Energy were preferred bidders in the competition run by the Commission for Energy Regulation (CER) to build a 400 megawatt gas powered station. Tynagh was 20 per cent owned by a company called Mountside which was associated with a relatively unknown Navan-based beef processor Mr Martin Blake. The other members of the consortium were the Turkish construction company Gama and the South African investment bank Investec, with 40 per cent each.
Tynagh saw off very significant competition from the likes of Scottish and Southern Electricity. Viridian and AES Electric were also in the frame.
In August last year Gama bought out Investec. The price and structure of the deal was not disclosed, but some idea of the value could be gleaned from the announcement the following month that Tynagh has signed a deal with the German energy group RWE. The deal - which would involve RWE operating the station - could generate revenues of up to €1 billion over its 10 year life - according to Tynagh.
Last week it was reported - in this paper - that Gama are now looking to offload some of their stake in Tynagh, with a value of €120 million being suggested for a 40 per cent interest. But it's not inconceivable that the entire Gama stake could be sold as many industry players may require majority control. The entire business is valued at around €300 million, which represents quite a premium over the assets which were put at just under €120 million in the 2004 accounts.
The explanation for why an electricity plant that is only half built can command such sums is simple. Tynagh Energy has a 10 year fixed price contract to sell its output to the ESB. The terms of the contract are not disclosed but are clearly very attractive, hence the appeal of Tynagh Energy.
Tynagh's contract with the ESB and a smaller one agreed between the ESB and Aughinish Alumina are reportedly worth €1.5 billion. Given that Tynagh's plant is around three times the size of Aughinish's it seems reasonable to assume that the contract is worth north of €1 billion.
The value of the company is presumably the discounted value of the income from the contract plus what ever upside the prospective buyer might see at the end of the contract. Given that it will be one of the most modern and efficient in Ireland the upside is significant.
To understand how the State - in the form of the CER - gave Tynagh what appears to be something of a licence to print money you have to go back to 2002 when there was a very real prospect of the economy's demand for electricity outstripping the generating capacity of the industry, dominated by the ESB.
In order to address the problems the CER hit on the idea of offering fixed contracts to incoming players. This would remove much of the risk involved in investing in a new power plant, which had up to that proved a significant disincentive to international and domestic players considering entering the market. The main source of risk was the dominance of the state owned monopoly, which meant that any new entrant would have to fight very hard to win customers.
The fixed contracts solved this problem, but it is a badly flawed approach. The first issue is that that judging from the corporate activity in Tynagh, there was plenty, if not to much fat, in the contracts. The fact that the negotiations with the ESB went right down to the wire, implies that it was not entirely happy with the deal engineered by the electricity regulator.
All of this in turn implies that the ESB may be locked into a contract that involves it potentially overpaying for electricity. And if this is the case, then ultimately this will be passed onto customers.
Clearly the fixed contract approach is unsustainable and taken to its logical conclusion could result in the ESB being locked into dozens of financially disadvantaged contracts that do little more than line the pockets of power plant investors. Meanwhile electricity prices will continue to rise.
Thankfully, the approach has been superseded by plans for an all-Ireland electricity market in 2007 that will involve capacity payments and other mechanisms to reduce the risk involved in investing in new plant.
Unfortunately, this initiative is being driven - on this side of the border - by the CER, the same people who failed to encourage any significant investment prior to 2003 and then came up with the botched strategy that was fixed price contracts.
