Viva Energy Group Limited (VEA) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Viva Energy Australia Government Fuel Security Package conference call. [Operator Instructions] I would now like to hand the conference over to Mr. Scott Wyatt, Chief Executive Officer and Managing Director. Please go ahead.

Yes. Good morning, and thank you all for joining us on this call to discuss the federal government's Fuel Security Package that was announced this morning. My name is Scott White, I'm CEO and Managing Director. And with me Jevan Bouzo, our Chief Operating and Financial Officer; and Lachlan Pfeiffer, our Chief Business Development and Sustainability Officer. Over the last 12 months, we've been working closely with the federal government to establish a framework which addresses the headwinds faced by the Australian refining sector and improves long-term confidence to underpin continued operations and investment in Geelong refinery which, in turn, protects the country's energy security. The Fuel Security Package announced this morning achieves this by providing material support during periods of low refining margins, effectively reducing Geelong's refinery breakeven margin while preserving the opportunity for Viva Energy to extract a fair return on investment as refining margins recover and as continued improvements in operating performance are achieved. The package also includes significant contribution to upgrade the refinery to improve fuel standards and reduce vehicle emissions. It also includes an option for the company to extend the arrangements for an additional 3 years beyond the initial 6 years of the program. This provides sufficient long-term certainty, which is necessary to make these investments. The Fuel Security Package consists of 3 main elements. The Fuel Security Services Payment provides a payment of up to $0.018 per liter on actual production of main grade fuels. The payment is determined in reference to a Margin Marker, which has been developed separately for each refinery and comprises public markets for crude, product and freight, which has been adapted to Geelong's operations. Payment under this structure will commence when the Margin Marker falls below AUD 10.20 per barrel and increases from $0.00 per liter to $0.018 per liter on a linear basis as the Margin Marker falls to AUD 7.30 per barrel. The Margin Marker has been designed to support the Geelong refinery when the refining margin is below the long-term cash breakeven levels, inclusive of all operating costs and an average capital expenditure. The lower breakeven level effectively reduces the risk of accumulating cash losses from refining operations during sustained periods of low refining margins. The second aspect of the Fuel Security Package is an introduction of minimum stockholding obligations for petrol, diesel and jet fuel for companies that import fuel into Australia. The first stage is expected to commence in July 2022 and is designed to maintain current average product levels in Australia. The second stage is expected to commence in July 2024 and will require a 40% increase in holdings of diesel nationally, lifting consumption days coverage to about 28 days. The structure of the minimum stockholding obligations will apply to Viva Energy. However, refineries are expected to be exempt from the increased stockholding requirements. In addition, the crude we hold at Geelong will be counted towards the holding requirements on a notional converted basis. We expect that a secondary trading market will develop in time to allow the trading of sector storage for those companies that have increased storage requirements. The third aspect of the Fuel Security Package is the requirement to bring forward the introduction of ultra-low sulfur gasoline from mid-2027 -- to end 2024 and to assess other potential petrol and diesel specification changes, which support further harmonization with Euro 6 vehicle emissions standards. The federal government will provide a 50% contribution, up to $125 million, towards the capital upgrades required at Geelong refinery to produce low sulfur gasoline (sic) [ ultra-low sulfur gasoline ] and a further $26 million to support any additional changes to fuel specifications definitely are agreed. We have long supported continued improvement in Australian fuel standards that result in better health and environmental outcomes and welcome this material support for the investments which are required to achieve these upgrades. For Viva Energy to receive the benefit of the Fuel Security Package, the federal government is seeking our commitment to operate the refinery through until 30th of June 2027 with an option for the refineries to extend the package for an additional 3 years. At the conclusion of the first 2 years, both industry and federal government will review the performance of the Margin Marker mechanism, the impacts of the minimum stockholding obligations and the outcome of the aromatics fuel specification review to ensure that the package is delivering the benefits that are expected. Overall, this is a balanced package to help protect the energy security requirements of government while providing the refining sector the level of long-term certainty necessary to retain operations and make ongoing investments to improve fuel standards and operating performance. We welcome today's announcement and thank Minister Taylor's department for their support, and we are committed to participate in this package, subject to the final terms and ultimate approval of the legislative package. Although the refining business has been heavily impacted by the pandemic, it remains a fundamentally solid business with prospects to make a material earnings contribution to Viva Energy as oil demand recovers in the period ahead. This package reduces the downside risk of operating through an uncertain period while preserving the opportunity to benefit from any recovery on refining margins, and this will help to underpin the transformation of our site into a broader energy hub. Continued refining is a great outcome for our people, shareholders and the broader Geelong community, and we appreciate the patience and support that we have received through the last year as this package was developed. I'd like to now open up the call for questions.

[Operator Instructions] Your first question comes from Mark Samter with MST Marquee.

Congrats on what's a great deal. I just had a quick question kind of around the minimum stockholding obligations. I guess just a starting point, do you have a feel on -- well, obviously very important, too important, but kind of in its totality -- what current stockholdings would be, and so the quantum of pain those guys are going to feel? Because I mean it certainly feels to me like, I guess, rightly, given what you and [ Minister Taylor's ] committed to do for the country and the refining industry, it's put you guys in an incredibly strong relative position to those who are pure importers.

Yes. I'll get Lachlan to address that, Mark.

Yes, look, I mean, from -- first point, obviously, there's a lot of detail to come on the MSO. So I think the detail of how it will be implemented will be important, and we have to work through all of that in the next few months. But broadly, the government has set the initial holdings, on an average basis to industry, is what they considered to be the current holdings. So the 20-, 24- and 20-day holding levels (sic) [ 24-, 20- and 24-day holding levels ] that they're commencing from 1 July '22 are expected -- are designed to maintain existing average holdings across the industry at the moment. And then the increase comes, the 40% increase, in July 1, 2024, for the diesel stockholdings.

Okay. And then just a question for -- this is for you, Scott or Jevan. But with what's going to be -- realistically [ sad events ] last year -- a much higher, almost guaranteed, set of earnings but certainly more visibility and less volatile in it, you're going to be running a probably, say, conservative, I'd say very lazy balance sheet. Very quickly, can you give us any steer on the range of opportunities you see for balance sheet capacity?

Yes, I can take that one, Mark, it's Jevan here. And thanks for the question. I think, definitely, over the past 12 months or so, we've talked about the uncertainty in refining, causing us to be a little more cautious, particularly around the balance sheet and our outlook generally, for investment in the business. And the package that we've announced today, I think, really deals with a lot of that refining uncertainty. It gives us confidence through the commitment period. And you obviously see that from the release. I think from a balance sheet perspective, it gives us the opportunity to think a little bit more broadly around the level of investment that we feel confident to make both in Geelong, the broader energy hub site and a new energy and new business opportunities, and really sets the foundation for us to do more on that in the near term. And so as you say, I think it's a great outcome for the refinery and definitely opens up some balance sheet capacity for us to continue to invest in the business.

Our next question comes from Michael Simotas with Jefferies.

And again, it's a great deal, well done. Can I just follow on from Mark's question around the balance sheet, Jevan? So it sounds like you're all sort of thinking more about this gives you flexibility to pursue investment opportunities. Do you think there'll be any headroom to potentially return some capital to shareholders?

Yes. I think that's always an option. It's probably not always our first preference. And I think we've got a pretty good range of investment opportunities across the business when you think about the energy hub, some of the works that we're going to be able to do at Geelong on the back of this package. And we've always said to the market that we'd be open to continuing to invest in the business, both from an acquisition opportunity perspective but also on new energies and new business opportunity perspective. And in the event that we've got excess capacity in the balance sheet and we can't find a good use for that capital, then we've demonstrated that we're pretty open to returning that to shareholders if that's the best use of that money. But I think at this stage, we're really pleased to have this package in place. We think it gives us a lot of certainty for refining earnings in that part of the business going forward and should at least enable us to open up some additional balance sheet capacity. What exactly we do with those funds over time, I think, is still to be worked through but would point out that we've got a pretty exciting opportunity for investment and growth in the business and the site going forward. And that will be our first and foremost focus at this stage. And as we've done in the past, if sensible opportunities don't arise, then returning money to shareholders always remains an option.

That makes sense. And then the second question I've got is just, can you talk about the financial implications of the closure of other refineries in Australia? I guess for you the biggest potential impact could be availability of local feedstocks?

Yes. I think -- so Scott here. Yes, I think -- as you know, Geelong process is currently about 1/3 of its [ diet ] from local indigenous crudes. And that's a feature of our location, I guess. And with 2 other local refineries closing, it should most likely make the availability of those crudes more available to us. But we always assess those relative to all the options that we've got and make, obviously, the best economic decision. So that won't always drive you to local crudes, that will also drive you to exploit other crudes that are available around the region as well as the more attractive. So I think it's one of those things that we always take a sensible economic decision on.

[Operator Instructions] Your next question comes from David Errington with Bank of America.

Yes. We think Angus -- Scott, as you said, you thank Angus and Mr. Morrison for the package. And as shareholders, we thank them, too. But on the answer to Mark's original question on the storage. I didn't really fully follow the answer that you gave. I mean I think the question was what competitive advantage will it now be to refiners? And this trading environment that you're talking about, we're trying to get an understanding as to what impact that's going to have on a refining margin. It should improve it, I would imagine, with a 40% increase in diesel requirements by '24. So I'd like a little bit of understanding as to what in dollars, in a sense, how much of a competitive advantage that's going to be obviously to Geelong with the excess storage capacity and probably Lytton as well. So -- and that's relative to a pure importer rather than like someone that's going to convert. But can you give us a little bit more color? Because I didn't really follow the answer that you gave. I didn't think you really gave us that much.

I think it's -- David, because I think that we actually -- it's hard to describe a value to it yet because it's some way off and the details are not -- they still need to be developed. And ultimately, the value of MSOs to the refinery will depend ultimately on the workings of the market at the time, which is hard to predict. So I think -- but overall, I think that it should benefit refiners in the sense that we're not obliged to meet the increase in diesel storage requirement stockholdings within the refining system. So it's an advantage, we get to account the crude towards -- on a notional basis towards our product storage as well. So we will be impacted by the locations where we need to import, but we obviously can offset that with our position of the refinery. So we feel we're pretty well placed to deal with the MSOs. But in terms of what benefit it ultimately ascribes to, we just have to wait and see.

You just negotiated $2 billion package, Scott. I reckon you'd have a fair idea of what the advantage is, but you just don't want to tell us yet. That's probably more the point, isn't it?

It's 4 years -- or 3 and a bit years away, David. We just need to wait and see before the increase in diesel storage requirements come into play. So we just need to wait.

Okay. No, that's cool. As a second point, can you give us a little bit -- I mean this is a bit of sort of maintenance stuff, but I'm really pleased that the package covers cash costs, which includes your CapEx as well. Can you give us a bit in -- like last year was a difficult year because production was low and -- or production was impacted because of jet, et cetera. But through the cycle, what would Geelong's cash costs be from an operating perspective? And through the cycle, what would your CapEx -- all on a per barrel basis, what would you be looking at? So as we got a bit of an idea as to how much this package covers.

I can cover that, David, it's Jevan here. So there are 2 ways to think about that. And if you track through some of our full year results presentations -- so I think it was Slide 32 at the most recent presentation, which gives you a good guide as to what the operating cost profile looks like. And broadly speaking, in Aussie dollar terms, if you look at last year or the earlier years, as an example, operating costs in Aussie dollars per barrel were around AUD 7 per barrel at the refinery. And CapEx is then over and above that. And when you think about CapEx through the cycle, we've had maintenance CapEx in previous years of around that $50 million -- $50 million to $60 million a year level. And there's a couple of major turnarounds. Our cat cracking turnaround, which has historically been around $110 million to $140 million and the CDU for turnaround of about $75 million, and they tend to relate to a 4- and 6-year periods. And then there's also the low sulfur fuel investment over that period, too. So if you average that through the cycle, you probably get to around AUD 2 a barrel or so, may be a little more. And bear in mind that in the context of the low sulfur fuel investment that we'll have to make during the commitment period, part of that is covered through the government grants program and the other part will have to be recovered through the support mechanism that we've got in place. So I think you're right, from a support perspective, at the $10.20 threshold, when that kicks in, that takes account of our operating earnings and all of the capital that we have to recover through the commitment period and is part of the reason why we get confidence to run for this time with the package in place.

So your AUD 7 per barrel for operating, that's cash? That's a cash operating cost? Or was that -- that's including depreciation?

It's a cash operating costs, David, EBITDA context.

Yes. So you're running at about roughly $2 a barrel of CapEx plus $7 a barrel cash operating, and it kicks in at $10.20. So you're pretty well covered from a cash operating perspective through the cycle. So it's a very nice package for you from a cash earnings perspective. Is that the way you think about it?

Yes, that's right, David. And we've focused pretty strongly on the cash earnings through the period of discussion with the government. And obviously, EBITDA is widely reported, but the CapEx can't be ignored, and it is there. And so in an industry like that, being able to cover our cash expenditure has been pretty important. And I think, as you say, a good outcome that the government's recognized that in the context of the package that's been put in place.

Yes. You reduce your volatility of earnings, you get your cash support, you get your CapEx provided, it's just a fantastic package. And I'm wondering what the catch to all of this is, but well done, great deal.

Thanks, David.

Your next question comes from Joseph Wong with UBS.

Just in regards to, I guess, the refinery and then the energy hub. So now that the government has taken some of the volatility from the refining, how does that impact your risk appetite for the LNG import? Would you be looking to take commodity exposure that end? And how is that discussion happening with your partners with Vitol and ENGIE?

Yes. I think it's a very much stand-alone project. There is, obviously, some interrelations with the other projects at Geelong, including the refinery, and there's a bunch of synergies that come from operating an LNG import facility alongside the refinery, particularly in terms of managing water. But I think from a commercial perspective and how we think about it, we -- the best outcome for refining doesn't necessarily change our risk appetite for the LNG facility. That will be a stand-alone decision. And obviously, it will depend on how we decide to take it forward with the partners that are involved in that. So that remains to be seen, obviously, a decision we'd take when we move to -- likely move to FID in the first half of next year.

Thanks your next question comes from Baden Moore with Goldman Sachs.

Scott and Jevan, can I just -- one follow-up question. Just to clarify on the capital management. Can you confirm essentially now, this completed -- the $100 million capital return still coming back to shareholders from here? And then second question would be just when you think about the market and with the MSO and the refining subsidy in place now, I was just wondering whether there's any new regulatory requirements that you've had to sign on for as part of this deal and how you'll market fuels. Or is there anything there that is worth flagging?

Baden, it's Jevan here. I'll just cover the first point on the capital management, and then I'll pass to Lachlan to talk a bit more around the package and the regulatory requirements. In the context of capital management, we obviously sold down the Waypoint REIT stake at the beginning of last year and committed to returning that money to shareholders at the time. There's $100 million of those proceeds remaining with the company. And earlier this year and late last year, we had said that we would not proceed with returning those funds until we got some certainty around the refining outlook. But at the time, we did state that we remained committed to returning those funds to shareholders in due course. And so I think it's fair to say that the company's commitment hasn't changed. And as we progress through the course of this year, we'll continue to assess options to meet that commitment.

Lachlan, do you want to cover some of the regulatory comments?

Yes. Sure. I mean there's probably nothing further to what we put in the announcement. So obviously, the key ones are the regulatory commitment to keep refining until June 2027 and then also to bring forward the fuel specifications for ultra-low sulfur gasoline. So I think they are the key ones which are part of this deal. The additional piece that we're working closely with the government on that's actually been part of a long-term engagement is further harmonization of fuel specs to the Euro 6 vehicle emissions standards. That's the process. And we've, as part of this package, also committed to bring forward one of the key reviews on that, which is a review of aromatics in gasoline. So we'll look to finish that off and do that review this year and then work with government about what can be done in terms of bringing gasoline and a high octane gasoline and the diesel fuel specs that harmonizes to Euro 6 forward. So there's nothing agreed on that as yet. And there is quite a bit of work to do to how best to do that fuel spec to meet Australian environmental conditions and operating conditions. That's part of the discussion that we want to bring forward with the government as well.

Our next question comes from Scott Ryall with Rimor Equity Research.

Congratulations from me as well. Just in terms of the upgrades for the low sulfur fuels, could you just confirm that can be done within your normal turnaround activity, please?

Yes. So we would aim to do all the work, to have it completed for tie-in when we do our next cat cracker turnaround, which will be mid-2024. And so obviously, that means work needs to start immediately. We've actually -- I mean we have done quite a bit of work already on thinking about solutions and an option. So it's not like we come from a cold start, but we will complete that work ahead of 2024, do the tie-ins and then be on grade before the end of 2024.

Okay. And then the second one, you've made a -- on the front page of your release, you've talked about the transition to multiple sources of energy as you participate in the long-term goal of energy transition. And that's all you're focused on there. Ampol, in there release this morning, had literally paragraphs on the decision supporting a government partnership on energy transition and decarbonization. Could you tell me why that's going to -- a matter of emphasis for you guys? Or it doesn't seem to be overly important in terms of the announcement this morning.

I mean we announced our energy hub last year, which is sort of the foundation of our energy transition, I mean 11 -- probably about 12 months ago. And in those 12 months, we've obviously progressed quite materially the LNG import facility project which, as I mentioned before, we're aiming to get to a point where we can take FID on that next year. That's now become the leading project in Victoria. We also announced earlier this year a partnership with HYZON Motors to establish hydrogen applications in commercial road transport, so buses and trucks with customers at Geelong and potentially a refueling hub and maybe a hydrogen manufacturing down the track as well. So I think we're quite well advanced already on our transition story. We are and we'll continue to work closely with state and federal government on that. And it was good to see Minister Taylor, in his announcement this morning, talk about wanting to work with the refiners more closely on the transition -- the energy transition over the next decade. And we would expect to be -- continue to be part of that. But it's really an ongoing dialogue that's already started with both state and federal governments because of the work we've already done.

[Operator Instructions] Your next question is a follow-up from Michael Simotas with Jefferies.

Just a mechanical question, what's the period of measurement for the production payments? So is it -- does margin need to be below that level for a month, a quarter, et cetera?

Michael, it's Jevan here. I can take that one. Yes, I mean we're still working through the finer details. We've thought about the chart in the release and, obviously, the way we report the refining margins to the market. And we've typically focused on monthly reporting in the context of refining margins. At the same time, we often release results on a quarterly basis. And when you think about the interim production payment that's in place at the moment, that's managed on a quarterly basis, too. So there's a little bit of work to do to finalize that, but you can assume that, that will be either monthly or quarterly. And so from a timing perspective, I think, relatively manageable for the company.

Yes. Okay. And I guess the reason I ask is, given the volatility in refining margins from a financial perspective, the shorter the measurement periods are better.

Yes, I think that's right. And I think the way to think about that, too, is, from a cash flow management perspective, making sure that the timing of cash flows relative to operating cost outflows aligns, too. So there's a little bit to work through on that, but I think you can assume that, yes, we'll be in a reasonable position.

There are no more further questions at this time. I'll hand back to Mr. Wyatt for closing remarks.

Yes. Thanks very much. Look, and thanks again for joining. It's obviously an important day for our business but particularly for the team and the business here at Geelong. I'm really pleased with the outcome. It's been a really good engagement with the government throughout the last 12 months. It's obviously taken time because of the complexity in developing a package that actually lasts the distance over a long term, and that was always going to be very critical to us to achieve that outcome. I think the package that's announced is a balanced package. It sort of protects the country's energy security and requirement of the nation but also provides us with the level of long-term certainty that we need to retain operations and make the ongoing investments to improve our business and obviously contribute in improving fuel standards as well. So I think it's an early or balanced outcome. It's obviously reframes our business and certainly reframes our refining business by removing the downside risk and volatility in refining whilst preserving the opportunity to enjoy the recovery in refining margins, which I do think is a real possibility in the future as oil demand recovers and particularly with the amount of refining capacity that's been removed as a result in COVID and will continue to flow through over the next year or so. So that's the opportunity that we are trying to preserve in this package, along with maintaining a really important part of our business. And I believe this package achieves all of that. And then look forward to getting on with the investments and operations that are ahead of us. But look, thanks again for joining, and have a good day.

That does conclude our conference for today. Thank you for participating. You may now disconnect.