Meridian Energy Limited (MEL) Earnings Call Transcript & Summary

Good morning, everyone. It's Owen Hackston speaking, Meridian's Investor Relations manager. I'm joined on this morning's call by Neal Barclay, Chief Executive; and Mike Roan, Chief Financial Officer. In terms of the format of today's call, we'll work through the brief pack that was attached to our market release this morning, and then we'll move to question time. When we get to that point, can you please follow the instructions of the call moderator who'll come online and talk you through how to queue a call. Thanks for that. And now I'll pass it over to Neal.

Good morning, everyone. I'm sure you've all caught up with the news, and are obviously interested in what we've got to say on this call. We do have a brief pack. We'll try and add some color and a bit more of the backstory as we go through it. As you're aware, Rio Tinto are terminating the contract as of the end of August 2021. In terms of when Meridian found out about this, it was exactly the same time as everybody else. I heard on the phone, and pretty well at the same time our comms people were receiving the notification. So we were as informed as the rest of the market. We do expect that they will wind down operations over that time. Now you need to recall that Meridian's contract with the smelter is a financial contract. So it is possible that the financial volumes will stay in place to the end of August 2021, but the physical volumes will start to drop off as they close pots and potlines, et cetera. We've had no real engagement with them as to how they operationally plan to do that, but we expect to have that in the next few days because I do understand they've got a plan. Our current contract and pricing stays in place for the next 14 months. The pricing around that contract is confidential. But what we have decided to do is to give you a bit more of the context in terms of the package that we had on the table with the smelter. I've given you some context in the past that what we were seeking was a stronger commitment to term. So the most recent deal that we had on the table firmly was a 4-year commitment to term. It had some reduced rates. It had a demand response premium associated with some demand response that we felt was in both parties' interests. And more recently, we -- the industry came together, and we were able to add in a transmission underwrite. Now the total value of that package was $50 million, pretty well from the get-go, increasing to sort of mid-$60 millions to close to $70 million over the next couple or 3 years. So we felt it was a pretty compelling package. We understand it met the U.S. dollar delivered energy cost target that they talked to us about mid-last year. We also understand it got the smelter to the midpoint globally. So from our perspective, it still looked like a pretty compelling smelter going forward. In addition, and as recently as Tuesday, I was talking to the Managing Director of our Pacific operations. And just reiterating a message that we've given them some time ago that we could actually do better than that if there was a stronger commitment to New Zealand. And what we were talking about there was a commitment for the full 10 years of the contract. And if Rio Tinto had been willing to stump up for that, then we could have got them a long way, we think, towards their ask of 1/3 off, which was introduced to us last December. So from our perspective, we have been seriously negotiating with this organization for quite some time. We've been doing it in good faith. We haven't been tinkering around the edges. We've actually made a meaningful offer. Others have come to the party as well, most obviously Contact, but certainly, Mercury and Genesis were there when we started talking about the transmission underwrite idea. And we think we've put a pretty compelling proposition to them, but they've decided that it's not good enough. Clearly, from our perspective, it looks like there's bigger issues at play in regard to the overall Rio Tinto portfolio. Very unfortunate, but it is what it is. So if we move to what that means for us. On Page 3, we've got a bit of a business update. I'll talk to the first couple of points, then I'll hand over to Mike. First off, we've confirmed with our Board that there will be no change to Meridian's current ordinary dividend policy. So 75% to 90% of free cash flows. Now analysts are projecting a pretty healthy result for this financial year, which we align with. So I think the ordinary dividend will be a strong one. But also, with immediate effect, we will end the capital management program. The reason for this is the Board are cautious, given that '22 and '23 will be challenging years financially, given the transmission work that still needs to take place to free up Manapouri and Clutha schemes. And we're also very mindful of maintaining a BBB+ credit rating. So the Board are taking a cautious approach and we think it's the most prudent thing to end that capital management program. So just to be really, really clear, the last payment under that program occurred in February of this year. And I'll hand over to Mike to talk through some of the other mitigations that we're working on.

Thanks, Neal. First one that we've tabled here is the swaption process that we have been running for 2023. Probably won't be a surprise for people, but we will discontinue or abandon that process. That said, we will probably still look for products that help us manage peak North Island risk. But certainly, our exposure to dry years or hydrology dissipates as the smelter load disappears. So that process isn't one that we need to continue. The current swaption that we have in place as well, we have rights to terminate that, which we intend to do. And saying that, we will have a conversation with Genesis to see whether there are a wider set of choices that might make sense for their portfolio and for ours moving forward. In terms of the portfolio response more generally, it won't come as a surprise to anybody that we've developed a series of mitigants over the past few years as this issue has been in gestation for a long, long time. So I'm going to talk to the Clutha Upper Waitaki Line Project in a bit and transmission more generally. But the first one, people may or may not remember, are the changes that we made to the operability of Lake Pukaki. And last November, we let the market know that the low range of that lake was now available for operational use, and that creates and allows us, or provides, increased flexibility to manage hydro storage across our catchments and, over time, will allow us to -- well in the short term, helps us manage any constraints between Southland and Canterbury and then, over time, help us manage energy flows between the South and North Island. Reasonable amount of gigawatt hours involved in there. So that frees up an additional 367 gigawatt hours of storage in Lake Pukaki, and combined with the earlier work that we did to access that lower range from 513 to 518 meters, created an additional 545 gigawatt hours of storage or about 25% additional storage, which really does give us increased flexibility, given the circumstances we find ourselves in. Of course, again, with the change that's been announced, we will talk to our wholesale competitors about bilateral contracts that make sense for them and for us. Again, we've had any number of conversations over the years with some parties in that regard. Portfolios are expected to change following the announcement as people rebalance and most likely thermal plant retires. So we don't have an update for you today on what that looks like, but we will do so as we make progress there. Just to note that we took some insurance earlier this year. We did put some sales on ASX a bit more through 2023, really just to stabilize our cash flows. Obviously, we didn't have any information as to what Rio Tinto would do at the time, but we thought it was prudent, as we've always thought the risk of either Rio staying or going was reasonably balanced. And I'm going to talk to this next part in a sec, but -- a bit more in a bit. But the -- we kind of -- once we've dealt with the -- or Transpower has dealt with the constraint between Southland and Canterbury is, the next challenge is the HVDC link. And when we look at that facility as we really see the constraint being the North Island reserve market, as opposed to transmission capacity on the link. So we have done some work ourselves on activities or options that would allow us to better manage the flows of energy across that link and participate in that North Island reserves market, hence, the reference to a battery -- North Island battery solution, which would allow us to do that. And last bullet, probably self-evident, is this frees up reasonable amount of energy for us. And our retail team, our customer team is looking forward to the opportunity that creates for them and for us to grow our brand with customers throughout New Zealand. So that will be an interesting and a good challenge for us. Last piece is really just to note we've got a wind farm up in the Hawke's Bay that's got a strong investment case. We haven't made any decision in relation to that investment. And of course, we'll take the events of yesterday into consideration as we think about that investment. If I turn over the page and just talk a little bit about transmission, this is a summary of the work going on to free up transmission between Southland and Canterbury. Much of it's beknown to you. Transpower announced that it will continue the work that it started as a result of ourselves and Contact funding or prefunding. The lines work cost about $97 million, just under $100 million for Transpower to complete that work. Again, they've tabled that that will be completed in June 2023, and we'll work with them in the meantime to mitigate the impact of line outages that may occur to facilitate that progress. But we will be encouraging them. They obviously have a material incentive now to not only build that facility as fast as they can, but also think about transmission constraints more generally. The -- of course, the key piece for us is, the completion of that line's work facilitates or enables the full export of generation out of Southland. You can see that in the graph that's captured on that page is the green slope line is utilization as we currently see it with NZAS in place, the gray line, horizontal line, shows capacity of those transmission lines. The red line shows the increase in capacity, and the blue line shows forecast utilization without that consumption in Southland. As I mentioned, Transpower's program is wider than just the Clutha Upper Waitaki Line initiative. There are -- they've noticed -- told the market yesterday that they've got a program, cost them about $600 million, certainly in last estimate, they said that it would take between 5 and 7 years to complete. So $100 million of that is on the Clutha Upper Waitaki Lines work. There's about $150 million, we understand, on the HVDC, which would facilitate a fourth cable. As I mentioned, we don't see the HVDC constraint is necessarily being that big a challenge, but we will encourage them to do that work. And the reason we see the challenge as being manageable between South and North Islands is, on average, there's about 300 megawatts transferred between South and North Island currently. If you add another 600 megawatts, given the consumption reduction in Southland, takes it to about 900 megawatts on average with a 1,200 megawatt link. Really, there is room so long as we can manage a better solution than we have for North Island reserves, where the HVDC is operationally constrained to about 950 to 1,000 megawatts at any point in time. So a battery, as we see it right now, that opens up that link and helps it use its full capacity, when we've done the economics on it, it's a bit of a no-brainer from a commercial perspective, and it creates additional flexibility for us. But the primary purpose would be to free up additional energy transfers between the South and North Island. And then the remainder of the spend for Transpower is on Central North Island constraints and the Auckland voltage work that they have confirmed will be completed through 2022 for the Auckland Voltage work and the Central North Island constraints, as I say, between 5 and 7 years, they've probably got a bit of work to do on what they need to complete. We're on record and have said previously that the Central North Island constraints, we don't feel really represent an impediment to us continuing to do our business, and the entire industry has an incentive to free those up in any event, as everybody has a material amount of energy that's produced and will be sent through those lines or South of that transmission constraint.

Yes. So I'll just sum up. I think we've gone through everything we need to. But clearly, the decision isn't the one we wanted. But at least it now provides clarity and we can move forward. I'm super confident, and I've said a number of times that Meridian will be a stronger business in the medium to long term. And we can manage through this disruption over the next few years as we get transmission and other solutions in place. And as Mike's just talked about, clearly, the Clutha Upper Waitaki transmission work is the most significant first up mitigation. It must be the #1 transmission enhancement project in the country at the moment. So we'll be working with Transpower to see if we can't accelerate that in some way. To date, it's been an option. Now it's a real, live, absolutely necessary bit of functionality for the market. Mike's talked a lot about solutions to ease the constraint on the HVDC. We think it's largely a North Island reserve market issue. So that will give us a lot of -- well, the market will, I believe, bring solutions to the table there. And then just one last point that we haven't touched on previously, but with this exit, it will change the allocation to beneficiaries under the new TPM forecast. Energy flows will change. So the [ BAU ] scope savings may be different. We don't have an idea of what that is, but we're just sort of flagging it. So that's what we had prepared to say. We can hand it over to questions now.

[Operator Instructions] Our first question comes from Andrew Harvey-Green, Forsyth Barr.

A few questions as you can probably expect. First one is just in terms of the wholesale price outlook. I mean obviously the ASX [ curve ] looks a little bit off the moment. But I'd be interested in just -- in your -- in terms of the UTS decision, and presumably that would actually have a -- if it sort of flows through and ends up being the final decision, a more significant impact on [ South Island sale ] prices, while those trends [ are relieved ]?

Hey, look, I think we're still working through what the UTS kind of might -- what effects it might have on the market. So probably a little early from that perspective. In terms of prices more generally, you would have picked up, I'm sure others would have as well, that the ASX wasn't strong volumes traded yesterday. And I should acknowledge that the market makers who typically provide liquidity had all stepped out of that market yesterday. But ASX fell for 2022, 2023 by about between $20 and $25 a megawatt hour on the news. The kind of price levels that you see, not unexpected from our perspective, but it will take a while for that market and views on price to really reform. I think, Andrew, is like all events of this magnitude, it takes a little bit of time for people to get their -- firm their views and capture information. So I think as a first stanza yesterday, reasonable adjustment to what was expected, but time will tell.

Okay. The second question is just around the bilateral discussions that I guess you'll be kicking off soon that's -- [ and we’re in it ]. Are you able to give us any, sort of speak, of what sort of -- you'll be looking at in those sorts of discussions?

Yes. I think it really is bulk energy, Andrew. So based on previous conversations, based on how we look at portfolios and set up right now, is obviously a bulk energy transfer that we're contemplating in the coming years. The real question for us and others is how does that help people shape their own portfolios, given the alternate choices that they have. Way too early to frame up what that might mean for outcomes. But I do really think it's a bulk energy kind of transfer as people adjust their underlying portfolios. The -- and they like to be, I'd say, dovetailed and transitionary alongside those other choices. So I don't see them as being necessarily long term arrangements, but I would see them as providing portfolio certainty and assurance during uncertainty at prices that are reasonable and delivery points that reflect the risks that people are taking on. So again, not as much detail as you might like, but I think if you're thinking bulk energy, you're in the right space.

Yes. I'm certainly thinking bulk energy, but I guess that still leaves quite a wide range.

It does.

I guess the -- in terms of these discussions, do you see -- how much of a -- how [ fit ] from Meridian's perspective, are you to [indiscernible] those discussions? Or are you more -- you're open to discussion for people coming to you?

So I think a bit of both, Andrew. [ Mind that ], we've got a pretty efficient market. I think contracts help manage some of that efficiency. And some of it's about managing security of supply as well to the extent people do make choices with their thermal facility. So I think the market is pretty good at ensuring that contracts help manage the uncertainty that's in front of people and help deal with those economic and secure supply choices or resilience. So -- no, we'll be on the phones with people. I'm sure they will have a good view of what that might mean. But it will take time, because gone from this being a possibility to this is the future that we now face. So we did -- I think -- I don't know if I gave you a time frame earlier as I was talking, but we expect in the next 4 to 6 weeks, we might have something that's a little more detailed and concrete than what I've given you today, which I'm sure you would say isn't much more than a statement.

Yes. Yes. No, that's a helpful thing. Question is, I guess, around the ordinary dividend policy and how rigidly is that actually going to be kept? Obviously, with no special dividends, [ you have ] a very strong balance sheet position. And there's no [ dry year ] risk going forward [ to be feared ]. So -- will Meridian really cut that ordinary dividend of [indiscernible] manageable or will you look through at FY '22 if [indiscernible] to some degree.

I think we'll take a long-term perspective on it, Andrew. So we're always looking forward a couple or 3 years. And FY '22 and '23 will be the challenging years, no doubt. So we will look through that. But we think that policy gives us enough flexibility to reward shareholders where there is underlying strong financial performance.

Okay. Second to last question from me. Just around -- given your understanding of the discussions you've had with Rio, I guess, in the past, do you have any sense of when and how that ramp down time frame might look like? When it might start, and what sort of stages you're looking at?

No, no, we don't. The understanding has always been that when we completed negotiations, either successfully or unsuccessfully, on continuation, we would move to a staged exit negotiation, if that was the outcome. And certainly, when Mike and I were talking to Alf Barrios here in December last year, we got a strong sense that there was no way that they saw themselves walking away with a relatively short notice period, e.g., 1 year. That's totally inconsistent with the notice that we got from yesterday. And I have had one verbal confirmation from our counterpart in Australia that suggests they're open to some sort of offer. But like I said, they've come out with a pretty clear and firm communication. So we've still got to work through what alternate options there are for a more orderly exit, and if there are any options.

Yes. Yes, which actually does turn into my final question which is, is there any viable [ scenario ] other than closure that you can actually foresee at this point in time, [indiscernible] might be one. Is there are any other viable [ scenario ] out there?

Look, it's hard to see it. I think -- yes, I heard it suggested yesterday that this was the next level of negotiating tactic. But if it is, it's a pretty cynical play in terms of their own employees and the community in Southland. So I don't think that's really at play. I think they've decided they want to close the smelter. Maybe there's a possibility to extend that closure period. But like I say, that's not consistent with the communications we've seen yesterday, and we haven't really seen anything other than that. Alternate ownership, well, they tried to sell it back in '12, '13 -- '13, '14 in fact, and it didn't really play out for them. So I'd see that's less likely as well. And also -- yes, and if you -- I do believe this is a portfolio play from Rio and they are looking to curtail supply as part of the overall portfolio mix. So whether a sale would be in their interest. But anyway, you need to probably go and ask them about that.

Our next question are from Grant Swanepoel.

Can you hear me?