MCY HY2019 Results Transcript

Mercury HY2019 Results Transcript Interim Results 2019: Analyst briefing transcript 26 February 2019, 11am Transcribed by West Pages: 15 Start of Transcript Operator: Thank you for standing by and welcome to the Mercury Interim Results Analyst Briefing Conference Call.

All participants are in a listen only mode. There will be a presentation followed by a question and answer session. If you wish to ask a question, you will need to press the star key, followed by the number one on your telephone keypad. I would now like to hand the conference over to Mr Fraser Whineray, Chief Executive. Please go ahead.

Fraser Whineray: Kia ora tatou, welcome to the Mercury First Half 2019 Results Briefing. My name is Fraser. I am here also with William Meek, Chief Financial Officer and we are looking forward to taking you through these half year results as well as there'll be some Q&A after that managed by the call operator.

What I would like to do, given it's just the half year, so we'll touch on the key points rather than go through each slide and just get straight to slide 7 with the half year for 2019 highlights. We had $302 million of EBITDAF. Hang on, I'll just click through on the slide so that it will load on the screen. $302 million of EBITDAF. The previous year was at $304 million. That was itself a record of record hydrology. We held $302 million, pretty much flat on 250 gigawatt hours less water. At $100, just to put that into context, if you assume that water was worth $100 that's $25 million less water to provide generation.

We had - so the hydro was down as you can see in the 3,901 gigawatt hours for the total book and hydro was down and then offset partially by 40 gigawatt hours of additional geothermal generation. As planned shuts were in the PCP and we had higher availability because of these planned outages there and that was a positive for those geothermal operations as well as our joint venture partners in those geothermal operations as well.

William will talk later to the long running slide we've had in there on market thesis around supply, demand, spot price volatility flowing towards the market fundamentals at more the mass market end of town and how that seems to be going against, as I said, a slide we have had in our deck for some time now. We paid the interim dividend, 3.3% up and we will talk to guidance later on but we continue to show an improvement in the ordinary dividends over the long term which is what a lot of our investors are obviously focused on.

The customer front end. I'll touch on a couple of slides there but it is a very, very competitive and difficult market.

We have net lost 7,000 customers, which is about probably 20% of actually what the gross losses are for everyone in the market because churn runs at about 20%. We have been focusing more on CLV, or customer lifetime value, and we've got far more capability in that and that isn't growing as we upgrade our IT platforms. So, it is very competitive and we will talk to that shortly.

We continue to invest in the core, right across the business. I've already touched on some of the ICT investments.

Just last week we went live with a very significant upgrade to My Account, for those of you that are Mercury customers, which not only produces better functionality for our customers but is far more dynamic for our team to

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 1 of 15

be able to modify offers and content and have that simultaneously appear through multiple different channels, as opposed to having to upgrade those all individually using third party support.

Whakamaru and Aratiatia, well under way and those units will be progressively buttoned up as we head towards winter. They've each got one unit to run next year. Following that there will be a little bit of a gap and then Karapiro will kick off for 2022, 2023 and 2024 across those three units, we announced that in January. That's a really important milestone because it's the fifth of nine. We have made the decision for substantial refurbishment to pick up some more capacity and efficiency, but the real driver for actually doing those refurbishments is because such significant infrastructure does need a long dated [indistinct} from time to time. Karapiro has been installed since 1947. We were able to lift performance along the way because now we have computers instead of slide rules and that makes a big difference and we've learnt a lot about how to refurbish these things.

So that is travelling very well. We continue to think about the balance of the four power stations as to when they might need their refurbishments and we are doing further work on that this year so we can consider the mediumterm CapEx requirements for hydro reinvestment.

In terms of looking to slide 8, key outcomes. As I said, it's a tough market. Some of the acquisition activity, you'd be more than familiar with the whiteware offers, a free month of power, which I can tell you in my house will be a lot, $400 credits. Non-price attributes can only take you so far but I think this market is still largely bounty driven at the front end and that does lend itself to churn two years later. We are very focused on trying to lift the acquisition rate we have, not on acquisition arrangements, but on the headline arrangements because you are just postponing the inevitable. In many instances competitors are heavily capitalising those investment costs in customers but they do come home to roost over time as they're amortised or written off. We prefer to, in the main, we have a very low balance or a very low asset on our balance sheet related to acquisition activity. Substantially below any of our peers.

In terms of - our churn relative to market has come under pressure. It's still lower than market but it has increased.

It has also increased in the Mercury brand because we've transferred Tiny Mighty Power which was a high churning customer segment. We transferred those customers into the Mercury brand as well as we just tidy things up branding-wise following the Mercury rebrand two and a half years ago.

Interesting bit of R&D at the front end on Mercury Drive. We have now got 18 cars on that Pure EV subscription service. There are a lot of people waiting to use that service. We do not promote it at all and we are just thinking about that product and tuning that product and thinking about suppliers, as to whether or not that's a proposition that customers are more interested in. So that's one of the pieces of R&D we've got on the go alongside things like our Southdown battery that we installed last August and we've got some data on this time around.

We also, just on digital experiences, launched Mercury Go, our app. That has also been supported by the My Account upgrade. The apps are a journey. They're a very important journey. You keep on adding functionality to them. We have made some significant advances. I think we're on our version three now since launch and that will continue to add functionality for our customers since the smartphone is what everyone seems to be glued to these days and I don't see that changing.

We have, on slide nine, made a significant consolidation, after four years of thinking, to one Auckland office in Newmarket. This is very important locationally for getting the best reach for our current employees, but also future employees over the long term, in a congested Auckland city, and also attracting the right human capital and retaining them by having a good work environment.

The so-called head office of this business has actually never sat with the retail business in its existence for 20 years and so this is also quite a significant change, apart from no-one, including me, having a set desk, so we're working through that as well. It's a very significant change in that the Executive and others are far more exposed to the retail business and therefore we can support Julia and Kevin, who are responsible for that and the technology

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 2 of 15

platform far more than we have when it was out of sight, a bit out of mind, at Greenlane. So, we're looking forward to seeing how that dynamic changes as well.

In terms of long-term value, it may roll easily of the tongue keeping nominal OpEx flat, but that is a challenge. Each year we try to set ourselves and we have managed to do for some time now and it gets, you know, we have to keep finding new ways of doing that. It is challenging and we are really pleased where that has been held and that is approximately $30 million lower than the peak OpEx that this business used to run back in about 2011 and 2012.

We have also, as you'd know, sold Metrix. We had an investment in Tilt back in May. Tried to take that private with Infratil last year. Did not succeed in reaching 90 per cent and then they've gone ahead, obviously, with their Victoria Dundonnell project which we will be providing capital to in their capital raising which is underway. So, we are pleased with Dundonnell. Obviously, we would have liked to take it private but didn't succeed last year.

Returns for shareholders, they're highlighted and you know about our long run track record on how we like to run dividends.

Just turning now to slide 12 on regulatory. A lot of stuff coming out last week. A Tax Working Group review. Very important to work through what is happening with non-consumptive uses of water. Not because I think it's likely but because it could have some quite direct but also very interesting and problematic dynamic impacts for New Zealand's renewable competitive advantage, but that looks like it's in a solid position at this point based on the principles that were laid out in that group. And certainly, capital gains tax was the focus for all of you landlords on the phone.

The Electricity Pricing Review was - a paper came out, the options paper. Consultation for a month, wrap the final report up by 31 May and then it goes through further, I think, political processes. I think it highlighted a lot of very helpful things to continue to improve the sector. We are pleased that this process is going on. We are delighted to see the low fixed charge tariff which every political party agreed prior to the election needs to be phased out. It is there and strongly agreed with. We think the market making needs to be addressed quite swiftly. It's a critical dynamic for keeping New Zealand's electricity system renewable. It's also very important for enabling competition.

The EA has been working on that but it does need to be resolved. That is also related to greater upstream fuel transparency.

We are waiting, we understand the UTS decision is out on Thursday from the Electricity Authority. Whilst our view is that it wasn't a UTS we certainly believe that there is issues that the EA needs to resolve in terms of having knowledge of and trading on information which was not transparent to the market during October and November.

We hope that they get to the bottom of those issues.

Interim Climate Change Committee: that seems to be travelling very well. They understand the construct of New Zealand energy versus electricity arrangements. How they're related, how the trilemma of price, reliability and renewability intersect.

I expect they’ll certainly conclude that electricity is the opportunity. We don’t need renewable electricity targets, we simply need bipartisan or multi-partisan low-carbon energy targets for the country. Then the electricity system can get on with the business of providing great outcomes.

So quite a bit on the regulatory front, which isn't surprising. We had a lot of reviews kick off last year which need to start landing this year, with the second full year of government. We’ll continue to engage on those. But so far, I think they are travelling in a reasonably good space.

Now I'll hand over to William who can talk us through some of the market dynamics and financials.

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 3 of 15

William Meek: Thank you Fraser. So, welcome and thank you to those on the phone. It's great to be here to present Mercury's 2019 Interims. It's particularly special today as it's Fraser's birthday and we'll be looking forward to the cake later.

I'll walk through the deck so we can get to Grant and the Q&A shortly.

The next two slides are really focused on a spot price dynamic. It's certainly been an interesting half year. We've seen some of the highest prices that the market has ever witnessed. It's a stark reminder of the importance of fuel and pricing.

So certainly, through that October/November period we saw very elevated prices. A combination of gas supply restrictions from Pohokura, lower coal stockpiles at the Huntly Power Station, thermal outages and lower hydrology across the island.

So those certainly combining to create some record price levels through October and November.

If we look at the calendar year, prices in Auckland have averaged almost $115, almost $100 in the South Island. If we look at the October to February five months stint, so February's almost over, we're looking at $185 prices in Auckland and $160 in Benmore.

So certainly, a stark contrast to where we have been in recent times. So, I think just let's pause to reflect on just the impact of gas, coal and hydrology in terms of setting prices for that market.

So certainly, when you look at these charts you can see a big adrenalin shot there in that October/November stretch, very high prices. Then we've seen that sustain through into more recent months. Hydrology has been below normal since early/mid-September.

Let's follow slide on 14, gives us another view of this price volatility. For those '80s pop fans Swing Out Sister sang a song called Breakout and we've certainly seen prices in October and November, and to some extent February, break away from that scatter plot trend.

So, again, all of those months are heavily influenced by gas availability in the market. So, we're seeing - that's unusual. It's certainly not something we expect to occur frequently. But it certainly has been a feature of pricing over recent months, and certainly during this interim period.

So, we, yes, I think it just highlights the importance of those fuel sources in terms of creating a vibrant electricity market here in New Zealand.

On to 15 and what this means to Mercury. There's a couple of charts here and a table. So this chart, I'll talk to the chart first. It shows a number of lines. So, storage on the Y axis, going up to 600 gigawatt hours. So, notional full in Taupo is about 580 gigawatt hours, 1.4 metres in Lake Taupo. So that's the sort of normal consent limit.

You can see the black line, that tracks the minimum hydro level experienced by Mercury since 1999. So, it's a combination of a number of years. But what we can see here is a very big triangle with pairs in Q2 of financial year, or Q4 calendar, where [unclear] lakes typically rise. Certainly, even the minimum rises.

Then you see this significant decay as you go into the summer and early autumn period, which is the driest inflow time for the Taupo catchment. So really wanting to signal that you need to actually lift Taupo's lake level in preparation for that decay in storage which is expected through the third quarter of the financial year.

That's reflected in the average storage chart in the grey line, which again shows on average over that 20-year stint the lake generally falls by about 200 gigawatt hours over that timeframe.

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 4 of 15

So that's interesting when you reflect on the high prices that manifested, particularly in October and November.

We've seen them sustain at slightly lower levels thereafter. So just highlighting the criticality of lifting that Taupo lake level in preparation for the dry summer/early autumn period.

So, the ability for the Company to realise opportunities is tempered. So, Q2 is a time where you need to be cognisant of those storage requirements as you prepare for spring/autumn.

So, we move over to the table, and again you can see the start of the year starts off quite wet. Then turns quite quickly in September, October and November to where you’ve got inflows tracking well below average for that second quarter of financial year, coinciding with those high prices.

So really moving to our market thesis which we've had for a number of years. Clear thing that has happened is wholesale price volatility has occurred, certainly assisted by some of the issues we've experienced in gas supply.

That has manifested in futures price increases. It did take some time in terms of that feeding through to futures prices in years two and three. But, certainly we'll touch on that shortly.

We have seen that reflecting through into C&I pricing recently. What we haven't seen is, we haven't really seen any retail churn reduction. Again, that's not surprising. The largest retailers are vertically integrated into generation.

Independent retailers will typically hedge, highly hedge, a year out based on forecast demand. So again, the market somewhat less exposed to those high prices than you may imagine.

So, we haven't seen that - seen any real pressure in terms of retail price movements because of the increasing futures price. So that's a dynamic. We are surprised at how aggressive competition continues to be in the New Zealand power market.

Slide 17, really looking forward into the futures and C&I market. So, you can see there very late in the piece futures prices starting to spike from where they were trading in the $75 to $80 range. So quite late in the piece, 22 February there. You can see prices two years out now trading at above $90 a megawatt hour. So that is feeding through now into pricing for C&I. I think it's worth thinking about the way commercial customers contract. They typically approach market or suppliers for contracts well ahead of their contract expiry. Certainly, it's never a good time to renew time your contracts when spot prices are at $300. So, there tends to be a delay.

So certainly, over that Q2 period the amount of renewals was relatively light. But you can't stay uncontracted forever. Certainly, while you have elevated spot prices being exposed to those as an industrial customer is less than desirable. So, we are seeing contract prices starting to lift significantly now.

Just touching on demand, certainly here this chart is already going for analyst decimal point accuracy. So, demand was actually down by 0.5%, so largely flat against the PCP. Again, typical themes: industrial down slightly for that, irrigation down a little bit for the interim period also.

Good to see Tiwai up at 620 megawatts, that's certainly helpful. So mostly seasonal effects there. Certainly, on outlook, we expect demand to reset and to grow slowly through time.

Touching on the retail market, which Fraser has already addressed. Certainly, a very focused approach around value versus volume. So that has reflected in lower ICPs over the period, so dropping 7,000.

Very pleased customer sat (satisfaction) lifting to 63% over that half year period. Certainly, it's good to see competition does keep things vibrant. We're certainly seeing a convergence in the market around churn rates, as everyone certainly improves their game and gives customers good choice. Which again I think is reflecting through into a pretty good outcome in terms of the EPR options paper.

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 5 of 15

Jumping forward now to just a financial bridge for EBITDAF. So, despite over 200 gigawatt hours less generation across hydro and geo, we produced a result only $2 million lower than the PCP. Unsurprisingly you're seeing quite big price movements there in generation and on your purchase volumes. So quite a big offset there. Generation obviously up due to prices. But buying energy for our customers pulling us down $120 million.

Not much movement in terms of the volume in pricing in that fixed price variable volume sales. So we did see mass market pricing up 4%, but C&I pricing broadly flat. Again, reflecting a pretty flat futures curve over the first half of this year versus the prior period.

We did see CFDs, you can see there's a disclosure at the back, but between derivative settlements with end users and others totalling about $58 million as a bridge.

So, a pretty good outcome with a result very similar to last year despite significantly lower generation volumes.

Fraser Whineray: So just turning now to guidance on Slide 22. The guidance is confirmed at $515 million on 4,150 gigawatts, but that is subject obviously to those caveats there. It is a volatile time on hydrology and the wholesale market. So, we just need to keep that in mind.

We have regular feedback that our guidance is the best public guidance in the market so we tend not to move it based on small numbers at this point in time. Because otherwise we would need to update you every time it rained in Taupo.

The ordinary guidance, unchanged for the dividend, up 2.6% on the previous year, 11th in in a row. And the stayin-business CapEx running there at about $95 million for guidance as well.

We've talk to dividends already on the prior Slide 23, so I'll skip that. But it's a clear trend of ordinaries and then also some capital management around specials and share buybacks. The price at which we bought back is noted for those both, which currently sit as Treasury stock. You'll be familiar with our funding profile chart.

But just before I go to Q&A I wanted to go to Slide 27 and just remind all of our buy and sell side what we normally run through in terms of investor relations, in retail, international roadshows and sessions here with access to senior management and engagement there. It seems to be well received.

We try and improve them every time and we indeed have one of those because they've done the capital markets days, are done every two years and we have one of those coming up this year in November and we're looking forward to seeing as many of you domestically and internationally there.

There’ll be plenty to share and no doubt we'll be able to get Evie, our '57 Fairlane along as well so you can admire that and maybe be taken for a test drive. With that, thank you very much. We'll conclude that part of the presentation and now happy to move through to questions and answers, thank you.

Operator: Thank you. If you wish to ask a question, please press star/one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press star/two. If you are on a speakerphone, please pick up the handset to ask your question. Your first question comes from Grant Swanepoel from Craigs Investment Partners. Please go ahead.

Grant Swanepoel: (Craigs Investment Partners, Analyst) Happy birthday Fraser.

Fraser Whineray: Thank you Grant.

Grant Swanepoel: (Craigs Investment Partners, Analyst) Well, thanks for question time. Just first of all thoughts on wind development in New Zealand, do you guys have any near-term plans to get some resources up and running?

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 6 of 15

Second question, on the trading of CFDs, you guys do a very good job year in year out of utilising your excess generation and your storage to trade near term. Did this catch you out a little bit with the once off in nature or the left field in nature gas shortage in November and December? You, more or less, gave a cost to the extra or the shortfall of hydro being $25 million, can you give some sort of idea of what you were short on CFDs due to this gas outage and would this have continued into January or would you have normalised the way you trade on that book?

Third question, just on retail, the 3.8% price increase on residential was a nice strong one, did you guys have an expectation that this sort of price increases can continue for a little while? On C&I, with the lift in forwards prices coming through, your competitors, I know you don’t talk for them, but they were indicating that they hadn't really been contracting into that market yet. Are you guys really active in that forward market? The final question - oh no, that was it actually, thanks.

Fraser Whineray: You (William) might address a few of those.

William Meek: So the first question, wind development in New Zealand, so you're aware we've got wind consents and land rights at two large sites, something we're certainly keeping a watching brief on. We certainly see that wind will have a bright future in New Zealand, so we believe it is the lowest cost generation source, so yes, when the time is right, we'll make an announcement about our wind development aspirations here. We're certainly encouraged with Tilt progressing, Dundonald and Tilt obviously also expressing some views around advancing the Waverley Wind Farm perhaps some time this year.

On the question around CFDs, so you can see in the disclosures, CFDs were about 11,000 gigawatt hours, we saw prices lift about $50 a megawatt hour, so that's a short position, so obviously that's going to hit there for about $55 million by itself. The CFDs are - it's a complicated portfolio because it includes futures contracts which can be quarterly, monthly, FDRs, includes end user contracts, which are more base load, multi-year, includes over-thecounter deals with generators, also includes close forward contracts.

So we look forward over this interim period, certainly the high prices in October were a surprise to us, certainly they weren't surprising after we found out there was going to be an extended gas outage and so there is, as you are aware, a UTS that's currently looking at the disclosures relating to that, but certainly ahead of that, there was no way you would have predicted prices would hit $300 without that significant field constraint in the market, so that was a surprise.

So you're probably also aware that generally market making was relatively poor, so your ability to actually trade contracts during that period was frustrated and so therefore that also made it difficult to move positions quickly and efficiently through that time. So I think we look forward to the outcome of that UTS around differential information because I think it does introduce risk for the market which is unnecessary, so you need to have where field constraints are going to impose significant risks or supply constraints to the market. All market participants need to be aware of those, so that would normally be the case in a well-functioning market. I think the bridges there on CFDs, you get pretty close in terms of the disclosures we've given.

Fraser Whineray: In term of retail, you mentioned the price was down: actually it wasn't a price lift, it's a yield lift.

The pricing has not lifted 3.8% on energy to any users in terms of what they experienced and there is a range of things, when you net out to an energy margin line, that come ahead of that, such as distribution tariffs and the way that previously regional changes and distribution tariffs have made that slightly more favourable.

C&I, yes, there is some activity in C&I. I think there's a bunch of people that are running pretty hot with the procurement manager at those organisations feeling pretty plucky about that over the last few years. But I would say that has reversed and there are people certainly after, a little bit during, but a bit after which have sought to decide not to take that risk on the spot market, lock it out for a range of reasons and there are some quite big names in there actually in terms of counterparts that had come to market.

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 7 of 15

Some of those we had transacted with. As you know after 2011, I think it was Energy Link, I don’t think it was the ASX thing, but the futures price then was very elevated into the $90s. We sold a lot then with a [unclear] and got the book pretty short at high prices and then they slowly rolled off over 2012, 2013, 2014, 2015, which led to yearon-year decreases of profitability, but the intent obviously is to sell high and buy low.

When you don't have Southdown, you can't necessarily go for that as to a strong short position, but there's still generally features of that where we can and we see value and we've got willing counterparties, you try and trade with them at times like this. Then either manage your book or buy back or de-risk that position in subsequent periods and the volatility in the market shifts the forward curve up and down.

So, I think there have been some people who have decided they're not going to stay spot, but the actual net aggregate spot is still a bit of a hard one to determine. But what we do know is that the summer shorts and the summer longs are instantaneously equal on this market and if there are too many people hanging out on spot it means long fuel charges from generators at times of stress, get very spicy and I think you're seeing that dynamic manifest as more and more people went on spot as you had October November.

Some parties have just been much more, well not disciplined, I guess they've got a philosophy on their fuel system, particularly with the Genesis on coal, of not being a benevolent provider to everybody by providing what used to be five times as much coal stockpile sitting out the back in Huntly. That doesn't exist anymore. So, I think the key thing to October November is to think through what are the bits of that are noise and what are the bits that are actually trends which have actually changed on a more permanent basis and then working out how to best optimise the portfolio into those dynamics.

Our portfolio or market thesis has been pretty clear. To be fair, we've had sort of two years of very high hydrology before now, before it's all snapped dry in August on us in Taupo and we've had to be very patient to wait for those market outcomes to arise, but now that they're here, we have to sift through. We're certainly not going to set up our portfolio on a construct that we're counting on lots of unplanned outages from Pohokura because that would be an incredibly conservative position to take.

William Meek: So Grant, just on the C&I, so again, slide 17 is the key. If you look at the futures price, which C&I price references, it's basically traded in Auckland between $75 and $80 since 2014. It's only essentially since 2019 you've seen that elevate and go north of $90. So a C&I customer will trade around that C&I price, so it essentially went flat for five years and now on the back of these elevated prices, you're seeing C&I contracts pretty much since January 2019 printing north of $90.

Fraser Whineray: I think part of that swap curve is it necessarily against expectations of future wholesale or spot prices versus the C&I as exacerbated by uncertainty around the gas situation. That's when William was commenting that the market would be more efficient and avoid unnecessarily risk perceptions, if that that was enhanced. Because I don’t expect that the ASX is necessarily, even though - and it's partly because of the low liquidity and market making at the moment, the ASX was necessarily efficient in the current circumstances over the long term.

That will mean on an expectations basis, which are driven by generation development, is probably below where the current ASX curve is, notwithstanding you don't make investment decisions for generation plant based on 3.5 years of a futures curve, so it's more of a 25-year decision.

Grant Swanepoel: (Craigs Investment Partners, Analyst) Thanks.

Operator: Thank you. Your next question comes from Aaron Ibbotson from UBS. Please go ahead.

Aaron Ibbotson: (UBS, Analyst) Hi there, good morning and happy birthday. So I've basically got two questions which are pretty much the same, but the first, I just wanted to probe a little bit on the C&I pricing and I guess the first question is what's the size of that plus sign? Because the $10 in context of currently averaging 74, if I've got it

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 8 of 15

right, you’re saying it's printing north of 90, the chart shows 100 and surely there should be a little bit of a margin considering that part of these contracts are FPVV, so presumably, so you're effectively signing away the option as well. So, I was just curious to know what the sign of the plus sign was, we're looking at 10 to 20 or you're looking 10 to 12?

Secondly, this is sort of a left-field question here, but I wondered in light of your expectations of increased wholesale prices and in particular increased volatility in wholesale prices, if you would consider getting yourself in the mix of trying to bid for or get access to a swaption from Genesis maybe not the size of Meridian, but something there to sort of protect yourself and have a bit more flexibility. Thank you.

William Meek: So, I'll take the first question, Aaron. So again, just coming back to contracting with commercial and industrial customers, so there are a couple of things that play out. So, you've got customers that are effectively rolling off some form of fixed-term contract, they may start that renewal process up to six months ahead of expiry, so their choice therefore is to run a tender process, accept the lowest price that's tendered or take wholesale price risk. That's essentially their options.

I think as you get out the back-end of the futures curve, the liquidity is certainly not as robust as the front-end. So, you're seeing curves - prices up at the $100 mark. I don't think you're going to be signing C&I up at that level, but certainly we're seeing contracts signing above certainly printing lines in the front now, as you're working through that. You're probably closer to a $10 or $12 lift on those renewals from where you were a quarter ago.

The flexibility for fixed-price variable volume versus just a swap, so while there is - you are giving customers some flexibility, the reality is with a commercial industrial customer, their decisions to actually produce widgets is not largely driven by power prices. It's actually driven by their capacity and the demand for their product. It's - and most big customers are pretty predictable in terms of the demand profile. So, there's not a lot in it between giving them the certainty.

Certainly, for us our preference probably is to sell a swap. It does create, I think, better dynamic incentives for the customer, that in the event prices are high, they can elect to effectively curtail production. But to be frank, if you're curtailing production, the few hundred dollars a megawatt hour, your value-add to your product is pretty low. It's really only relevant for those energy-intensive companies like pulp and paper, steel mills, those sorts of things, where the value-add is lower.

For someone like SkyCity, an office block, it's just not economic for them to be curtailing production, and they typically don't. So, I think you can overstate the value of flexibility to a customer on those contracts.

Fraser Whineray: In terms of the - you're talking about swaptions and bits and pieces. Just for the background, we used to manage some of this with flexible gas contracts into our gas-fired power station in Southdown. That was a covered call there.

We used to actually have two - we've had two swaptions in the past for derivatives with Genesis, and we indeed did bid on the latest, or the previous round, which cleared a year or two ago on swaptions. Clearly there are people that valued them more highly, and that's because they have South Island hydro plant.

If you have South Island hydro generation, you have an inverse correlation to your sales book, whereas if you had North Island hydro generation you have correlation with the demand coming from your sales book for your fuel system.

So, yes there might be some aberrations, and that might shift around, but typically lots of water in the South Island leads to lower swap prices, and ours, as is shown in our investor deck, the amount of water in Taupo is typically uncorrelated with swap prices. We tend to enjoy the benefit.

Indeed, last financial year we had lots of water, and we also had some pretty reasonable correlation of when the prices were elevated, and did well.

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 9 of 15

The dynamics around pricing, fuel options and derivatives, or associated derivatives with that, is something that we continue to look at time to time. You've got to remember that in paying for this swaption, because they're not cheap, and paying for the exercise of that swaption, what other arrangements are possible to mitigate risk, but also where do you set your portfolio based on an expectation of hydro production? On average 4000 for us. We set the portfolio to be slightly long typically, because we don't have Southdown. When we had Southdown, we could set the thing short, on average.

So, we have to keep on sifting through what we saw on October, November, thinking about gas disclosure rules, when they're going to be fixed up, when market-making's going to be right, and what was the noise versus the signal in what we observed, to then assess how should we best establish our portfolio? If we think that there's some optionality that we need to go back to there, then there's actually about four or five ways to achieve that. It's all about going for the lowest cost way of dealing with that.

Yes, a very serendipitous and great outcome for some of the party to - who worked October, November very hard, but as I said, you don't set your portfolio up for - by design, if you can manage it in other ways, for a Pohokura unplanned outage, which is not transparent to the market if - otherwise you actually wouldn't bother hedging much at all. You'd sit there and play the market more.

Aaron Ibbotson: (UBS, Analyst) Thank you. Sorry, can I follow up with one quick question?

William Meek: Yes. Aaron Ibbotson: (UBS, Analyst) So, this is sort of an accounting question that maybe I should know, but I don't.

How should we expect Tilt to flow through the accounts? Maybe it's in here but I didn't see it where I expected it.

Secondly, just on following up on Grant's question on the CFD book, so in my - when I try to model you for the second half, I - based on historical patterns, it looks like you are likely to be a little bit actually short, if your hydro predictions are correct. Do you think you will end up being short, or do you think using your average hydro expectations that you will muddle through and be able to stay neutral through the second half?

William Meek: [Aaron], the first one, accounting for Tilt, Tilt's accounted for as an investment, so we don't meet the test of significant influence yet. When we have a director that will change, and we'll equity count Tilt.

Right at the moment you'll be seeing the investment carried at cost, and you effectively recognise dividend income in other income, in our - once we equity count it, you'll see it. It will drop below the line and be accounted for in the share associates profits.

Aaron Ibbotson: (UBS, Analyst) Okay. Sorry, but when will your director actually come on line, then?

William Meek: It's post the capital raise.

Fraser Whineray: We're working through that.

Aaron Ibbotson: (UBS, Analyst) Yes, okay. Thank you.

William Meek: We'd expect - yes, it should be this financial year.

Operator: Thank you. Your next question comes from Andrew Harvey-Green, from Forsyth Barr. Please go ahead.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Morning team.

Fraser Whineray: Good morning, Andrew.

Andrew Harvey-Green: (Forsyth Barr, Analyst) [Unclear] for me. I think it's going to be a bit of a scene there. A couple of questions. The first one, I guess a couple of inter-related questions just around where ASX curve has gone, and thinking about - the level of ASX prices have gone, when do you think new generation might come in? If

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 10 of 15

you think - in essence, where prices are, you'd think building new generation right now would make sense. Are you assuming ASX prices might fall a bit? How long do you feel you need ASX prices to stay this leave before you might push go in some of your options?

Fraser Whineray: Yes. Well, as I mentioned Andrew - thanks for those questions. The decision to build, taking into account longer timeframes in the ASX curve will provide, and so yes, if you could say this ASX curve is going to last forever, then obviously then it seems a lot of generation development would be on the money.

I think, at the moment there's a risk premium built into it, because of uncertainty. Uncertainty around a couple of things. One, is I think the liquidity is seriously down on that curve, and therefore that means that you get an extra premium in these stressed times, on the difference between expected wholesale and spot market outcomes, and the curve.

Secondly, we've got some things running around on UTSs due Thursday, gas disclosures, and the EPR, and the combination of those to actually make sure that the market's well-functioning.

So, I think there's a bit of a risk premium built into at the moment, that - well given the dynamics of generation development, you shouldn't necessarily be sustained. Notwithstanding, that not everything produces ASX-style power. That's - geothermal does, everything else actually produces a different style power, and you have to think about how that actually relates to the ASX curve, depending on how that plant can be dispatched.

So short, yes, I think Neil was making some comments on development. They've been in wind for some time.

We've been looking at wind, and now through Tilt, but looking at wind for 15 years as the fuel system has developed. So, wait to see how the market responds, but do - for the long-term supply and demand dynamics, not just necessarily the short-term dynamics.

William Meek: I think too, Andrew, it's - when you're looking at a - let's just take a 100-megawatt windfarm as a rough example. So, you're looking at signing an EPC contract with a supplier, worth $200 million to $250 million, negotiating an O&M agreement that might last 20, 25 years. Making sure your consents are fit for purpose, and you're getting the right turbine design inside that envelope, making sure your land agreements will work, that's not something you magic up in five seconds. Those are pretty significant discussions. They've got massive value implications and it takes time. If we clicked our fingers today, it would still take 18 months to two years to see power in that project, complete to the grid.

I think it's - I think you're getting signals from market participants, and yes, certainly we'd agree, if prices are sitting at $100-megawatt hour, why isn't someone building a power station? I think the only implication of that is, no one's ready.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Yes, sure. Okay, and the second question I had was just around the electricity price review, and I guess you made a number of comments earlier on. I'd just be interested in terms of if all of the green recommendations went through, what sort of earnings impact would you potentially expect? I guess you might have a little bit of a negative impact in the short term from prompt payment discounts being banned, but is there anything else in there that you see as having any potential earnings impact?

Fraser Whineray: That's a great question, and something obviously we need to tally up as an Executive here. We haven't gone through the - well, it must be 25 ‘green’ ones, but the prompt payment discount didn't say there was no post-payment penalties. So, there's not necessarily any earnings impact there, but we will - we'll go through the whole lot and acknowledge that, at the moment, it's still an options paper, and we've still got some consultation to go.

I think there's some opportunities in it, and certainly upping gas disclosures and market-making obligations would be a positive thing, and I think the low fixed-charge tariff removal would be a very positive thing as well, over the

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 11 of 15

medium term, for this company, and the sector, and the consumers. There could - I think there's equally opportunities in it, Andrew, in the high-level.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Yes, sure. Okay, thanks. That was all I had.

Fraser Whineray: Okay, thanks Andrew.

Operator: Thank you. Your next question come from Nevill Gluyas from First NZ Capital. Please go ahead.

Nevill Gluyas: (First NZ Capital, Analyst) Good morning, team. I'll buck the trend, so I won't wish you a happy birthday. Sorry to do that, I feel bad now. Now, so a couple of questions, just to push a little bit harder on the new build question you've had a few times already, and also we're getting the sense that the people are getting near some kind of button pushing, whether that's to lock in options, or heaven forbid, even to start new generation. Can you give us some kind of flavour as to when you think the timing for generation is coming? I guess to add to that, the fact that the forward curve doesn't necessarily tell us the truth - or sorry, doesn't necessarily tell you the price path against which you're evaluating investment. That suggests that maybe your view of future prices is a bit lower, well certainly lower than the ASX curve is predicting. If you can give us some colour, not asking necessarily for the price path, but some colour as to what you think that - what is going to be setting that benchmark price in the future?

So that's just pushing on that. One other question on the EPR as well - let's push a little bit harder on that one obviously don't have the PPD exposure number yet. But I'm interested in your thoughts also on the proposal that the EA could put together propositions for un-switched customers, you know, that 40% of customers not yet switched. I just wonder what you thought your exposure was to that and or whether or not you think it's even achievable to execute some kind of plan like that.

Then on to some sort of slightly more - less interesting questions. Just interested to know how much working capital was tied up in the first half the ASX margin balances and just if prices did return to normal how much of that would be released in the second half - just to get a sense of that.

Also the - I think there was talk of the IFRS changes occurring and what the components of those were in the first half.

Then if you could just give us a little more colour around FY19 guidance being maintained. Obviously you've got the hydro volume set and you've told us about the $10 million reduction for Metrix so I just wondered if you could give a bit of colour on those other aspects. Thanks.

Fraser Whineray: Okay. William will take the last few on working capital, swaps and IFRS guidance. I'll kick off with the benchmark price issue, let's just deconstruct that in the ASX view. But what it is is obviously you start off with a view of what you think spot prices will be on average assuming average conditions which typically relates to South Island hydrology. Then you've got to make - then you're converting it into the ASX which is the shape which is square - it's square power. You've also got to deal with volatility from that spot price. You've also got to deal with fear or risk.

So when you're making a decision on wind turbines for example you have to think about that benchmark ASX price and, with the ASX you have to a view a forward spot] price for 25 years which is fairly prognostic in this day and age. Then you've actually got to think about things like location, shape of power, correlation with other wind farms, ability to co-optimise that wind with other assets you may have so that you've actually got something which is saleable.

No one actually buys wind power really at an end user level because most customers just - in fact all pretty much say I want the all you can eat package whenever I want it. I don't care if your wind turbine is turning or not.

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 12 of 15

So the benchmark price can indicate quite a few things. But before you break it down to work out what will actually happen with a stand-alone wind farm there's quite a few steps to go through. I think the benchmark price as I said previously, I think it's lacking some liquidity at the moment because of the market making. It's got some additional fear in it because of a lack of thermal disclosures on both fuel and plant for particularly upstream gas. So therefore I'm not sure that it's necessarily representative of the long term over which you may consider building a power station.

If it was of course then you'd expect it to - a lot of stuff to be built and therefore it would be a dynamic response incurred because ultimately in a growing market the price should be set by the LRMC of new plant. Bearing in mind though when people are talking about the LRMC to get plant away they could be talking about a different shape, a different location for their assets. So they're not all - not all those numbers are fungible.

I think William touched on it. There are a lot of things that have to be ready before you can push play on one of these large investments. A lot of things need to come together. It's not a spread sheet which optimises and says 3:00pm next Tuesday is a good time - or next - 2020. It doesn't - you don't get choices like you can in say foreign exchange markets where you can actually trade all you can want, all you can eat. This is – these are real things that involve human and financial capital, a lot of partners, a lot of stakeholders and some big supply arrangements as you're well aware of.

So optionality on push and play is not typically derived from the circumstances you saw in October, November and that dynamic. It just doesn't exist like that. So over time will stuff be built? Yes. Look - well we're only talking about a matter of time. If we didn't think - if we hadn't have thought that wind was going to be something that will be built over the next five to 10 years and there's other parties with those options as well then we wouldn't maintain our consents.

So I think what you're talking about is largely ’when’ not ‘if’ and whether it happens in three years or five years or sooner than that is kind of I think - I think relatively moot. I'm not expecting any developments to have any necessarily material dynamic impact on what we're seeing.

Then again just remember that when you decide that's the perfect hour and day to push play on a wind farm then you've got to realise that it will take 12 to 24 months to actually bring it online. So that's certainly well outside any current volatility. So it's not like you can just bring it on when you feel like it.

The Big Switch concept which they run in the UK. You need to remember that these activities of big switches have been tried in New Zealand before. I think you need to go back and look and see how were they successful, which customers cared, why, why didn't they. Then what are the non-price attributes - service, paying by cheque, am I contracted or not, do I get air points, can I get discounts on e-bikes, do I get free power days, do I just simply like that company. Do I donate to Starship?

There are - as much as electrons kind of look and smell the same - there are differentiators in this market. Now they get worn down when big bounties are put in front of people. But in terms of the Big Switch, yes it's been tried before. There's a lot of customers out there that are actually on fixed term contracts which would need to be broken too. So, we'll see where they get to. I think it's actually quite a difficult one to implement on a large scale.

Frankly if you looked at the equivalent of doing that in banking, broadband and other products, insurance, which broker you use, I think it's - which supermarket you go to - it seems like an incredible reach through given the knowledge and marketing and competitiveness in switching at the moment that's going on in the market. I think the most important thing that the EPR should focus on is the additional competition actually getting to fairness on vulnerable customers.

As I mentioned earlier there's a fair bit of product selection by design that goes on with larger and smaller competitors which is exclusionary. I think as much as they can all be virtue-signalling about what's really great are

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 13 of 15

they actually really putting their money behind treating those customers in a fair manner. So that's all I'll say on the Big Switch.

Then there's a range of accounting and working capital and interest rate swaps and goodies. So, William I'll let you‌ William Meek: Yes, on the working capital balances Nevill we signalled there's about a NZ$40 million movement and the bulk of that attributable to ASX margin calls. Looking forward we would expect to see that forward curve come back. So you'd see some of that retiring. Some of those will mature so that they also step out.

It is very difficult to forecast. We've seen margin calls swing on a day by NZ$15 million. So it's quite - it's highly volatile. But we would expect to see it come back because the ASX falls will come back - we expect it to fall back from its current elevated level of circa NZ$100. But it's very, very difficult to call at this stage.

On guidance, so we're guiding at 4,150 but that's a reasonably mechanistic outlook. It's where we're sitting today.

So while it's likely to be slightly dry in the short term who knows what the current - the remaining four months of the year have to offer? So obviously the calculation for adjustments to primary hydrology are pretty basic in terms of what that might mean for us.

In terms of being short or square we're comfortable with where we're positioned right now. We think we've certainly got some opportunities when prices are quite elevated while the Pohokura outage is on. We've got a Kupe outage potentially to come. Certainly, where the lake sits that does now present some opportunities for us to use water in a discretionary fashion. So, we're basically comfortable where we are right now.

Nevill Gluyas: (First NZ Capital, Analyst) Thanks for all those answers. Just a follow-up on the last one on guidance. Does that mean if prices did come off - I mean as you say it doesn't seem likely given the current pressures - but if they did does that mean we should expect to see a slight improvement in guidance even if water rides as per mean?

William Meek: Well the prices - I expect it's going to be right at the margin. So, we're comfortable with where we're balanced in terms of our outlook for the remainder of the year. That will come back to just where rainfall trends for the next four months. So, at the moment that guidance is based on a mean expectation for the remaining four. Who knows, I mean some of the bigger storms that come through, I mean we were meant to have a devastating storm on the weekend. That didn't happen but could easily have manifested had that front moved by a few hundred kilometres.

Fraser Whineray: It will all be relatively - it'll be at the margin I think as William said. But it's typically the two by two.

Who else has got lots of water? Notwithstanding having lots of water doesn't mean that there's lazy long tranches coming out of our competitors either in the spot market. But it seems to be that there's - what's the country's hydro dynamics or probably fuel dynamics? Then what's our fuel dynamics. You pop those on the two by two and we know that us having no fuel and the prices being really high which doesn’t manifest that often is risk for us and then vice versa and the two by two matrix.

But it's kind of - in the context of our bulk of our investors getting ordinary dividends and how we position the book it's not huge but it is - it can be material to us. We certainly spend a huge amount of time and energy looking at those issues and decisions.

Nevill Gluyas: (First NZ Capital, Analyst) Great thank you. The last question - super high value - everyone will be very excited - around the IFRS changes - I expect all the parts are there in the financial statements. I just wonder if you could hold my hand through the impact of 16.

William Meek: We presented in the last deck for the full year what the projection would have been. I think IFRS 16 is worth about NZ$6 million to OpEx. We're on track for that because our leases haven't changed from what we

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 14 of 15

were forecasting back then. There is a pretty comprehensive bridge in that one for the 17 and 18 comparatives when we adjusted for 15 and 16 but not IFRS nine.

Nevill Gluyas: (First NZ Capital, Analyst) Okay thank you, awesome.

Operator: Thank you. Your next question comes from Stephen Hudson from Macquarie Group. Please go ahead.

Stephen Hudson: (Macquarie Group, Analyst) Hi guys. Just a couple of quick ones.

Fraser Whineray: Hello Stephen.

Stephen Hudson: (Macquarie Group, Analyst) Hi there. Just on Vector's LLR decision last year. Have you built in anything into guidance for that or do you believe it's supportable? Then just I suppose another one for Will just on your cost of debtors. It think it's come right down to 5.8% down from 8.2%. Does that imply your NZ$20 million saving guidance is a little bit conservative?

Fraser Whineray: Right, so on LLRs we were receiving everything. They weren't getting passed one. So, all that’s factored into our numbers. That's been the situation for a little while now. There may be decisions which actually reverse that in future. So we'll see how that rolls out. But that's all - the fact that we're not getting them is all in the numbers, [in the] single digit millions.

William Meek: On the IFRS saving - that NZ$20 million was post tax. You've got to take NZ$0.28 off that number.

So we are expecting on an assumption of constant debt and debt has risen for the half year that you'd be looking at a NZ$20 million plus saving post tax.

Stephen Hudson: (Macquarie Group, Analyst) Yes, that explains it, thanks.

Fraser Whineray: Thanks Stephen.

Operator: Thank you. There are no further questions at this time. I'll now hand back to Mr. Whineray for closing remarks.

Fraser Whineray: Look thank you very much everybody for taking the time to join William and I and colleagues on this call. We do appreciate the questions and the engagement. Several of you we will be catching up with over the next week or so as we round out the half year. Looking forward to the balance of the financial and the calendar year. There's plenty to get on with. We appreciate your input. Thanks a lot.

End of Transcript

HY2019 Results Briefing Transcript by West | 26 February 2019 | Page 15 of 15