EnergyAustralia calls the Piper and heads back to the trenches

Despite the 60 MW capacity upgrade at Mt Piper, EnergyAustralia is struggling

Last month, the parent company of gentailer EnergyAustralia, the Hong-Kong listed CLP, announced a goodwill writeoff and profit downgrade for its Australian subsidiary.

In summary the goodwill on the Australian business of $HW15 billion is to be written down by $HK6 billion to $HK7 billion. It also revealed that in the current calendar year, there has been lower electricity supply from Mt Piper in NSW due to coal availability and maintenance (forced outages) at Yallourn in Victoria.

The increase in wholesale prices as seen in the June half will also result in some negative mark to market outcomes on electricity  derivatives. Pity this impact wasn’t separately itemised as its cash flow impact can be hard to measure.

Management states that as a result of these factors  the operating earnings (normally they use an acronym ACOI) for EA for the first five months were HK$731 million.

ITK Comment

Translating the numbers into A$  and providing some context compared to 2018

However, 2018 is probably not the right comparison.

On our numbers assuming operating profits is EBIT (earnings before interest and tax) and if the same derivative accounting methodology had been employed for the past four years (unlikely), EA is just doing a little worse than historically. But of course, back in 2015 and 2016 electricity prices were half their current levels and as a generation heavy company higher prices should mean higher profits.

Generation Output

Ignoring the wind, and several minor peaking stations, the three workhorses in the EA stable historically have been Yallourn, Mt Piper and the combined cycle gas station in NSW, Tallawarra.

Some perspective on output is below. It can be seen that for all its travails total output from Yallourn has held up, but Tallawarra doesn’t want to run, not enough well priced gas, and more recently Mt Piper’s been in the doldrums.

Overall output is down about 20% year on year, or about 4 TWh.

That’s helping, along with restricted hydro output, in keeping electricity prices higher than you might have expected given all the new renewables. Yesterday’s outage at Mortlake will take away another 300MW for a few months.

Figure 1 EA principal station 3 mth output, annualized. Source: NEM Review

Figure 2 EA output, year on year. Source: NEM Review

Looking forward is the real issue

EA’s Yallourn asset is going to do it tough in the medium term. ITK projects lots more renewables in Victoria and South Australia.

Stockyard Hill – a 500 MW wind farm – by itself will have an impact but it’s far from the only asset still to ramp up fully in the South Australia, Victoria, Tasmania region.

Then of course there is the Victorian and South Australian  home solar scheme chewing into demand.

ITK also expects that exporting power from Victoria to NSW, always more difficult than it seems, will probably be even more constrained during the works required to prepare for Snowy 2 and the ISP Stage 1 projects.

But that’s a minor detail.

Mt Piper issues should not be a surprise to RenewEconomy readers

ITK published a note discussing Banpu’s results on May 6. Banpu is a Thai domiciled company that owns Centennial Coal.

In turn Centennial is a major supplier to the NSW coal generators. In particular Centennial owns and operates the Springvale  2 coal mine which is basically the sole supplier to Mt Piper.

Most readers will already be aware that Springvale 2 required a special act of NSW Parliament to keep operating having lost an environmental court case in, from memory, 2017.

The environmental issues are one thing, the coal quality issues another. They are not going to be overcome by an Act of Parliament. As a result Centennial Coal has asked, according to the Sydney Morning Herald, for permission to increase coal  trucking to  0.5 mt of coal from Clarence Colliery to Mt Piper.

That’s only about 35 km so I would guess the total annual trucking coal transport cost at say $3-$4 m based on $0.2 t/km. Maybe a bit more allowing for round trips, but in any event a manageable number.

Further, one suspects that the cost is borne by Centennial and not Mt Piper.

Even so, it’s not a pleasant outcome and probably requires the Clarence Colliery to work a lot harder than intended.

EA doesn’t want to spend the capital building a coal rail unloader because like every other coal generation company it basically sees its business in sunset mode.

It’s plan then is to run the assets as hard as you can, but with an aim to phasing them out over time. EA doesn’t exactly say that, but it’s pretty obvious. ITK’s forecasts of new wind and solar see coal losing about 2GW of market share in NSW over the next six years.

The closure of Liddell in 2022 and Eraring going back to normal levels (55-60% of capacity) will take care of say 60% of that market share loss but other generators will still see volumes fall.

As with Victoria, once the NSW Govt’s zero interest solar and battery loans to households take place it should see an increase in penetration of that power source in NSW and a corresponding reduction in apparent demand.

NSW householders have been slower than most to put on solar and of course the State Govt’s policy support for anything in electricity has been negligible.

All talk no action, a typical example being deputy premier John Barilaro huffing and puffing about building a nuclear power plant on top of Barnaby Joyce’s country palace in Armidale.  With that sort of puff posturing how can you expect any genuine understanding of the needs of State?

Of course, if Yallourn  can’t be made to run better, or drought restricts hydro output in Tasmania or the Snowy, then the loss of NSW coal market share will be smaller.

But because NSW coal costs are higher than those in Victoria or Queensland and because NSW is a net importer anyway, the default option for new supply is to want to flow into NSW.

One day – despite the best efforts of the AEMC to make it as hard and expensive as possible – there might even be enough transmission to let power flow around easily.

Not much long term comparative advantage

The question is why if you are CLP would you want to be in Australia? This question extends beyond CLP to many foreign investors and even locals.

It used to be the country where the rule of law protected your business and making a profit was regarded as a market of astuteness.

Now, however, thanks to both the Victorian and Federal Govt, consumer electricity prices are being controlled.

The Federal Government has become a major investor in electricity generation and retailing (4th largest by customer numbers) through Snowy and Snowy is making large investments, such as Snowy 2.0, partly because that is what the Federal Govt wants rather than for commercial reasons.

We are on record as saying we don’t think the private sector would be that happy about financing Snowy 2.0 if it was a public company.

The network owners (wires and poles) have had their legal rights eroded. It’s true that to some extent they wires and poles owners took full advantage of their legal rights and gamed the system.

Still, eroding their rights has increased the cost of equity by increasing the investment risk.

There is, of course, no Federal decarbonization policy.

But nevertheless, over time, more policy initiatives here and then in Asia seem likely, if not inevitable. The long, strong  arms of global warming  squeeze more tightly year by year until eventually – like an egg – land and sea will be scrambled once again.

Eventually the Chinese Govt will put self-interest first and start closing down its coal generation industry. But not until much more misery has befallen us and them and popular unrest starts to ferment.

That’s not so much in this election cycle, except maybe in Queensland, a State that has seen catastrophic fires, floods and droughts all in one year, clearly an outcome made more likely by climate change but conveniently ignored by the small in numbers but powerful in the Qld Govt CFMEU.

For EnergyAustralia, as for AGL and to a lesser extent Origin, and for the Queensland Govt, the question is what to invest in and earn a return. AGL has already signaled it sees its future as more likely outside of the energy sector than inside.

Why would you invest in the electricity sector even if there was an investment opportunity when the Federal and State Govts have signaled they don’t want you and don’t want you to make a profit?

It was fine for the Govts to sell the assets to the private sector but only so long as they did the right thing and didn’t make any real money and in fact kept generation prices low enough so that plants had to be closed.

But once prices go up they are the bad guys, markets aren’t working and its time for Angus Taylor, the small consumer’s new best friend to command and conquer.

EA has no particular skills in building wind or solar plants and its cost of capital is as high as or higher than others in that space.

EA has large loads both retail, commercial and industrial. It could use those loads  to fund renewable energy via new build but the returns are unlikely to exceed the  damage to the returns  of the thermal plant.

Proposed investment in pumped hydro, Cultana South Australia, or pumped hydro offtake, Genex in Queensland doesn’t seem to this analyst to offer much in the way of near term returns.

We argue the price signal for more dispatchable investment isn’t in the market at present.

When it is there, on a daily basis, batteries can rush (be built in 12 months easily) into the 1 hour and 2 hour daily market (morning and evening peaks).

Investment in gas generation, has historically not been very successful in the NEM (see Origin) or Pelican Point, or Swanbank E and looking globally, particularly in the USA seems likely to struggle going forward even with “normal” gas prices. 5 States in the USA now have policies that are essentially anti gas as well as anti coal.

They would be Arizona, California, Colorado, Nevada and to an extent Virginia. See this WRI article on gas v solar and storage.

EA historically has already written off much of the price it paid for Yallourn following the flooding incidents and earlier periods of low electricity prices. Costs are undoubtedly still rising as the mine gets further from the power station each year  and probably the fuel quality gets even worse, if only a little.

The work force in Victoria is always expensive at power stations and expects to be paid more each year.

Who would buy my beautiful roses?

CLP has looked closely at an IPO of EA in the past, around 2012 from memory, but the timing was wrong, there was a profit downgrade cycle and there was management noise.

Once profits settle down an IPO could still be done, CLP would lose on the deal but it would be rid of an investment with a largely unhappy history.

My extremely rough guess, rougher than a cheesegrater on a baby’s bum, gets me to about $4.5 – $5.5  bn of enterprise value. Credit rating will always be an issue for a large participant.

That $5 bn midpoint is based on 7x  a guess at EBITDA of A$700 m. You can compare the $5 bn with a higher value of Snowy paid by the Federal Govt. Much higher. Australian fund managers will buy the business at the right price.

They care about decarbonization, sort of, but mainly they care about how it will impact the profits of their investments.

Although they invest for the benefit of future generations they will see those benefits as being maximized by not overthinking ESG and just making some money for the fund this year.

Not all funds think that way, perhaps even a smaller number than previously but that is, in my view, the consensus.

For trade buyers, Alinta is the first point of call. Alinta owns Loy Yang B, an isolated asset solely dependent on coal from LYA’s mine. CEO Jeff Dimery seems to like coal generation, perhaps it goes with breeding horses, and in any event likes a challenge.

Alinta wouldn’t face, in my view, any insurmountable trade practices issues and keeps trying, not all that successfully, to build a retail client base.

AGL and Origin would both have trade practice issues around retail market share concentration.

Given the Federal Government’s desire to get bigger in electricity and given the romance of coal that so attracts the Prime Minister and the Energy Minister perhaps the Federal Government would buy EA and put it with Snowy.

It could be the black and white minstrels show revisited. As picturesque as this no doubt seems it’s perhaps unlikely and would also face some ACCC  token scrutiny.

In the end we expect EA to try to work through the challenges, to run its thermal stations in  “maximise 10 year cash flow” mode and to keep looking at whether a business such as it is can earn a long-term return on capital investing in Australia.

If someone like Alinta made it a good offer I expect CLP management would give them a good hearing.