Australian Treasurer Scott Morrison has blocked both Chinese companies bidding for a 50.4% share of the lease to operate New South Wales electricity distributor, Ausgrid.

Morrison said the decision was taken on national security grounds.

Somewhat ominously, Morrison's media release only refers to a 'review process' having identified critical power and communications services that Ausgrid provides, and no suitable mitigation measures available for the risks that arise.  

But which part of the review process killed the deal? Was it advice from Foreign Investment Review Board (FIRB)? The National Security Committee? Or was it advice from xenophobes within his own party or others in the Senate?

First impressions are that. in terms of the state of Australia-China relations, this one will hurt.

When the Chinese bid for S Kidman and Co was blocked earlier this year, it could be seen as a one-off.  Kidman's assets were at least unique in some sense, accounting for 2% of Australia's agricultural land mass.

But what makes Ausgrid so unique? 

State Grid, the Chinese state-owned company bidding for Ausgrid, received approval to acquire South Australian electricity distribution assets in 2012.  It was then approved to buy Victorian electricity distribution assets in 2013. These investments were both judged to be in the national interest.

And then last year State Grid was cleared by the FIRB to purchase the lease to operate Transgrid's New South Wales electricity distribution and telecommunications assets.  Ausgrid's telecommunications assets are meagre in comparison and the NSW government was also retaining a 49.6% share.

Then there was the decision by the Philippine government to allow State Grid to be the single largest owner of the company that runs the country's electricity grid. It's managed to live with that decision, even while locked in a territorial dispute with China in the South China Sea. It is almost unfathomable that an Australian government should be more sensitive to security risks from Chinese investment than the government of the Philippines.

Remember, this was a lease.

The seller of a lease sets the rules around how the asset can be operated. And if those rules get broken, the lease can be terminated and the owner gets to step back in. The lease set out by the NSW government for Ausgrid would almost certainly have included detailed provisions around providing a stable supply of electricity, as well as covering other issues like data security. 

And in case the NSW government wasn't paying attention, the Commonwealth government would have checked the terms of the lease via the FIRB and imposed additional safeguards if it saw fit.

That's what happened last year when the NSW government approved State Grid to purchase the lease to operate Transgrid's assets.

In giving his final approval last November for Transgrid's sale to a rival bidder than offered more money, Treasurer Morrison said that the safeguards imposed ensured that the national interest was protected.

But now in the case of Ausgrid we are expected to believe that no suitable safeguards were available. 

The Chinese will have every right to feel disappointed. In 2012 the Australian and Chinese governments signed a memorandum of understanding to strengthen cooperation on delivering infrastructure. 

Australian federal and state political leaders have been running continual investment roadshows throughout China talking up these assets. And yet when Chinese companies do stump up the cash — more cash than domestic investors or those from other countries are willing to put on the table — they get knocked back.

The Chinese will also be confused. What hurdles will they face next time?  In the eyes of Chinese investors, the sovereign risk of investing in Australia must surely have just jumped.

Even worse are the implications for NSW. Remember, these assets are owned by NSW taxpayers and the Baird government has a mandate to lease them to raise funds for new infrastructure construction.

The sale of Transrid last year produced a bonanza that funded a whole range of new projects and delivered thousands of new construction jobs. NSW has by far the lowest unemployment rate of any state. But the pipeline of funding has now dried up. Premier Mike Baird will no doubt be hoping to sell the assets to another bidder but the fact only Chinese companies made the short list back in March suggests that he will have to accept a significantly lower price.

Further, would selling them to, say, a Japanese investor really solve the problem? If there are genuine national security risks from foreign investment in these assets, surely the Treasurer could not seriously contemplate their sale to investors from any country.  

One final thing to be clear on: unless all foreign investors are barred from buying these assets, it cannot be said that the decision was driven by public opinion. It is true that the public are not supportive of foreign investment in infrastructure. But academic research clearly shows that the objection of the Australian public is with respect to foreign investment generally, not Chinese investment specifically.

The outlook for Australia-China economic relations is more clouded than in a long time. Don't expect a rash response from the Chinese. But any special status that Australia enjoyed in the eyes of the Chinese government and investors, which led to the signing of the historic FTA in 2015, is evaporating fast.

Photo courtesy of Flickr user Leonora Enking