Origin Energy: How to manage its exit from coal

Origin Energy (ORG) released its interim results on Thursday. These points are not intended as an investment view but simply as some things arguably of interest to readers.

• Our key thought remains much as it has for some time. ORG is earning itself the right to grow by performing better but the trick will be to (i) sell the interest in APLNG sometime in the next few years and (ii) to replace Eraring (scheduled to close by 2032) with competitive dispatchable renewable generation. Despite the big improvement in the balance sheet it remains constraining and there is still no dividend. Utilities are supposed to be healthy dividend payers.
• Underlying ebitda (earnings before interest tax and depreciation) is summarized in the following table and the key electricity and gas gross profit, half yearly chart

Figure 1 Origin key ebitda numbers. Source: Company

 

Figure 2 Origin energy markets electricity & gas gross profit history. Source: Company

• ORG’s net debt has improved with net debt:ebitda down at 3.9 times. Interest costs will fall by about $70 m following the replacement of expensive hybrid debt with more conventional debt.
• APLNG (the largest of the QLD LNG producers) in which ORG has a 37.5 per cent interest reduced its own debt by about US$400 m and was still able to pay some cash to shareholders. APLNG trains seem to be performing well and ORG states it’s on track to reduce its “distribution breakeven” to A$40 barrel of oil equivalent by mid 2019.
• In our opinion APLNG’s performance should be compared to that of a chasing team in a one day cricket match. In the back half of the project life, the reserve quality and the cost of operations will go up so APLNG needs to get (significantly) ahead of its life time cost projection in the first half of its life. In other words, it’s great it’s doing better, but that’s what is required.

Despite customer losses in QLD, state policy has probably assisted

Origin has the largest electricity retail market share in QLD but at the moment its only real generation there is Darling Downs gas station.

That will change as 350 MW of Clare and other solar PV projects come on line in the June quarter. This meant that ORG was exposed to expensive hedging in QLD to QLD Govt owned generators.

This was going to be a particularly nasty problem as much of the gas to run Darling Downs had notionally been sold to export LNG producers.

As things turned out the change in QLD govt policy has let ORG off the hook a bit. We note that Darling Downs operated at 25% capacity factor compared to a historic level of around 55%.

In fact the less efficient open cycle Mortlake station in Vitoria at 28% had a higher capacity factor than Darling Downs.

Overall electricity gross profit analysis looks as follows. Note that we have combined residential and large business for simplicity.

Figure: 3 Electricity gross profit. Source: Company

In the end it’s a very similar story to AGL. Almost identical $MWh revenue for household and business customers, and a slightly bigger improvement but similar level of gross profit per MWh.

That could be considered a win for ORG compared to AGL given the much higher level of AGL self generation.  However, we would not draw conclusions based on such shallow and rushed analysis.

Origin has clearly taken lots of market share in gas

Some years ago Origin clearly decided to win market share in wholesale gas, aggressively lining up supply contracts and then using the book to go out and win deals. In our view this strategy is a bit riskier following the sale of Lattice but have yet to see how that will play out in full although ORG’s average cost of gas increased to $5.60  18% up on last year.

Just as clearly AGL made a conscious decision to cede market share in wholesale gas. It didn’t have the contract or upsteam position to support its role as the no 1 gas supplier in the market.

However the risk for AGL in ceding market share is that its fixed pipeline contract costs go up on a unit basis. AGL’s gas import strategy and the relative cost of that compared to producing and shipping gas from the Northern Territory remain an important issue. For the half ORG’s gas gross profit is analysed:

Figure 4: ORG Gas gross profit. Source: Company

 

David Leitch is principal of ITK. He was formerly a Utility Analyst for leading investment banks over the past 30 years. The views expressed are his own. Please note our new section, Energy Markets, which will include analysis from Leitch on the energy markets and broader energy issues. And also note our live generation widget, and the APVI solar contribution.