Meridian Energy Limited (MEL) Earnings Call Transcript & Summary

Good morning. It's Owen Hackston speaking, Meridian's Investor Relations Manager. Welcome to today's call, which follows on from last week's announcement of a contract extension agreement between Meridian and NZAS. I'm here in Wellington with Neal Barclay, Meridian's Chief Executive. Mike Roan, Meridian's CFO, is on the line rather symbolically calling in from the Manapouri Power Station. You may be reassured, our CFO spends his summer holidays inspecting the company's generation assets. It's also Mike's birthday today. I'm sure he can think of no better way of celebrating than doing an investor call. For the call, Neal and Mike will talk through the business update that accompanied our market announcement last Thursday, and then we will take questions. When Neal indicates we are ready for questions, the operator will come on to the call and outline the process for asking questions. Neal, over to you.

Thanks, Owen, and welcome, everyone, on the call. The purpose of this call is to provide some insight into the amended 4-year deal that we've concluded with NZAS and announced to the market last Thursday -- last week on Thursday. We worked hard to provide solutions that we believe are of lasting value to the smelter and acceptable to our shareholders. We're delighted that Rio Tinto has accepted the terms of this extended closure offer, which provides certainty for the Southland community and the time, the region and the electricity industry needs to do the best job to transition to a new future. I'll start off recapping some background on how we got to this point. On the 9th of July last year, NZAS gave Meridian notice that they would cancel the existing electricity agreement effective at the end of August 2021. In doing so, they chose to decline a number of contractual amendments that Meridian had already offered that we believed would have added significant value to the smelter and ensure it remained a viable operation for many years to come. We talked about the nature of those amendments on our investor call last July. Having received the cancellation notice, on the 17th of July, Meridian put a firm offer to NZAS that gave them an option to extend the closure date of the smelter to the end of August 2024. The pricing of that offer was at a significant discount to any price conversations we'd had with NZAS up to that point. And it reflected the fact that if the smelter closed in August 21, then transmission constraints and transmission losses would lead to higher levels of spill and lower generation revenues from Meridian for a few years. To ensure we created ourselves enough time to mitigate these impacts, a cents on the dollar-type arrangement made commercial sense for Meridian. For that reason, the price included in our extended closure offer does not represent a sustainable price for the electricity sector in New Zealand. This is an exit agreement, and there is no option for NZAS to extend the contract beyond 2024. While the price in that July 2020 offer did not change during subsequent negotiations, the terms of our extended closure offers were refined during December to allow NZAS the option to reduce the contract volume to 400 megawatts from 1 July 2022 and given the passage of time to extend the term of the agreement to 31 December 2024. Now a 400 megawatts smelter works for us, and in fact, in some ways, it might be preferable toward the end of the 4-year period as we work with the Southland community to encourage new business into the region over that time. We have not been part of the negotiations between the New Zealand government and Rio Tinto regarding site remediation and transmission costs. But last Wednesday evening, we received notice from NZAS and its owners that they would accept our offer, and we were able to close on an amended contractual agreement that night. So I'll now hand over to Mike, who will talk you through some aspects of the contract amendments in a bit more detail.

Thanks, Neal. And just picking up on Owen's comments at the start there. It is a real privilege to sit in this power station. This asset is a tremendous part of our business. And it's quite nice to be having this conversation with investors on my birthday, certainly compared to the alternative. So I'm going to talk to Slide 2 of the presentation, primarily. As I do, first, it's important to remember that the agreement that we have with NZAS is contract difference, and that agreement has been in place since 2013. Been amended a couple of times since then. But key point is it's a financial contract that provides price certainty for NZAS. Doesn't provide supply certainty or it doesn't direct electricity from the Manapouri Power Station to NZAS. Rather, NZAS purchases electricity it requires directly from the wholesale electricity market alongside many other participants. By way of example of that is in December 2020, Manapouri generation was generally below the level of older consumption. So in that regard, this agreement is similar to many other contracts Meridian has in place with customers around New Zealand. Second thing is a full copy of the contract can be found on Meridian's website, the amendment summarized in the presentation that I'll talk to in a minute. They'll also be posted on our website. So anyone with hankering can work their way through the detail by heading over there when they have time. So what we've agreed to do with NZAS was adjust the underlying agreement as follows: we've adjusted the price and that price is fixed through the 4-year term. This enables -- to enable it, we removed the language in the agreement that referred to CPI escalation and aluminium price participation. We also introduced an option for NZAS to reduce consumption from 572 megawatts to 400 megawatts by providing us with 6 months' notice. The first time they can do that is 1 January 2022. But based on our modeling and given current aluminium price and exchange rates, this deal means NZAS is likely to be profitable for 4 years. So the option really gives them some downside protection should aluminium prices trend down again and if they choose that option, also provides us with arguably a better transition, as Neal mentioned. And the last thing that we changed of note in the agreement were the end provisions or force majeure provisions. These are a little complex, so I won't do justice to them here. But to summarize the changes, they previously required that for an order for NZAS to secure relief against contract quantity following an event of force majeure, that NZAS' response to the event of force majeure had to be consistent with the nature and scale of response expected of a smelter with at least 10 years of operational life left. And that was reflective in the contract term. That meant that there's an exceptionally high bar for them to meet in terms of the new investment, including any capital that they would have to potentially be required to make. And in our view, that wasn't any longer appropriate for a smelter that will close on 31 December 2024. So we've made changes to reflect and provide for a response FM that's appropriate for a smelter with that remaining life through December -- or up to December 2024. NZAS of course needs to still do everything they can reasonably and safely be expected to do to restore consumption if they want relief against contract quantity. If in event of force majeure, and this is in the agreement already, but if in the event of a force majeure reduces the smelter's ability to consume electricity less than 400 megawatts, then either NZAS or Meridian can terminate the contract on 3 months' notice. Other than that, all the other provisions like smelter demand response and -- or key provisions like smelter demand response and price separation remain. We've also adjusted the terms of the backend contract that we have in place with Contact Energy. Tenure of the new agreement with Contact replicates the new term with NZAS. The price is different to the earlier contracts as is the volume, which is now about 100 megawatts on average, unless NZAS elects to move to a 400-megawatt smelter, and then that volume is prorated in that agreement. I will say that without Contact's support and commitment, we wouldn't have been able to form a new agreement with NZAS so I want to take a second on this call to say thanks to them as well. And before I hand it back to Neal, I also want to cover the mitigations that we presented back when we talked to this topic in July, and you’ll find them in the presentation back then. We covered 3 areas. There was transmission, there was physical flexibility and there was portfolio flexibility. First up, and this relates to transmission, as you’ll see on Page 4 of this presentation, Transpower is on track with the Clutha Upper Waitaki lines project and expect to complete it by May 2022. And like Contact, I'd like to note, they're incredibly proactive back in 2020, Transpower, that is, and mobilized very quickly, given NZAS' determination to focus on this upgrade. And they really did and continue to show what can be done when things change. Back in July, we also noted we weren't overly concerned about sending energy across the HVDC link. Our focus was primarily between Southland and Canterbury. But that's -- there were limitations in the North Island reserves market that required some attention should NZAS exit. So at that time, we tabled a proposal to build a 100-megawatt hour battery that could or would provide those reserves. I think at the time, I said the economics were a no-brainer for that battery if NZAS were to leave. And good news is they continue to look positive. But of course, if we succeed in finding a home for all of the NZAS consumption through new sources, then the economics don't look as compelling. So we're thinking about it in terms of an insurance option that we will commission prior to NZAS' closure, depending on where we are with that new demand. The closure delay is, of course, beneficial in 2 ways, actually. And the first, we would expect that there'd be new generation of battery technology to emerge over the next couple of years, which should be useful from that perspective. And we're confident that our 100-megawatt hour battery can be deployed well within the 2024 time frame. When it comes to physical flexibility, what we talked about was Lake Pukaki storage and how we've been able to add a further 367 gigawatt hours to that storage. That was done in November 2019, so I won't talk to that anymore here. We're just repeating that message. And portfolio flexibility was threefold. We talked about swaption with Genesis, which terminates end of December 2022. With the news last week, we'll recommence deliberations for replacement of that swaption, noting that Harapaki provides us some flexibility should we choose to build that wind farm and/or we struggle to engage with counterparties for a new type swaption. The wholesale sales was the second development that we talked to back in July, which noted that we've made 50 megawatts or about 50-megawatt of ASX sales from September '21 through 2023. They obviously aren't as important as we thought they might be back then. The last thing we talked to was how we continue to grow our retail business. Our operating stats will be out next week for the first 6 months of this financial year, and Neal and I will talk to this more generally when we present our interim statements. But fair to say that we continue to grow our retail business, and 4 years provides us with ample time to build and manage our portfolio, subject to new supply in Southland. So that's pretty much it for me. Neal, I'll hand it back to you.

Cheers, Mike. Look, we are very comfortable with the way our mitigation strategies to encourage new demand in the region are progressing. I'll just touch on each of the main, if you like, the big-ticket potential items and how we're going with them. Process heat. We've completed high-level assessments looking at converting fossil fuel heat processes to electricity. This includes looking at small- and large-scale opportunities across a number of different industries. We also work with counterparties to understand the transmission requirements there to get these projects off the ground. I think these opportunities represent a renewed interest by these sectors in decarbonization of process heat, and it's looking encouraging. I think long-term contracts with sustainable NZAS-type pricing will get many of the smaller-scale decarbonization projects over the line. And we think the opportunity could be as much as 250 to 500-gigawatt hours, just in that sector. So you can expect to hear much more about that as we progress. IT infrastructure. We've been working alongside the data grid team since August last year and what will eventually be potentially a 100-megawatt data center in Southland connected by fiber optic cable with the East Coast of Australia. The proposition looks positive, and it's progressing ahead of plan. We understand that Remi Galasso and his team have land options secured and have started engineering work on the facility. The significant next step will be securing the first customer. Green hydrogen. Now I realize there are many skeptics around the economic viability of green hydrogen, but the interest we are seeing from a large number of credible players suggests that the opportunity for production and export of green hydrogen is realistic. The race to secure what will become a massive market is on. We are developing a process to consider that current multiple proponents who we are engaged with then to attract other possible partners as well. And in parallel with that process, Meridian and Contact have also initiated a $2 million joint study into green hydrogen. There’s 3 key aspects of that study: one, the market analysis and economics; two, site engineering costs and scale, plant flexibility, product storage and transport; and three, flexibility benefits to the power system, i.e., dry-year storage and a contribution to the New Zealand battery initiative. Now whatever we come up with, the economics of a scale hydrogen production facility in Southland start to look like a no-brainer, if the facility can also provide demand response services to the electricity industry. Seasonal demand responses like these will not only be a very valuable option for the provider but also a very efficient option for the New Zealand electricity system to manage system security as our reliance on gas and coal diminishes. So I think Mike has already referred to the Clutha Upper Waitaki line project, so I'll just move on to our summary page from here. I think to sum up, we're obviously very happy that we've been able to conclude arrangements to extend the closure of the smelter out to December '24. It was clearly in our commercial interest to do so, but it was also a very good outcome for south -- for the Southland region of New Zealand, and it will provide all concerns, certainty and time to manage the transition. I think the transition itself will create many opportunities that will ultimately deliver greater benefits to New Zealand than exporting electricity in the form of aluminium. I'm personally very energized to start 2021 on these terms. So we'll now take some time to execute on some really exciting opportunities for life beyond the smelter that will deliver new clean energy solutions that will benefit not only Meridian's business but its customers and the wider economy. The 4-year deal also provides ample time for Transpower to continue their excellent progress delivering the necessary transmission enhancements, which, along with the North Island reserve enhancement opportunities, i.e., the battery, will allow the NZAS load to be exported from the lower South Island to the rest of New Zealand if those new demand opportunities are slow in arriving. I guess the thing you're all wanting to know is what does this mean for Meridian's dividend. All I can tell you at this stage is that Meridian's dividend policy has not changed, but noting that the existing policy does provide the Board with a reasonable degree of flexibility. We'll be in a better position to provide further guidance at our half year results announced on the 24th of Feb. In particular, you can expect to hear from us on the interim dividend for FY '21, how we're thinking about flexibly managing our balance sheet and where we're at with the timing of our Harapaki wind farm option. So just one final closing comment from me. I think prior to last year, I personally would not have chosen for NZAS to exit New Zealand in 2021 or 2024 for that matter. And since they have taken that decision, it's driven us to seek out a raft of opportunities and if we can execute well, they will create a far more robust and diversified business. So whilst getting off the NZAS drug cold turkey would have been pretty tough, we do need to go drug-free. This 4-year transition period, given our inherent balance sheet strength is, I believe, very manageable and in the best long-term interest of our company. So now we can stop talking for a bit and take some questions.

[Operator Instructions] Our first question comes from the line of Grant Swanepoel.

Eventually, we get a deal done. That's fantastic. 2 questions. First one is around your comments on process heat, talking about 250- to 500-gigawatt hours. It looks like fairly near term, that opportunity could come up. With all the forward book you've put in place, how is the supply-demand balance looking without the Harapaki build over the next few years?

Yes. Grant, just a couple of aspects. That 250 to 500 gigs, it's reasonably near term, but it will take through to, I think, 2, 3, 4 years to execute on. So there is a bit of time. In terms of the overall portfolio mix and position, I think I'll hand to Mike to provide a bit more context for that.

They're in really good shape, Grant. With the contract we've got in place, and as those contracts expire, they just give us optionality. So if we find higher value opportunities in that C&I space, we might continue to roll them over but if the new growth opportunities don't emerge, we'd continue to do so. But if the opportunities to grow new loads are high value, then rolling over in the C&I business, we can do that as well. So no concerns with the existing portfolio, and the choices that we've got in front of us, with or without Harapaki, I think is probably the key point.

Could we expect -- Mike, could we expect to see you guys ease back a bit on your retail land grab over the last couple of years?

I think it's just been organic, Grant. So we've -- again, come to the value, right. It creates a margin for us above wholesale price. Rather than selling residual volumes into the spot market, we've chosen to sell to retail customers and just grow value organically that way. So no, I think we're quite comfortable with the growth we've seen in our underlying book. And as I said, if we did see any particular challenge in front of us, we do have contracts rolling off all the time that just allow for [ substitution ]. So we feel pretty comfortable with the way we're tracking.

Great. And then my second question -- sorry?

I was just going to add, Grant, that growth in retail has been done at a profitable level. So it's sort of no regrets in some regards. And I don't see that easing up whilst we're successfully executing on it.

And then I think that back-to-back contract with Contact is expected out later on this week. Are we -- should we consider the price that you've set with Contact is similar to the price you have with Rio? Or does the flexibility in the Contact contract mix it up a little bit?

Yes. Grant, I think it would be wrong for us to comment on the contract price that we've got with Contact and how that might compare to the contract price that we put in place with NZAS.

Our next question comes from Andrew Harvey-Green.

A couple of questions from me as well. First of all, you talked very much as if there's -- there is no -- well, currently on the existing contract, there is no option for NZAS to extend. Do you not expect them to come back in a couple of years' time and potentially look to stick around for a little bit longer? And sort of how would you approach things if that did take place?

Yes. Andrew, I mean they have certainly shown a tendency to want to renegotiate contract terms over time. So it's entirely possible that they'll approach us and want to extend. But what we're trying to make clear is that they don't have any contractual right to do so. So if we were to engage in or entertain such a thought, it would be because that was our next best option, and we think we're working on some stronger potential options than that at the moment. So yes, they're more likely to want to engage at some point, particularly if aluminium prices hold up the way they are. It's a very profitable smelter now. But the optionality from their point of view is gone at this point.

Yes. Okay. Second question, and it kind of alludes to some of the things you were talking about as well around the force majeure. Am I right in effectively saying that they are not going to be spending the CapEx refurb work, and if that potline then falls over, they can call force majeure on it? Is -- or are you expecting them to spend that CapEx?

Well, just one angle on this, Andrew. A technical plant failure due to poor maintenance does not constitute a force majeure event, in our opinion. But of course, that’s where you start getting lawyers involved, and we've had an experience with that. It was about 10 years ago when a transformer at the site failed, and they lost a potline. They’d ended up getting settled with that particular issue. So I don't -- that doesn't constitute a force majeure event in our view. And so we would fully expect them to maintain the asset in a way that it's operational, sensibly operational for the next 4 years. Mike, do you have any -- no? No, we're good.

Yes. Okay. So -- because there was expected to be some work, I think it was on the potline, wasn't there? Some deferred CapEx on that. So you expect that effectively to go ahead?

Yes, absolutely. If it's required to keep the plant operational safely for the next 4 years, then it should absolutely go ahead, and we would expect it to do so.

Okay. And last question I had was just around hydrogen in site. And I think people have talked about hydrogen as being a great thing to be doing at that smelter site. Is that a requirement from your perspective or there'll be other local sites that it's working equally well?

No. It's not a requirement. It's just the site has got some existing facility that you might be able to acquire off the smelter and utilize. There's nothing inherently fantastic about it. So I mean it's close to the port. So there's some existing infrastructure, Andrew, that a new hydrogen facility might be able to avail itself of. But time is also of the essence. And whilst the smelter is operational, it's taking up that space. So we'll see how it plays out.

Next question is from [ Peter Wakeman ].

Two questions. The first question is I heard you mentioning the forward contracts on ASX regarding the ASX -- not the ASX, the price. And you didn't say that you saw the significance or someone said that. What do you think is sort of an effect with wholesale prices when an announcement is made, say, closing the smelter and then a contract continuing it from an earnings point of view for [ Meridian ]?

Peter, I think Mike is the best person to handle that one.

Yes. Peter, my reference was back in July, we had -- on the investor call back then and in our presentation notes that we had made some sales on ASX to help us manage the risk should NZAS provide us with a termination notice that they eventually did in July. So that was my reference back then. And my reference to they seemed more important than Clutha smelter consumption would be gone August 2021. They seemed reasonably important at that point. Obviously, the smelter consumption will stay around until 2024, December '24. So those sales aren't as important as we thought they were back in July. That was really my reference there. Wholesale price forecast, I’d just be wrong, Peter, if I gave you any form of wholesale price forecast. The only reference that we do have really is, again, back in July and after NZAS provided that notice of termination, that wholesale prices did fall on ASX. The ASX prices fell between $20 and $30 a megawatt hour on that notice and have since risen. So that's about as good as a proxy I could give you, but trying to provide a forecast, I'll just be wrong, Peter, as wrong as the next person.

Okay. The next question. Regarding other possibilities of valuating to Meridian's portfolio. Is there any point in using the water, say, from Manapouri to -- for water bottling or water tankers or something like that?

Peter, because I understand that there has been -- it has been looked at by different parties over the years. And I think what you're referring to is a large amount of water that gets discharged from the Manapouri Power Station into Deep Cove. And if that freshwater could be harnessed and used somehow, that would be potentially a value-enhancing opportunity. We personally wouldn't engage in that. It's not part of our core business. And there are environmental concerns and issues with bringing large ships into that national heritage site to collect that resource. So that would be probably the sticking point in terms of getting anything up and going on that. But we personally would not engage in that as a business model. I should never say never of course.

And that's electric ships?

Well, that's -- the world is changing at a rapid rate.

Our next question is from Cameron Parker.

Firstly, congratulations on a good result. Excellent for the market. One question, really, and that's just on the swaptions and in terms of alternatives. Mike, you've mentioned you'll be looking at alternatives. Can you give us a flavor of time frames, what sort of alternatives are out there? And does this mean you -- the current form of swaption with Genesis will be expired and not renewed?

Yes, Cameron. Thanks. Good question. Look, so I'll answer the last piece. We don't know whether it'll be renewed or not. And obviously, we'll have an ongoing conversation with Genesis. But we don't have a specific answer for when we'll reengage. We'll pick that up in the next couple of days. I think as Owen opened the call, he said I'm still kind of on pseudo holiday, campervanning around the country. So we'll reconnect with various people involved and work out the process moving forward. But one thing we did say on a previous call was that we were exploring the options with a number of counterparties. I think we see it -- could be wrong, so I'll narrow in a little bit, 3 or 4 counterparts that were willing and able to provide us with a form of optionality that would help us deal with that dry-year risk. And again, today, one that I mentioned, which would be a change in approach, was utilization of energy from the likes of a new energy source like Harapaki to change the way that we ran our lakes, which would then in turn help us manage their hydrology risk. So we've got a few options. Obviously, we're limited by the expiry date, and anyone who has built anything would need us to move forward reasonably quickly. But it's recommencing a process that we kicked off way back in 2018, Cameron.

We have no further questions at this time. I'd like to hand back to Neal for any further remarks.

Okay. Well, thank you all. We did delay this investor briefing by a couple of days to allow a few more of you to get back to work, so hopefully, that was helpful. Clearly, there's further news to follow at our interim result announcement, which will be on the 25th -- 24th of Feb. So look forward to talking to you all then. In the meantime, have a good rest of the week. Thank you very much. Bye.