KGB INTERROGATION: Grant King
Origin Energy CEO Grant King tells Business Spectator's Alan Kohler and Stephen Bartholomeusz:
Stephen Bartholomeusz: Grant, listening to your earnings presentation, the thing that struck me was apart from a pretty solid result you’re sitting on a lot of cash – net cash of $3.7 billion, available facilities of $5.3 billion. I think you’ve said that $3 billion of that would be kind of loosely devoted to the LNG project. What are you going to do with the rest of the balance sheet? There’s a lot of capacity there.
Grant King: Well, firstly to not just agree, but to add further to your diagnosis that that’s just the line of sight for cash and committed facilities. If we were really motivated to do so, we’d arguably gear our balance sheet up even further than that and clearly we’re generating surplus cashflow, operating cashflow in the cashflow statement is about a billion dollars, so from my perspective I’m only adding to that opening point you made.
Having said that, our capex for the coming year is around $1.5 billion, so we are certainly maintaining relatively high levels of capex by any measure, for a period of time when most companies have cut back dramatically, I would imagine. We have a higher level of internal capex and so, to illustrate that, post-June 30 we’ve settled the Pangea acquisition for $660 million, so not an unsizeable chunk of that for example.
Secondly, we don’t forecast acquisitions, so clearly in our mind we remain forever hopeful from a strategic point of view, that particularly in New South Wales, the government might ultimately bring its retail assets to market. You know that’s a billion, a billion and a half dollars involved in that transaction.
SB: You say ultimately. There’s a question mark in your voice there.
GK: Yeah well, just to ever-so-slightly flesh that out, whether it were the government or anybody else vending a major asset like that in a contested process, if you’re not seen offering memorandums in the sale process, document out now, initial offers, short listing, due diligence, that means you’re four to six months away straight away, I think it’s fair to say. There’s nothing in it. There’re no offering memorandums. There’s nothing in the market. I think at best you could say it’s not going to happen this year.
We do have to pay that $700 million of tax in November or December from the Queensland LNG joint venture with ConocoPhillips, because there is some tax payable on that transaction. That’s not bad news. It’s a cash outflow, but of course that means fully franked dividends for shareholders and one of the reasons we doubled our dividends was that we knew with that big tax payment coming up, no point keeping big pots of franking, we might as well increase the dividend and get the dividend out. So dividend payments doubled and we’re now paying out around $500 million a year in dividends I think, so quite a substantial dividend, which we’re very pleased with and we’re very proud of, because frankly, a lot of companies on a dividend per share basis have probably had their dividends depleted substantially in the current environment. We’ve doubled our dividend per share and then as we head into the end of next year you’re right in so far as I said earlier that in our minds we think that in the current economic environment one would be prudent when you make big capital decisions – which the LNG decision would be – and have line of sight to funding. So we’ve got in our mind that roughly $3 billion is what we want to have line of sight to, yeah.
Alan Kohler: What do you mean by line of sight?
GK: We’ve all been on hold and this is another whole discussion, but if you take the view that the RET [Renewable Energy Target] legislation will pass, there’s bipartisan support for it, we’ve got quite a pipeline of projects which we’ve not committed to until that legislative framework is clear. Now, to put that in perspective, we would say somewhere between probably 6, 7, 8, 9,000 megawatts of renewable generation has to be built and in practical terms, probably between now and 2015 to 2017, so that by 2020 there’s the renewable energy being generated, the 20 per cent target.
Now, if the regulatory framework or legislative framework is clear, we will also start spending a significant amount of capital on renewable energy projects and we have quite a pipeline, of initially wind projects and later geothermal projects, if we can prove the technology works which we will commit to once that legislative framework is clear.
Just to give you a benchmark, wind generation costs say about $2 million to $3 million, so you average two and a half million plus dollars per megawatt to build. If we were to build 500 megawatts a year for a couple of years, that’s $1.5 billion a year on renewable generations, but we actually don’t have trouble stacking up the fact that we could have quite substantial opportunities to deploy capital over the next two, three, four years.
AK: I’m wondering on that subject whether that’s how you’re going to meet your RET plans or will you be more likely to actually buy RET? It just seems to me that a lot of the RETs are going to be generated by or produced by households, aren’t they?
GK: There are plenty of RETs that are coming from solar hot water at the moment, but you aggregate them all up front if that’s the way to describe it. But fundamentally we will need generation to be built.
The way solar hot water’s treated, is you gross up the next ten years, 15 years, 20 years into an upfront, one-year number. Once it’s in, it’s credited once. It doesn’t give you an ongoing contribution.
AK: So, what is your total RET-based capex, do you think, over the next five years? Where do you think you’re heading with that?
GK: We think about 3,000 megawatts might be the best way to describe it, we think. Let’s say you need 9,000 megawatts and we’re 25 per cent to a third of the market, that’s the level that we’ll need to be seeing a line of sight to. Now, up to date we have contracted for that capacity and used other people’s balance sheets to frankly have access to a lower cost of capital, so that’s where we’ve had a change. It might not always be changed, so it might come back, which is why we’ve developed a pipeline rather than commitment. At the moment the RETs are certainly generating adequate returns for Origin to be the direct investor.
AK: I’m just trying to figure out whether that’s a bigger capex commitment than LNG.
GK: No. In gross terms, no, but we are carried through some of the LNG expenditure. So for example, we’re carried through to FID [final investment decision], so our share of Australia Pacific LNG total capex has been funded by Conoco pretty well through to 2010, but in gross terms yeah we would expect the gross expenditure on LNG would be bigger.
How Origin redeploys that $5 billion for the total process of AP LNG is actually just as important to Origin as the half of the projects that we kept and a lot of that deployment – if direct legislation makes that future environment clear – could be on renewables and drive just as much growth and contribution to the business sooner than the LNG project will.
SB: Grant, a lot of the discussion about the renewables targets and legislation focuses on the fact that it’s going to pull forward a lot of wind investment which is not necessarily ideal. You’ve got a very big exposure to geothermal. Is that going to get pushed further out because of the focus on wind?
GK: Yeah. We’re in control of that ourselves, because currently at Origin we would say we’re probably 22 to 25 per cent market share of the retail market and we would aspire to 30 per cent to 40 per cent over the same timeframe. So let’s just pick a third of the market, per se, for the explanation. Because the RET liability is on retailers to acquit, then we are a gatekeeper, as are the other retailers. As a gatekeeper we can control whether we choose to acquit by more wind earlier, nothing and building a liability and acquitting at a future period, or wind today and banking and carrying forward or some or any combination of technologies thereof.
Clearly the commercial and economic puzzle to unlock is: what technologies does one bet on and at what rate does one deploy those technologies in satisfying your RET obligation or liability.
We’d be very happy to have 2,000 megawatts of wind and 1,000 megawatts of geothermal in our mix in 2017 and 1,000 megawatts would be a big geothermal project, yeah, a very big geothermal project.
SB: Apart from the RET liability and you do have a very large retail business, is there an issue for you in relation to reliability of supply and whether there’s going to be sufficient base-load built over the next decade or so?
GK: That’s a good question. In a sense, the notion that our electricity supply system is at risk with this legislation is quite misleading. The end-of-life issues for plants are dealt with by this industry all the time. Plants last a long time and they eventually get old and fade away and managing end-of-life issues is very common.
Secondly, Origin, for example, and the evidence is in the proof, or the proof is in the evidence, in that we’re building what will be a 550-megawatt open-cycle power station in Victoria, because as a retailer we don’t want to be exposed to any potential unreliability in the system. Whether or not that unreliability arises because of an increasing amount of wind and the intermittency of wind, or whether it arises because of end-of-life issues in respect of base-load generation plants.
The only risk is if the rate of change is greater than the rate at which people can deploy new assets and that’s why Origin has consistently argued policy-makers that you go early and you go slow, rather than late and have to go hard. Because if you go early and slow, the industry will source the capital and build the assets that need to be built, but in our view we will not and we don’t think retailers in aggregate will allow an under-investment to occur in the system that leads to reliability in power generation.
AK: But that raises the question of what you think of the subsidies being paid for the brown coal generators in particular – do you think that will delay the implementation of gas base-load power?
GK: Based on our diagnosis, the RET means probably a fair bit of wind, a fair bit of intermittency and therefore a fair bit of open cycle gas and so we say that gets determined by the RET policy lever. The rate at which gas substitutes for coal in base-load generation is really driven more by the CPRS [Carbon Pollution Reduction Scheme] and in respect of the existing 45,000 megawatts of generation, which is primarily coal.
It would be quite fair to say, if the carbon charge is at zero or $5 or some very low number then the rate of gas penetration will be lower and if the rate of carbon is higher, then gas penetration will be higher. As for the compensation, if you think of it in economic terms, it’s for the curtailment of life of some of the more carbon-intensive coal-fired power stations. The thing that affects whether they run or not is their cash variable cost and by introducing a carbon charge or a carbon permit and pick a number, $20, a tonne, then where brown coal ones which are, what, 1.4, 1.5 tonnes a megawatt, at $20 a tonne they’re going to cost $30 more cash per megawatt to run than their current cost, which is probably less than $10 a megawatt.
So whether they run or not is a function of the cost of the permit, not the compensation and the compensation is there to recognise that their life has been curtailed because the consequence of introducing a carbon cost is that it will change their operating pattern and cause fuel substitution. Hopefully I’ve explained that in a way that’s helpful. Does that make sense?
AK: Well yeah, but as you said, you’re building this gas power station at Mortlake. That’s currently open cycle, isn’t it?
GK: Correct. Yes.
AK: What would it take for you to turn that into a closed cycle power station?
GK: If the government and the opposition – surprise, surprise – announced tomorrow they’d also reached an agreement on the CPRS, then we would immediately look very close at the economics and if our view was that the implied carbon outcome was going to be probably anything more than about $20 – and that doesn’t mean tomorrow, it means four or five years out when it’s running – we would probably look to combine cycling in which case it would become a thousand megawatt base-load power station.
AK: Right, but isn’t the nub of the issue for Australia in meeting any kind of serious carbon reduction target by 2020 that the Latrobe Valley, in particular, will have to be phased out and replaced with gas and isn’t it the case that the sooner we get on with that the better?
GK: 'Yes' is the short answer, but not for self-serving reasons. Yes, because if we begin making sooner the economic dislocation is less and you actually get a least cost to the economy outcome because if at the end of the day people have got more time to adjust, you get the right plant mix built, there’s a whole bunch of reasons why the answer is 'yes'.
AK: But what do you need the government to do in order to accelerate that because you’re a builder of gas power stations?
GK: Yes. One of the things that we just happen to puzzle quizzically over is that there’s bipartisan support and no doubt community support for the RET scheme and you guys know the numbers. I mean wind costs $120, $130 plus therming, so it's at least $120, $130 a megawatt hour compared with say base-load gas at $50 a megawatt hour. You can therefore, from that, conclude that the wind cost would imply a $60, $70, $80 a tonne carbon cost, right. So, we have bipartisan agreement to introduce that scheme to reduce carbon, but we can’t get agreement on a CPRS which is targeting the lowest possible cost of carbon and probably somewhere in the $10 to $20 range to reduce carbon. I think there’s just a completely strange disconnect that I don’t get, because by far the most sensible thing to do is implement the CPRS soon, with a slow and gradual tightening of the debatable permits, a slow and gradual increase in carbon and what that would cause is a substantial change in capital investment and a far improved generation mix if reducing carbon is the objective.
SB: Grant, given the lead times for new capacity, if we don’t get the transition path right, if it isn’t that slow, progressive path that you’re talking about and given the amount of funding that surrounds existing coal-fired generators, is there a possibility of a supply shock?
GK: Well, we say no, because power plants will always run at their cash positive level and carbon prices, certainly if they’re only $10, our view is that even the brown coal industry will in greater part probably still be operational in 2020. Perhaps the oldest of the oldest of black coal, for maintenance cost reasons, not fuel cost reasons, and perhaps the most carbon-intensive of the brown coal may be off by 2020, but the majority of coal-fired power stations operating today will still be operating in 2020, but they will be operating on a different basis.
The key understanding here is that – and I can only describe it sort of in a colloquial way – what happens with fuel substitution is that a say a four-turbine coal-fired power station that used to run four turbines all the time all year might run two turbines all the time all year and two turbines all winter and all summer, but not in the shoulders. Now, that will substantially reduce carbon emissions, but the power station will still operate, but it will bid in a different price into the national electricity market in order to recover its fuel cost for operating on that basis and all our modelling will say that the coal-fired generators will simply change their position in the merit order, but will still actually recover a substantial amount of the carbon cost they’re paying and will still, you know, still be operating albeit on quite a different duty cycle right through to 2020 and of course gas substitutes the difference, so as the cycle plant runs longer people start to build combined cycle gas plants to make up the difference.
There’s nothing that’s constraining the generators from passing the carbon costs into the black electricity price in the pool, but there’s absolutely no reason why electricity won’t clear if the generation exists. Supply will be satisfied and demand will be satisfied. The generation is there. It will just cost more. So, there won’t be a supply shock, but some people might say there’s a price shock. But there has to be a price effect in order to cause a fuel substitution, so we believe that the attempt to manufacture some supply crisis is frankly quite misleading.
AK: Right, so in fact to be specific about that Richard McIndoe of TRUenergy has been talking about that in order to achieve his own ends. Are you saying that he is being misleading?
GK: If I was running that station and you said that I was only going to get $20 a megawatt hour and I had to pay $30 inclusive of carbon, I wouldn’t be running it. But if, as a result of not running it, the prices were $60 a megawatt hour, I’d be turning it back on. Make no mistake about it, I’d be turning it back on. Does that make sense?
AK: Is that what’s going to happen though?
GK: Yeah, course. The market won’t be short electricity. It will have to pay whatever price it has to pay. See the system actually works because the price will rise to the point where there’s enough generation, but the price of that generation which is now inclusive of carbon will cause fuel substitution to lower the carbon intensity.
AK: I mean there’s another element to it which is also political, which is the regional development issues concerning the Latrobe Valley, which I presume the Victorian government is extremely worried about.
GK: But the reality is the Latrobe Valley, in our view, will be generating power in 2020. The total megawatts of output in the Latrobe Valley may be less, should be less in order to reduce carbon. Most of the power stations will still be running. Most of the people working the power stations will still be working there. The average cost of generation will go up for a coal-fired generator and as Karen says they will therefore bid a different price into the market and they will be dispatched according to their competitiveness against all other forms of generation.
AK: Well do you think they could be using gas instead of brown coal?
GK: To give you a different example, it’s just an exercise in logic. If brown coal power stations operate as they do at 0.8 emissions intensity, simply because of the lower carbon intensity of black coal. The interesting and simple puzzle is that Victoria ought to import black coal into Latrobe Valley, right, because they’ve nearly halved their carbon emissions, ok, and you’re not going to find that as a realistic option preferred because Victorians will not be overly enthused about importing New South Wales or Queensland black coal, right, but if you really just think about it as an economic and technical problem, then you would simply substitute less carbon-intensive fuels for more carbon-intensive fuels.
It’s important to remember that black coal is far less carbon-intensive than brown coal and if you substituted black for brown, you would have an enormous reduction in carbon emissions in Victoria. Now, the other way of getting there is these coal-drying projects, where the aim is to make brown coal like black coal and so it’s very important and when you go back to the compensation arguments, it’s very important to understand that what the brown coal generators own is two assets; a brown coal resource and a power station built to run on brown coal. If coal-drying works, then that reduces brown coal’s carbon. The carbon in terms of our brown coal begins to look more like black coal and there is still substantial value in the resource that’s owned by those generators and therefore why should they be compensated for it.
AK: Well, why do you think parliament is blocking the ETS and passing the RET?
GK: Look, my view – and I guess I’ll rely on you guys to understand the difference between a kind of a personal view and a logical, reasoned view, not that there’s a difference – but I think the community intuitively believes that renewable energy is good, that irrespective of carbon our fossil fuel resources are finite and therefore intuitively no matter what the cost and I’m not sure people really do understand the cost, but intuitively no matter what the cost, it is a good and worthy thing to increase our understanding, knowledge, pricing and competitiveness of renewable energy. I think that that is gaining momentum to the point where the if you like the concern particularly by business around the impact of the CPRS has brought complexity to that debate to the point that the community is less clear about the benefits of making that change and particularly when that change is expressed in the consequence or in terms of job losses which clearly quite now is a matter of great concern to the community.
Now, I think it’s fair to say that we in the gas industry see a change for our fuel type from coal to gas as job-creating, but that certainly people have been much more willing to buy the argument that the CPRS is a job destroying initiative and for those that have wanted to advance that argument I think it’s created some momentum. I mean it’s created some traction in the community. Now, I don’t know whether that is the true reason and that is my opinion, but that almost always political alignment occurs when community alignment occurs and, you know, political division exists when community division exists.
AK: I presume you’re also a bit unhappy because as I understand it four million RETs have been issued, 70 per cent of which have been issued to households for solar hot water and heat pumps and a lot of that I imagine replaces gas.
GK: No.
AK: No? Is that wrong?
GK: Well, it’s immaterial.
SB: Grant, can I switch topics briefly, but the AP LNG project which seemed overnight even there’s a scramble going on for LNG customers. The other projects have got some contracts in place. You haven’t yet. Is that a concern?
GK: No. There’s a bold answer for you! Just to use the example of the Gorgon LNG export deal to China. Firstly, I think that’s been flagged for some time, so I think it’s just the sort of final signing that’s been announced, but it's a huge deal at $50 billion, on the one hand. On the other it’s 2.5 million tonnes or about half of a LNG train and from my memory I’m thinking Asia Pacific LNG is about 150 million tonnes a year. The deal is actually, as big as it is, is quite small in the context of the LNG market firstly.
Secondly, we’ve said consistently that the PNG and Gorgon projects are the two projects which have now been, for the better part of five years, active in the market and I think anybody would have to say progressing to FID probably within this calendar year and they’ve always been ahead of the CSG industry at large and Origin and Conoco through AP LNG specifically.
The third set of observations would be that I think over the last three months we’ve seen people go from the absolute bottom where the world was going to end and you couldn’t engage anybody in a sensible conversation about anything to one where people are looking through the current recession. Even if the recession lasts, I think people are now looking through it. Bearing in mind we’re in the market, the contracts post 2014 and 2015, we’re beginning to see a more confident view of the future particularly in the region into which we’re marketing. So, hopefully those sets of comments provide some context for you in that regard.
AK: We will have to end there, thank you.
GK: Thanks for your time.
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