Contact Energy Limited (CEN) Earnings Call Transcript & Summary

Good morning, and welcome to the Tauhara project update here at Contact Energy. Today, we're going to have our CEO, Mike Fuge, give an update on the Tauhara project 1 year in and joined by our CFO [indiscernible]. Over to you, Mike.

Thanks, Matt. And look, the purpose of today is just to bring you up to speed with the project. We're coming into the end of the drilling campaign. We've got a fair chunk of the contract well and truly contracted now, and we did think it was an opportune time just to give you an update. So we want to [ go ] straight into it. In terms of project and it's -- the world in which it's going to operate and the economics, the market conditions have materially improved over the last 12 months. And the decarbonization demand, we expect to accelerate the resource itself, which Dorian will talk to, is absolutely world class, and that has enabled us to upgrade the expected station output to 168 megawatt. Look at the execution. It's a bit tougher, obviously, because of COVID but also because the station capacity expansion, which we've talked about, but the technology choices we've made early in the project to enable that capacity increase to be possible. The project costs overall, we expect to be about 21% or $140 million higher than anticipated when we took our FID almost a year ago. Look, what are why the implications of this? We're going to continue to invest in strengthening our renewable development capability. It's fair to say we have a fantastic resource under the ground there. And well, it's beholden on us to develop our major project capability to ensure that we can deliver these projects well. The rate of returns, the IRRs for the projects remain incredibly attractive, particularly compared to both renewable and more traditional alternatives. So you can see on the right there our assessment. The market has only strengthened the economics and demand for this project. The resource has got better and better. And in execution, schedule and cost remain a challenge, but we're building the capability to ensure that, over the medium to long term, we indeed do have the capability to execute these major projects well. If we just go to the market and how it's looking, obviously, a feature of the last 12 months has been in the announcement of new data centers or people intending to build data centers, including Microsoft, DCI and AWS. There was our own relatively small announcement about Lake Parime. But these data centers, we do see is a very positive development for New Zealand, particularly in the quality of the brands we're attracting in. In energy-intensive industries, look, Tiwai, you saw the news this morning. It appears that an extension beyond 24 is more likely than it was. The economics, as everyone is aware, have improved markedly. And you've seen challenges internationally with higher energy prices where aluminum smelting capacity has actually been taken out of market because it simply is not economic. For our own part, we have signed 2 major electricity users around up to the Tauhara project in terms of PPAs, [ OG ] and Pan Pac, which is a great vote of confidence, both in the renewable project that is Tauhara but also on the intent of these international companies to stay in New Zealand for the long term to support the industrial base in this country. And of course, there's the work that we have been doing with Southern Green Hydrogen around hydrogen in the Deep South. We put the RFI. We've got a short list of preferred bidders, and we're targeting April 2022 for an announcement around there. So look, demand growth over the last 12 months has been incredibly positive. There's also been a lot of hard work that's been going with process heat conversion. We're not going to claim all of the credit here. Some of our competitors have been pretty much involved in the conversion of processing boilers. And we also would like to acknowledge the role of EECA on the GIDI funding process, which has got stuck into process heat conversion projects. You can see the carbon price there and that -- the rise over the last 12 months has actually got us to our future faster where we can see processing conversions of being incredibly competitive. They're now in a zone where, with the carbon price, they would be paying on otherwise traditional gas or coal actively considering conversion to electricity is a real viable option. And even in baseline thermal substitution you can see, on the right-hand side there, the amount that the carbon price is now attracting in terms of baseload electricity at $71 -- $75, sorry, and what the equivalent gas price would have to be to maintain that $85 a megawatt hour. This in essence motivated us to and Genesis to get together and sign that long-term PPA, which commences on January 2025 off the back of Tauhara. And we think that provides momentum for further PPA discussions. Okay. On that note, Dorian, over to you.

Thanks, Mike. So I'll just give an update on the resource. So regarding the station capacity or the plant capacity, when we design the plant with the EPC provider, we always have one eye on a potential upside depending on the quality of the resource. The issue is you only get to really understand the full quality of the resource post bid when you finished your drilling campaign. Some of the things we look for is the location of the resource, if you want it to be as close to the plant as possible, but also the temperature and the fluid flow. You want to have the right combination of those 3 things. And now we've largely finished all of our drilling, we're confident that we do have that, so we can take the plant up to 168 megawatts, which is about 140 gigawatt hours of additional generation. And in terms of extra CapEx, accounts for about 1/3 of the additional CapEx increase that we're talking about today. The capital required for the extra megawatts is relatively low at $2.7 million per megawatt, which is really good. And it does -- obviously gets the benefit of being able to leverage the plant, the EPC part of it, if you don't need to increase the size of that. The extra CapEx is required for obviously a slightly bigger thing field and a bit more drilling to account for the extra fuel that's required. As Mike said, the market is looking more positive. In particularly, you saw the announcement today from Rio, probably not a surprise to most people if you sort of understand the client demand and what's going on with global aluminum prices that everyone was sort of expecting it to come, but it's obviously good that that's now been announced. But what that does mean is the market is becoming more and more conducive for new award development. And it means that understanding resource potential, if they -- a very important topic, that's actually understanding long-term value. So in the past, we've talked a lot about consented fluids that's available to us, which actually -- it's very difficult for anyone to derive some sort of meaning financial -- meaningful financials from that. So what we're trying to do now is talk about what's the most important topic is actually how much extra generation do you think you're going to get from your fluids. And on the left-hand side of your chart that -- I'm sorry, right-hand side of your chart, that's what we're doing. There's a topic here called specific energy, which is how much generation you expect to get per unit of fluid. And you can see there the Tauhara resource is very, very good at $45, I think it is -- I mean $46 [indiscernible] per megawatt. It's almost -- dollars a kilotonne, is almost double what we are getting on the Te Huka plant that's on a different part of the field. And the reason why the resource -- the values coming through so much more there at Tauhara is both the quality of the resource in terms of the heat within it, but then that allows you to leverage the latest technology around part design. We're using a triple flash, which basically means we're recycling the steam 3 times. And to do that, you actually need to have a high quality of steam. So it's those 2 topics, leveraging the latest technology and the quality of the resource, which have enabled us to get such a big uplift in the specific energy relative to the Te Huka projects already on the field. And overall, that's increased our expected output from the Tauhara field by 0.2 terawatt hours per year to 2.7. Actually, those of you who have been watching Contact for a while will know this is actually the second upgrade. I think when I joined back in 2018, we were saying the field was going to deliver 250 megawatts plus Te Huka, which is 2.3 terawatt hours of output. They're actually now 0.4 above that, which we're very happy about. Just to give yourself a full picture here, if you've got the same chart there on the specific energy for the Wairakei field, you'll know why we keep going on about GeoFutures and building 170 megawatt plant up at Te Mihi to replace Wairakei based on this chart because the specific energy up at Te Mihi is considerably higher there. You can see at 36 megawatt hours per kilotonne as opposed to the 25 down at Wairakei. And that's what drives that 0.6 terrawatt hours of additional generation that we get from GeoFutures, but no extra steam consents. So that's why we're so excited about that particular investment. And overall, what does this mean in terms of our geothermal development currently sitting at 2.3 terrawatt hours per year? We expect it -- when fully built out in terms of consented fluid from Tauhara plus the GeoFutures project completed, we expect it to increase by 3.2 terrawatt hours to 6.4. There's a little bit of rounding, obviously, in that calculation. The -- I mean, a caveat here that, I mean, these numbers are based on assumptions; and the more we develop the field, the more accrete we're going to get at those assumptions. And I think the last topic just to mention around resources, we're obviously constrained by the amount of consent that we can actually take, the amount of fluid we can actually take off Tauhara. So logically, can we take more? And I think the answer to that is all potentially, but we are more relatively novice on the field at the moment if you like. The Te Huka, which is the one that's running, is quite small. In terms of the amount that we'll be extracting and reinjecting, that goes up by an order of magnitude when we're operating Tauhara. So that will start to give us more data around the sustainability of the field in the long term, which is going to be required if we're going to ask for an increase on our consent. It is [ fun to mine to us all ] because if that is possible, obviously, there's a lot of value in that for us, but that will be a few years away just to manage expectations.

Thanks, Dorian. Right. I mean this is the third item, which we flagged earlier this morning. So look, it's fair to say the team, we mobilized some shortly after FID, but COVID has thrown a bit of a curveball at us, both in terms of getting access to labor, keeping the site productive but also supply chains. And it's fair to say that, over the Christmas period in particular, the team have worked incredibly hard to mitigate a whole range of potential issues quite successfully. The EPC contract that we've given a COVID schedule extension and approved that; and look, we've had to be very flexible and adaptable in terms of the construction strategies that we've got in place. It hasn't been a one size fits all. And a lot of instances, we have matched the remaining scope with the capability of the different contractors we have here in new segment. Around cost, the expected project costs are up by $140 million to $818 million. That's the all-in project costs. And that relates to -- firstly, we talked about the marginal capacity expansion as a result of the drilling campaign and the steam field separation system, which now allows us to deliver that higher output. The drilling campaign, in particular, has been a fantastic example of risk mitigation with the much improved understanding the people have acquired as they've drilled, being applied to the next well and the next well and the next well after that. We've been delighted with those outcomes. The separation plant complexity, look, the triple flash. It was beyond what we expected given some -- the experience we had almost a decade ago with Te Mihi. We're learning from that, and we've got our -- very much gone on top of that scope requirement now with the near completion of detail design. And then there's been the costs associated with COVID, whether it's been the escalation in commodity prices, the very tight New Zealand construction labor market with unemployment at an all-time low and some global supply chain constraints. Now in the chart below, we have actually broken that down about roughly where that $140 million increase lands and how it can be divvied up. But we're confident that, number one, we've now got the capability in place to deliver the project on the schedule that we've put out there in terms of second half next year. And number two, we've got a good handle on the cost with an allowance for any more uncertainty caused by COVID. If we're going to develop this fantastic pipeline of development projects around Tauhara and Wairakei. It's really important for us as a company that we build the major project capability and sustain it over a good long period. And so that's very much what we've been doing in this last 12 months, is complementing the resources we had with new resources, including Jack Ariel, the major projects Director, who has significant international experience and just building up the capability to match what was a very agile internal team. We've had to think on our feet in terms of matching the scope that we had in front of us with what's actually available here in New Zealand. And we've brought together a range of contractors to deliver the different pieces of scope, whether it's the flash plant, the flow lines and pipelines leading into the plant and the buildings, which will contain the control -- control systems and electro-equipment. This will be key to the future. It's important that once we get matched for, we keep going. We maintain that capability. New Zealand is a small place. Major project capability, by and large, is in short supply. Now that we've got a good team led by Jack, together, the intent is that we will maintain that team. In terms of geothermal development going forward, look, we expect that geothermal development typically will range between $4.5 million to $5 million a megawatt, which will be dependent on the resource quality, which Dorian talked to, and also the technology choices you make, whether you go for the open cycle or [ buy a rec ] plant. It's important to hold those numbers but also set them in context, remembering that geothermal typically has those very, very high capacity factors in excess of 95% compared to, say, 35% to 40% for wind or less than 20% for solar, if you're lucky. We expect that the increase in construction costs will be recovered through both the updated PPAs that we might sign in the future and indeed, the market pricing, and you can already see the effect in the forward curves on the ASX on that. Look, on that note, we've got one more slide there, which we issued today. We're happy to take questions because, I imagine, there's a few questions out there around both the project itself, the resource, what's happening in the market, the commentary from Rio earlier in the day. Happy to cover that full scope.

Yes. Thank you very much for your questions. Can you please send through Q&A function and then we'll just get around to them. I got a couple of questions coming through. The first one is from Andrew Harvey-Green from Forsyth Barr. Could you please provide any more specifics on the 34% of cost that has been tagged as COVID uncertainty as part of the 53% COVID impacts bulk.

Yes. It's just the change of contracting strategy, is to provide cover in terms of any reimbursable elements we have -- we still have in the plants go, also to cover any material price increases for works, which -- or materials, which aren't yet ordered. Dorian, is there anything else...

Yes, it's -- a lot of it is around more of the go-forward stuff. We know we've reflected what we set them to commodity prices and construction rates based on what we know at the moment. But as Mike said, because of the environment we're in, whereas previously, we would have had fixed price protection on some of these packages of work. We're not going to be able to get that. We don't expect completely. So you've got reimbursable elements now we've been there. So we've got to manage the risk around that, which I'm sure we will do based on the additional capability that we've got in around managing contractors, productivity levels to deliver at a certain price, which is not something you have to worry about with a fixed price contract. So it's topics like that, Andrew.

The second question for Andrew, is there any impact on the TCC closure from today's announcement?

No, there's not. Obviously, the whole thing with TCC is the flexibility that we have in picking a closure date. And obviously, the market dynamics, as demand holds up, they could offer that. TCC provides an excellent insurance policy for Tauhara delays. So in that regard, we haven't changed our plans in terms of the potential closure, 24. But the big thing we hold on TCC, we are flexible, and we will maintain that flexibility to ensure that we can respond to market demands as they arise.

And Andrew, as you all know from our operating stats, we haven't been using TCC as much as we've used in previous years. So we've got plenty of operating hours under the previous C5 investment to keep us going if we need to keep TCC going a little bit longer to align to Tauhara coming online slightly later.

Perfect. Thanks. Our next question is a small delay to Tauhara completion. Does the higher cost and supply constraints, meaning any delay for the next field's decision, when should we expect the next potential FID?

Look, we're working on options. And the short answer is no because they're separate teams. And the big thing that we've been very acutely aware of in the development of this geothermal pipeline is that we didn't overstretch the team. So the idea was that we always had a sequence so that the drilling, the reservoir modeling, the actual build, the EPC contracting as far as possible was sequential and so that major project capability that we build up -- those up -- build up under Jack can go from one project to the next. We are still looking -- we're still -- we still managed to submit our resource consent for GeoFutures at the end of last year. We are looking at other options around potential further development at Te Huka, and we expect announcements around the timing of those to come forward. But certainly, GeoFutures, on track for a mid -- second half '24, '23 announcement for FID. And we'll continue to look at other options we've got to bring any projects we can forward.

Yes. The other thing I'd add on that is we talked a bit about data centers, and they actually want additionality, which basically means that they want to be able to point to a specific renewable asset that's been built to supply their electricity. So obviously, that means as these data centers come to New Zealand, you need to build perhaps to support them. You can't rely on existing assets and existing generation. The other point, obviously, the data centers load its baseload like our geothermal. And in order for them to get their carbon targets, they need to actually better demonstrate that they have renewable supply actually aligned on a [ half hourly ] basis to their consumption. So that means other forms of renewables, which are more intermittent aren't attracted to them. So that's our understanding. So another big tick for geothermal, so yes, I guess we should watch that space.

And to kind of just reference you back to that market analysis that would produce the demand growth we've seen and one is over and above what we anticipated from Tiwai. And Tiwai is more likely than not it seems to stay open after '24 when, remember, our decision on Tauhara, the FID decision was based on Tiwai going at the end of '24. So all of those factors combined to actually put a pretty strong pull on everyone's renewable energy development pipelines.

There's a question just on that point, Mike, seeing positive demand growth signs in market, how much demand growth in gigawatt hours do you expect between now and 2025?

What we have been experiencing is in the order, I think, the last 2 years, 1% to 2%. It's all been normalized. I would expect that to continue. The big unknown is -- in there is these step changes that we've seen with the addition of data centers in particular. Those announcements typically will bring with them anywhere from 0.1 to 0.4 terawatt hours with each 1 of those announcements and that could increase on that number of 1% to 2%, which is reflecting the usual economy growth but also the entry of EVs into market.

The next question comes from Jeremy Kincaid from UBS. Could you give us an idea of what the health theory is for Tauhara pre and post capacity and cost upgrades?

We normally go for long-run marginal costs as opposed to levelized cost of energy, which would be low 60s now. So when you consider what the wholesale price is and actually what we won't expect it to go to in the long term around levelized sort of burden cost of long-run marginal costs, that's still a pretty attractive project, which is why you noticed that an IRR is actually funny enough not too dissimilar to what we originally thought it was going to be because the upsides and the downsides were largely offset.

Next question from Stephen Hudson from Macquarie Securities, "Two for me. Any obvious implications from today's announcement or SIB CapEx levels in the medium term? And two, have you built in a contingency percentage into the $818 million"? How much is the...

So -- No, so obviously, we're not going to disclose our contingency for reasons of commerciality. Fair to say that we think it's an appropriate balance to reflect the mixture between a drilling campaign, which is drawing to a close; an EPC contract, which is lump sum; and remaining scope with the mixture of lump sum and reimbursable. The other thing that we run over there is a probabilistic model between -- to ensure that our costs are reflecting. We're aware of what the P90 and the P50 costs are going to be. And it's fair to say that our modeling reflects what we're putting in front of you today, is looking close to the P90. So we take those levels of care around this, and we think, on that basis, we've got a pretty robust allowance for contingency.

Yes. And even, we're not expecting to have any impact on our stay-in-business CapEx. Some of the bigger impacts are stay-in-business CapEx is Omicron and lockdowns and having to sort of isolate our critical workers around the operating sites and meaning that we can't get as much sort of maintenance done as we would normally do. So yes, no extra impacts from this.

The only sort of key stay-in-business CapEx question is potentially the Wairakei extension post 2026, the capacity expansion, but there's no read-through from these costs onto the CapEx for that project, Stephen.

[indiscernible] stay-in-business CapEx. Yes. Fair enough.

Next question is from Cam Parker from Craigs Investment Partners. Can you please provide an indication of the remaining hours on TCC prior to closure?

Off the top my head, I don't know what we -- I know we [ bottomed ] it a lot and we've got enough. [indiscernible]

We'll get back to you on the answer. I think it's 5,000, but don't quote me on that. But as Dorian said, it was enough to get us through to -- in '24 [indiscernible]?

End of '23 at least.

End of '23.

A question from Jonathan Davis from ACC. Are you looking to contract out a percentage of Tauhara generation and PPAs prior to completion?

We already have much of those deals with OG and Pan Pac and the Genesis Energy. So if you take those deals collectively, they add up to 80, 87 megawatts. We've got capacity for 168. So we're just over 50% contracted, 50 and the other half nicely exposed to what looks a very attractive merchant strip.

There's one final question in the chat. And that's the question on -- do you have any comment on the Climate Change Commission's position on [ VGS ] projects?

We've been actively engaged with the Climate Change Commission on, initially -- their initial position on geothermal was a tad negative. And number one is -- a couple of differences there. Number one is our geothermal resource is extremely low CO2 intensity. Both Wairakei and Tauhara are between 20 and 50 grams per kilowatt hour, which makes them competitive with embedded wind and solar carbon footprints. So we're engaged on that. The second thing, which people always have underestimated, is the economics of geothermal in this country, is that they've always underestimated the consequential development pipeline that was possible. And we think it's got far more potential than what both, I think, with some of the Transpower reports and the Climate Change Commission in terms of their assumptions. Remembering geothermal compete -- particularly low CO2 geothermal as we have. It's a natural competitor overseas as nuclear energy, which is a cost -- order of magnitude costs higher. The last thing is that what we are excited about and we're getting on with this year is the ability to do carbon capture from geothermal. And we hope to have that trial underway by the end of the year. The thing about geothermal, which people forget, is that the gases, when they come off, are very pure. So the CO2 is -- CO2 and [ CF2 ] align virtually. So it's easy to capture and with a little bit of clever technology, get back into the disposal stream and back to the reservoir from which it came. So we're quite excited by that possibility. So those 3 factors combined, we think there's a lot more upside to geothermal than maybe people thought there was 18 months ago, and we've been engaging with critical stakeholders on that.

Great. Thanks for the question today, and thank you for joining us and look forward to seeing you with our results on the 14th of February. Thanks all.

Cheers.