Origin Energy: Coal capacity not worth the cost for ORG

About the author:

Max Vickerson
Author name:
By Max Vickerson
Job title:
Analyst
Date posted:
18 February 2022, 1:00 PM
Sectors Covered:
Industrials, New Energy

  • 1H22 underlying net profit was less than we’d expected (-39% on Morgans forecast) with no skew to 1H Energy Markets earnings and some hedging and trading losses in the Integrated Gas business.
  • Guidance for FY22 EBITDA rose 5% on strong commodity pricing for APLNG.
  • Origin Energy (ASX:ORG) is planning on an early closure of its Eraring coal plant in August 2025 as the company sees ongoing difficult conditions for baseload generation.
  • We downgrade our rating to HOLD with a reduced target price of (login to view).

Eraring early closure

ORG announced it has given notice to the Australian Energy Market Operator (AEMO) of its intention to close Eraring in August 2025. If market conditions shift, ORG could extend the operation of the plant.

In our view though we see this as unlikely given the additional capital needed to be invested ahead of 2025.

Moderate Eraring earnings impact if electricity prices don’t moderate

Our high level estimate of the cost difference between the ongoing running costs of Eraring and a portfolio of financial contracts (1GW baseload swap and 700MW of cap) suggest only a moderate pre-tax cash impact of $51m pa (analysis on p4).

This assumes though that NSW wholesale prices remain at similar levels to their current prices.

The NSW roadmap is anticipated to bring in large volumes of renewable energy which could put renewed pressure on baseload prices. ORG has also pointed to the introduction of Snowy 2 and Kurri Kurri as competing sources of flexible generation which could also dampen prices of capacity contracts.

Forecast and valuation update

We have reduced our FY22 underlying net profit forecast given ongoing challenges in the Energy Markets business and the impacts of hedging, LNG trading losses and write downs in the Integrated Gas business. The overall impact is a 31% reduction to $404m.

Our long term forecasts for underlying net profit have also been significantly reduced as we expect depreciation to accelerate given the earlier closure date for Eraring.

ORG has not broken out the current written down value of Eraring but we assume that it represents ~38% of the PP&E amount, given the capacity of the plant compared to the total portfolio. This lifts our D&A forecast materially until FY26.

The net effect of the plant closure and updated near term assumptions is to reduce our valuation and target price to (login to view).

Investment view

We downgrade our rating to HOLD given our reduced target price. We think that the additional uncertainty evident in the energy market given Eraring’s early closure warrants some degree of caution.

Given that the company is taking a patient and considered approach we think investors should likewise do the same given the recent strength in ORG’s share price.

There is the potential that ORG, or its Energy Markets business, could come into play as a takeover target given the move to close its only coal plant. We imagine though that any potential move of this nature would be unlikely to take place without more regulatory certainty following the next federal election.

Price catalysts

  • Investor strategy day on 9th March.
  • 3Q quarterly report due in April.
  • Energy commodity price movements.
  • Exploration success, particularly in the Beetaloo basin.

Risks

  • Energy commodity prices: oil, gas, LNG, electricity and carbon.
  • Domestic energy market regulation.
  • Generation plant performance.
  • Interest rates and changes to tax regimes.

Find out more

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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