Start of Transcript
Operator: Good day and thank you for standing by. Welcome to Mercury Annual Results Analyst Briefing 2023 Conference Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session.
To ask a question during a session, you will need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again.
Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Chief Executive, Vince Hawksworth. Please go ahead.
Vince Hawksworth: Kia ora tātou everybody and welcome to the Mercury results presentation. I'm joined by William Meek, our Chief Financial Officer, who will be familiar to many of you as well.
So if I start with what is the third page of the presentation, our highlights. Look, a really pleasing year from our perspective. Hydrology driving record production, nine terawatt hours. A new wind farm fully commissioned at Turitea also adding to that result.
But of course, hydrology was a record at 5.2 terawatt hours. So a really pleasing year backed by scale of production. But not only backed by scale of production, also by the addition of what was the Trustpower retail business, which towards the end of the year, became part of the new Mercury branded retail business.
Which we are again, really pleased about how that brand change went. On a refreshed technology stack that deals a loyalty program bill, web applications, and providing a single brand experience. The next stage being to continue to transition customers onto that single stack.
We also continued our development program and the development program meant that Kaiwera Downs 1, which has 10 turbines, has now seen seven of those 10 turbines erected. And whilst we were anticipating production in early October, at this stage, we're expecting to see first production from that site this week.
We have back energised to the site. So again, that's ahead of time and I think is a credit to the team but also a credit to the learnings we had out at Turitea. Look, we can't really go past the fact that customers were impacted by what was a benefit to us in hydrology, but by enormous amount of rain in certain areas of the country.
And we're pretty proud of the way we approached both in Auckland, Hawke’s Bay with Cyclone Gabrielle, supporting customers who were affected by those massive inflows of rain and water. And we will continue to work with our partners to support those customers.
I suppose a successfully scaled business, and that's what we have got, we have more generation, more retail customers, have led to an EBITDA result of $841 million and our 15th year of ordinary dividend growth. And William will talk more to that in a moment.
When we look forward though and we look at this need to decarbonise the environment to support industry to decarbonise, we stand really to support that through our generation development pipeline.
And we're in the advanced stages of being able to commit up to $1 billion into new projects, with two wind farms and one geothermal project approaching final investment decision.
We also have a longer tail of opportunities which I will talk to later in the presentation. But $1 billion, a significant investment opportunity in the context of New Zealand decarbonising.
I'll pass onto William now for the next two or three slides to talk about the financials in more detail.
William Meek: Thanks, Vince, and good morning to everyone on the call. So we're now on slide 4. So a strong lift in trading margin to $1.163 billion for the year. We saw operating expenditure lift by about $116 million to $346 million. Again, reflecting the increase in scale. I'll come back to OpEx. Giving us a $260 million improvement in our EBITDAF to just over $840 million. So a record for Mercury.
NPAT is actually significantly lower at just over $100 million, down from $469 million. Last year's result significantly improved as a consequence of the gain on sale resulting from the divest of our Tilt Renewable shares in funding the acquisition.
It's probably worth just calling out there have been some quite significant changes in IFRS, particularly around the recognition of fair value movements in derivatives Particularly derivatives that are not in a hedging relationship.
So now, derivatives that aren't in a hedging relationship, which would, for us, include the very large Manawa hedge which has got nine years to run, load following contracts on wind
farms cannot be in hedging relationships, fair values, realised or unrealised now essentially are recognised through fair value movements in the income statement.
You will notice that the headline income statement does not have EBITDAF in it anymore. So to see EBITDAF, you need to go our segment note which restates some of those fair value movements, bringing up the realised into either revenue cost rather than sitting below the line in fair value. Strong increase in operating cashflow. So up almost $230 million, again, reflecting that improvement in EBITDA.
Stay in business CapEx leaping to $120 million, largely related to our work in retail integration, the turnaround at Kawerau to install a new generator and turbine, the ongoing refurbishment at Karāpiro, so pleased to see unit 2 there operating now after quite a long outage, so an outage of almost a year, and the start of our geothermal drilling campaign which will continue for the next two years.
Growth investment at $177 million. Largely driven by Turitea at $96 million and Kaiwera Downs at $92 million in the financial year. And a full year dividend of $0.218 per share, taking declared ordinary dividends just over $300 million.
Onto slide 5. Just a deeper dive into the EBITDA bridge between last year and this year. So Vince has touched on the increases in generation. So certainly hydro was very strong.
We saw a record wind generation.
Geo was actually quite weak. So outages to affect the turnaround at Kawerau and some unplanned outages also at our Rotokawa site. We saw sales yields lift. Supporting that, the increase in retail scale. Also a full year – this relates to a full year of the Trustpower retail business as part of the Mercury family.
We saw a $67 million movement largely as a consequence of the cash out of the Norske Skog transaction in the prior year. Other income was down. Last year we had significant trading gains in carbon. So those were worth $27 million. And we received the interim settlement for the Kawerau outage worth $26 million.
So that explains the movement in other income largely, and then we saw that operating cost increase of $116 million, bridging to the $840 odd for EBITDAF in '23.
Slide 6. So just a deep dive into operating expenditure. You can see $70 million related to retail growth, again, largely the Trustpower business integration. We saw OpEx of $16 million and we saw CapEx of $17 million on top of that. So sitting there at $33 million for the year.
cash costs to affect the integration, which Vince will talk to shortly. We saw a $14 million lift in our asset maintenance cost. And certainly inflation, given it is higher, running through the business, completing the bridge to that $346 OpEx print for '23.
And where's the money going? So the last chart there, really bridging from EBITDAF through to a $50 million odd reduction in net debt. Big changes there really. Investing $271 million. We've touched on that in the CapEx. Again, the growth programme between KD1 and Turitea and our stay-in-business CapEx.
Interest in tax at just over $100 million a piece with that dividend paid with cash. So there was a DRP active during the period, reducing that slightly, and a working capital movement of $50 million.
I'll hand back to Vince.
Vince Hawksworth: Thanks, William. So this slide tries to capture our strategic intent. I think some of the really important things to note here is that in the last quarter, we launched our new purpose, Taking Care of Tomorrow: Connecting People and Place Today. We think that's more reflective of the opportunity the business has to make a real difference in the energy transition.
And alongside that, updated are 2035 long term aspirations which are centred around the assets that we enjoy, the communities that we serve, the customers that we value, our people who we think make a difference, our very important adaptive culture leading to the commercial outcome where we see commercial growth in generation in Aotearoa and the supporting nature of that for our ambitions as being key and important.
Alongside that, we expect at the end of this financial year and leading into the next financial year, to update our three year objectives for FY25.
Moving to the next slide where we talk about some of those people issues. Look, we can never be complacent about health, safety and wellbeing. And of course, total recordable injury frequency rate or TRIFR is seductive but it is a lagging indicator.
So whilst we're pleased with the direction of travel there, we know we're only one incident away from that not being a great number. So really important to us is our newly refreshed health, safety and wellbeing policy which really focuses not only on what we do from a process point of view and process safety, but also the culture of safety and thinks about both the physical and mental side of wellbeing.
On the other chart on the right hand side here, we capture some of the things that are important and if we really want to create a powerful and diverse workforce in the future. And as you'll see, whilst we are progressing on all of those metrics, we are a way off of our targets.
And that really is important because that pushes us to strive harder. We have though, implemented leaders of our ethnic diversity program. We hope to see that help that particular area.
Internal mobility is a really important thing and it's about growing our own rather than simply recruiting from outside. And our women in leadership has improved on the back of the retail acquisition. So we can't be in a position where we take that for granted.
That said, a shift in our cultural index is important. We still have a ways to go as we integrate 1400 staff under one brand. So we don’t take the M&A challenge that comes when you've got people from different backgrounds as an easy challenge to overcome.
So going to the next slide. So I talked earlier about our commitment optionality of up to $1 billion of generation investment that we can make in this financial year, driven by two wind farms and a geothermal project.
We have final investment decisions expected for Kaiwaikawe, Kaiwera Downs 2, and Ngā Tamariki OEC5. All of those are subject to the final commercial discussions that need to occur. In some cases with suppliers, and in some cases with off takers. But look, the winds are blowing in the right direction, as you might say.
I've talked to Kaiwera Downs 2. And of course, we have also invested quite considerably in understanding the Puketoi wind farm which we believe with optimisation, can come into the discussion beyond this financial year.
As we also show on the chart to the left hand side, we have a number of other projects that we're yet to announce. But we are well advanced on understanding them and you can watch this space in the future.
Just to reinforce that, on this slide, we just note where those major projects are. We're particularly pleased with the way that Kaiwera Downs 1 has gone. Yes, it's a smaller project. But it has proven our multi contractor model and it will be great to have that fully operational at least on time but possibly ahead of time.
And the next slide really just gives a picture of Kaiwera Downs and reinforces what I have just said. So we can move onto the next one. Increasingly for businesses like ours, ESG is becoming an absolutely key activity. The environmental, social and governance aspects.
I think historically, we have seen a lot of work in this space but a lot of that work has been seen in almost – in different silos. Our chart on the left here tries to start to bring together some of the things that we are doing under each of those headings.
But some points and notes here, this is the seventh year that Mercury has been a 100% renewable generator. We have really stepped up our program with our approach to customer care. That's through both our own propositions, through working with others, including with competitors like Genesis, but also supporting other propositions which appeal to particular vulnerable customer groups. Nau Mai Rā being an example of that.
We are active in understanding our supply chain aspects through modern slavery initiatives. We continue to invest in the restoration of natural environments. So things like the Waikato Catchment Ecological Enhancement Trust. And that becomes important as we look into the future, going beyond greenhouse gas disclosures, and start to think about how the taskforce on nature related financial disclosures will be adopted by New Zealand organisations and we are committed to taking a leading role in that space. So, lots of work to come down the track here
Of course, for us being 100% renewable, our challenges in terms of scope 1 emissions really all revolve around our CO2 intensity. We have adopted science-based targets from the SBTi initiatives and that will drive some of our investment into reducing greenhouse gas emissions. That includes things like reinjecting the CO2 at our geothermals. You can see on the left-hand side there some targets we have adopted as part of the SBTi program which has a formula to – I guess which is the formula that we are using to assess ourselves This will be challenging, particularly challenging when we look at natural gas sales.
Going onto the next slide, I will pass onto William and we will talk a bit about hydrology, gas and the market.
William Meek: Now, slide 14. Some hopefully familiar scatter plots obviously updated for FY23 actuals. So, FY23 being a wet year produced a whole lot of prints in for the delta to national storage averages which were clearly above, so wet conditions, high lake levels, lower prices, but still materially higher than the trend we would have observed from 1999
We are seeing an absolutely higher curve fit in spot prices and its correlation with storage levels across New Zealand.
We are also seeing a waning of the connection between gas prices and electricity prices, so those scatter plots are widening. Again, the flexibility of gas or the lack of gas availability is reducing the link between gas and power prices The Methanex outage again this year was helping in terms of loosening some gas supply to thermal plants over this winter.
Three key charts on slide 15. We are seeing our international coal prices come off their peaks in mid-2022, so the pressure is certainly off there. We have our large coal stockpile at the Huntly Power Station. That's mostly still running on gas at the moment and obviously people will be aware of the circuit breaker issue there at E3P so we are seeing three Rankine units committed at the moment so that is good in terms of continued reliability of meeting peak demands in the New Zealand system
Carbon prices are well off their peaks which were over $80 NZU again back in mid-2022. So, we did see concern around forestry credits and how the ETS Framework might treat those and so we saw quite a sharp decline in NZU prices through to mid this year. We did see quite an abrupt U-turn there from a policy level so we have seen a spike with the NZUs back above $50 a tonne. Again, that will be, again, over time increasing costs to greenhouse gas emitters in New Zealand
Electricity futures We have been above $150 for a three year look forward since early 2022, so you are still seeing sustained prices, still reflecting relatively expensive thermal fuels and we did see an uptick in futures prices out to May 2023 as a consequence of the Genesis announcement taking E3P out of the stack. Probably a key takeaway is probably that last bullet, that forward electricity prices are affected by renewable energy and intermittency and how often the most expensive generator sources set prices and shouldn't be compared directly to the levelised costs of energy for new capacity, particularly intermittent generation from wind or solar. Again, another chart we like to reproduce. Certainly, this demonstrates the record hydro generation over FY23. That was 5,209 gigawatt hours versus a mean of around 4,050, so significantly higher. It's certainly the wettest year on record for the Waikato catchment with records going back to 1927 and it's an outlier, so it's several hundred gigawatt hours higher in terms of inflows for the catchment We spilled over 1,000 gigawatt hours So, between the generation uplift and spill we're up about 50% on average levels
Last year was dry at just under 3,700. You can see in the yellow line is this year which is the storage track for Lake Taupō. We are actually hitting the top, so setting new sort of maximum levels across the year in several places where it hits the top of the blue shaded area which reflects the minimum or maximum lake level at that time of the year over the last 24 years, so that's since essentially Mercury, or previously Mighty River Power, has operated the Taupō catchment. If you go beyond that to the days of ECNZ's operation you can get some quite strange outcomes because they were optimising the entire hydro system rather than the catchment separately.
We did actually squeak over our normal operating limit by a few centimetres. It's the first time we have done that since 2011. Probably the last callout on this slide is just the comparison between futures prices and spot prices We did see spot prices relatively low for the year on the back of wet conditions but the futures prices were actually quite high. That's showing the average monthly futures price three months earlier, so the market consistently expecting prices to be stronger than how actual spot prices turned out. Clearly, couldn't predict the fact that we had persistently wet weather reoccurring because those markets tend to try to mean revert on hydrology I'll hand back to Vince
Vince Hawksworth: Thanks William Just talking to a few issues around our core business
This slide talks about existing assets and the work we are doing. Karāpiro rehab, William mentioned earlier with the first machine now back in operation. I think what's really important is when you give these long-life assets a birthday you also give the opportunity to lift performance, so over the full life of the project we expect to gain 17 megawatts of capacity at Karāpiro.
Kawerau geothermal, we were out for two months, largely focussed on the full replacement of the generator and turbine now as a result of the major incident we had a year and a bit earlier. This was a really big turnaround, very complex, many, many people hours, 53,000. Look, we are back in service now and that service, that station, is now relatively stable as we have come out the back end of that turnaround.
We have also commenced our drilling program, that 14 month eight well program, expected to be about $128 million. We have started the first hole and it's all about reinvestment in the capacity of the Kawerau, Ngā Tamariki and Rotakawa fields to offset decline and that's early days yet but we will continue to report back on how that goes
Going to the next slide looking at sort of retail or sales Look, we increased total connections across the year. That was pretty important to us when we bring the two
brands together. As I say, bringing two brands together, a major merger of two cultures, two sets of people, we thought it was pretty important to be able to lift connections whilst we were doing that. We were able to do that and that's very pleasing.
We have continued to sell into CNI as the forward prices have meant that folks are still looking for long or have been looking for longer term contracts So, we have done that and we have also looked to manage yields, mass market yields being somewhat influenced by the addition of the Trustpower customer mix, but generally speaking, a pleasing year leading into the rebrand.
Going into a little bit more detail on the integration, listeners may recall that the sort of call to action that we have had with that was one team, one brand, one technology stack and being future ready. The June 2023 brand change was a really big milestone. That's enabled those customers on the Gentrack stack, largely ex-Trustpower, to access the Mercury loyalty rewards program and at the same time we updated our bill, we updated the website and we introduced a new app, so quite a lot of technology change inherent in that brand change.
I think we surprised ourselves somewhat by the willingness of ex-Trustpower customers to download an app with over 100,000 customers doing that. At one point for two weeks, it was the fastest set of app downloads in New Zealand was the Mercury customer app We are now into the process of migrating customers off SAP onto Gentrack and we have done our first pilot migration a couple of weeks ago and we are just assessing the lessons out of that, but largely speaking we are pretty pleased with how that went and expect to continue migrating customers through the period to the end of October.
From a costs point of view, well, we have spent $33 million and we still believe we are on track for the synergies over the three year period. Of course, those will come, particularly as
we get off legacy technologies
Going to the next slide. I mentioned earlier the issues associated with Cyclone Gabrielle but more broadly I think the issues associated with affordability and hardship in general of which of course energy hardship always gets called out I think because irrespective of people's living conditions it's an essential service. We are active and we have developed a number of support mechanisms which are outlined there on the left-hand side, but we are really
mindful that we are New Zealand's largest electricity retailer
We are a large multi-product retailer and that does require us to stand up and step up to look after vulnerable customers. We are particularly pleased that we have been able to
start working alongside our colleagues who we can compete with hard but also recognise that the solutions for people in hardship come from collaboration that is appropriate under the Commerce Act.
The next slide turns to decarbonisation and I think we have talked now for many of these meetings about our commitment to decarbonising New Zealand I think the chart there is pretty interesting because it does show how residential prices have moved over time and it shows that largely the cost of electricity has tracked lower than inflation, but we don't shy away from the fact that the transition is going to require significant investment across all parts of the sector. Whether that's in generation or whether that's in transmission, whether that's in distribution, a whole of sector approach is going to be really important.
In achieving that we also still believe that thermal peaking will play a really important part because if we are to support a pathway to a largely renewable sector then we do need to meet those peaks in the middle of winter if the wind doesn't blow and the sun doesn't shine, so we think that sort of collaborative overall pathway forward, as described in the Boston Consulting Group work, is really important. I am going to pass back to William now who is going to talk to a bit of a round up on financials and take us home.
William Meek: Two slides to go before Q&A. Slide 22 is really touching on Mercury's capital structure and strong balance sheet Certainly, some reporters are concerned about long companies not having the balance sheet to support essentially the decarbonisation necessary for New Zealand. This slide should assuage concerns about Mercury's ability to underwrite its generation development investment program.
We see a very strong improvement in our capital structure between 2022 and 2023. Over that time, we invested $1.53 billion in the last two years in growth projects between the Trustpower retail business, Tilt Renewables and our ongoing investment in windfarms under construction $600 million of that was funded from the sale of our Tilt shareholding, but still that leaves $900 million invested over that two year period. EBITDA has lifted from – we tend to be trending around the $500 million range to over $800 million. I will touch on guidance shortly. We are in a strong position at the good end of the BBB+ range from S&P.
Again, a callout there for our debt. Mercury does have $550 million of capital bonds, so $275 million of that will be treated as equity by Standard and Poor's in terms of them calculating our gearing ratios So, quite a lot of headroom there Essentially, we could increase our gearing by $800 million without a change in our earnings and still be
operating inside that BBB+ S&P rating. Then a final callout, we do have an active DRP. We have confirmed that the DRP will be active for our final declared dividend this year with a discount of 2%.
Last page. So, a callout for guidance. EBITDAF guidance for FY24 of $835 million, so very similar to this year's result Again, composition quite different We are expecting a normalisation of hydrology back to mean, 4,067, so that's a slight uplift reflecting the efficiency gains at Karāpiro. So again, we will expect to see those play through over the next two years also with steady increases. We are expecting a normalisation of geothermal generation, so we won't be having these large outages. Then wind has been normalised also with new wind coming on, so a full year of Turitea South and essentially three quarters of the year with generation from KD1
Some other callouts there
We do have about $10 million increase in transmission pricing We are expecting the final settlement for insurance of Kawerau during the financial year to just under $20 million. Increases in operating expenses taking us through to that final guidance of $835 million. I'll hand back to Vince for concluding remarks and click into questions.
Vince Hawksworth: Thanks William. So, look, obviously a really interesting year for us. High generation driven by high hydrology, first full year of Trustpower, rebrand and really advancing our generation development pipeline whilst taking care of our core assets So, a lot of work, a lot of hard work from the team here, but developing a platform for the next decade of growth and opportunity as New Zealand decarbonises.
We will move to questions I think operator please.
Operator: Thank you. We will now conduct the question and answer session. As a reminder, to ask a question please press star one, one, on your telephone and wait for your name to be announced To withdraw your question, please press star one, one, again. Please stand by as we compile the Q&A roster.
[Long pause]
Operator: Just one moment please Our first question is from Vignesh Nair from UBS Please go ahead.
Vignesh Nair (UBS, Analyst): Hi Vince and William, can you hear me?
Vince Hawksworth: Yes, we can.
Vignesh Nair (UBS, Analyst): Awesome, great. Congrats on a great result. I just had two quick and easy questions to begin with. Firstly, just looking at the projects in the pipeline of 300 megawatts or so in the next 12 months for FID, can you maybe just talk a little bit about what you need to see from here I suppose to have full confidence in bringing those to market? Perhaps both from a supply side front, so raw materials pricing and EPC contracting, but also on an offtake and demand side?
Vince Hawksworth: Yes, thanks Vignesh. Look on the supply side, obviously we want to see the best pricing that we can get. We are very close to finalising that pricing. I think –I don’t know which global wind players might be listening to this, but look, there is still competition. I think New Zealand, at this stage, we’re in a position where some of those big global opportunities haven’t quite ramped up yet, so we think timing is pretty reasonable.
I think what’s probably more challenging is making sure that we can access on-the-ground people in New Zealand. There is competition for civils and balance plant type suppliers, so we very much want to continue the very strong relationships that we’ve had with some of those players with the work we’ve already done. I think we’re in a reasonable position from that because our projects aren’t considered vapourware We go in a straight line, we do what we say we’re going to do. So that’s quite helpful.
On the offtake side of things, as you can imagine, those are pretty important commercial discussions. It’s well known that Kaiwaikawe is a project that we’ve been working with Genesis on. We continue to talk to Genesis, we still anticipate concluding arrangements such that we can deliver that project as we wanted to, albeit significantly later than we’d originally envisaged.
OEC5 is a project that we can make a choice about integrating that into our portfolio but we’re always talking with other industrials or players that want long-term arrangements OEC5 obviously beefs up our baseload and KD2 is obviously a project which is somewhat dependent on outcomes at the bottom of the South Island.
Vignesh Nair (UBS, Analyst): Yes, that all makes sense and just talking sequentially in terms of cost pressures from, say, steel prices and freight rates, are you seeing project economics get sequentially better or are you still seeing some constraints in terms of pricing for projects?
Vince Hawksworth: Look I think you could look – freight rates have obviously come off from where they were in that immediate COVID period and as have some commodity
prices. But the reality is we’re not buying the freight rates or the commodity price, we’re buying the output from a supplier and then those suppliers have plenty of choices for where their kit goes to.
So I don’t think you can draw a sort of straight line equation or algorithm that reflects all the way through and you only have to look at the global media to see that some of those companies have suffered massive margin squeeze, so there’s a sort of new normal that we would expect to see, which won’t look like what we saw in maybe back in the Turitea days.
Vignesh Nair (UBS, Analyst): Yes, okay. That makes a lot of sense, thank you. Secondly, I suppose just a bit of a hypothetical question on Tiwai, I think you’ve been pretty open about the fact that you’ve been in discussions with Meridian and NZAS. I think talking to Meridian, the pricing discussion has moved to a more flexible one linked to aluminium prices
I’m just keen to hear your views on this, is this sort of flexible style of pricing arrangement something you will consider as part of your capacity allotment, assuming that goes ahead? What’s your view in incorporating, I suppose, more direct commodity price risk on wholesale prices?
Vince Hawksworth: Yes, look firstly for absolute clarity, we’ve had no discussions with Meridian or with Contact because that would be in breach of our Commerce Act obligations The only conversations we have are with Rio, with Tiwai But look my observation would be that the tone and nature of the conversations are about Tiwai being a long-term player that understands its obligations to Aotearoa New Zealand that’s wanting to reset its relationship with the country after some pretty difficult press and action.
But at the end of the day, Mercury is still a relatively small tail on a big dog and they’re kind of – the discussions they’re having with others have to land They understand what we can deliver, I think they understand the value of flexibility. It was publicly announced the deal they did with Meridian on flexi demand supply balancing under the current contact. So I think all of that stuff comes into the mix in this conversation.
I think we’re just getting to a – I’m an optimist, that we are getting to a more mature way of thinking about what’s in the longer-term benefit of the country, which is, I think, a sustainable industry base that provides jobs and economic wellbeing served by a renewable energy sector that can perform for customers
Vignesh Nair (UBS, Analyst): Okay, that’s very helpful, thanks Vince That’s all from me.
Operator: Thank you. Just a moment for our next question please. Our next question, we have Grant Swanepoel from Jarden. Please go ahead.
Grant Swanepoel (Jarden, Analyst): Good morning team. First question around – or a bit of clarification. Twelve to 18 months ago you set your FY24 target of $800 million. That didn’t include Kaiwera, so your 835 has three quarters of the 147-gigawatt hours Kaiwera over and above what you were looking for back when you had your strategy day. Plus the 18 million in the guidance from insurance is related to FY22. So a normalised 817 guidance only, with the Kaiwera difference, pretty flat on where you were looking for a couple of years ago. So getting to my question, does that assume that the margin uplift from C&I has been totally taken up by cost pressures?
William Meek: You’ve got a very mechanical calculation there in terms of what it is. The $800 million was always a stretch We increased from seven to eight largely on the back of the Tilt and Trustpower transactions. We always contemplated other things would happen and it was a stretch target for us in terms of hitting the 800. So I think it’s totally fair to back out the insurance, it’s a one off and it’s potentially compensating for costs incurred because of a major plant outage.
But in terms of the underlying business, we’re in the hump right now in terms of retail integration, so we’ve doubled up We’ve still got two retail systems running, we’ve procured extra licences for the Gentrack system as we port across, but we’re still paying for licences on the Mercury stack, so we’ve got a very big focus around how we lift our productivity and efficiency as we roll through and complete our retail integration.
Grant Swanepoel (Jarden, Analyst): Thanks Vince.
Vince Hawksworth: Look Grant, I think I’d just add that there are definitely headwinds, but what I would say though is we are in the phase of massive integration of people and technology. We have really strong belief about our ability to work through that Those headwinds, inflationary headwinds though, are real. I think everybody is seeing those. But our ambition is clear. We can work through this, we can get onto this single stack, get the people, get the customers across and see those synergies come out over the next two years or so.
It was always going to be a three-year journey and I would say for an M&A, there are many, many stories, the world is littered with disasters, we’ve got over the first Everest, which is the brand change.
Grant Swanepoel (Jarden, Analyst): Thank you. Just quickly on guidance or continuation on guidance, with on the new event that we’re moving into, some of your competitors are indicating that wind gets a nice kicker from that. Are you assuming any of that in your guidance and if not including in your guidance, do you expect that to occur and around your hydro forecast, you started to show how your dam levels are through the roof at the start of FY24, why have you not indicated a higher-than-average guidance for hydro at 4067, only 17 above a 4050 average year?
William Meek: I’ll respond to the second one first. So yes, we did come into the financial year or close last year about 100 gigs higher than average. We’ve actually had, which feels surprising, because it feels like it rains every day, but we’ve actually had belowaverage inflows to the Taupo catchment over the last seven weeks, which is why we’re largely – which is also the wettest time of the year for us, so we’re expecting to turn out an average year based on look forward. So you’ve got a negation of dryer weather against that opening position.
Vince Hawksworth: Can you just repeat the first question, Grant, because I didn’t quite catch it.
Grant Swanepoel (Jarden, Analyst): Sorry, so Meridian was indicating the other day that an El Nino event, which we’re moving into, should push wind volumes higher than an average year Do you guys also expect that?
William Meek: We haven’t – we’ve just forecasted expected wind. I mean last year was below average in terms of just average wind speeds and a lot of easterlies, which is not the prevailing wind for New Zealand and it’s unusual to actually have really wet conditions, but not have high wind, because wind and rain are positively correlated normally. So no, we haven’t, we just assume we’ll generate our mean levels of wind.
Grant Swanepoel (Jarden, Analyst): Thanks, last, just a couple of quick ones, Kaiwera Downs 2, big wind farm, is that dependent on a Tiwai positive stay decision? Second one, just on carbon volatility, can you give an indication of what you’re expecting from a carbon profit over FY24? The final one, with the market-making losses now being removed from EBITDA and pushed below the line, do you guys have any of that impacting your FY23 numbers?
Vince Hawksworth: So the first one, KD2, look I think the simple answer is yes. I mean if Tiwai doesn’t stay, I think South Island generation’s going to be not the place to be putting
any new stuff. But the second two I’ll probably pass to William, carbon and market making.
William Meek: Yes, so on carbon, obviously with movement in the curve, curve came down significantly, has balanced up slightly. Yes, I mean we’re normally budgeting trading gain in the $15 million, $16 million range and our trading gains for last year, which had no gains in carbon, still matched that number. FY24 market making, so yes, we’ve got a different view. Market making is not a cost to Mercury, so our market making obligations in terms of our trading book are more than offset by trading, so in that respect we’re different.
I think Contact’s explanation for bringing it below the line, it’s not actually market making obligations, it’s actually just the fair value for derivatives. So derivatives you’re trading are not in a hedging relationship, therefore gains and losses realised or unrealised are taken through fair value. So that’s what actually IFRS says.
Ours, if you go back to our segment note, you’ll see a restatement, so we bring back all realised gains and losses from derivatives back into revenue or cost, so it goes back up above the line for us, so we’re not keeping it below the line, so our EBITDA number includes the cost of market making as well as any trading gains or realised gains or losses from any derivatives that are in a non-hedged relationship
Grant Swanepoel (Jarden, Analyst): Thanks Will and thanks Vince for those answers.
Vince Hawksworth: Thank you.
Operator: Thank you Just one moment for our next question please Our next question, we have Cameron Parker from Craigs Investment Partners. Please go ahead.
Cameron Parker (Craigs Investment Partners, Analyst): Morning guys, congratulations on a great result. Just first question is assuming Tiwai stays and just your confidence in that would be great, what are your priorities in terms of protecting that g watt that Mercury has traditionally gained and so the flexibility and so forth out of its hydro units and are you considering any sort of other assets such as batteries?
William Meek: A couple of comments from me, Cam We’re actually in a pretty good position, we’ve got the largest wind portfolio in New Zealand. That being said, the vast majority of it is actually under load following contract. So with the Amazon contract, which will kick in next year, Turitea, so essentially we’ve got three quarters of Turitea essentially sitting in our portfolio which needs to be firmed. It doesn’t actually need to be firm,
because that’s a value decision, so of that portfolio I think that’s quite positive. So Mercury certainly does have options.
Our C&I book is 3500 gigawatt hours between physicals and financials, so we do have choices. Those are firm contracts. We’re not selling wind or solar profile to those customers typically, so it’s at the meter and we back ourselves to manage our exposures If price premiums justify essentially firming, then again, Mercury would be happy to enter into contracts where essentially the risk of firming stays with us to give the customer confidence around their power costs.
So I think we’re in a strong position for the next decade in terms of dealing with intermittency. We are looking at batteries. While the volatility in the market has increased, it’s still not easy to get a battery to work in terms of just raw economics. You still need bigger peak/off peak differences I think the investment case for Meridian up at Bream Bay, they’ve certainly got an uplift in terms of actually impacting reserve prices, which prefers a benefit to their hydro portfolio in the South Island. We don’t have that. But batteries are certainly something we continue to look for. I think they’ll play an increasingly important role as we look to deal with demand peaks. So yes, they’re there, we’re unlikely to be looking to build a battery during FY24 given the current developments that are on our plate today, but it’s in the mix.
Cameron Parker (Craigs Investment Partners, Analyst): Yes, great Thanks William, thanks. Also, just with regards to gas or thermal peaking, all the participants are essentially agreeing that it’s required for the future, but we seem to have people retiring gas plants, asset owners with their assets up for sale in the upstream area, where do you think that solution might come from in terms of that support for a transition for New Zealand’s renewable generation?
Vince Hawksworth: Yes, look it’s challenging, isn’t it and the BCG report was pretty clear that the most economic way forward was a good mix of renewables with a very, very small percentage of gas peaking. There are consented sites ready to be built. I think the challenge is having a political regulatory environment that allows those decisions to be made. Certainly Mercury would be happy to support through contracts, that sort of investment. We’re not trying to be so pure about that, because we actually think, if you look at the trilemma, the issues turn up with security of supply and we know that peak demand on a cold winter’s night is a critical thing there, at least cost and we know that the cost of gas peaking plants is well understood.
So that facilitates the biggest amount of renewables possible to decarbonise the whole of the energy consumption, which means more EVs, more of the sorts of projects we are seeing with New Zealand steel, more use of electricity in the industrial process. So if you sort of look at it from that perspective, then I think given a bit of time, logic should prevail.
Cameron Parker (Craigs Investment Partners): Great, thanks, Vince. Just lastly for me, just with regard to operating expenses, obviously you’ve got synergies to come through from your work through the Gentrack stack and so forth. What’s the long-run OpEx for your business at this scale going forward?
William Meek: It’s lower than it is currently. Inflation is a monster. When you’re running at 6%, 7%, that is quite a challenge for – well I think all businesses and it does – it certainly does focus the mind We’re seeing inflationary increases in specialist areas which are just obscene. It’s therefore do challenge you to explore new ways of doing things and what is essential. So we are working on that.
We did not – no one two years ago would have been expecting inflation to be running at 6%, 7% through this time so it’s quite materially different from where we are. We’ll see whether the Reserve Bank and the rest of the world’s got inflation under control. So I think the genie is still out of the bottle at the moment but people are expecting it to come back So yes, we’re very focussed on delivering the synergies in our Trustpower retail business case, we just need to get customers through onto this stack. So essentially everyone’s inside one process, one system, to really move forward.
We have seen some increases in terms of maintenance costs in our generation business. Some of those in terms of procurement of gear are somewhat unavoidable because you’re beholden to often sole source supply but again, yes, the business is very focussed around how it manages its cost structures into the future.
Vince Hawksworth: Yes and Cam, you can be assured that that’s something that William and I agree on. It’s lower than it is now.
Cameron Parker (Craigs Investment Partners): Yes, that’s great. I look forward to seeing that, it’s good. All right, thanks, guys. That’s all from me.
Operator: Thank you. Our next question, we have Stephen Hudson from Macquarie Securities NZ. Please go ahead.
Stephen Hudson (Macquarie Securities NZ, Analyst): Hi, guys. Thanks for taking the questions. Just a couple from me. On the geothermal outages, I think it cost you sort of 210 gigs this year. Can we just add that back to ’24 or will you not fully recoup that?
Secondly, just clarifying the market making gains and carbon trading gains That was – it sounds like it was 15 this year and going to 30. Is that what you were saying before, Will? On Ngā Tamariki, congratulations on getting the consent there. I just wondered if you can give us a sort of a rough cost for the additional unit there? Would we be safe in using $80 to $90 for the cost?
Then just lastly, maybe a longer view question around the BCG report and some of your earlier comments on sharing the burden of the investment. We’ve obviously got about half of that investment is going to supposedly come from the distribution companies that are owned by councils and community trusts. Have you got reasonable confidence that they actually have the wherewithal to invest their share? Sort of $22 billion of that $42 billion and if not, where is it going to come from?
William Meek: Okay, so that’s – there’s a lot of questions there, Steve, so we’ll kick off. So geonormalised, yes, you’d expect putting aside a very major maintenance outage on a geosite, that you’d be running availability certainly above 95 Potentially higher than 96 across the geofleet. So yes, you do get a big step up. so I think last year was actually the lowest geothermal generation we had seen since Ngā Tamariki commissioned back in 2013. So the Kawerau outage was quite long and it came out slightly earlier than we’d expected but yes, normalising geo, just assume availability of 95 and you’ll generate that sort of 200 gig uplift.
On carbon costs, no, the trading gains are losses. So no, no, no, not between – I mean we had an abnormal – very abnormal gain back in ’22 on the back of those – that sharply rising curve. So we’re still forecasting an annual trading gain between essentially power and carbon of sort of $15 million. Carbon costs at Ngā Tamariki – Ngā Tamariki is sort of our first station that’s up for sequestration so only a quarter – a quarter of the emissions –well a quarter of the emission are currently sequestered. So that’s working successfully. We’ve got plans to essentially sequester more.
Recognise that an expansion does increase your carbon footprint in the absence of carbon capture at Ngā Tamariki so that’s still – that’s part of the business case in terms of what we do there around the carbon footprint for the expansion and ongoing operation at that site. Distribution networks
Stephen Hudson (Macquarie Securities NZ, Analyst): Sorry, Will – sorry, Will, I meant for the new unit what would be the levelised cost for that new unit coming on rather than just the carbon cost. What will it cost you to build that extra 47-megawatt unit?
William Meek: We’re still working through that so you won’t have to wait very long to find out, I hope.
Stephen Hudson (Macquarie Securities NZ, Analyst): Would 80 or 90 be a reasonable guestimate to plug in?
William Meek: In terms of levelised cost? It’ll be in that range, yes.
Stephen Hudson (Macquarie Securities NZ, Analyst): Yes, okay. Cool.
William Meek: Then on distribution networks, yes, certainly based on the BCG reports, there’s significant investment required into distribution. Yes, the funding for that, yes, I mean those questions remain. Particularly possibly for the smaller ones. That being said, there’s certainly precedent around customised price paths in terms of the real question will be for some of these small networks, they’re amortising those costs across relatively few customers.
So exactly how that pans out in a regulatory environment, we will see but there is no doubt we – the sector’s enjoyed some reductions in lines charges as a consequence of lower interest costs over the last pricing period. From ’25, obviously we’d be looking at a harder environment and further investment required on top of that so we’ll step up. So that will be, unfortunately, one of the costs of essentially decarbonising the country and that the distribution lines companies are going to have to make investments which ultimately will flow through in terms of higher tariffs to customers.
Stephen Hudson (Macquarie Securities NZ, Analyst): Very good. Thanks, Will.
Operator: Thank you. Our next question is from Andrew Harvey-Green from Forsyth Barr. Please go ahead.
Andrew Harvey-Green (Forsyth Barr, Analyst): Morning, Vince and Bill. Just a couple of questions for me. First of all, just to dig in a little bit more onto the operating cost guidance for next year. Just I guess wanted to understand what the synergy – sorry, any further integration costs coming through next year? I’m assuming there are basically no synergy benefits coming through for FY24. That’s going to be an FY25 story. The way you’re talking, it sounds like that. Then lastly, in terms of the – I think you highlighted now, operating costs are going to be coming in completely as well. I presume that’s sort
of low single digit million dollars but if you’re able to give a bit of a feel on that, that would be good.
William Meek: Yes, so slide 19 said we’d spent $33 million on integration split between OpEx and CapEx. So that leaves us with $17 million of the $50 million. So we’re expecting $17 million That’s all sitting in OpEx at the moment So there’s probably –there are some risks some of that will be capitalised. So again, in terms of the guidance difference between where we were sitting for ’23 and where we out turned a big chunk of that was actually just accounting. We just saw a movement from OpEx to capital. Yes, synergies, we’re very focussed. So we will – there will be synergies in FY24 so we have got an increase in operating costs with a full year of NOW broadband in the group. So that does lift costs in terms of a change in retail scale. So there are some synergies in the number but yes, we’re very diligently working through how those materialise So we’re seeing some good wins. Half our reconciliation, some of our – some of the metering, some of the costs are not – they’re not turning up in OpEx, they’re turning up in direct costs, too. So we’re confident we’ll be bridging and reconciling back to our business case outcomes.
Andrew Harvey-Green (Forsyth Barr, Analyst): Yes, okay. No, that’s good, thanks. Then just a couple of questions on the generation pipeline First of all, in terms of the FIDs we’re looking for FY24 Are you able to give us a sense, are we looking at first half or second half for those decisions? Sort of reading between the lines in terms of what you’re saying, it sounds like Ngā Tamariki expansion might be the first one off the rank but I guess that might also depend on the smelter decision, too.
Vince Hawksworth: Yes, I think Ngā Tamariki probably is the first one because it’s not reliant on other commercial discussions. Then the other two are a little bit dependent on the discussions with the offtake parties So – but they – you know, they’re a bit like London buses, they could all come along at once. It’s kind of we’re not in full control of that conversation.
Andrew Harvey-Green (Forsyth Barr, Analyst): Yes. Then second question relates to that pipeline. I thought it was noticeably absent Mahinerangi stage 2 in terms of that list but obviously it’s one that’s approaching that’s sitting there consented. Is it fair to say that that’s likely to come after Puketoi and Tararua repowering? Is that the way we should interpret that?
Vince Hawksworth: I think all we’re saying, really, is that with Mahinerangi stage 2, we have a number of choices around that. I mean obviously the technology is going to be different to stage 1. Stage 1 has now been operating 12 years so there’s a kind of a –there’s quite a lot of optionality about what we do there Whether – how that stacks up versus Puketoi is again optionality but certainly we don’t have that with a locked-in timeframe where we see that as choices. But clearly, it’s got a resource consent as has Puketoi.
So – but we probably also want to look at some adjustments around things like tip item and stuff like that to optimise that site. So I don’t think – you shouldn’t read too much into all of that, Andrew. It’s just within the full portfolio when we go beyond these immediate three.
Andrew Harvey-Green (Forsyth Barr, Analyst): Okay, that’s great That’s all from me, thanks.
Operator: Thank you. Just one moment for our next question, please. Our next question, we have Nevill Gluyas from Jarden. Please, go ahead.
Nevill Gluyas (Jarden, Analyst): Good morning, team. Two detail questions from me and then two, perhaps a little more wandering. Detail questions. Just to confirm the cadence on the drilling programs - those re-works - hasn’t really changed and you wouldn’t expect it to change after OEC5 so sort of $128 million, you’ve given us that guidance in the 14 months. Should we expect that roughly every four years, I think is the cadence in the past?
William Meek: Yes, so this drilling program is large. So essentially it’s creating resilience in the fleet across the three fields at Rotokawa, Kawerau and Ngā Tamariki. So you would expect a gap, all things being equal.
Nevill Gluyas (Jarden, Analyst): Right.
William Meek: That being said, sometimes you can be surprised so you would see a – you would see an extension in terms of the time between this planned program and the next So that’s certainly the intent
Nevill Gluyas (Jarden, Analyst): Great, thank you. Yes. All right and the second detail question, virtual asset swaps. Put in place, obviously some time ago, they’re winding off now. Any reason to expect them to be replaced or are they going to just gradually wind off?
William Meek: Sorry, what’s winding off?
Nevill Gluyas (Jarden, Analyst): The virtual asset swaps between William Meek: Oh, the VAS. Oh, okay.
Nevill Gluyas (Jarden, Analyst): Well in your case, obviously between – yes, yes.
William Meek: Well with the FTR market, you probably – the need for the VAS is probably lower.
Nevill Gluyas: (Jarden, Analyst) Yes.
William Meek: So you can. You can certainly cover bases for us between islands quite easily Between the – you know, FTRs or into ASX futures, too So no, at the moment, in terms of a direct arrangement between us and Meridian, probably not.
Nevill Gluyas (Jarden, Analyst): Great. Okay, thank you. Then a slightly more wondering. Well I guess this one’s reasonably direct. Very clear answers, I think, about the peaking requirement. I guess as the largest retailer now, you perhaps have one of the larger opportunities to develop VPPs in your own demand response program which is also highlighted in the BCG report I just wonder if you’re in a position yet to have any plans for that? Is it on the horizon?
Vince Hawksworth: Yes, nothing we can really discuss with any confidence at the moment. I think, you know, the way to think about us in that space is as William’s indicated, in a retail space, we’re incredibly focussed on getting fully integrated on one platform. As we get integrated on that platform with our technology renewal, we’re making sure that that technology can move from being fit for now to future ready. Things like VPP, how we might interface with customers, is work we are doing in the background but unlikely to announce anything during this financial year.
Nevill Gluyas (Jarden, Analyst): Very clear, thanks. That’s useful. Then the last, really –well it’s about how we should think about the futures curve and of course asking anyone about this is an exercise in speculation about what the market’s thinking but I just wondered if you thought the current curve beyond this year reflects the way of new renewables that are coming online and whether or not you think it’s a reflection of that or whether that the market is waiting to see these things actually in the ground and running before it starts to react? I’m just interested in your commentary there.
Vince Hawksworth: I don’t – I’ll let William go with – he’ll probably be a little bit more analytical than perhaps I will be. The way I look at these things is, there’s been so much
talk and vapourware that the market tends to look for spinning turbines or – and real megawatts as opposed to bragawatts or other watts that might turn up.
Nevill Gluyas: (Jarden, Analyst) Yes.
Vince Hawksworth: So I think there’s always a degree of conservatism in the way people think stuff will turn up. I think that’s probably founded in reality.
William Meek: Yes, just to add to that, Nevill I mean the flippant answer would be if I knew that, then I would have won lotto a couple of weeks ago and I wouldn’t be on this call. But yes, it is – it certainly is interesting. We certainly – you know, that – I think that whole trilemma when you look at it through that lens, particularly the interplay between reliability and renewability, how that plays through. I mean clearly Contact’s Tauhara Station will start up this year but that has ramifications for TCC. So while it’s an uplift in energy, it’s a decrease in capacity.
So I think that call out we had in one of our slides around just how end user pricing or how market pricing can be quite different from the levelised cost of energy because at the end of the day, the market needs to supply the demand curve. It’s – and how that balances. So what is the – what is that price of peaking and then what really happens?
We still – I don’t think we still haven’t seen what happens in the event of an acute national drought yet. I think that – those – the impacts of those sorts of events can inflate prices quite significantly also. So I suspect you’re going to get conservative operation of hydro schemes generally across the market to preserve flexibility That possibly leads to increased spill in some cases.
Nevill Gluyas (Jarden, Analyst): Right, yes.
William Meek: But I think it’s just the – you know, with long right-hand tails on prices, it’s just the payoff of being able to generate when things are tight are much greater than, say, what happens when prices are very low for short periods of time given people were largely hedged in the short-term.
Nevill Gluyas (Jarden, Analyst): Yes, so a lot of risk featuring in people’s decisions about lake levels That makes sense Okay, thanks for the thoughts So that’s all from me.
William Meek: Thanks, Nevill
Operator: Thank you I would like now to hand back for closing remarks Thank you.
Vince Hawksworth: Thank you, Operator and look, thanks to everybody for dialling in. Thanks for all the questions. As usual, wide ranging and stimulating. I suppose leaving
the call, we would just say that Mercury is a changed business, both in scale and our opportunity to do things in the future. We appreciate the support of our investors, our customers and our staff and we’re looking forward to another productive year. Thank you. End