Mercury HY2020 Results Transcript Interim Results 2020: Analyst & media briefing transcript 25 February 2020, 11am Transcribed by West Pages: 15 Start of Transcript Operator: Ladies and gentlemen, thank you for standing by and welcome to the Mercury Interim Results Analyst Briefing. At this time all participants are in 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, Mr Fraser Whineray, CEO. Thank you, please go ahead. Fraser Whineray: Kia ora koutou everybody. Welcome to this interim results webcast for the FY2020 financial year. We are pleased to be joined by members of the analyst community, owners and also media today. With me is William Meek, our Chief Financial Officer and we are pleased to go through the presentation in the usual manner and then get to Q&A afterwards. I'm just going to flick through to slide 3 just to cover off the highlights. The EBITDAF was $258 million, it's down $44 million versus PCP. Most of that was due to a reduction in hydro generation, a smaller extent a reduction in geothermal generation due to planned outages and also the removal of Metrix which we sold for $270 million so those earnings don't exist in the results this time around. William will elaborate on the bridges in the subsequent slides but we are very pleased with where things have landed against PCP once you normalise for hydrology. Just to be clear, the way we work here is management doesn't get rewarded for floods or penalised for droughts, we tend to normalise those things out and focus on the underlying business and we are very pleased with the half on a normalised basis. It is still a very dynamic market. We will talk more to that later in the presentation. Tight gas deliverability and higher prices is flowing through to the spot market. There have been some fairly significant swings in the southern hydro lakes, at one point going about 25% over the maximum allowable storage in the country, which quickly disappears as those levels have to be spilt. That higher spot price, more volatile spot price, is also feeding through into ASX futures and also therefore into retail margins, which are squeezed. The market remains highly competitive. There are a couple of natural responses in that market dynamic which really picked up from October 2018. The first is, and it's deja vu from 2003, if you get a stressed gas market renewable generation gets built. That's what we're doing with Turitea. It's what one of our investee companies Tilt Renewables is doing with Waipipi. Those two projects combined are 3% of New Zealand's electricity. That's a very significant investment. The second thing we do is we think very carefully about channel management. We don't have to make trade offs with buying gas, running thermal plant, maintaining thermal plant, et cetera having closed Southdown in 2015, and so we think very carefully about the optimal sales channels for the renewable generation which we are going to run irrespective really of market conditions. So we have been focused very carefully on spot, commercial and industrial
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in all the different flavours of mass market channels and we also exited the Farm Source arrangement just before we hit the second half of - or the second quarter - and that's been very helpful for us in our portfolio management as well, particularly given the dry conditions. The same business CapEx, $53 million, up slightly on PCP. Drilling campaign at Kawerau, two of those. Also of course the ongoing hydro refurbishment work where Whakamaru and Aratiatia have been completing their final units which are due to close up in the second half of the financial year. That hydro refurbishment program starting in 2010 and then also some work on ICT culminating of course for the owners in $0.064 per share interim dividend. That's an increase on the PCP. Full year guidance is on track at $0.158 and that will make it the twelfth year of ordinary dividend growth. Now we'll just get into a bit more of the bridging and the factors underlying that for the first half with William. Thanks. William Meek: Thank you Fraser. I don't want to labour this because these bridges for first half performance 2020 versus the prior comparable period are pretty straight forward. Certainly, generation was down, as Fraser has said, by 377 gigawatt hours. Just over 300 of that was hydro and 70 attributable to lower generation from our geothermal fleet. Quite a lot - there were two major outages undertaken at Kawerau and Nga Awa Purua, those essentially happen every two years, so that really explains the decrease there for those geothermal power stations. Obviously less hydro, less geothermal generation affects energy margin, EBITDAF and underlying earnings, so against the PCP we're seeing those bridges down accordingly. However, when we normalise for hydrology, we don't control how much it rains. The year, certainly the half year, was slightly below average for an inflow. Slightly actually higher on an inflow basis than the prior comparable period but the starting late position much lower and then we're finishing higher than the PCP. OpEX operating expenditure was actually $5 million lower in half year 2020 at $94 million. About $8 million of that is explainable by Metrix OpEX in the prior period and again those geothermal outages driving slightly higher OpEX, so clawing back about $3 million into that bridge there from $99 million to $94 million. It's probably worth just touching on free cashflow. Free cashflow actually was $1 million higher than the prior year. Again, we saw cash taxes and interest costs down $11 million combined and then we saw a significant improvement in the prudential security posted to that improved it which affected the prior period, so we actually saw quite strong cashflows at $127 million versus $126 million this half year. Growth investment of $41 million. Again, that's all attributable to the ongoing construction at Turitea which Fraser will take us through shortly. I will hand back to Fraser. Fraser Whineray: Great, thanks. Just on slides‌ William Meek: Oh sorry, no I won't hand back to Fraser, I'll talk to five. We've got a very cool bridge here on EBITDAF. Again, if we just break this down. Once we normalise for the sale of Metrix, which is worth $14 million, so we get our continuing operations, primary hydrology and geothermal generation being lower at last year's prices, it is worth just over $50 million, gives us essentially a volume adjusted EBITDAF of $235 million. Then we proceed into the bridge for the core of the business. Prices were lower so that pulls us down, but then you see some significant bridges really across that entire portfolio, so a step up of $23 million increase across the portfolio reflecting high end user yields, gains in the CFD position, so there is a disclosure in the appendix showing the CFD position there against the PCP. It's a net short position, so obviously lower prices to benefit that. So you've got a $41 million improvement there on the prior period and CFDs lifting essentially to that profit from $235 million to $258 million which is really reflecting that improved performance across the generation and sales portfolio. Fraser Whineray: Just on slide 6. This is a slightly retuned graphic of what we've been working to and you might have seen in our annual report pretty much in the front couple of pages for the last few years and it's just the same
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Purpose and same Mission. Just reflecting those five dots in the middle there, the five pillars as we would see them or forms of capital is another way of describing them, which we see as important to the long-term success of the Company, the outcome of which is energy freedom. The latest push on energy freedom, which as you're well aware is a lot to do with energy sovereignty for the country, and that means not importing expensive high carbon fossil fuels, when we’ve got renewable electricity here. Therefore, electrification of transport being a tremendous green growth opportunity, which we've been banging on about for some time now. The latest version of that after the 2016 rebrand with the bike, the 2018 version of Evie the 1957 Fairlane, we got converted in a Dunedin garage, is now the iconic Kiss Oil Goodbye campaign, featuring a great 1970s track, the best breakup song we could find actually, from the Manhattans. So that’s just been recently launched after a lot of preparation and a half, and we’re looking forward to continuing to push, with many other people in the country actually on e-mobility. It used to be about electric, just little electric cars, which looked a bit funny. Now of course it’s trucks, cars, buses, ferries, bikes, scooters, tugboats and air taxis et cetera. So, electricity is a much wider remit and we think that’s very positive for the country, and also positive for the outlook. So, we’ve expressed those 5 pillars in 3- and 10-year views of what success looks like in the last annual report, if you're interested in how we defined those. But fundamentally we look at those pillars and go, well if we want to be a business in 50 years’ time, then all of those pillars which are externalities, which have choices, need to be with us on that journey to lead to good longterm commercial success. That’s why we focus on those, and indeed the Group KPIs, which I'm subject to and the executive and many others, have references to all 5 of those pillars. On page 7 our key performance indicators, these are the 5 pillars down the left and then we’re just giving expressions to those in some data across the page. Just a couple to highlight, I'm always particularly pleased when we reach the first of July or the first of January, when we have no high severity health and safety incidents. It has been several years now since we’ve had any high severity incident, and you never know you've got there until you've actually finished the year end, unlike being able to forecast financials, so very pleased with that. That is a much bigger focus for us than TRIFR which can include some insignificant issues actually, the main thing is low probability, high consequence events. Our gross generation emissions intensity, it’s pretty similar at about 30kgs of CO2 per megawatt hour, that’s because of trapped carbon dioxide coming out with geothermal fluid. Just to remind you that is a gross figure, and of course we have the largest and first carbon tenders, which we entered in to about 8 years ago, backed by New Zealand, exotic and native forests. Which means that we actually operate in a carbon positive position more than probably offsetting that, as well as our gas sales to all of our 40,000 residential duel fuel customers, for which there are trees backing that as well. Lastly, we made a big commitment to complete the Turitea Wind Farm, first half was in March we talked about, second half was in around October. So that’s steaming ahead and we’ll come to that shortly. In terms of page 8, regulatory developments, there’s plenty of that, it won't all fit on the page, there's Zero Carbon Bill, there’s a lot more to do with water, there’s the Electricity Pricing Review, so we could fill that with several pages but we just highlight a couple of things there. The work on the Electricity Pricing Review, we’re pleased with where that report concluded, the industry structure is good, it’s dynamic at optimising the trilemma, that supports the Productivity Commission and the ICCC review of the sector as well. We see there’s going to be some bans on saves and win backs, we actually - you’ll see later on in a chart that we’re not saving that many at the moment, so that's not expected to be a very significant impact for us, and in fact may produce some positive dynamics as well. There’s work on PPDs going on, and importantly for us also GLOBUG which is a critical prepay product for relatively underserved part of the market, because of credits, credit
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issues or credit constraints put on by our competitors, that is a critical product for about 25,000 to 30,000 customers and makes sure that the lights stay on. So, we’re pleased that that was unscathed through the Electricity Pricing Review. Fresh water, there’s been a lot of focus on that, that is particularly around the role of hydro storage, and the criticality of that in New Zealand’s energy system, given you can only have maximum 4 terawatt hours, unless you get massive floods like at the end of last year in the bottom of the South Island when it got to 5. But typically, 4 terawatt hours is the consented capacity of New Zealand’s hydro storage. That is the sort of scarce limit in our system. I've also got other ongoing matters around Waitangi Tribunal claims, and bits and pieces, which will produce some noise and are process heavy for us, but we note there that it’s unlikely Mercury will be affected by that, and if we were then we need to be compensated. In terms of Turitea, the large project, we have many works underway around relocating a public road to avoid, or reduce risk with respect to public road movements, that the Manawatū Gorge is shut. So, there’s a lot of traffic going between Palmerston North and Pahiatua, which goes over the same road. So, we shifted a public road, so that our blades and access to the site wouldn’t have to be on a blind corner, so we’ve done that. Our site’s fully established, a lot of components you might have seen in the media, are starting to arrive, some on the west in New Plymouth, and some on the east in Napier. We have all the foundation cages in New Zealand, we have 16 lots of towers, the cells and all the bits that go above those foundations, and we have the blades for 33 turbines which came in from Italy as well. So, they're in the process of being transported, so there's plenty of activity there. Transmission and connection which is a separate contract which we hold with Electrix, that is well underway as well as the bit that Transpower needs to connect in at Linton. So just some key dates there, and down the bottom, a reminder of how much it’s costing, but then also just noting we need to - when you're putting these blades up and craning them up, there's one sort of irony that the number of low wind days you get to do the craning, is obviously made more problematic by the quality of a high wind site. So, we are subject to weather conditions to put those things together for safety reasons, and we also are watching closely to see what other components coming out of China may or may not be affected by the manufacturing capacity of China at the moment, with that virus floating around. So now I'll hand over to William to talk about the quite interesting and exciting market dynamics. William Meek: Thanks again Fraser. So, we’re now on slide 10, again this is a familiar slide to most of you I hope, in terms of market outcomes, series of ticks there on the right, certainly supply and demand, rebalancing, we do have the conditions for demand growth, despite power prices being elevated. We’re certainly experiencing a lot of volatility and that's an ongoing feature of the market. Our futures prices remain elevated really reflecting the forward view of thermal fuels, and the impost of carbon on the market, which I'll expound on shortly. That continues to hold up commercial and industrial pricing. We've seen a very modest reduction in churn, we do note certainly the approach across the sector in terms of mass market acquisitions and saves is different, and that has been called out by some of our peers already. Certainly, around retail pricing, noting a pretty significant reduction across almost all distribution networks given the 5-year price path review, lowering their cost of capital, so we’re seeing quite significant, or expecting significant decreases in lines. That being said, we recently have seen moves on the market around retail pricing at the end of the last half. So again, looking at the chart, certainly you can see the yellow line reflecting the 12-month rolling spot price, peaking in November 2019, which effectively captures the super Tuesday prices of October and November in 2018. Our prices hit $300 and $200, you can see them falling back, but still spot prices remain elevated. We have
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seen spot prices regress significantly in January and February of this year, which is not obviously reflected in to these results. But we have seen some pretty interesting basis effects between the South Island and the North Island as a consequence. I touched on gas, we’ve seen disclosures from Contact and Genesis around their fuel position, certainly that is driving forward in to those spot prices without some reasonable downward moves in them securing those contracts for gas or coal. That does create quite a significant floor for spot prices, so that is - and then obviously with the moves around climate change, and the Zero Carbon Bill, certainly would seem likely that carbon prices over the medium to long term, will continue to rise. Certainly, Mercury with its long-term forestry contracts, is essentially protected from those changes if the market price for carbon continues to increase. Turning to slide 11 which touches on demand, again it's a pretty consistent theme, we have seen on a normalised basis demand rise by almost a per cent. Again, led by our cities and the irrigation sectors, irrigation can be seasonal. Yes, irrigation is certainly seasonal depending on whether it's wet or dry, so there is some sensitivity there. Industrial users, some of them remain sensitive to the high prices we experienced, certainly up to December of last calendar year. Tiwai is not at full output with particularly the extra pot line came on line about a year ago, but we’re seeing them without 25 megawatts off the pace from their peak megawatts of 622. Obviously, the Rio Tinto strategic review of the smelter is expected to conclude in March, and we look forward to that announcement. Couple of join the dots charts here, again really signalling how prices are persistently and stubbornly above historic trends, again reflecting that underlying increase in thermal fuel costs and the lift in carbon prices over recent years. So, in the yellow dots on the left on the first scatter plot, there's 8 of those yellow dots, 6 of them essentially signalling that national storage was above average on a monthly basis, over the last 8 months. So, December is clearly an outlier, we saw inflows in to South Island catchments of almost biblical proportions, with some South Island lakes well above normal maximum operating ranges. I think in terms of the historical inflow record which goes back to 1927, there is only one period where we see South Island storage exceeding the levels there, which is sort of about 1600 gigawatt hours above average for that time in December, which is characteristically you expect to see South Island lake levels near full. Again, just correlating spot prices of both gas and wholesale price. Again, an ongoing trend where you're seeing elevated spot gas and elevated high prices. So again, an inescapable truth there that thermal fuels, which still represents at least 15% of national generation, being effectively the marginal price setters to the market. Touching on portfolio management, so really focused on how we have been operating Lake Taupo over the half year. Again, just explaining the chart, the dark blue shaded areas represent the highest lake level that we have seen since particularly Mercury or Mighty River was formed back in 1999. So you can see the range there with essentially lakes trending towards more full in December/January and then falling back to a seasonal low in April or May on the dark line. So we started the year slightly below average at 100odd gigawatt hours and then essentially finished the financial year with the lakes very close to the top. So we experienced - you may recall there was some bad weather just before the new year, which did seem to top up Lake Taupo. The year, you can see in the tables, started wet. So July and August were above average in terms of in-flows. It went dry September, October, November and then December was around about normal. All in all, a slightly below average in-flow year for the catchment. You can see the timing of generation again against averages, certainly our pullback in generation levels in October and November certainly helping the lake level rise in anticipation of the planned and scheduled HVDC and gas field outages in Q1 of this calendar year, so Q3 financial.
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So anticipation - what wasn't expected was that huge in-flows into the South Island, which saw very high lake levels and quite a lot of wholesale price pressure in the South Island, which has caused bases running about 2.5 times. So February, we're sitting here with prices around $80 in the North Island and sitting around $30 in the South Island, so quite a significant gap. So quite an interesting example of the types of pricing that could be experienced under a Tiwai exit scenario, where you essentially would have 600 megawatts more generation going across the DC link. So the price separation from the North and South Island, given restraints across the DC, are the sorts of things we're observing now, triggered by a DC de-rate because of outages. It's a very interesting comparison for what we could see under that scenario. The key takeout, again, being active management of Lake Taupo to essentially anticipate the higher prices during those outages, which in effect you can see there spot prices trending $90 in January, in the $80s in February, out of line with where future prices we're expecting to be given the very strong in-flows to the South Island. We have seen very high thermal commitment too. So it would appear certainly there's quite a lot of contracting to manage that basis for us between North Island and South Island - North Island thermal generators and South Island hydros. Fraser Whineray: Now turning to customers, the graph here excludes the exit of the Farm Source contract, which was managed in an orderly fashion in the half year just actually before we got into Q2 and that has been very important for us. We wanted to take a slightly longer net generation position to the market and the farmer load is very high correlated with the grass curve to refrigerate milk and therefore pulling back on the commitments or draw on Lake Taupo between 1 October and the end of March when that is accentuated actually suited our portfolio very well to actively manage that and given the volatility in the spot market but also some of the uncertainties in the futures market until market making got back underway on 13 January. So we, as William has touched on, put a slightly more defensive position into the book and that has played out quite well in the light of dry conditions in the Taupo catchment, which still persists but that is not causing us any reasons for concern on a dynamic basis. Obviously on an absolute basis some years you get water, some years you don't. It's not actually about whether that happens. It's how you manage it and what your strategies are to work in both wet and dry conditions. So on the loyalty of existing customers, that chart there is just slightly - you can see churn, the wins and losses are coming down slightly. We're not surprised that some churn could be coming off for the market as a whole given the counterfactual of spot pricing, futures pricing and also C&I channels. We have been focused on making sure we're very - well, we're very focused on which customers we're trying to bring on so we don't just actually run through a bounty, an expensive channel to acquire through and discounting when that customer is highly unlikely to see any daylight in terms of profitability, and we have been very disciplined on that. So customer numbers have declined slightly, though I think they are at pretty much the same level they were four years ago. We will continue to take a dynamic view to looking at forward pricing as to the allocation of how we should optimise our sales channels and that is a different goal to if you want to grow a book to sell it or if your sales team don't mass-market sales team doesn't have an integrated counterfactual to commercial and industrial, then you'll likely keep churning without adding any value to your book. In terms of guidance, we revised guidance down slightly. We take pride in the guidance we provide to market, with a bit of a midpoint. We tend not to adjust it unless it's worth more than $10 million at this time of year, but there was enough gigawatt hours of hydro generation on a reasonably new mechanical basis looking forward, that we took
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the opportunity to adjust it here. Of course, we update our expectations of hydro generation for the full year at each operating statistics as well. So, that's down slightly to $500 million, and our ordinary dividend guidance is maintained at $0.158. Stay-in-business CapEx slightly higher, to deal with an additional Rotokawa well. We have had the rig working two wells, production injection well at Kawerau, and now we've demobilised that and we're taking it across to Rotokawa to replace a well, because one needed to be abandoned from well casing corrosion. So, field's good, it's just there was a few issues with casing corrosion about the 600-metre depth. Just a final comment. This is my last formal results presentation on behalf of Mercury. The Company is on track for its twelfth year of progressive dividends. I think there's two companies ahead of us on the NZX for that, and one of them gave their results this morning. So, I don't think they'll have progressive ordinary dividends going forward, so I think we're still chasing Ryman Healthcare, who is up to about 16 years in that record. You can't progressively grow dividends without actually growing earnings, and you can't actually grow earnings without making good investments and actually having a balance sheet to do it. So, we've got growth outlooks in all four parts of our company now, wind, geo, hydro and retail, having invested a lot in underlying systems and opportunities. It's a much simpler company. It's far more integrated in terms of the way it thinks, particularly channel optimisation. We've got a very strong balance sheet with some very good projects to put that balance sheet to work against. If you don't have projects, and/or you don't have a good balance sheet, then of course you buy PPAs. Buying PPAs is a completely inferior growth opportunity than actually putting the capital to work yourself in a commercial manner. So, it's been my privilege to lead the Company since 2014, in conjunction with the Executive and a very motivated set of enterprise leaders, and the people here. I've been an executive in the Company for almost 12 years, since 2008. Most critically in the middle, we went through the listing, and that really did completely change the dynamic. Non-political appointees to the Board, and so professional governance layers, and also the transparency afforded by you, our owners, analysts, and the public, increased a lot. It's not because there's a daily share price moving around, it's actually knowing that when you're making decisions you're going to have to answer to a range of constituents after the fact, face-to-face in many instances. That is a very powerful human dynamic on making sure you make good long-term and consistent decisions. There has been an improvement on trilemma since the MOM processes, pricing renewability, and reliability the system is solid, even when you get big dynamics coming through such as some of the gas problems we have seen since October 2008. The market is responding in the right way, capital is getting put to work. It's getting put to work in a way which doesn't involve a lot of fanfare. Electricity is a very interesting piece of infrastructure, because it's not like roads or broadband, which can run slow. You can't queue your customers. They'll get - even through the peaks, it has to be at the same standard, which is a very tight standard. So, all of that tends to be done in advance, with extremely high reliability to consumers. That quietness of getting on with it masks one key factor, when decarbonisation is so popular at the moment, and will be ongoing, that it's actually the electricity sector that has led the largest decarbonisation this century, out of anything in New Zealand. In fact, it's removed more emissions than domestic aviation, simply by geothermal predominantly, and wind investment by many in the sector. That is a tremendous achievement, and one which started long before this whole decarbonisation really started firing up. That actually lifted New Zealand's renewability from the 60s into the 80s, and with the other investments I've just mentioned earlier, that renewability of electricity will continue to grow. Of course, there's no need to worry about the renewability of electricity; that's fine. We actually need to worry about the renewability of energy that relates to the Company purpose of energy freedom, because - and that's a great opportunity for New Zealand.
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Thanks for all your support, and I wish you all the best. Thanks again for joining us on the call today. Nga mihi nui, kia koutou, katoa. We are happy to take questions under the advisement of the administrator. Operator: 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 or hash key. Once again ladies and gentlemen, it's star-one and wait for your name to be announced. Thank you. We have multiple questions in the queue. Our first question is from Grant from Craigs. Please ask your questions, grant. Fraser Whineray: Kia ora, Grant. William Meek: Hi Grant. Grant Swanepoel: (Craigs, Analyst) Good morning, team. Fraser, thanks for many fun years, wish you luck and joy in your new job. Fraser Whineray: Thank you. Grant Swanepoel: (Craigs, Analyst) My first question - pleasure. My first question is on OpEx. You guided at the start of the year I think it would be up $5 million. It looks like your geothermal, the work is done. It was just up $4 million in the first half. Is that the worst of it? Should I be considering that to be reversed out in FY21? William Meek: Yes, so the guidance before your OpEx is still good. So, in terms of this year, that is okay. We're working through what the implications are for next year. We've still got refurbishments happening on hydro, but yes, that's - we haven't worked through that yet, Grant, what that might be, whether that's going to reverse out. Grant Swanepoel: (Craigs, Analyst) Thank you. Then on your comment that the prompt payment discount changes come up within the next six months, Contact and MEL have now put through their changes. Are you planning to do away with prompt payment discount? If you are planning some changes, can you give us some sort of quantum of what that might impact earnings by? Fraser Whineray: We don't think it will impact earnings, Grant. What we're doing at the moment, per the public note from the Energy Minister, is just reviewing the cost of managing follow-ups for amounts that aren't paid on time, to see if they are indeed cost-reflective. There are some components of our prompt payment discount which actually don't relate to paying on time. They're for other things. So, we are also going to be more defined with those, and so that requires a few system tweaks to achieve that. There isn't a ban on prompt payment discounts, they just need to be cost-reflective, was the view from the Minister. That's certainly well supported by customers, the majority of which enjoy it. For customers that can't pay on time because of real struggles with cashflow, and they're consistently in that area, we are unique in offering the GLOBUG proposition, which has a price point which is equivalent to post-pay less prompt payment discount. So, that is a way that those customers can achieve that. We think choice in the sector is very important, and we know other companies have actually introduced simple products without them, and other products with prompt payment discounts. At the end of the day, I think that choice is a good thing for the market. So, we're not expecting financial impacts from modifications there. Grant Swanepoel: (Craigs, Analyst) Thanks, Fraser. So, can I infer from your commentary that your products that are on prompt payment discounts are nothing like Contact's where they about a mid-teens not paying on time?
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Fraser Whineray: Ours would be probably close to the late single-digits, and we have gone through that on an analysis of seeing if it's recidivism or - or, sorry, I should say repeat, it's not bad, it's just whether it's repetitive, and what other reasons why, and whether or not we should recommend an alternative product for them. There's actually not that many that do that every time. I can't speak for other people's portfolios. Remember, what is it, 25,000 of our customers are on a GLOBUG product, so if they happen to be on a post-pay product, yes they would probably be struggling with getting their prompt payments on time. So, I guess we get the benefit across the portfolio of having those different products, which makes our post-pay look probably better. Grant Swanepoel: (Craigs, Analyst) Thanks. Genesis indicated they plan to pass on the Vector distribution company discounts coming through in 1 April. Is this Mercury's intent as well? Fraser Whineray: Look, as a general principle, changes notified by the lines company will be passed through. Some of those lines charges are going slightly up, and in some instances they're going a lot down. As a general principle, we pass those through. We haven't undertaken a mass-market - widespread mass-market price change since April 2018, on energy, by the way, either. Grant Swanepoel: (Craigs, Analyst) Okay. Have you been asked to tip anything to the Tiwai cap? Fraser Whineray: We made our positions on Tiwai pretty clear around the time of our second stage of the wind farm being confirmed late last year. Look, there's some opportunities, I think, for that, Grant, is probably how I'd phrase it, but simply a drag race on price doesn't cut it. They need to work out something that's actually going to benefit New Zealand in its long-term outcomes. Holding a 12-month notice period to the market as, I think other my peers have said, does not allow for an orderly transition. I think unless you see something that suits New Zealand come from the other side, I've got a pretty dim view of providing further support for an asset which is actually going to conclude anyway. It's not whether they stay or go, it's just when they go. We have said that quite clearly. When they go will likely be within the timeframe of any of the current renewable projects that were commissioned in the last decade, and those to be commissioned. Grant Swanepoel: (Craigs, Analyst) Thanks. Just on that renewable build, are we starting to face a bit of a risk of overbuild? You've got Turitea coming on, you've got Tilt's Genesis builds coming on. You've got Contact hell-bent on doing Tauhara, at least the first stage. Now Genesis is announcing solar. Is this a start of a five-year oversupply path? Fraser Whineray: I don't know. I think the pricing of gas and the delivery of gas, the pricing of coal plus carbon, is still - it's still impactful in terms of marginal decisions, and also sales to C&I customers to a degree. Those are key decisions for those that are pushing play. We have pushed play on Turitea, so I guess the right place for that question is all those that have yet to commit the capital, because they're the ones pushing for it. As I said, I think there's a very, very big difference between putting the capital in it yourself, and buying a PPA, in terms of market valuations for companies. Grant Swanepoel: (Craigs, Analyst) Thanks, Fraser. That's it from me. Fraser Whineray: Thanks Grant, Thanks. William Meek: Thanks, Grant. Operator: Once again ladies and gentlemen, if you wish ask a question, it is star-one. Our next question is from Aaron Ibbotson from UBS. Please ask your question, Aaron. Fraser Whineray: Kia ora, Aaron.
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Aaron Ibbotson: (UBS, Analyst) Kia ora, good morning Bill. I actually wanted to take this opportunity to ask slightly bigger picture questions, after a long career, Fraser. Without any hint of your future job, but do you have any view of, broadly speaking, the potential for the decarbonisation of process heat in New Zealand? If you say the last few years, it seems that the intensity of discussion around it have gone up. Do you see that as a big, or a small, or a five - or a 10 - or a 20-year opportunity? Could you give some colour on your thinking, on your last earnings call, please, with Mercury, for now? Secondly, and I guess you sort of alluded to it in Grant's question on the Rio, but I don't think I've heard it expressed clearly. Do you basically have a strong preference for the smelters staying or leaving if you sort of exclude any direct support from Mercury? Could you give some sort of idea of how you think Mercury would be impacted if they did choose to leave? Thank you. Fraser Whineray: Okay, sure. So thanks for those questions Aaron. The first one is and being conscious of where I’m going to by the way, the first one is that the positive arbitrage on fuel costs is actually with electrification of transport. Because electricity is $0.30 a litre and liquid fuels, diesel would kind of be $1.50, that’s excluding taxes, petrol is kind of $1.80 or $1.50 excluding taxes as well. So, you’ve kind of got a five for one benefit on electricity costs and that’s why something becomes mainstream not just because it happens to be trendy or green. You’ve got to actually have a bit of product. Cars are getting better but the SRMC basically of transport will flow through to a lot of stuff. So that’s got a positive price outcome for consumers and structural costs in the economy. Electrification of process heat is actually the other way around because one of the reasons why electricity is so good against liquid fuels is because you don’t lose 60% out the radiator and the tailpipe, so it’s highly inefficient to use energy in that way. Process heat, a lot of the heat you use to raise steam or whatever you need to do for steel making or other – or drying milk or whatever it happens to be, it’s quite efficient to use gas and coal for that. I think if you’re looking for what is the big driver though, it’s actually about a resilient economy which is sustainable. So if we go down the path of picking winners and forcing changes in specific industries, you might find you’re just effecting the carbon leakage anyway. The main thing that needs to happen I think is actually set some very transparent rules so people can make long-term investment decisions and you can then deal with how to either substitute technology when the right capital decision comes up, or run a different series of offsets somewhere else where it’s more efficient to do so. So I’m into a broad-based price ETS’ as opposed to someone picking winners constantly down in Wellington when it comes to decarbonisation. So I’d say e.transport is the answer Aaron, that is the one that we’ve been pushing for a long time because we think there’s that cost, pollution, structural/economic benefit for the country and I think that will be a faster cab than process heat. Some forms of process heat of course you just cannot use electricity to achieve, particularly in very high heat applications such as steel. As for Tiwai, look we’ve kind of got to the point of relative indifference I guess if I put it politely. It kind of just goes on and on. I don’t know how many times we’ve been around this mulberry bush and so at some point you get to the state where you just go, maybe it’s just better – and that’s why we say, look it’s not a question of staying or going, it’s just a question of when they’ll go and how we’re positioned for that. Now we’ve said all along we think we’re best placed for that. All our assets from the North Island, they are all renewable. You’ve seen as William pointed out the example of the price spreads that come up when you put some stress on the DC. Classic example over the last month or so. So, I think my view from their perspective as I said back in October, well I think when the Tiwai review was announced – it might have been beforehand – as you really think you’re going to favour a brown coal smelter in Australia over a renewably driven smelter in New Zealand? It’s just – I’m just not sure how the Rio chief executive
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is going to really stare that one down with capital providers. Not just equity but also senior debt. Because the old decarbonisation is working its way well through the capital market. The other thing I’d say is on the transmission pricing, I think the EA has opened a little door there. I think that’s probably reasonably pragmatic. I’ve some sympathy for that, but at least just remember I’m not sure Mercury ah Manapouri is providing 600 megawatts continuous baseload all the time and hen it’s not, will the smelter be prepared to turn off or will it actually take power from the rest of the grid. When it comes from the rest of the grid you’ve kind of got to pay for other parts of the grid as well. So you might be getting slightly overcharged but I think it’s a little glib to just say the only power cable they rely on is the one to Manapouri. Aaron Ibbotson: (UBS, Analyst) Sorry, was comprehensive answer but just if you’re trying to see the impact on Mercury, is that something you have stress-tested or looked at short term versus long term impact or anything like that? You say you’re indifferent, certainly when I run my numbers it doesn’t look indifferent to Mercury’s earnings [unclear]. Fraser Whineray: Well no what I’d say is we’re kind of indifferent to actually doing – it’s getting a bit tedious. So it’s either stay or go, make your mind up. There’s nothing really we can do to change that and the point is so yes you spend your time worrying about something you can’t control or focusing on what you can. So the point for us though is we actually see Auckland prices on some modelling becoming higher in a Tiwai gone scenario than if it stays. Because just remember our assets aren’t just about gigawatt hours, it’s the largest provider of reserves, the Waikato hydro scheme in the North Island. So I think South Island prices will go through a lull and probably come back and stay pretty flat for some time depending on what other demand load you can put in the bottom of the South Island like data centres or indeed build some initial transmission capacity. But then in the North Island when you’ve got less thermal production and very volatile outcomes because as you know the rate everything is set for New Zealand’s energy system is deep energy storage which cannot be facilitated by batteries or other means, then I think it’s going to be – the North Island is going to be in relatively good shape. It’s not the price you sell to the end consumer for that really makes a difference, it’s the price that you get at your factory gate for your electricity that makes a difference. So that’s why I think we’re in a – yes there’ll be some short-term issues but in the long run – well in the long run Aaron, it’s gone anyway. So, you know, they do it now or they do it later. That’s what it is. Aaron Ibbotson: (UBS, Analyst) Okay, fair enough. Thank you very much and best of luck. Operator: There are no further questions from the telephone. I now hand the call back to Mr Whineray to take any further questions in the room. Unidentified Male: Do you want the question now? Fraser Whineray: Yes, we’ve got one question in the room here. Geoff Dobson from EV Talk. Wonderful to have you here, Geoff and hopefully that microphone is switched on for you. Geoff Dobson: (EV Talk, Journalist) Working? Fraser Whineray: Yes, it is. Geoff Dobson: (EV Talk, Journalist) Just now that you’re leaving, sort of what you see for the future for Mercury and especially how e-mobility is likely to impact on electricity? Fraser Whineray: Yes, that’s great. Well when we first kicked off the - Geoff, the e-mobility to the point which was actually on the day I was announced, I had to then go home and explain to my wife why I had to go and buy a new car because I might have been pushing the electrification of transport but - so that first day was definitely a negative value day for my household.
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But we committed then, in the September 2014 ASM, or October, I think it was, to a fleet of about 90 electric vehicles when there were about only 200 or 300 in New Zealand but it was just after the Mitsubishi Outlander PHEV had been announced in March of 2014, which was particularly good timing. That’s turned into the number one selling new electric car in the country so - and in the other new - the second hand one of course is the LEAF, which is winning. So we see that e-mobility will lead to a good expansion over the long term. It takes a long time to get going but once it’s going, I think the impacts for the regions of price for electricity to transport are encouraging. If you did a static match analysis, you’d say you need another seven to eight terawatt hours a year of electricity to do that. That may indeed, because of charging time and being lost across the transmission and distribution grid which doesn’t need to expand which then lowers the cents per kilowatt hours of T&D charges on customers which is very, very positive. So we see a - it’s not just about cars now though, as I mentioned before. There are huge numbers of electrification options ranging from those that use no electricity like scooters and bikes. That’s great, that people are moving around and we support that. I think it’s a good idea. They’re enjoying energy. To the heavier end of town with trucks where the commitments of Waste Management and their trucking fleet. Adecco [correction: ‘Alsco’], empty container trucks going from South Auckland down to the port. Now, of course, Auckland airport - Ports of Auckland now even has a tugboat which is equivalent to their most powerful tugboat in their fleet. The first electric tugboat in the world. So a lot of stuff is going to electrify. Seven terawatt hours for cars, another five terawatt hours for trucks and as I said, it’s going to be done because of pricing. So I think over the long term, that’s a good thesis but how quickly it comes about is different. At the end though, I’d have to say that I think you have to move onto autonomy quite quickly after electrifying and that’s because if everyone can drive - if you set the petrol price today to $0.30 a litre, you’d have gridlock. So we actually do need to get more cars and more people per lane on any given road because people are simply going to want to travel more for that price. I think it’s a great possibility for New Zealand and - but that requires a bit to get your head around. Autonomy is quite complicated, not just for the technology but also everyone that is not in an autonomous vehicle, to actually deal with it on a common carriageway. So I think it’s a great long-term outlook and it absolutely plays into New Zealand’s strength. Geoff Dobson: (EV Talk, Journalist) Will you carry this over to Fonterra as well? Fraser Whineray: The electrification of transport? Well I think it - when you’ve got to look at the number of forums where the electrification of transport can apply and increasingly applies because you can watch technology curves and see when it comes around. Just like we’ve sat there with vehicles on one side and - or just basically battery technology and on the other side, wind turbines. Those two are perfectly intersecting in New Zealand. You can still even watch the technology curves on trucks or other cars or other forklifts and a whole bunch of stuff. We’ll be looking for - I’ll certainly be interested in opportunities in that space. E-mobility has been something I’m particularly passionate about for a long time. Okay, I think - thanks Geoff. We’ve got one more question on the line? Operator: That’s right. Our next question is from Nevill Gluyas] from Jarden. Please ask your question, Nevill. Fraser Whineray: Kia ora Nevill.
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Nevill Gluyas: (Jarden, Analyst) Thanks team, hey kia ora, I just snuck in at the last minute. Three questions from me. Just the first one, just to check off in terms of the CapEx guidance uplift this year, just in relation to the Rotokawa casing corrosion. There’s no reason to expect that’s some kind of systemic issue? It’s just specific to that well, I’m assuming? First question. Second question, just following on a little bit from Aaron’s query, maybe posing the same question about process heat conversion another way. At $35 a tonne CO2 or thereabouts, where it looks like we’re heading at a mid-point for ETS, what do you think an electricity price would need to be for that sort of process heat conversion to be break even? Just the last one, it’s just a kind of a view question. Obviously, we’ve seen a few charts and a few explanations about high gas prices driving high electricity prices but I’m just wondering how much of the data we’re observing is actually the other way around? It is actually high marginal electricity demand driving up gas prices in a shallow market? Thanks. Fraser Whineray: Okay, well William will go one and three and I’ll go two. William Meek: So the casing corrosion issue. So Rotokawa, it’s quite an unusual geothermal field in that it’s quite the field is quite compartmentalised. So while that might be in some cases 500 metres from another production well, it actually shows no connectivity. So there are parts of the field that are subject to corrosion. So we are - the new wells being installed at Rotokawa are using an alloy which is much more resistant to particularly the corrosion which is largely a carbonic - it’s a carbonic acid, light acid, which is just C02 and fluid that’s heated that’seffectively eating the well casing. So it’s not a systemic issue at the field but it’s - this is not the first well that’s suffered corrosion - a corrosion issue. So it’s not something - it’s certainly something we’re actively managed and certainly the change to the well casing to alloy should make a big difference to the well life. Fraser Whineray: So and… Nevill Gluyas: (Jarden, Analyst) So just follow on then, just a question whether or not that has any implications for later year’s CapEx? William Meek: Again, difficult to tell. We’ve got a well safety program where essentially the well wall thicknesses are measured, I think at least every two years and certainly that process therefore identifies whether you’ve got a corrosion issue. Obviously, sleeving is an option so you can run a sleeve to effectively continue to use the well in the absence of affecting a repair. Then the well is abandoned and you need to drill a make-up well. So it’s certainly over the life, we’re expecting to see new make-up wells necessary. Not because of - just because of casing corrosion, just generally. You often experience well decline for other reasons and therefore make-up wells are required. Fraser Whineray: Also, Nevill, just on that. Sometimes you can repair the carbon steel well with an alloy liner. This one, which we’re replacing, we couldn’t do that because of the way that the well had changed at that particular point but quite often, we can just drop a liner and that’s quite cheap compared to drilling a new well. So there are other ways - there are some other ways that it can be managed as well. So in terms of industrial heat, you’re saying you wanted to know what do you think the number is for industrial heat applications as a counterfactual? I think it does depend on the use but all I’d probably say on that is, it is below the [LRMC] of new plant. Significantly below the LRMC of new plant before you electrify most industrial heat uses and I
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think that that is - that is one of the challenges to it as I said. You’re adding cost to do it for industrial heat. You’re reducing costs on a marginal basis for transport fuels. Nevill Gluyas: (Jarden, Analyst) Really useful. Thanks for that. William Meek: So the third question just around intersection of thermal fuel prices and wholesale prices. I mean, I think one of the challenges we have seen is that gas quantities, so daily deliverability has been a challenge for thermal operators in New Zealand. So therefore, they have been rationing fuel and making decisions a bit like a hydro. So when am I going to use my fuel to best effect? Certainly Contact has disclosed that it’s secured gas now and into the future and therefore it’s re-engaging back into C&I. You’ve certainly seen TCC come back online and we are surprised at the high-level thermal commitment this month given prices are still volatile. Still tracking at about $80 a megawatt hour yet you’ve got almost every thermal plant in New Zealand is running at a time you’ve still got quite a lot of South Island water but obviously HVDC constraints. So this week is interesting. HVDC is fully available for I think five more days before they go back out on outage and you’re seeing quite depressed prices and those constraints have largely disappeared. But certainly, there’s no doubt that there’s - there is some contract or construct between both - on a portfolio basis, Contact’s obviously got hydro and thermal but there’s certainly - you’re seeing thermals generating at prices generally based on fuel disclosures that sort of don’t really make sense. The real interesting thing will be as you go forward in time as yes, under the fuel prices that they are projecting, you’re still staring at wholesale prices that are going to remain elevated until those fossil fuel prices fall back. Nevill Gluyas: (Jarden, Analyst) Got you, thanks. Yes, so it sounds like you’re sort of - the thesis you’re forming about the market at the moment is with this higher thermal availability, your commitment levels are partly going to be due to - connected to the basis difference we’re seeing between the North and South Island… Fraser Whineray: That’s right. Nevill Gluyas: (Jarden, Analyst) …and some of these thermal providers, either internally or externally have sold products to cover that separation. Fraser Whineray: Yes. I think the other aspect, Nevill, is just to look at individual risk management through the lens of each company and what measures you’ve got to manage either a variable fuel or a variable spot price dynamic but more to the downside of where you want to avoid a short squeeze. So yes, the ASX futures market is very important to the market actually clearing fuel. I think the issue that arose in 2017, which wasn’t adequately dealt with by the regulator on closing constraints, which is still working its way through the [MDAG, I think it’s called. That is an issue too because I think it changes the flexibility of what gets cleared in a half-hourly stack and we’ve noticed that actually it’s got a lot steeper in terms of how the half-hourly stack clears, which leads to increased volatility. So I think they - that needs to be tidied up. That’s why I think generators should have the ability to close a constraint. Not generate one but close one if they can. Otherwise, what’s the point of having a plant? So I think that’s part of it but then also, if you’re a buyer of fuel, of thermal fuel, you’ll think about what are your choices in terms of reservoir management on your hydro, OTC contracts, the future market which needs to be there with decent enough liquidity or you may have the choice of buying gas or coal. In which case then, you’re trying to make decisions there or indeed buy PPAs in that case to offset those costs.
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So shadow pricing of coal out of Indonesia is probably one area where gas prices may be - may look to as well if someone is looking to purchase some gas from one of the existing users or fields. So that’s just some other perspectives on it. I think it’s really important that the stock market clears well half hourly, the ASX futures has got some liquidity and then I think that makes some - makes for a better optimisation of the whole market. It’s certainly way better than any one central controller could possibly achieve and I think it’s important that it stays that way. Nevill Gluyas: (Jarden, Analyst) Completely agree, so nice points. Thanks, Fraser. Fraser Whineray: Thanks, Nevill. William Meek: Thanks, Nevill. Operator: There are no further questions so I’ll now hand the call to Mr Whineray for closing remarks. Please go ahead. Fraser Whineray: Well thank you very much everyone for joining the FY2020 interim results call with William and I. We’ve enjoyed the questions. We’ll be catching up with several of you over the coming week or two and I’ll certainly be looking forward to saying farewell and acknowledging support to those that I catch up with. For those I won’t be catching up with, thank you again. It has been my privilege to lead Mercury and also be a member of the executive for more than 11 years and I wish Mercury the very best and hope that we can count on your support, both in challenge but also in good times as well, going forward. Kia ora tatou, thanks very much. Operator: Ladies and gentlemen, that does conclude the call…
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