Mercury NZ Limited (MCY) Earnings Call Transcript & Summary

Good day and thank you for standing by. Welcome to Mercury Annual Results Analyst Briefing 2023 Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Chief Executive, Vince Hawksworth. Please, go ahead.

[Foreign Language] everybody and welcome to the Mercury results presentation. I'm joined by William Meek, our Chief Financial Officer, who will be familiar to many of you as well. So if I start with what is the third page of the presentation, our highlights. Look, a really pleasing year from our perspective. Hydrology driving record production, 9 terawatt hours, a new wind farm fully commissioned at Turitea, also adding to that result. But of course, hydrology was a record at 5.2 terawatt hours. So a really pleasing year backed by scale of production, but not only backed by scale of production, also by the addition of what was the Trustpower retail business, which towards the end of the year became part of the new Mercury branded retail business, which we are, again, really pleased about how that brand change went on a refreshed technology stack that deals a loyalty program bill, web applications and providing a single brand experience. The next stage being to continue to transition customers onto that single stack. We also continued our development program and the development program meant that Kaiwera Downs 1, which has 10 turbines has now seen 7 of those 10 turbines erected. And whilst we were anticipating production in early October, at this stage, we're expecting to see first production from that site this week. We have back energized to the site. So again, that's ahead of time. And I think is a credit to the team, but also credit to the learnings we had out of Turitea. Look, we can't really go past the fact that customers were impacted by what was a benefit to us in hydrology, but by enormous amount of rain in certain areas of the country. And we're pretty proud of the way we approached both in Auckland, Hawke's Bay with Cyclone Gabrielle supporting customers who were affected by massive inflows of rain and water. And we will continue to work with our partners to support those customers. I suppose a successfully scaled business, and that's what we have got, we have more generation, more retail customers, have led to an [ EBITDAF ] result of NZD 841 million, and our 15th year of ordinary dividend growth. And William will talk more to that in a moment. When we look forward though, and we look at this need to decarbonize the environment to support industry to decarbonize, we stand ready to support that through our generation development pipeline. And we're in the advanced stages of being able to commit up to NZD 1 billion into new projects of with 2 wind farms and 1 geothermal project approaching final investment decision. We also have a longer tail of opportunities, which I will talk to later in the presentation. But NZD 1 billion is a significant investment opportunity in the context of New Zealand decarbonizing. I'll pass on to William now for the next 2 or 3 slides to talk about the financials in more detail.

Thanks, Vince, and good morning to everyone on the call. So we're now on Slide 4. So a strong lift in trading margin to NZD 1.163 billion for the year. We saw operating expenditure lift by about NZD 116 million to NZD 346 million, again reflecting the increase in scale. I'll come back to OpEx, giving us a NZD 260 million improvement in our EBITDAF to just over NZD 840 million. So a record for Mercury. NPAT is actually significantly lower at just over NZD 100 million, down from NZD 469 million. Last year's result significantly improved as a consequence of the gain on sale resulting from the divestment of our Tilt Renewables shares and funding of the acquisition. It's probably worth just calling out there have been some quite significant changes in IFRS, particularly around the recognition of fair value movements in derivatives, particularly derivatives that are not in a hedging relationship. So now derivatives that aren't in a hedging relationship, which would, for us, include the very large [ amount of ] hedge, which has got 9 years to run, [ loved ] following contracts on wind farms, cannot be in hedging relationships. Fair values realized or unrealized now essentially are recognized through fair value movements in the income statement. You will notice that the headline income statement does not have EBITDAF in it anymore. So to see EBITDAF you need to go to our segment note, which restates some of those fair value movements bringing up the realized into either revenue or cost rather than sitting below the line in fair value. Strong increase in operating cash flow, so up almost NZD 230 million, again reflecting that improvement in EBITDA. Stay-in-business CapEx leaping to NZD 120 million, largely related to our work in retail integration, the turnaround at [ Cotto] to install a new generator and turbine, the ongoing refurbishment at Karapiro, so pleased to see unit 2 there operating now after quite a long outage, an outage of almost a year, and the start of our geothermal drilling campaign, which will continue for the next 2 years. Growth investment at NZD 177 million, largely driven by Turitea at 96 mill, and Kaiwera Downs, NZD 92 mill in the financial year. And a full year dividend of NZD 0.218 per share, taking declared ordinary dividends just over NZD 300 mill. On to Slide 5. Just a deeper dive into the EBITDA bridge between last year and this year. So Vince has touched on the increases in generation. So certainly hydro was very strong. We saw a record wind generation. Geo was actually quite weak. So outages to affect the turnaround at Cotto and some unplanned outages also at our Rotokawa site. We saw sales yields lift. Supporting that the increase in retail scale also a full year, that relates to a full year of the Trustpower retail business as part of the Mercury family. And we saw a NZD 67 million movement, largely as a consequence of the cash out of the Norske Skog transaction in the prior year. Other income was down. Last year, we had significant trading gains in carbon. So those were worth NZD 27 million. And we've received the interim settlement for the Cotto outage worth NZD 26 million. So that explains the movement in other income largely. And then we saw that operating cost increase more than NZD 116 million bridging to the NZD 840 million-odd for EBITDAF in '23. Slide 6. So just a deep dive into operating expenditure. You can see NZD 70 million related to retail growth, again largely the Trustpower business integration. We saw OpEx of NZD 16 mill, and we saw CapEx of NZD 17 mill on top of that. So sitting there NZD 33 million for the year cash costs to affect the integration, which Vince will talk to shortly. We saw a NZD 14 million lift in our asset maintenance costs and certainly inflation giving its higher running through the business, completing the bridge to that NZD 346 million OpEx [ print ] for '23. And where is the money going? So at the last chart there, really bridging from EBITDAF through to NZD 50-odd-million reduction in net debt. Big changes there really investing NZD 271 million. We've touched on it in the CapEx. Again, the growth program between KD 1 and Turitea and our stay-in-business business CapEx. Interest and tax, at just over NZD 100 million apiece with that dividend paid with cash. So there was a DRP active during the period, reducing that slightly, and a working capital movement of [ NZD 50 million ]. I'll hand back to Vince.

Thanks, William. So this slide tries to capture our strategic intent. I think some of the really important things to note here is that in the last quarter, we launched our new purpose, taking care of tomorrow, connecting people and place today. We think that's more reflective of the opportunity the business has to make a real difference in the energy transition. And alongside that updated our 2035 long-term aspirations, which are centered around the assets that we enjoy, the communities that we serve, the customers that we value, our people who we think make a difference are very important adaptive culture, leading to the commercial outcome, where we see commercial growth in generation [indiscernible] and the supporting nature of that for our ambitions as being key and important. Alongside that, we expect at the end of this financial year and leading into the next financial year to update our 3-year objectives for FY '25. Moving to the next slide where we talk about some of those people issues. Look, we can never be complacent about health, safety and well-being. And of course, total recordable injury frequency rate or TRIFR is adaptive, but it is a lagging indicator. So whilst we're pleased with the direction of travel there, we know we're only 1 incident away from that not being a great number. So really important to us is our newly refreshed health, safety and well-being policy, which really focuses not only on what we do from a process point of view and process safety but also the culture of safety and thinks about both the physical and mental side of well-being. On the other chart, on the right hand side here, we capture some of the things that are important and if we really want to create a powerful and diverse workforce in the future. And as you'll see, whilst we are progressing on all of those metrics, we are a way off of our targets. And that really is important because that pushes us to strive harder. We have, though, implemented leaders of our ethnic diversity program. We hope to see that help that particular area. Internal mobility is a really important thing, and that's about growing our own rather than simply recruiting from outside. And our women in leadership has improved on the back of the retail acquisition. So we can't be in a position where we take that for granted. That said, a shift in our cultural index is important. We still have ways to go as we integrate 1,400 staff under 1 brand. So we don't take the M&A challenge that comes when you've got people from different backgrounds as an easy challenge to overcome. So going to the next slide. So I talked earlier about our commitment optionality of up to NZD 1 billion of generation investment that we can make in this financial year, driven by 2 wind farms and a geothermal project. We have final investment decisions expected for Kaiwaikawe, Kaiwera Downs 2 and Nga Tamariki OEC5. All of those are subject to the final commercial discussions that need to occur, in some cases with suppliers, and in some cases with off-takers. But look, the winds are blowing in the right direction as you might say. I've talked to Kaiwera Downs 2. And of course, we have also invested quite considerably in understanding the Puketoi wind farm, which we believe with optimization can come into the discussion beyond this financial year. As we also show on the chart to the left hand side, we have a number of other projects that we're yet to announce, but we are well advanced on understanding them and you can watch this space in the future. Just to reinforce that on this slide, we just know where those major projects are. We are particularly pleased with the way that Kaiwera Downs 1 has gone. Yes, it's a smaller project, but it has proven out a multi-contractor model, and it will be great to have that fully operational at least on time, but possibly ahead of time. And the next slide really just gives a picture of Kaiwera Downs and reinforces what I have just said. So we can move onto the next one. Increasingly for businesses like ours, ESG is becoming an absolutely key activity, the environmental, social, and governance aspects. I think historically we have seen a lot of work in this space. But a lot of that work has been seen in almost in different silos. Our chart on the left here tries to start to bring together some of the things that we are doing under each of those headings. But some points to note here, this is the 7th year that Mercury has been a 100% renewable generator. We have really stepped up our program with our approach to customer care. That's through both our own propositions, through working with others, including with competitors like Genesis, but also supporting other propositions, which appeal to particular vulnerable customer groups. [ No Myra ] being an example of that. We are active in understanding our supply chain aspects through modern slavery initiatives. We continue to invest in the restoration of natural environment. So things like the Waikato Catchment Ecological Enhancement Trust. And that becomes important as we look into the future going beyond greenhouse gas disclosures and start to think about how the task force on nature-related financial disclosures will be adopted by New Zealand organizations and we are committed to taking a leading role in that space. So lots of work to come down the track here. Cost for us being a 100% renewable, our challenges in terms of Scope 1 emissions really all revolve around our CO2 intensity. We have adopted science-based targets from the SBTi initiatives. And that will drive some of our investment into reducing greenhouse gas emissions. That includes things like re-injecting the CO2 at our geothermals. You can see on the left-hand side, there are some targets we have adopted as part of the SBTi program, which has a formula to -- I guess, which is the formula that we are using to assess ourselves. This will be challenging, particularly challenging when we look at natural gas sales. Going on to the next slide, I will pass on to William, and we'll talk a bit about hydrology, gas and the market.

Now on Slide 14, some hopefully familiar scatterplots, obviously updated for FY '23 actuals. So FY '23 being a wet year produced a whole lot of prints and for the delta to national storage averages, which were clearly above. So wet conditions, high lake levels, lower prices, but still materially higher than the trend we would have observed from 1999. So we are seeing an absolutely higher curve fit and spot prices and its correlation with storage levels across New Zealand. We're also seeing a waning of the connection between gas prices and electricity prices. So those scatterplots are widening. So again, the flexibility of gas or the lack of gas availability is reducing the link between gas and power prices though the Methanex outage was, again, this year was helping in terms of loosening some gas supply to thermal plants over this winter. So 3 key charts on Slide 15. We're seeing international coal prices come off their peaks in mid-'22. So the pressure is certainly off there. We have our large coal stockpile at the Huntly Power Station. That's mostly still running on gas at the moment. And obviously people will be aware of the circuit breaker issue there at e3p. So we're seeing 3 Rankine units committed at the moment. So that is good in terms of continued reliability of meeting peak demands in the New Zealand system. Carbon prices are well off their peaks, which were over [ NZD 80 ], again back in mid-'22. So we did see concern around forestry credits and what -- and how the ETS framework might treat those. And so we saw quite a sharp decline in NZU prices through to mid this year. We did see quite an abrupt U-turn there from a policy level. So we've seen a spike with NZUs back above NZD 50 a tonne. So again, that will be, again, over time, increasing costs to greenhouse gas emitters in New Zealand. Electricity futures, we've been above NZD 150 for a 3-year -- sort of 3-year look forward since early '22. So you're still seeing sustained prices, still reflecting relatively expensive thermal fuels. And we did see an uptick in futures prices out to May '23 as a consequence of Genesis announcement taking e3P out of the stack. Probably a key takeaway is probably that last bullet that forward electricity prices are affected by renewable energy intermittency, and how often the most expensive generator sources set prices and shouldn't be compared directly to the levelized cost of energy for new capacity, particularly [indiscernible] generation from wind or solar. Again, another chart we like to reproduce. So certainly, this demonstrates the record hydro generation over FY '23. So that was 5,209 gigawatt hours versus a mean of around 4,050 gigawatt, so significantly higher. Certainly the wettest year on record for the Waikato catchment with records going back to 1927 and it's an outlier. So it's several hundred gigawatt hours higher in terms of inflows for the catchment. We spilled over 1,000 gigawatt hours. So between the generation uplift and spill, we'll be -- we're up about 50% on average levels. Last year was dry at just under 3,700. You can see in the yellow line is this year, which is a storage track for Lake Taupo. We are actually hitting the top, so setting new sort of maximum levels across the year in several places where it hits the top of the blue shaded area, which reflects the minimum or maximum lake level at that time of the year over the last 24 years. So that's since essentially Mercury or previously Mighty River Power has operated at the Taupo catchment. So if you go beyond that to the days of ECNZ's operation, you get some quite strange outcomes because they were optimizing the entire hydro system rather than the catchment separately. We did actually squeak over our minimum operating limit by a few centimeters and it's the first time we've done that since 2011. Probably the last call out on this slide is just the comparison between futures prices and spot prices. So we did see spot prices relatively low for the year on the back of wet conditions, but the futures prices were actually quite high. So that's showing the average monthly futures price 3 months earlier. So the market consistently expecting prices to be stronger than how actual spot prices turned out. Clearly, I couldn't predict the fact that we had persistently wet weather reoccurring because those markets tend to try to mean revert on hydrology. I'll hand back to Vince.

Thanks, William. So just talking to sort of a few issues around our core business. This slide talks about existing assets and the work we're doing. Karapiro rehab, William mentioned earlier, with the first machine now back in operation. I think what's really important is when you give these long-life assets a birthday, you also get the opportunity to lift performance. So over the full life of the project, we expect to gain 17 megawatts of capacity at Karapiro. Kawerau geothermal, we were out for 2 months, largely focused on the full replacement of the generator and turbine is now as a result of the major incident we had a year and a bit earlier. This was a really big turnaround, very complex, many, many people hours, 53,000. Look, we're back in service now and that service -- that station is now relatively stable as we've come out the back end of that turnaround. We've also commenced our drilling program. That 14-month, 8-well program expected to be about NZD 128 million. We've started the first hole. And it's all about reinvestment in the capacity of the Kawerau and Nga Tamariki and Rotokawa fields to offset decline. And that's early days yet, but we'll continue to report back on how that goes. Going to the next slide, looking at sort of retail of sales. We increased total connections across the year. That was pretty important to us when we bring the 2 brands together. As I say, bringing 2 brands together, a major merger of 2 cultures, 2 sets of people, we thought it's pretty important to be able to lift connections, whilst we were doing that, and we were able to do that and that's very pleasing. We've continued to sell into C&I as the forward prices have meant -- folks are still looking for long or have been looking for longer-term contracts. So we have done that. And we've also looked to manage yields, mass-market yields being somewhat influenced by the addition of the Trustpower customer mix. But generally speaking, a pleasing year leading into the brand -- rebrand. Going to a little bit more detail on the integration. Listeners may recall that the sort of call to action that we've had with that was 1 team, 1 brand, 1 technology stack, and being future-ready. So the June '23 brand change was a really big milestone. That's enabled those customers on the Gentrack stack largely ex-Trustpower to access the Mercury loyalty rewards program. And at the same time, we updated our bill, we updated the website and we introduced the new app. So quite a lot of technology change inherent in that brand change. I think we surprised ourselves somewhat by the willingness of ex-Trustpower customers to download an app with over 100,000 customers doing that. And at one point for 2 weeks, it was -- the fastest set of app downloads in New Zealand was the Mercury customer app. We're now into the process of migrating customers off of SAP on to Gentrack. And we've done our first pilot migration couple of weeks ago, and we're just assessing the lessons out of that. But largely speaking, we're pretty pleased with how that went and expect to continue migrating customers through the period to the end of October. From a cost point of view, well, we've spent NZD 33 million, and we still believe we're on track for the synergies over the 3-year period. Of course, those will come, particularly as we get off of legacy technologies. Going to the next slide. I mentioned earlier the issues associated with Cyclone Gabrielle, but more broadly, I think the issues associated with affordability, and hardship in general of which, of course, energy hardship always gets called out, I think, because irrespective of people's living conditions, it's an essential service. We are active. We've developed a number of support mechanisms, which are outlined there on the left-hand side. But we are really mindful that we are New Zealand's largest electricity retailer. We are a large multi-product retailer, and that does require us to stand up and step up to look after vulnerable customers. And we're particularly pleased that we've been able to start working alongside our colleagues who we can compete with hard. But also recognize that the solutions for people in hardship come from collaboration that is appropriate under the Commerce Act. The next slide turns to decarbonization. And I think we've talked now in many of these meetings about our commitment to decarbonizing New Zealand. I think the chart there is pretty interesting because it does show how residential prices have moved over time. And it shows that largely the cost of electricity has tracked lower than inflation. But we don't shy away from the fact that the transition is going to require significant investment across all parts of the sector. So whether that's in generation or whether that's in transmission, whether that's in distribution, a whole of sector approach is going to be really important. And in achieving that, we also still believe that thermal peaking will play a really important part because if we're to support a pathway to a largely renewable sector, then we do need to meet those peaks in the middle of winter if the wind doesn't blow and the sun doesn't shine. So we think that's sort of collaborative overall pathway forward as described in the Boston Consulting Group work is really important. So I'm going to pass back to William now who is going to talk to bit of a roundup on financials and take us home.

2 slides to go before Q&A. Slide 22 is really touching on Mercury's capital structure and strong balance sheet. So certainly there are some quarters concerned about [ MOM ] companies not having their balance sheet to support essentially the decarbonization necessary for New Zealand. So this slide should assuage concerns about Mercury's ability to underwrite its generation development investment program. We see a very strong improvement in our capital structure between '22 and '23. Over that time we invested NZD 1.53 billion in the last 2 years and in growth projects between the Trustpower retail business, Tilt Renewables and our ongoing investment in wind farms under construction. NZD 600 million of that was funded from the sale of our Tilt shareholding. But still, that leaves NZD 900 million invested over that 2-year period. EBITDA has lifted from -- we would tend to be trending around the NZD 500 mill range to over NZD 800 million. And I'll touch on guidance shortly. So we are in a strong position at the good end of the BBB+ range from S&P. Again, a call out there for our debt. Mercury does have NZD 550 million of capital bonds. So NZD 275 mill of that will be treated as equity by Standard & Poor's in terms of them calculating our gearing ratios. So quite a lot of headroom there. Essentially we could increase our gearing by NZD 800 million without a change in our earnings and still be operating inside their BBB+ S&P rating. And then a final call out, we do have an active DRP. We have confirmed that the DRP will be active for our final declared dividend this year with a discount of 2%. Last page. So a call out for guidance. EBITDAF guidance for FY '24 of NZD 835 million, so very similar to this year's result. Again, composition quite different. We're expecting a normalization of hydrology back to mean, 4,067. So that's a slight uplift, reflecting the efficiency gains at Karapiro. So again, we'll expect to see those play through over the next 2 years or so with steady increases. We're expecting a normalization of geothermal generation. So we won't be having these large outages. And then wind has been normalized also with new wind coming on. So full year of Turitea South and essentially 3/4 of the year with generation from KD 1. Some other call-outs here. We do have about NZD 10 million increase in transmission pricing. We're expecting the final settlement for insurance of Cotto during the financial year to just under NZD 20 million. Increases in operating expenses taking us through to that final guidance of NZD 835 million. So I'll hand back to Vince for concluding remarks and quick into questions.

Thanks, William. So look, obviously a really interesting year from us. High generation driven by high hydrology, first full year of Trustpower rebrand and really advancing our generation development pipeline whilst taking care of our core assets. So a lot of work, a lot of hard work from the team here, but developing a platform for the next decade of growth and opportunity as New Zealand decarbonizes. We'll move to questions, I think. Operator, please.

[Operator Instructions] Our first question is from Vignesh Nair from UBS.

Congrats on the great results. I just had 2 quick and easy questions to begin with. Firstly, just looking at the projects in the pipeline of sort of 300 megawatts or so in the next 12 months for FID. Can you maybe just talk a little bit about what you need to see from here, I suppose to have full confidence in bringing those to market, perhaps both from a supply side front, so raw materials pricing and EPC contracting but also on the sort of offtake and demand side.

Yes. Vignesh, look the -- on the supply side, obviously, we want to see the best pricing that we can get. We are very close to finalizing that pricing. I think -- I don't know which global wind players might be listening to this or -- but look, there is still competition. And I think New Zealand at this stage, we're in a position where some of those big global opportunities haven't quite ramped up yet. So we think the timing is pretty reasonable. I think what's probably more challenging is making sure that we can access on the ground people in New Zealand. There is competition for civils and balance plant type suppliers. So we very much want to continue the very strong relationships that we've had with some of those players with the work we've already done. And I think we're in a reasonable position from that because our projects aren't considered [ wipe away ]. We go in a straight line. We do what we say we're going to do. So that's quite helpful. On the offtake side of things, as you can imagine, those are pretty important commercial discussions. It's well known that Kaiwaikawe is a project that we've been working with Genesis on. We continue to talk to Genesis. We still anticipate concluding arrangements such that we can deliver that project as we wanted to, albeit significantly later than we had originally envisaged. OEC5 is a project that we can make a choice about integrating that into our portfolio. But we're always talking with other industrials or players who want long-term arrangements. OEC5 has obviously beefed up our base load. And KD 2 is obviously a project, which is somewhat dependent on outcomes at the bottom of the South Island.

Yes, that all makes sense. And just sort of talking sequentially in terms of cost pressures from, say, steel prices, and freight rates. Are you seeing sort of project economics get sequentially better or are you still seeing some constraints in terms of pricing for projects?

Look, I think you can look, freight rates have obviously come off from where they were in that immediate COVID period and as have some sort of commodity prices. But the reality is, we're not buying the freight rates or the commodity price. We're buying the output from a supplier who -- and then those suppliers have plenty of choices for where their kit goes to. So I don't think you can draw a sort of straight line equation or algorithm that reflects all the way through. And you only have to look at the global media to see that some of those companies have suffered massive margin squeeze. So there's a sort of new normal that we would expect to see, which won't look like what we saw in -- maybe back in the Turitea days.

Yes. Okay. That makes a lot of sense. And secondly, I suppose just a bit of a hypothetical question on Tiwai. I think you've been pretty open about the fact that you've sort of been in discussions with [ Meridian Energy and NZ ]. I think talking to Meridian, the pricing discussion has sort of moved to a more flexible one linked to aluminum prices. I suppose I'm just keen to hear your views on this. Is it sort of flexible style of pricing arrangement, something you'll consider as part of your capacity allotment, well assuming that goes ahead? And sort of what's your view in incorporating, I suppose, more direct commodity price risk on wholesale prices?

Yes. Look, firstly, for absolute clarity, we've had no discussions with Meridian or with Contact about -- because, yes, that would be in breach of our Commerce Act obligations. The only conversations we have with Tiwai. But look, my observation would be that the tone and nature of the conversations are about Tiwai being a long-term player that understands its obligations to Aotearoa, New Zealand, that's wanting to reset its relationship with the country after some pretty difficult press and action. But at the end of the day, Mercury is still a relatively small tail on a big dog. And they kind of -- the discussions they're having with others have to come -- have to land. They understand what we can deliver. I think they understand the value of flexibility. It's publicly announced the deal they did with Meridian on flexi demand supply balancing under the current contract. So I think all of that stuff comes into the mix in this conversation. I think we're just getting to -- I'm an optimist that we are getting to a more mature way of thinking about what's in the long-term benefit of the country which is, I think, a sustainable industry base that provides jobs and economic well-being, served by retail -- by a renewable energy sector that can sort of perform for customers.

Our next question we have Grant Swanepoel from Jarden.

First question around a little bit of clarification. 12 to 18 months ago you said your FY '24 target of NZD 800 million that didn't include Kaiwera. So your NZD 835 million has 3/4 of the 147 gigawatt hours of Kaiwera over and above what you were looking for back when you, I guess, [indiscernible] plus at NZD 18 million in the guidance from insurance is related to FY '22. So a normalized NZD 817 million guidance only with the Kaiwera difference, pretty flat on where you were looking for a couple of years ago. So getting to my question, does that assume that the margin uplift from C&I has been totally taken up by cost pressures?

Yes. You've got a very mechanical calculation there in terms of what is the NZD 800 million was always a stretch. We increased from [ 7% to 8% ] largely on the back of the Tilt and Trustpower transactions. We contemplated -- we always contemplated other things would happen. And it was a stretch target for us in terms of hitting the NZD 800 million. So yes, I think it's totally fair to back out the insurance. It's a one-off and it's essentially compensating for costs incurred because of a major plant outage. But in terms of the underlying business, we're in the hunt right now in terms of retail integration. So we've sort of -- we've got double -- we've doubled up. So we've got 2 -- we've still got 2 retail systems running. We've procured extra licenses for the Gentrack system as port across, but we're still paying for licenses on the Mercury stack. So we've got a very big focus around how we lift our productivity and efficiency as we roll through and complete our retail integration.

Look, Grant, I think I'd just add that, yes, there are definitely headwinds. But what I would say, though, is we are in the phase of a massive integration of people and technology. We have really strong belief about our ability to work through that. Those headwinds, the inflationary headwinds, though, are real. I think everybody is seeing those. But our ambition is clear. We can work through this. We can get onto the single stack, get the people -- get the customers across and see those synergies come out over the next 2 years or so. And it was always going to be a 3-year journey. And I would say for an M&A, there are many, many stories, the world is littered with disasters. We've got over the first Everest, which is the brand change.

Okay. Clear. Just quickly on guidance or continuation on guidance. With a linear event that we're moving into, some of your competitors are indicating that wouldn't get some nice kicker from that. Are you assuming any of that in your guidance? And if not including in your guidance, do you expect that to occur? And around your hydro forecast you started, you showed hydro dam levels are through the roof at the start of FY '24. Why do you not indicate a higher than average guidance for hydro at [ 467, only 17 above 450 of this year ]?

I'll respond to the second one first. So yes, we did come into the financial year. We closed last year about 100 gigs higher than average. We've actually had -- it feels surprising because it feels like it rains every day, but we've actually hit below average inflows to the Taupo catchment over the last 7 weeks, which is why we're largely -- which is also the wettest time of the year for us historically. So we're expecting to turn out average year based on look forward. So you've got a negation of dryer weather hits the opening position.

And if you could just repeat the first question, Grant, because I didn't quite catch it?

So you earlier were indicating to me the other day that an El Nino event, which we're moving into, should push wind volumes higher than an average year. Do you guys also expect that?

No, we haven't -- we just forecasted -- just expected wind. I mean last year was below average in terms of just average wind speeds. And a lot of [indiscernible], which is not the prevailing wind for New Zealand. And it's unusual to actually have really wet conditions, but not have higher wind. So you sort of -- because wind and rain are positively correlated normally. So no, we haven't. We just shared we'll generate our main levels of wind.

Last -- just a couple of quick ones. Kaiwera Downs 2, big wind farm. Is that dependent on a Tiwai positive stay decision? Second one, just on carbon volatility, can you give an indication of what you're expecting from a carbon profit over FY '24? And then the final one, with the market making losses now being removed from EBITDA and put below the line, do you guys have any of that impact in your FY '23 numbers?

So the first one, KD 2, well I think the simple answer is yes. I mean, if Tiwai doesn't stay, I think South Island generation is going to be not the place to be putting any new stuff. But the second, I'll probably pass to William as to carbon and market making.

Yes. So on carbon, obviously with the movement in the curve, curve came down significantly, has bounced up slightly. Yes, I mean, we're normally budgeting trading gain in the sort of NZD 15 mill, NZD 16 mill range. And our trading gains for last year, which had no gains in carbon still match that number. FY '24 market making, so we've got a different view. We don't -- market making is not a cost to Mercury. So we've still -- our market-making obligations in terms of our trading book are offset -- more than offset by trading. So in that respect, we're different. I think context explanation for bringing it below the line is, it's not actually market-making obligations. It's actually just the fair value for derivatives. So in derivatives you're trading and not in a hedging relationship. Therefore, gains and losses realized or unrealized are taken through fair value. So that's what actually IFRS says. Else, if you go back to our segment note, you'll see a restatement. So we bring back all realized gains and losses from derivatives back into revenue or cost. So it goes back up above the line for us. So we're not keeping it below the line. So EBITDA number includes the cost of market making as well as any trading gains or realized gains or losses from any derivatives that are in non- hedge relationship.

Our next question, we have Cameron Parker from Craigs Investment Partners.

Congratulations on great result. Just first question, assuming Tiwai stays and just your confidence in that would be great. What are your priorities in terms of protecting that -- that Mercury has traditionally gained and so the flexibility and so forth out of its hydro units? And are you considering any sort of other assets such as batteries?

A couple of comments from me, Cam. We're actually in a pretty good position. We've got quite -- we've got the largest wind portfolio in New Zealand. That being said, the vast majority of it is actually under load following contract, so with Amazon contract, which will kick in next year. Turitea, so essentially we've got 3/4 of Turitea essentially sitting in our portfolio, which needs to be firmed. It doesn't actually need to be firmed because that's a value decision. So of that portfolio, I think that's quite positive. So Mercury does have -- certainly does have options. Our C&I book is 3,500 gigawatt hours between physicals and financials. So we do have choices. Those are firm contracts. We're not selling a wind or solar profile to those customers typically. So it's at the meter. And those -- we still -- we back ourselves to manage our exposures. And if price premiums justify essentially firming, then again Mercury would be happy to enter into contracts where essentially the risk of firming stays with us to give the customer confidence around their power costs. So I think it's -- we're in a strong position for the next decade in terms of dealing with intermittency. We are looking at -- we are looking at batteries. Still -- while the volatility in the market has increased, it's still not easy to get a battery to work, in terms of just raw economics. You still need bigger peak, off-peak differences. I think the investment case from Meridian up at [indiscernible] got an uplift in terms of actually impacting reserve prices, which confers a benefit to their hydro portfolio in the South Island. We don't have that. But batteries are certainly something we continue to look for. I think they will be -- they'll play an increasingly important role as we look to deal with demand peaks. So, yes, they're there. We are unlikely to be looking to build a battery during FY '24, given the current developments that are on our plate today. But it's in the mix.

Yes, great. And also just with regards to gas and thermal peaking, all the participants are essentially agreeing that it's required for the future. But we seem to have people retiring gas plants, asset owners with their assets up for sale in the upstream area. Where do you think that solution might come from in terms of that support for a transition for New Zealand's renewable generation?

Yes, look it's challenging, isn't it? I mean, the BCG report was pretty clear that the most economic way forward was a good mix of renewables with a very, very small percentage of gas peaking. There are consented sites ready to be built. I think the challenge is having a sort of political regulatory environment that allows those decisions to be made. Certainly, Mercury would be happy to support through contracts that sort of investment. We're not trying to be so sort of pure about that because we actually think if you look at the trilemma that the issues turn up with security of supply, and we know that peak demand on a cold winter's night is a critical thing there, at least cost. And we know that the cost of gas peaking plants is well understood. So that facilitates the biggest amount of renewables possible to decarbonize the whole of the energy consumption, which means more EVs, more of the sorts of projects that we are seeing with New Zealand steel, more use of electricity in the industrial process. So if you sort of look at it from that perspective, then I think given a bit of time, logic should prevail.

Great. And just lastly for me, just with regards to operating expenses, obviously, you've got synergies to come through from your work through the Gentrack stack and so forth. What's the long run sort of OpEx for your business at the sort of scale going forward?

It's lower than it is currently. Inflation is a monster. When you're running at 6%, 7%, that is quite a challenge for, I think, all businesses. And it does -- it certainly does focus the mine. We're seeing inflationary increases in specialist areas which are just [ obscene ]. And it's therefore do challenge you to explore new ways of doing things, and what is essential. So we are working on that. We did not -- I think no one 2 years ago would have been expecting inflation to be running at 6%, 7% through this time. So it's quite materially different from where we are. We'll see whether the Reserve Bank and the rest of the world has got inflation under control. So I think the genie is still out of the bottle at the moment. But people are expecting it to come back. So, yes, we're very focused on delivering the synergies in our Trustpower retail business case. We just need to get customers through onto the stack. So essentially everyone is inside 1 process, 1 system to really move forward. We have seen some increases in terms of maintenance costs in our generation business. Some of those in terms of procurement of gear are somewhat unavoidable because you're beholding to often sole source supply. But again, yes, the business is very focused around how it manages its cost structures into the future.

Yes, and Cam you can be assured that that's something William and I agree on, it's lower than it is now.

Yes, that's great. Look forward to seeing that. It's good.

Our next question we have Stephen Hudson from Macquarie Securities NZ.

Just a couple from me. On the geothermal outages, I think it cost you sort of 210 gigs this year. Can we just add that back to '24? Or will you not fully recoup that? Secondly, just clarifying the market making gains and carbon trading gains, that was -- it sounds like it's NZD 15 million this year and going to NZD 30 million. Is that what you were kind of saying before? Well, on Nga Tamariki, congratulations on getting the consent there. I just wondered if you can give us a sort of a rough cost for the additional unit there, would we be safe in using sort of NZD 80 to NZD 90 for the cost? And then just lastly, maybe a longer-view question around the BCG report and some of your earlier comments on sharing the burden of the investment. We obviously got about 1/2 of that investment is going to supposedly come from the distribution companies that are owned by councils and community trusts. Have you got sort of reasonable confidence that they actually have the wherewithal to invest their share, sort of NZD 22 billion of that NZD 42 billion? And if not, where is it going to come from?

Okay. So there's a lot of questions there, Steve, so we'll kick off. So, geo normalized, yes, you would expect putting aside a very major maintenance outage on our geo side that you'd be running availability in the sort of -- well, certainly above 95 gig, potentially higher than 96 gig across the geo fleet. So yes, you do get a big step up. So I think last year was actually the lowest geothermal generation we've seen since Nga Tamariki commissioned back in 2013. So the Cotto outage was quite long and it came out slightly earlier than we had expected. But normalizing geo, just assume availability of 95 gig, and you'll generate that sort of 200 gig uplift. On carbon costs, no, the trading gains or losses, so no, no, no, not between -- I mean we had a very abnormal gain back in '22 on the back of those -- that's sharply rising curve. So we're still forecasting sort of annual trading gain between essentially power and carbon of sort of NZD 15 mill. Carbon cost at Nga Tamariki. Nga Tamariki is sort of our first station that's up for sequestration. So only 1/4 of the emissions -- well, 1/4 of the emissions are currently sequestered. So that's working successfully. We've got plans to essentially sequester more. Recognize that an expansion does increase your carbon footprint in the absence of carbon capture at Nga Tamariki. So that's still -- that's part of the business case in terms of what we do there around the carbon footprint for the expansion and ongoing operation at that site. Distribution networks...

Well, I meant for the new unit what would be the -- sort of the levelized cost for that new unit coming on rather than just the carbon cost. What will it cost you to build that extra 47 megawatt unit?

We're still working through that. So, you won't have to wait very long to find out, I hope.

Would sort of 80 or 90 be a reasonable guesstimate to plug in?

In terms of levelized cost, it will be in that range. Yes.

Yes. Okay, cool.

And then on distribution networks, yes, certainly based on the BCG reports, this significant investment required into distribution. Yes the funding for that, yes, I mean, those questions remain, particularly possibly for the smaller ones. That being said, they certainly precedent around customized price paths in terms of -- the real question will be for some of these small networks. They are amortizing those costs across relatively few customers. So exactly how that pans out in a regulatory environment, we will see. But there's no doubt, we -- the sector has enjoyed some reductions in launch charges as a consequence of lower interest costs over the last pricing period. From '25, obviously, we'll be looking at a harder environment, and further investment required on top of that. So we will step up. So that will be unfortunately one of the costs of essentially decarbonizing the country, and that the distribution alliance companies are going to have to make investments, which ultimately will flow through in terms of higher tariffs through to customers.

Our next question is from Andrew Harvey-Green from Forsyth Barr.

Just a couple of questions for me. First of all, just to dig in a little bit more onto the operating cost guidance for next year. Just I guess wanting to understand what the synergy -- sorry, any further integration costs coming through next year? And I'm assuming there are basically no synergy benefits coming through for FY '24 that's going to be an FY '25 story. The way you're talking it sounds like that. And then lastly, in terms of the -- I think you highlighted now operating costs are going to be coming in completely as well. I presume that's sort of low single-digit million dollars. But if you're able to sort of give a bit of a feel on that, that would be good.

Yes, so Slide 19 said, we'd spent NZD 33 million on integration split between OpEx and CapEx. So, that leaves us with NZD 17 million of the NZD 50 million. So we're expecting NZD 17 million. That's all sitting in OpEx at the moment. So there's probably -- there are some risks some of that will be capitalized. So, again, in terms of the guidance difference between where we were sitting for '23 and where we outturned a big chunk of that was actually just accounting, which is just of movement from OpEx to capital. Yes, synergies, we're very focused. So we will -- there will be synergies in FY '24. So we have got an increase in operating costs with a full year of now broadband in the group. So that does lift costs in terms of a change in retail scale. So there are some synergies in the number. But yes, we're very diligently working through how those materialize. So we're seeing some good wins. Half-year reconciliation, some of the metering, some of the costs are not turning up in OpEx, they are turning up in direct cost. So we're confident we'll be bridging and reconciling back to our business case outcomes.

Yes, okay. That's good. And then just a couple of questions on the generation pipeline. First of all, in terms of FIDs, we're looking for FY '24, but give us a sense are we looking at first half or second half for those decisions? Sort of reading between the lines in terms of what you're saying, it sounds like Nga Tamariki expansion might be the first one off the rank. But I guess that might also depend on the smelter decision too.

Yes, I think Nga Tamariki probably is the first one, because it's not reliant on other commercial discussions. And then the other 2 are a little bit dependent on the discussions with the offtake parties. But they're a bit like London buses, they could all come along at once. It's kind of we're not in full control of that conversation.

Yes. And then second question related to that pipeline. I thought there was noticeably [indiscernible] stage 2 in terms of that list. But obviously, it's one that's [indiscernible]. Is it fair to say that that's likely to come after Puketoi and [indiscernible] repowering? Is that the way we should interpret that?

I think all we're saying really is that with Mahinerangi stage 2, we have a number of choices around that. I mean, obviously the technology is going to be different to stage 1. Stage 1 has now been operating 12 years. So there is a kind of a -- there's quite a lot of optionality about what we do there, whether -- how that stacks up versus Puketoi is, again, optionality. But certainly, we don't have that with a locked-in time frame. We see that as choices, but we -- clearly, it's got a resource consent as is Puketoi. But we probably also want to look at some adjustments around things like [indiscernible] and stuff like that to optimize that site. So I don't think -- you shouldn't read too much into all of that, Andrew. It's just -- it's within the full portfolio when we go beyond these immediate 3.

Our next question, we have Nevill Gluyas from Jarden.

2 detailed questions for me, and then sort of 2 that's perhaps a more wondering. Detailed questions, just to confirm the cadence on the drilling programs, those reworks hasn't really changed. And you wouldn't expect it to change after OEC5. So sort of NZD 128 million, you've given us that guidance for 14 months. Should we expect that sort of roughly every 4 years, I think, is the cadence in the past?

Yes. So this drilling program is large. So essentially it's creating resilience in the wealth fleet across the 3 fields at Rotokawa, Cotto and Nga Tamariki. So you expect to [ get ] all things being equal. So that being said, sometimes you can be surprised. So you would see an extension in terms of the time between this player program and the next. So that's certainly the intent.

All right. And the second detailed question virtual asset swaps put in place, obviously, some time ago, they are winding off now. Any reason to expect them to be replaced or are they sort of going to just gradually wind off?

Sorry, what's winding off?

The virtual asset swaps between -- in your case between you... yes.

Well, with the FTR market, you probably -- the need for those there is probably lower. So you can certainly cover basis risk between [ islands ] quite easily between the FTRs or into ASX futures too. So at the moment, in terms of -- the direct arrangement between us and Meridian, probably not.

Great. Okay. And then slightly more wondering. I guess this one is reasonably direct. Very clear answers, I think, about the peaking requirement. I guess as the largest retailer now you perhaps have one of the larger opportunities to develop [ VPPs ] in your own sort of demand response program, which was also highlighted in the BCG report. I just wonder if you're sort of in a position yet to have any plans for that. Is it on the horizon?

Yes, nothing we can really discuss with any confidence at the moment. I think the way to think about us in that space is as William has indicated, in retail space we're incredibly focused on getting fully integrated on 1 platform. And as we get integrated on that platform with our technology renewal, we're making sure that that technology can move from being fit for now to future-ready. And things like VPP, how we might interface with customers is work we are doing in the background, but unlikely to announce anything during this financial year.

Very clear. And the last, really -- what was about how we should think about the futures curve. And of course asking around about this [indiscernible] speculation about what the market is thinking. But I just wondered if you thought the current curve sort of beyond this year reflects the sort of the wave of new renewables that are coming online. And whether or not you sort of think it's a reflection of that or whether that the market is waiting to see these things actually in the ground and running before it starts to react. I'm just sort of interested in your commentary there.

I'll let William go with -- he will probably be a little bit more analytical than perhaps I will be. Other way, I look at these things as there's been so much talk on vaporware that the market tends to look for spinning turbines or -- and real megawatts there as opposed to [indiscernible] or other watts that might turn up. So I think there's always a degree of conservatism in the way people think stuff will turn up. And I think that's probably founded in reality.

Yes, just to add to that, Nevill. I mean, the flippant answer would be, if I knew that then I would have won lotto, couple of weeks ago, I wouldn't be on this call. But yes, it certainly is interesting. We're certainly -- I think that whole trilemma, when you look at it through that lens, particularly the interplay between reliability and renewability, how that plays through, I mean, clearly contexts. Sahara station will start up this year, but that has ramifications for TCC. So while it's an uplift in energy, it's a decrease in capacity. So I think that call out we had in one of our slides around just how end-user pricing or how market pricing can be quite different from the levelized cost of energy because at the end of the day the market needs to supply the demand curve and how that balances. So what is the -- what does that price of peaking and then what really happens. We still -- I don't think we're still haven't seen what happens in the event of acute national drought yet. And I think those -- the impacts of those sorts of events can inflate prices quite significantly also. So I suspect you're going to get conservative operation of hydro schemes generally across the market to preserve flexibility that possibly leads to increased spill in some cases. But I think it's just that -- with long right hand tails on prices, it's just the payoff of being able to generate when things are tight or how much greater than say what happens when prices are very low for short periods of time, given people were largely hedged in the short term.

Yes. So lot of risk featuring in people's decisions about lake levels. It makes sense.

I would like now to hand back for closing remarks. Thank you.

Thank you, operator. And look, thanks, everybody, for dialing in. Thanks for all the questions. So as usual, wide-ranging and stimulating. I suppose, leaving the call, we would just say that Mercury is a changed business, both in scale and our opportunity to do things in the future. We appreciate the support of our investors, our customers and our staff. And we're looking forward to another productive year. Thank you.