Turitea Wind Farm Announcement Analyst media briefing transcript

Turitea Wind Farm Announcement Transcript Turitea Wind Farm Announcement: Analyst/media briefing transcript 12 November 2019, 10:30am Transcribed by West Pages: 8 Start of Transcript Operator: Ladies and gentlemen, thank you for standing by and welcome to the Mercury Update on Turitea. At this time, all participants are in a listen only mode. After the speaker's presentation there will be a question and answer session. To ask a question during this session you will need to press star one on your telephone. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, to Mr Fraser Whineray. Thank you, please go ahead.

Fraser Whineray: Thanks very much. Kia ora koutou and thanks everyone for joining this conference call this morning for the - to cover off the announcement we made to the NZX at 8.30 that we're going to conclude the balance of the Turitea Wind Farm, which is about 80% of the size of the first part, and through to the second half of 2021 for a final commissioning for the entire project. That project will end up being New Zealand's largest wind farm currently and will be representing a total investment of some $450 million is what we've planned for.

We are very pleased to announce that. It has been like the first stage, some time in the making, though we are we have felt the synergies with the existing construction to allow Vestas and their subcontractor Downer to simply roll on and continue with the balance of plant to be compelling, as well as of course the co-benefits which we have mentioned before between Turitea and the Waikato Hydro Scheme in being able to deliver profiles that customers actually want, as opposed to simply wind profiles which can be a struggle for customers to accommodate.

We have got some specifications there which contrast the north and the south on slide 1 of the materials that were circulated. We are going for the same Vestas V112 turbine but with a software modification to make it 3.8 megawatts and that actually provides a lift in yield from the southern end, even though the wind speeds and net capacity factors are slightly lower. This is coming in at 370 gigawatt hours per annum, the first stage 470 and there's a slight - you can see the EBITDAF impacts on the bottom of stage one from both of them which will phase across FY21 and FY22. Largely should be done by then and possibly a little bit of full year impact coming through in FY23.

We have got some scale efficiencies as we mentioned when we announced the north end with respect to transmission. All the transmission line is done in the north end and the south end just simply tees into it and of course we have accommodated some aspects of the transmission to allow eventual longer-term expansion to the ridge to the east at Puketoi.

The next slide just highlights the two, it should be one you're familiar with, just highlights pictorially from a satellite photo what the stages look like and the approximate specifications of those and also notes about 30 kilometres to the east of the Puketoi site. We have also added a slide in with respect to Tiwai and Rio's review of the smelter which is going on at the moment. There has been plenty of analyst research, quality analyst research on that, over the last couple of weeks. The key thing isn't actually a decision as to whether they will stay or go, it's a decision of

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when they will go and it's either in 2021 or at any point at their option probably to 2030 when we believe it is highly likely that they will.

Therefore, you have to assume that at some point during the life of a project there will be a change in what happens down there. Now, if it was earlier, that allows for greater thermal response. If it's later, it allows for greater partial or full demand substitution with new opportunities potentially in the South Island which might offset the extensive and lengthy transmission build to get the power out of the deep south.

Our view is that the market situation is clearly showing a strong need for energy to be brought into the electricity sector. We are sitting here with above average hydrology today. Prices are over $250 and this is a clear signal that energy needs to be brought on. We don't believe that a decision to, so called, “stay� next March from the smelter will have any material impact on the business case because that simply means they could give notice at 12 months' time anyway and that doesn't actually change the reality of the situation.

We are pleased for this expanded foray into wind. In total we will have about 840 gigawatt hours and that compares with our hydro at 4020 and geothermal at 2600. It becomes a meaningful part of our portfolio and we are certainly committing to this asset class and also as we have, to a degree, through our investment in Tilt.

Now just to be clear, we have been running a balance sheet approach, a dividend policy, to enable these investments not to curtail on our 11 year track record of ordinary dividend growth. In fact, it's the opposite. The way that we have set things up means that by running what will probably be industry leading EBITDAF and CAGR for the next few years, that should actually allow us to grow distributions, not shrink them, in all of the [unclear].

We have certainly got plenty of balance sheet capacity on senior debt. We also have treasury stock as well, which was bought for [$100 million] and is now worth just shy of [$200 million].

So, there are no concerns about funding that as well as maintaining what we are very focused on which is our ordinary dividend performance and growth over the long term, which means we are only keen on lifting ordinary dividend performance when we can actually demonstrate ordinary core earnings have sustainably lifted as well and that's what these investments will deliver.

We are happy to now, operator, take any questions on the update to the Turitea project.

Operator: Thank you. Ladies and gentlemen, we will now begin the question and answer session. 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 the pound hash key. Once again ladies and gentlemen, it is star one. Thank you. Our first question is from Grant Swanepoel from Craigs. Please ask your question Grant.

Grant Swanepoel: (Craigs, Analyst) Good morning team.

Fraser Whineray: Hey Grant.

Grant Swanepoel: (Craigs, Analyst) Morning. First question, just on - so by calendar year 2021 you have another 1300 gigawatt hours coming onto this market. What do you think is going to happen to wholesale prices at that point or do you just assume that Genesis and Contact are going to close down their thermal operations at that point?

Fraser Whineray: Yes, well I don't think they're necessarily closing things. I mean that's their decision to make because 1300 gigawatt hours in the context of the total thermal generation in the market is quite small. I mean the total thermal generation in the market is probably closer to 8000 gigawatt hours currently. What it means as far as their fuel commitments, which are all very short term, so it's quite different to how it was historically when a lot of renewable generation came on and bumped up hard against a lot of take-or-pay gas and coal. That is a very different scenario now because everyone is contracting the short term because of thermal uncertainties.

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I'm not seeing any screaming pressure from one side which is that there will be a surplus of generation, because as I think one analyst showed or discussed, I think thermal generation has actually become a bit of a floor not a cap on spot prices and certainly not an abundance of cheap coal or gas plus carbon coming to market. So, at the moment spot prices, as I said, $250 and you've got above average hydrology, that's a sign of a market under stress. You'd expect over time spot prices to [tend closer to LRMC of new gear] as opposed to necessarily be stretched.

The challenge is if you don't get onto it early enough you can't go down to Bunnings in the weekend and fix it.

These things take a lot of time to bring on and so that's a signal that we clearly see, because we don't see the upstream gas and coal dynamics changing any time soon.

Grant Swanepoel: (Craigs, Analyst) Okay, so I am assuming that 20% of thermal demand is what you are assuming is going to be cut back on. Also, you're assuming that the current contracting in the 180 PJ gas market is going to continue to be quite constrained into the future. That this current environment is going to prevail if people didn't build wind. Can I just take that as your assumption and move from there?

Fraser Whineray: Well no, I wouldn't describe it quite like that. I think - I'll say what our assumption is, is there are some constraints upstream in gas in terms of economic delivery and also in some instances, physical delivery. The market is clearly showing signs of stress. In terms of whether they will abate or not, we don't see that. We see it slightly improving but probably not by much and that is a clear signal that there's economic electricity being brought on cheaper than what can be delivered by the thermal plants.

Now this is deja vu all over again. We were here in 2003 and after the Maui determination spot electricity prices went up as gas repriced and that led to a huge expansion of renewability in New Zealand, particularly in geothermal, but also in wind. So, we're kind of back where we were where gas becomes, and coal, but gas becomes stressed in particular and so renewable investment is built and that's the competitive dynamics in the market between competing fuel systems in an unsubsidised system.

Grant Swanepoel: (Craigs, Analyst) That period [unclear]. Next question. Just in terms of your risk on Tiwai. You talk about Tiwai just being a continued [rolling]. You don't see this review as something maybe a little more stressful and a stress point on the industry and that it might have been a bit more prudent to wait until that March outcome to decide, because a Tiwai closure, the market has knocked your share price 11% since that announcement. All things being equal, the market is assuming that that is a risk point, why is Mercury considering [it] something different?

Fraser Whineray: Oh yes, I think it's slightly different this time because it's actually Rio doing a review rather than Pacific Aluminium, so that is a slight difference of approach. But at the end of the day, Grant, if you're sitting around thinking about the long-term interests of our owners and the business case outlook, you have to assume that the smelter is going to go. Right and so if you waited until March/April, what would happen is if they said they will stay, that doesn't mean stay for a long period of time relevant to a business case to invest in wind. What it does mean is that they'll stay with 12 months' notice and you can expect two to three year intervals, depending on when the election is probably, you're going to see the sabres getting rattled again.

I think it is a slightly higher risk, but in the end, you should also think about the risk of the current spot and wholesale pricing dynamics flowing through to residential prices and the political impacts that that's going to have.

Because that doesn't fit easily in a spreadsheet, but I can tell you that is a very, very real risk to a regulatory system, a regulatory space. It's hard to model but it could be severe if it's not managed well.

Grant Swanepoel: (Craigs, Analyst) So your Board believes that to make an NPV positive [of maybe] $5 million or $6 million on a company that makes $500 million is worth the risk of not waiting until March.

Fraser Whineray: No. The point is, Grant, is it's more than at an NPV sense. The point is I don't see how it can really change your business case decision because if you've got a certainty that they will stay for 12 months and

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they will threaten to go again, meanwhile the electricity sector is showing significant stress, I can tell you the biggest effects that have been on our share price haven't been Tiwai, they've been regulatory matters.

You really do have to think carefully about the stress in the electricity market. At the moment we are going to be borrowing for far cheaper than our business case and the electricity prices are going to be far higher than our business case. I would say the front end of this is looking pretty good and Tiwai in my view is unlikely to go at this point, but they could. But on balance, we don't - it isn't a go or stay Grant. It's a go now or go later.

Grant Swanepoel: (Craigs, Analyst) Okay.

Fraser Whineray: All of those timeframes manifest within the business case.

Grant Swanepoel: (Craigs, Analyst) Thanks Fraser. I'm looking forward to your strategy this afternoon.

Fraser Whineray: Yes, look forward to seeing you there.

Operator: Our next question is from Andrew Harvey-Green from Forsyth Barr. Please ask your question Andrew.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Morning Fraser. I guess a couple of questions, more detailed questions from me. The first one is just underlying assumptions around your wind discount factor. I think you comment here I guess about the Otahuhu price being at $100 and $80 is your assumption. Is it reasonable to assume I guess you're looking at a locational plus wind discount factor of around about 20% for the wind farm now?

William Meek: William here Andrew. I can talk about that. If you look at Linton prices right now, you're sitting there slightly around about a 10% factor down on TWAP. This increases it by a few percentage points more. That assumes essentially you've got no - there's no optimisation happening across your hydro portfolio.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Yes. William Meek: Those are the sorts of numbers we are expecting there. Certainly we are very comfortable with a 222 megawatt wind farm. There is certainly some synergy between the way we operate the Waikato River hydro system and this wind farm. Also, certainly given where full prices are sitting and our preference for a C&I type contracting, certainly there's an opportunity there in terms of locking in some longer dated pricing at the front end of this wind farm as we step up 800 odd gigawatt hours in wind by mid 2021. It's a complicated calculation because you will get a hydro energy improvement.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Yes. William Meek: You can certainly store water through energy and certainly being exposed to wholesale prices at the moment it looks like a good play given, even ignoring super October 2018, prices are still rolling at $130 a megawatt hour in Auckland. They're pretty crazy prices.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Yes, indeed. Okay, so I guess based on the current market you would probably argue the $80 is relatively conservative, notwithstanding I guess longer term we expect things to trend back towards long run marginal cost [in the] generation.

William Meek: Yes, I mean you will be able to - we haven't given any LRMCs here but certainly the economics, given the capital cost, operating cost, are pretty easy to back calculate what they might look like. We're pretty happy. I mean to Grant's earlier point, I mean our consents do expire for Turitea in 2021 and so you've got, certainly there's an imperative there, but the synergies are having a continuous program and delaying by five months does create a gap in terms of that program and in terms of the way that might work for the wind farm, so that was certainly a consideration in terms of just having these things line up.

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But first and foremost, the market is just signalling stress. We can't see in the short term any drivers to particularly improve that so we think it's imperative that essentially new capacity is brought to bear to bring wholesale prices back down to, I wouldn't say more normal levels, but certainly lower than the low 100s we're seeing at the moment.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Yes, sure. Next question is just a clarification I guess around the OPEX numbers you have there of $12/$13 a megawatt hour. Is that the contract average you're looking at there, so in essence the contract starts lower and then grows at 2% per annum? Or is that the starting point for OPEX? William Meek: Yes, so that's our medium term number. Obviously through the life cycle of 25 years those numbers will change. You've got a, you know, long term arrangements with Vestas do have some escalation through the time.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Yes, okay. Just a last question from me, I guess just thinking about the dividend profile. I guess at the full year result there was certainly talk of once stage one is completed having a reasonable uplift in the dividend. Is that still the expectation based on the earnings that will come from stage one or would you look to wait until stage two is completed before you do that just given the additional CapEx that is going into the business?

William Meek: Yes, our dividend policies are clear around the 70% to 85% of free cashflow. Certainly the first slide of the deck there is showing a forecast of $55 million increase on EBITDA, so you would expect to see that flow through progressively into dividend profile while those plants are rolling through. There was a question at the results, our 2019 results, around whether we would move, because we're at the high end of the dividend payout band and we would just [balance at] the end, but certainly that's not the intent. We are expecting to see absolute increases in dividend payout over time according with that uplift tin earnings.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Yes, great. Okay, that's all from me. Thanks.

Fraser Whineray: thanks Andrew.

Operator: Our next question in the queue is from Janine Rankin from Mercury [sic]. Please ask your question Janine.

Janine Rankin: (Manawatu Standard, Journalist) Hello, from the Manawatu Standard. Yes, I was just wanting to check in with you about stage two, the southern area. A lot more people are affected in the vicinity there and just wondering how much extra homework you have to do to satisfy your resource consent conditions about the impacts on the environment and on the people who live there.

Dennis Radich: Hi Janine, it's Dennis Radich here.

Janine Rankin: (Manawatu Standard, Journalist) Hi Dennis.

Dennis Radich: Hi, so there's two things to say on that. One, the key condition that relates to I guess engagement with the community around constructing this wind farm relates to essentially a radius of residences within a distance of the turbines themselves. Our current community liaison work that was instituted for the north is incorporating all of those residences for the north and the south, so we are pretty well covered in terms of who needs to be in the conversation. In terms of any other resource consent conditions obviously we follow those religiously and the ecology work and various other things to satisfy those conditions has been well under way for in excess of a year now.

Janine Rankin: (Manawatu Standard, Journalist) That's great. Thanks very much.

Fraser Whineray: Thanks Janine. Thanks for joining the call too.

Operator: Our next telephone question is from Jamie Grey from New Zealand Herald. Please ask your question Jamie.

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Jamie Gray: (New Zealand Herald, Journalist) Hi Fraser. I just wondered if you could‌ Fraser Whineray: Hi Jamie.

Jamie Gray: (New Zealand Herald, Journalist) G'day. I just wondered if you could tell me what Mercury's thinking is in the event of a worst-case scenario where Tiwai did actually choose to pull out in 2021. Can you just tell me what the likely response to that would be?

Fraser Whineray: Well there's two things to that which speaks to not just this investment case. I mean this investment case doesn't actually really change how the market will have to reset and there's plenty of research on that that has come out around I think finally, because it wasn't the case several years ago, of the extensive transmission work and the cost of that required to get power to the South Island, absent some demand substitute in the South Island coming forward.

With Mercury, as we highlighted by a bit of that research, we are least affected. It's not the marginal 370 gigawatt hours, it's our entire 7 terawatt hour portfolio. But we are all in the North Island which is on the right side of the HVDC link and we also have no thermal plant. We mothballed Southdown in late 2015 and I am delighted that I am not having to recontract that for gas right now. That would be a challenging situation on price and quantity. So, we don't have any thermal response, we will have low cost renewables and we are in the North Island.

What we will do is have to manage our channels carefully but in the end we are going to be continuing to generate our amount of electricity and it will be for those that have assets which are stuck in the bottom of the South Island and those that have thermal plant to make some really crunchy decisions, but largely we don't have to make any decisions. We just have to withstand that outcome but also look for the opportunities in it as well.

Jamie Gray: (New Zealand Herald, Journalist) What about in the big picture? Is it going to be a major disruption to the entire market do you think?

Fraser Whineray: One of the - once everything is settled out, I mean most modelling that I've seen shows a four to five reset period, assuming there's no substitute demand picking up some or all of the load in the South Island.

That will be about a four or five year reset period. Spot prices would be volatile. The issue of deep energy storage for the country in terms of how to back up a South Island drought would be brought forward and that will require some good thinking from seasoned industry experts as to how the market needs to be designed to accommodate that.

But in some instances I've seen modelling, I think Energy Link's modelling came out, showed that actually post Tiwai in five years prices in Otahuhu are higher than they would be in the counterfactual and at Haywards, which is Wellington, they're pretty much the same as they would be in the counterfactual and power prices would be lower in the South Island.

So, the whole thing would need to reset. It's been dynamic in the past and there's a couple of key well known challenges that would have to be addressed. One issue is obviously if you build the transmission for $600 million plus, you also have to consider, well, what demand side could be encouraged down there to remove quite a lot of that transmission upgrade. If you do build it for $600 million, you've also got to ask the question of who is paying?

Jamie Gray: (New Zealand Herald, Journalist) Thanks for that.

Fraser Whineray: Thanks Jamie.

Operator: Once again, ladies and gentlemen, it is star one. Our next telephone question is from Gavin Evans from Business Deck. Please ask your question Gavin.

Fraser Whineray: Kia ora Gavin.

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Gavin Evans: (Business Deck, Journalist) Yes, morning. Just coming back to the - just trying to test what's changed for you guys since March? I mean obviously I think, if I'm hearing you properly, power prices are staying a lot stronger than you thought they would be, but what else has come into this decision?

Fraser Whineray: Well partly when you go out and procure the first stage of, well what [unclear] first stage of a wind farm, that's like an 18 month process. I sort of said, slightly facetiously, you can't go to Bunnings and fix it in a weekend. That takes about 18 months and at that point we're going okay, well let's go ahead. It's naturally physically split into stages anyway as a result of the way the resource consent landed. Then at that point we were highly surprised that there weren't a lot of shovel ready projects ready to go in the market and that since the analysis of one of the circumstances that led to the elevation in spot market prices back in October weren't just about [unclear].

They were actually about quite a few things in fact and so therefore you've seen this persistence we've had for 13 or 14 months now of power prices, spot market monthly prices, above $115, which is well north of the LRMC of plant] to bring on. Then when you look at the dynamics which have led to that, you go, well some of those aren't actually going to change any time soon because of the actual SRMC of gas and coal. With carbon charges as well.

Then we decided, well, is it possible to, with the synergies that we've talked about in both construction and operation, modify the contracts to bring on stage two. So we investigated that to see if we could bring it on for less, same or less cost, than stage one and that's what we were able to do and so we thought, well, we'll push play and go ahead with this and complete it.

Gavin Evans: (Business Deck, Journalist) Right, yes, because obviously low interest rates and as you said, lower costs than business case and higher power prices. You also mentioned, and I don't want to overplay this, but you talked about the political risk of these high wholesale prices coming into the residential market. Did you really mean that?

Fraser Whineray: Well I think you've got C&I repricing by $20 to $30 a megawatt hour at the moment.

Gavin Evans: (Business Deck, Journalist) Yes. Fraser Whineray: [Already books at these] spot prices are out of the money which is why you've seen us take an approach, a very disciplined approach, to the notion of aggressive discounting tactics to attract new customers, because frankly that's just uneconomic. You might as well go and sign up a 10 megawatts C&I contract for north of $100‌ Gavin Evans: (Business Deck, Journalist) Yes. Fraser Whineray: ‌and 10,000 customers at a time. But we have come a long way since 2014 and since that election and in 2020 I think, after the ICCC and EPR and Productivity Commission Reports, the smoother path we can have for a strongly performing electricity sector which is a solution to decarbonisation which other countries do not have at their fingertips like New Zealand does, we need to make sure that the sector is performing. The right response into this stress and based on what the drivers of the stress are, is that generation development is brought forward. The counter is that generation development doesn't happen and then everyone will say well you've been talking up your LRMCs, so why didn't you?

Gavin Evans: (Business Deck, Journalist) Yes. Fraser Whineray: That's actually a risk, right. We had economic projects that are ready to go and so that's why we have chosen to push play on that in the interest of sustainable growth, but there's also some other dynamics which can play out. But at the moment you've got electricity, since September last year, I mean you go back the few previous years before that, you're sitting at around $60 to $70 a megawatt hour in the wholesale market and now it's been running north of $115 for over a year. That ultimately does flow through and you have to be quite, you know, that sort of step up well above LRMC is something that needs to be considered in the mix.

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Gavin Evans: (Business Deck, Journalist) Sure, okay, thank you.

Operator: There are no further questions at this time. I would like to hand the call back to the speakers for any closing remarks. Please continue.

Fraser Whineray: Right. Well thank you very much for all of your questions and for joining the call. We do appreciate them. We are very pleased with our announcement today and we are looking forward to getting on with the extensive work required just to bring that to bear. For those of you at our Investor Day this afternoon, we are looking forward to catching up and discussing things further. Nga mihi nui kia koutou katoa. Thanks very much.

Operator: Ladies and gentlemen, that does conclude the call for today. Thank you for participating. You may all disconnect. Goodbye.

End of Transcript

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