Challenging Times For Power Retailers

This story features AGL ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: AGL

-Spike in discounting
-Oversupply worsens
-Lack of pricing volatility
 

By Eva Brocklehurst

The Australian national electricity market is fraught with challenges. Summer is coming to an end with no significant peaking in demand witnessed, and therefore no price spikes. Citi notes average volumes, ex smelter closures, continue to track above FY14, but that is only a small positive for retailers after a mild FY14.

Meanwhile, the churn issue continues to focus attention. February revealed electricity transfers rebounded strongly, with both AGL Energy ((AGL)) and Origin Energy ((ORG)) warning of a spike in discounting. JP Morgan suspects March and April will shape up as important months for retail margins. Victorian churn has consistently been higher than other states, driven by a combination of more attractive de-regulated retail margins and a benign wholesale environment.

Churn may not be a perfect indicator of retail margins but the broker observes the decline in churn registered in FY14 was followed by a period of margin expansion. As such March appears to be shaping up as a make or break period for east coast retailers. Citi agrees that churn is an important indicator and a proxy for the level of competition in each state but observes a reduction in churn overall, and suggests this should continue into March. Lower churn rates are a small positive for retailers as this reduces discounting pressure and the added costs from having to retain and win new customers.

The data suggests to Morgan Stanley that discounting remains elevated. Temperatures and churn information also signal that times are challenging for the wholesale and retail power markets. Grid demand has been falling for some time so the market is well aware of this trend but none of the utilities canvassed by Morgan Stanley were prepared to forecast the low point in demand.

The electricity oversupply situation appears set to worsen, in Morgan Stanley’s view, with 200MW of new wind capacity to be developed over FY15-16, 20MW from a potential solar feed-in tariff auction in Queensland and the completion of the renewable energy target (RET) review of additional capacity by 2021. The broker expects average pool prices, relevant for AGL’s base load plant in NSW and Victoria, are likely to remain flat until at least the mid 2020s.

LNG load has lifted Queensland’s electricity demand, the only region to register growth in electricity demand in the summer months. Solar penetration in Queensland also continues to rise rapidly and JP Morgan believes it will be difficult to disaggregate the impact of weather and solar and LNG demand on electricity in the 2014-16 ramp-up period for LNG. The most significant impact on NSW demand was the closure of the Kurri Kurri aluminium smelter. Victoria’s underlying demand fell 7.6% versus the previous summer, as Alcoa closed its Point Henry smelter. South Australian demand was weak too, the broker observes, likely emanating from unseasonably mild weather in January and a higher solar PV contribution.

JP Morgan observes one of the key themes emerging from the reporting period was the amount of caution suppliers were urging over near-term electricity demand. Moreover, the review of the RET is looming, with potential to drive a further wedge into the supply/demand balance. JP Morgan believes a number of external threats could affect returns from electricity generation in coming years and the RET review outcome tops the list.

Stock-specific impacts from the current climate for electricity include the lack of pricing volatility, which limits any earnings upside for AGL, particularly in NSW and Victoria, in Citi’s view. Peak demand drives volatility in prices and creates earnings risk if not fully hedged. Citi suspects AGL is unlikely to fully hedge all its old power stations in case of unforced outages. Therefore, it is exposed to short-term price weakness on some of its spare generation capacity.

For Origin, LNG production in Queensland is the key catalyst driving electricity demand. Queensland volatility was limited in February and, while benefiting retailers with short exposures, this limits Origin’s upside from pushing spare gas through Darling Downs, in the broker’s view. In terms of volumes, the speed of the LNG ramp up in Queensland will determine short-term volatility. The broker will be watching keenly the ramp up of APLNG operated production, while growth will be a strong leading indicator for commissioning and, in turn, electricity demand.
 

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