AGL eyes the future, crunches numbers on fossil fuel split

AGL’s new boss is due to unveil a strategic update in the Hunter Valley next week. Staff have been crunching numbers on splitting off its fossil generators. At the very least, writedowns are expected, along with a clearer vision for solar and storage.

When Johannes Teyssen announced last year that E.ON, Europe’s biggest energy utility, was going to spin off its centralised fossil fuel assets, he made it clear that he had no choice.

“We are convinced that it’s necessary to respond to dramatically altered global energy markets, technical innovation, and more diverse customer expectations with a bold new beginning,” Teyssen said. “E.ON’s existing broad business model can no longer properly address these new challenges.”

So, E.ON decided to split its assets along the lines of the old and the new, the dirty and the clean, from in front of the meter to behind the meter, and from the past to the future. Others, such as its big European rivals RWE and Vattenfall, are considering similar moves.

NRG, the biggest privately owned utility in the US, has also declared the future will reside in distributed generation – solar, storage, electric vehicles and micro-grids – rather than the centralised model that has dominated for more than a century.

Next Tuesday, Australia will get an idea of how quickly Australia utilities will follow down the same path. AGL Energy is scheduled to hold a major strategy meeting, inviting several dozen analysts and institutional investors to the Crowne resort in the Hunter Valley to hear new CEO Andrew Vesey’s vision for the future.

That, and the future of other utilities such as Origin Energy and EnergyAustralia, is under closer scrutiny following the release of the Tesla Powerwall, with its cut in prices, market hype, and promises of a 100 per cent renewable future.

Even before it has delivered its first product, Tesla has accelerated the timetable for battery storage by as much as five years, forcing utilities such as AGL Energy to fast-track their own push into the home storage market.

The question for Vesey is how quickly AGL will go down the path of its international peers? Already Vesey already has gained headlines by putting a “use-by” date on its recently purchase coal-fired generators, and has challenged its New Energy division to become the main competitors of the incumbent business. It has given the division equal billing within the company’s new hierarchy.

But just how far will Vesey go? He was hired because of his eye for solar and storage, having worked with AES, the US utility that has made the biggest inroads into the battery storage market.

Will AGL Energy – finding itself in a market that, because of its high prices, excellent solar and tariff structure, puts it at the cutting edge of the battery storage revolution – follow in the path of E.ON? Or will it adopt the RWE and NRG model and hedge its bets into the future.

It is known that in Vesey’s first 90 days in charge, AGL staff have been crunching the numbers on how a split along the lines of E.ON might add up, although it is thought that right now the numbers don’t. There is probably still too much money to be made from the incumbent – and in the case of coal – its recently purchase assets.

Under the vertically integrated model adopted by the big three retailers, the retailing part of the operation acts as a counter-point, or a hedge, to their fleet of wholesale generators.

That has worked fine until now. It has provided solid growth and their market power has kept out competitors. But the new technologies, particularly rooftop solar, battery storage and energy efficiency devices, mean that business model may be cannibalised from within; their own consumers are emerging as their major competitors.

It’s not just the hardware, it is new software that will allow consumers to trade amongst themselves and with the grid, putting them in direct competition with the centralised generators.

E.ON decided that the conflict between the two was too great to be able to manage each business to its maximum. Vesey’s big call in his tenure at AGL Energy will be to decide if and when to make that break.

The reasons against putting the fossil fuel generators into a separate company include their exposure to variable cash flows, and therefore potentially higher debt costs. And it exposes them to fossil fuel divestment issues – placing all the fossil fuel generators into a single listed entity may narrow the investment options.

At the very least, it seems most likely that AGL will have to take write-downs on some of its assets, its gas generators in particular.

The key reason for that is that battery storage will not just remove much of the need for peaking gas generators, it will also lower the average wholesale prices for electricity generation.

Morgan Stanley says that if its forecasts are right, then new household and commercial renewables of 600-800MW per annum, with battery firming, could replace any major baseload plant shut-downs, e.g. Mt Piper (1,400MW) or Vales Point (1,320MW) by the 2020s.

It says that if battery capacity reaches 10 per cent of NEM generation capacity, that will replace the need for much of the gas-fired peaking plant installed today.

AGL has already said it it will mothball more than one-third of the capacity of its 1,280MW Torrens Island power station in Adelaide in 2017, just 10 years after it bought the ageing natural gas plant for $417 million. Its peers have already written down the value of their gas generators.

The future of its Liddell coal plant in NSW will also be under scrutiny, although it is tied with the Tomago aluminium smelter, and it was bought for effectively zero under its deal with the NSW government.

Morgan Stanley says the impact of solar and storage could shave $100 million off the earnings of both AGL Energy and Origin Energy by 2020. That provides an imperative to act. But Vesey faces a bunch of challenges – in changing an old business model, fending off new players, and dealing with reputational issues arising from its opposition to the renewable energy target and coal seam gas activities.