AGL Energy: Wholesale energy tailwinds too strong to ignore
About the author:
- Author name:
- By Max Vickerson
- Job title:
- Date posted:
- 05 April 2022, 9:00 AM
- Sectors Covered:
- Industrials, New Energy
- NSW electricity futures have continued to climb with FY23 at $152/MWh, almost three times the price from 12 months ago.
- The effects of hedging may mean the full impact of higher prices won’t be felt until FY24 but nevertheless we expect a material increase in retail and business tariffs in the medium term.
- We upgrade our rating to ADD and increase our target price to (login to view).
Wholesale energy prices continue to rally
Electricity prices are rallying in all states with winter futures prices strongly lifting given tight conditions in the spot coal market.
Newcastle coal prices have fallen to USD258/t according to Trading Economics but we estimate this would still require electricity prices of over $900/MWh for a typical spot exposed black coal plant to break even.
Domestic gas prices are also starting to rally with Victorian CY23 gas futures lifting above $12/GJ effectively setting a floor of $140/MWh for a typical open cycle gas turbine (peaking) plant to break even just on fuel costs.
The DMO uses a two – three year hedging window so the recent increases aren’t reflected in the draft pricing issued in late February. Given the tight conditions in international energy markets we expect wholesale energy prices to remain elevated and influence tariffs significantly from FY24.
Utilisation of coal plants appears to be limited in the March quarter with capacity factors ranging from 41% (Eraring) to 73% (Bayswater). We understand that some participants are running their plants more gently to manage the timing of maintenance outages. This is also exacerbating the supply shortage in addition to fuel pricing.
AGL is largely sheltered from coal pricing issues with its long term contracts in NSW and owns the mine for its brown coal operation in Victoria. AGL’s Liddell plant was one of the plants with lower utilisation (46%) but this is already factored into our numbers.
Forecast and valuation update
We have deferred some of our expectations of profit increases into FY24 despite the tight spot electricity market now. We are allowing for delays to DMO price increases as well as longer duration hedging while the market was weaker.
We expect stronger earnings in FY24 – 25 however given the tightening electricity spot prices. We also assume long term cost reductions of ~$30m pa across all years from our previous estimate given the ongoing cost out program.
The net effect is to increase our valuation to (login to view).
Clearly electricity generators are a higher risk proposition now than several years ago with the energy transition well under way. However, like any commodity, electricity prices are cyclical and right now the wholesale market conditions are paving the way for strong earnings to follow in FY24-25.
We upgrade AGL to an ADD rating with our updated price target and potential 12-m TSR of 14% (10% capital upside with 4% unfranked dividend yield).
AGL’s major near-term catalyst is the demerger. Wholesale market conditions are ideal for the legacy generator Accel Energy to separate from the new retailer AGL Australia.
We think the risks of tight balance sheets have diminished and there could be a rerate upwards once the market gets clarity on the new structures.
- Commodity prices (gas, electricity, carbon).
- Energy markets regulation.
- Performance and reliability of generation plant.
- Interest rates.
- Changes to tax regimes.
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