Are AGL and Origin going broke?

Australia’s two large, listed electricity gentailers have recently delivered some bad news to their shareholders. AGL announced a massive write-down of $2.7bn ahead of their half year results, while Origin warned of lower profits than expected.

As usual these announcements serve as a Rorschach test. At least one commenter sees them as a kind of morality tale about the dangers of buying coal plants. The reality appears more complex.

The largest component of AGL’s write down relates to onerous contracts for wind farm offtakes. The first few wind farms to be built under the mandatory renewable energy target (MRET) were too expensive to make money from their energy alone, so liable retailers like AGL and Origin paid high prices (in some cases north of $100/MWh) for their output and the associated RECs that they needed to meet their liability. The impressive declines in the cost of wind and large-scale solar in recent years mean these early contracts are well out of the money. Both wholesale and REC prices are on the decline. Figure 1 below shows how AGL’s share price peaked around the same time wholesale prices shot up following the closure of Hazelwood.

Figure 1: AGL share price

Source: AGL website

Notably, Origin who must have similar levels of exposure to those high cost early renewables have not seen a requirement to write their value down. Origin’s impairment charges in recent years have been connected to their upstream gas business (AGL got out of upstream gas a few years ago).

Origin report their half year results next week, but their guidance note warns of lower profits than previous forecasts. The reasons are largely unsurprising – low demand and low wholesale prices have made their power stations less profitable, and they are facing headwinds on some of their gas contracting. None of this proves that they shouldn’t have bought their coal plant (Eraring)which would have made them a handsome profit in recent years as wholesale prices surged. The share price effect (below) of the surge is less marked than AGL’s as Origin was battling headwinds in its upstream gas business at the time.

Figure 2: Origin share price

Source; Origin website

So, what does the future hold for these businesses? Both appear disinclined to invest much in new generation, having largely withdrawn from the renewables development business (although AGL co-owns a renewables fund with QIC that has recently developed Coopers gap and Silverton wind farms). AGL’s coal fired Liddell generator in NSW is due to close in the next two years and its Torrens Island Power Station A (TIPS A) gas plant in SA is also near the end of life. TIPS B is 45 years old and is likely to close some time this decade. This will leave it with two large baseload generators, Loy Yang A and Bayswater, which are believed to be the lowest cost coal plants in their respective regions.

Origin’s only coal plant Eraring is scheduled to close in 2032. Its lower exposure to coal than AGL has left it better place to fend off environmental shareholder activists, with Origin being able to show its scheduled plant retirement dates are consistent with a 1.5 degree climate scenario.

Both have a portfolio of flexible plant including gas and hydro that they have signalled will be augmented with big batteries over the next few years. These appear likely to be co-located with existing or closing fossil fuel plants to take advantage of the existing connection points and good transmission links. It’s not clear to what extent the batteries are intended to be money spinners in their own right or whether their main role is to help hedge the gentailers’ large retail books.

As their generation portfolios shrink, the two may look to their retail books to deliver more profit – they are the two largest retailers in the country after all. However, re-regulation of retail prices for small customers has put an effective ceiling on the profitability of this business segment. It’s also not clear how easy it is for them to significantly grow their customer base when they are already the largest retailers, and every new rooftop PV installation reduces their sales volumes. AGL’s strategy appears to be horizontal integration with its emerging internet/telco business. Meanwhile Origin is partnering with innovative UK retailer Octopus.

While it’s not clear how they can achieve significant growth in their core businesses, this doesn’t mean Australia’s two energy giants are on the way out. They still have significant market shares in both generation and retail to defend.

Note: none of the above constitutes investment advice. I have no view on where their share prices will go in the future…