Big utilities stall on wind and solar, despite the economics

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Most of the major “gen-tailers” in Australia have hit the pause button on renewables, hiding behind Coalition policy. It will likely turn out to be a bad idea.

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 “Simplicity in planning fosters energy in execution.

Strong determination in carrying through a simple idea is the surest route to success.

The winning simplicity we seek, the simplicity of genius, is the result of intense mental engagement.” Clausewitz

It seems clear to us that Australia’s biggest gen-tailers – the utilities that dominate both electricity generation and retail – won’t decarbonise their portfolios any faster than policy makes them – despite the favourable economics.

Over the past year, as part of the Energy Insiders podcast team, we’ve spoken with all the key players. They include:

Brett Redman, the CEO of AGL; Greg Jarvis, the head of markets at Origin; Mark Collette, the head of markets at EnergyAustralia; Jeff Dimery, the CEO at Alinta; Gordon Wymer, the head of commercial at Snowy Hydro; and Jon Stretch, the CEO at ERM.

Collectively, this group are the energy establishment as far as generation and retailing go. Four of the group represent companies owning the vast majority of non government coal generation, most of the gas generation fleet and, including Snowy, the vast majority of the non Tasmanian hydro fleet.

We never expect these people to reveal their deepest plans and we also expect that – to an extent – the messages are tailored to the perceived audience.

In addition to the interviews there are numerous conference presentations, annual result conference calls and actual announcements to build up a sense of “things”.

But here’s the remarkable point: Only one management team has a specific goal of increasing its renewable energy under contract beyond what’s already announced.

Yet every one of the executives we’ve spoken to on the list above makes the same observations: namely, that new wind and solar have a lower required price to earn cost of capital than any other form of generation.

True, cost is far from everything, price matters just as much. The most valuable product is often not the cheapest. Still, if wind and solar have lower LCOEs [levelised cost of energy] than competing technologies then it makes sense for a system planner to use as much as possible.

And yet the energy establishment has clearly – on balance and on average – hit the pause button on VRE (variable renewable energy) development.

ITK’s back of the envelope run-through of our project data base produced the following table:

Gentailer VRE commitments
Figure 1: Gentailer VRE commitments. source: Company, ITK

The first point to note is that – other than Alinta – nothing much has been announced this calendar year, and in the case of AGL, Origin (ORG) and EnergyAustralia, nothing since 2017.

Equally and notwithstanding some PPAs (power purchase agreements) and assets held prior to 2017, EnergyAustralia clearly hasn’t committed to much in total. In the end we think it will be their loss. They are dealing themselves out of the market.

Only Alinta, to our knowledge, has an unmet published target and that has been raised to 1500MW, as we report exclusively from this week’s Energy Insiders podcast. AGL has mentioned 1GW, but not recently, Snowy had an 800 MW target which it says it has met with 880MW, and at stunningly low benchmarks too.

The total of projects financed via PPAs or owned and developed by the big six is less than 50% of the total new investment made in Australia, so it’s a loss of market share considering their starting point in generation.

Note that ERM is really strictly a retailer, with a sweetheart energy deal with is half sister Sunset Power. So it can’t be expected to do much generation investment even if it had a balance sheet (which it doesn’t).

In addition, the big guys have seen about 9 TWh or 4.5% of the total NEM electricity energy market go to behind the meter (via rooftop solar PV). Origin has been notable in reporting the impact.

That share of rooftop solar will surely increase. Although 5% may not sound much, it’s essentially all coming out of the historically profitable household market where margins might be say $20/MWh compared to $4/MWh in big business.

For the industry, that 9TWh is about $200 million per year of lost gross margin.  Cumulative energy efficiency would represent another $200m of lost margin per year.

The good news for Gentailers is that the Victorian and Federal Govt default price plans essentially reduce the incentive to be efficient, and reduce the incentive to put in behind the meter solar. But that probably won’t make much difference.

On another level, market development is going too fast for regulators but it’s also going too fast for the big gentailers.

AGL for instance has spent a ton of money in recent years. Redman said on the AGL conference call:

Where we’re just coming off the back of having invested hundreds of millions of dollars, that AUD 450 million in total in system development. We’re factoring in the structural benefits of those changes, but activity level change, a big shift is not necessarily in the outlook.”  P17 AGL raw conference call transcript

Even for a company of AGL’s size, $450m is a big systems development spend (includes $177m in FY19 alone), and if some of that spend is based around one assumption – acquiring and keeping customers – and then the rules are changed, then some of the spend might be wasted. This is another headwind to Gentailers from the Victorian and Federal Govt’s default price “laziness reward”.

Equally, systems development costs for the 5 minute settlement  market, to compete in demand response and to compete in new grid services (FCAS, fast frequency response) will be large and without any clear view of how this will lead to a return.

Open cycle and combined cycle gas plants are expected to struggle in the 5 minute market and, other than transmission access, the big gentailers have zero comparative advantage in the short term trading market where batteries are likely to emerge as the most economic way to trade.

The rewards in this market will go to owners of the smartest trading software. Since you don’t need much to own a battery it’s likely competition will be fair and excess returns small once things settle down.

Nor do you find the big coal generators particularly supportive of new transmission. Some of the least enthusiastic comments about the ESB driven rule changes that speed up the tortuous RIT process came from the likes of Sunset Power.

Dispatchable generation is going to lose lots of market share

AGL and EA in particular, but also ORG have a wish list of dispatchable energy projects represented as pins on a map.

These include gas, pumped hydro and in some cases batteries. A wish list is not a strategy, far less a committed plan. Moreover focusing only on dispatchable energy will clearly lead to a massive loss of market share.

Five years ago wind and solar were less than 5% of NEM energy today they are 15% by 2030 probably over 50%. Studies show that wind alone can provide 70% or so of NEM energy requirements over the average year. Add in solar and not much is left for the vital but small component of dispatchable power.

The least talked about but most likely reason for AGL keeping Liddell open another 9 months is it helps AGL profits that year. Similarly, ORG needs to replace Eraring earnings.

An example of how to do it is provided by Nextera, in our view by far the World’s most successful utility with 15 year EPS compound annual growth rate of 78%, its ten-year share price up 380%, market cap going from $12 bn in 2003 to $95 bn in 2019.

There are many reasons for its success but the main one is investment in wind and solar, where its gone from 1.7 GW of wind in 2002 to a management estimated 23 GW by 2022. Solar from zero in 2009 to over 10 GW by 2022 and battery storage from zero to management estimate of 1.75 GW by 2022.

Nextera committed and made it work. They also invested in transmission. We see room for AGL, ORG and EA to get into transmission and see it as potentially a great way to deploy capital

Transmission could lower prices and increase reliability

To digress for one moment, we note that the Federal Govt says its policies are aimed at reducing prices and is concerned about reliability.  There is clear evidence that new transmission would reduce prices. Do we see any support for the ISP or the Coag Energy Council from the Federal Govt? We do not.

Just on the price reducing benefits of new transmission. Jeremy Tustin, executive director at Acil Allen, presented on the impact of the “Energy Connect” – the proposed South Australia- NSW connector – last week.  Acil’s estimate s of the benefits was substantially larger than presented in the RIT.

Figure 2. Source: ACIL Allen, presentation to Spencer Gulf conference August 2019.

These are decent savings that the Federal Govt could support if it really cared about customers and not just its mates in the coal industry.

There are a variety of other transmission projects where basically, in ITK’s opinion there are either price or reliability benefits or both. IF the Federal Govt cared it could take on board all the work done by the industry, in recognizing the transmission build benefits and do something to speed it up.

But it doesn’t. The Federal Govt sits on its hands despite its hand picked body the ESB telling everyone that more transmission is needed and it should be prefunded. Unfortunately, so few people in the mainstream media have even the most remote clue about these issues and they never ask the Government to comment.

Running round the companies.

AGL

AGL has  basically done  its new VRE (wind & solar) through PARF an off balance sheet vehicle owned by QIC and AGL. AGL owns 20% only.  PARF hasn’t announced any new contracts since Coopers Gap in 2017.

And there is no suggestion that PARF is going to grow. AGL is doing a share buyback. Investors like buybacks but equally they signal management can’t find an investment with a better return than that on the company’s existing assets.

At it latest results conference call  AGL said any new contracts would be for short term PPAs. Short term PPAs are not as good as long term PPAs and we take it as a signal that AGL isn’t interested in the space.

My sense is that  AGL is trying to wind back Andy Vesey’s strategy as quietly as it can without annoying either its stakeholders (increasing numbers of shareholders won’t invest in carbon intensive generators) or its employees.

The senior management team has been greatly changed since Brett took over.  We have sympathy for AGL and its easy to understand why it might give up on electricity just as it has more or less given up or scaled back in gas retailing.

The Federal and Victorian Goverments are determined to tax large gentailers as hard as they can. Large gentailers are blamed for high electricity prices and high electricity prices are taken as a sign of exploitation by gentailers rather than a natural outcome of markets functioning properly.

Mainteance capex in in the coal plants rolls on at $350m per year pretty much $9-$10 MWh. Bayswater/Liddell has close to $1 bn of that  clean up liability when the plants do close. I can just see Trevor St Baker with his massive balance sheet buying 50% of that liability. Unfortunately, AGL no longer publishes a separate sustainability report and the NPV of the environmental clean up is shown at $350m.

Origin

ORG has committed to 1200MW of new VRE since March 2016, but hasn’t announced any new contracts since taking a small part of Crudine Wind farm for Sydney Airport. It’s announced nothing new in 2018 or 2019 year to date.

We suspect that they don’t see a return on capital high enough for their shareholders. In addition, there is the perpetual issue of VRE displacing gas in QLD, Victoria and South Australia.

Stockyard Hill was a great PPA for ORG from an asset that was a decade in the making. But there is no sign of the next one. ORG faces essentially all the same issues as AGL  and is more impacted by price regulation. For us ,ORG has yet to identify its long term role in the Australian electricity industry. Is it a retailer? A generator?

EnergyAustralia

In our view EA is making haste as slowly as possible on VRE.

Like AGL, ORG and Snowy it would actually like to build a new gas plant if only the investment signal was there.

All these big gentailers see less competition in gas than in wind or solar, but equally that high gas prices mean they are the first fuel substituted when the wind is blowing or the sun is shining, and – guess what – that’s a lot of the time. Nothing hurts a good investment case like a bad capacity factor or a high fuel cost.

Of all the big three, in some ways EA might be the best suited for a land grab or roll up strategy in VRE.

In NSW, it’s got a decent customer base and Mt Piper is quite well suited to a firming role. Nothing coming from the company indicates that this is even a remote possibility though. EA seems to just want to hang on, with no clear growth strategy. Yallourn, meanwhile, faces ever increasing volume and performance pressure and Mt Piper’s coal supply options are unexciting.

We note that from Cultana to Genex/Kidston and its battery investment in Victoria, that EA has worked hard on developing options. The Genex/Kidston pumped hydro project does include a large solar farm and perhaps even a large wind farm. Still, this project has still yet to hit FID (financial close) and still is far short of a comprehensive long term strategy of how to remain relevant in a VRE dominated market.

Alinta

Alinta has a can do strategy and is far more growth oriented than any of the other companies discussed here with the possible exception of Snowy. Alinta was proactive in its Loy Yang B turbine upgrades and completed one unit giving a 40MW improvement in about 6 weeks.

LYB unit 2 lifts output by 40 MW following upgrade
Figure 3: LYB unit 2 lifts output by 40 MW following upgrade. Source: NEM Review

Jeff Dimery noted that Alinta has raised its target across Australia for controlled (owned or under PPA) VRE from 1000 to 1500MW. More announcements have been indicated for the balance of this calendar year.

At the same time Alinta would happily buy Liddell if it could be had at the right price. Alinta is kind of the Queensland of the industry backing both fossil fuels and renewables at once.  Finally, Alinta has a significant West Australian business, and a significant off grid West Australian business at that. The economics of firmed VRE are particularly competitive in the off-grid market.

Snowy

Snowy has signed up 880 MW of long term (20-25 year) PPA with 8 separate projects. Of those about 4 projects have reached financial close. One of the points Gordon Wymer made in his podcast (although he didn’t say it in so many words) is that a bank wanting to get on the Snowy 2 syndicate would have a better chance if it was financing one of the 8 projects that Snowy has contracted with.

Still as far as Snowy goes 880 MW is the end of the line for now, and that’s despite the FY18 RET shortfall. Snowy like everyone else would like to put a new gas peaker in if that could be made to work. Actual announcements of new gas peakers though are scarcer than those for new VRE. Bottom line don’t look to Snowy for more just now.

ERM

ERM is primarily a retailer, its expertise is really in software and its balance sheet is very, very modest by the standards of the companies in this note. Still, like everyone else, it’s not reported any new deals in some time.

Comment: Thermal generators are threatened by lower cost VRE

Historically the large gentailers employed a strategy of going slow on new VRE by only contracting sufficient for their mass market customers. They left the 55% or so of liable non mass market volume customers to fend for themselves.

As the industrials and large commercials had no electricity expertise they were slow to get moving. Equally, it took time for VRE developers to find the gap in the market.

This forced up the price of LGCs to a level where the prevailing wisdom was if you could get a plant built in 12-18 months, get say $80 an LGC and $80 for your energy produced you could make a big dent in paying back capital costs in just a couple of years.

And so there was a rush of new developments. Not just VRE projects but market developments. The big gentailers have to some extent been disintermediated . That is they have lost market share either to smaller retailers or to the direct PPA market.

The rush of new VRE development showed what a disgraceful job AEMO and the AEMC had done preparing for the change by upgrading rules and building new transmission. All the work that should have been done before the VRE build, and now it ha to be done on the fly, raising costs and reliability concerns simply because of bad rules and inadequate planning.

Here at ITK we didn’t forecast the MLF issue but we and others certainly forecast that there would be transmission difficulties and it is just inexcusable that AEMO and the AEMC didn’t get this sorted ahead of time.

The big gentailers eventually realized there was lots of investment taking place and that VRE economics had rapidly improved, so, perhaps reluctantly they’ve played a part.

Nevertheless, the six companies covered here in the end haven’t held anything like their share of retailer or thermal energy in the VRE market.

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