Last week we looked at the Clean Energy Finance Corporation and saw its enormous potential as a catalyst and potential financier of the “Energiewende” – or energy transition – that is increasingly taking hold in Australia.
Another, albeit quite different, company with government shareholders that could be doing a whole lot better in the renewable space is the Snowy Hydro Corporation.
The longer story short is that Snowy doesn’t generate many renewable energy certificates because most of its hydro generation was built before 1997.
It now needs a lot more RECs because after its purchase of rising retailer Lumo, it is net short (sells more electricity than it produces). Snowy doesn’t appear to have had any interest historically in participating in new REC creation, and our reading of the corporate documents indicates to us that it tries to play down its image as a renewable company.
Snowy now needs to participate in the REC market, but since its profits have fallen sharply over the past couple of years and its balance sheet is at some risk of having its BBB+ debt rating downgraded its ability to finance a new wind or PV farm is very limited.
In our view it’s time the privatisation of Snowy was revisited and the company which mostly operates in an ever changing private sector had more flexible capital sources and became more open in its reporting and presentations. In the meantime don’t look at Snowy to be much help in meeting the REC target despite its 13% Federal Govt ownership.
Snowy’s profits have declined
For analysts, typically the two of the more important financial numbers for a utility company are its ebitda and its debt (ebitda = profits before interest, tax and depreciation).
Ebitda used to be around $300m. It went up in the drought as even though the dam levels were low that very scarcity made what remained have a high value. Ebitda increased again during the carbon pricing period but over the past couple of years ebitda has declined despite buying “Lumo retail” and the 667MW Colongra gas peaker in NSW,.
This matters because the Colongra and Lumo acquisitions were debt financed.
These days the most common way to think about debt is to compare the ratio of debt:ebitda. In general the higher the ratio the worse. However the more predictable the ebitda, and the faster its growing, the higher the sustainable debt load, so toll roads or wires and poles networks can manage lots of debt, but generators and resource companies not so much.
The chart below shows an increase in this key ratio to about 3.7X in FY15 but this is a bit misleading because Lumo, which cost $600 m was only acquired in September 2014 and so only contributed to Snowy profits for 8-9 months. If Snowy made or was able to make half yearly accounts available we would have a better idea of the real run rate. Still we think the ratio would still be well over 3.0X and its supposed to be perhaps 2.0X for a BBB+ rating.
What this means is that Snowy’s prime focus is likely to be on getting its debt:ebitda ratio down over the next couple of years and that in turn inevitably means less new capital investment and cost cutting as well as a focus on revenue maximisation.
On the other hand because Snowy is now the 4th largest electricity retailer (by customer numbers) in Australia with over 1 mn customers (ERM is the 4th largest by electricity volumes), it actually sells more electricity than it generates and needs more RECs than it produces.
So this gets us back to the point that (i) because it is a hydro generator and hydro is the fastest startup and most reliable backup generation in the NEM (although eventually to be overtaken by batteries) and (ii) because it is now net short generation Snowy is a prime candidate to be participating in meeting the REC target. But so far its contribution has been a big fat zero. In fact the 2015 corporate objectives don’t even seem to contemplate investing in wind or solar plants.
For instance the 2015 strategy review, point 2 was headed:
“Maintain and utilise our energy mix – hydro, gas and diesel” emphasis added,
The next bullet point is headed “Explore new technologies and opportunities in the energy market” but there is no mention of any thing specific other than a battery trial in Red Energy and smart metering.In fact a Feb 2013 article outlined Snowy’s reasons for thinking it had no need to invest in REC generating capacity. However since that article was written Snowy has purchased Lumo and its REC requirement has greatly increased.
Snowys REC creation
Although Snowy’s generation is mostly “renewable” ,its also old (built pre 1997) and for the most part does not qualify for RECs which have to come from “new” renewable generation. Looking at REC-Registry.com.au it appears that the baseline for Snowy REC is about 4.5 TWh, significantly more than it has generated in recent years. We think though that Snowy may be able to vary that base line under certain circumstances.
In the past few years the strategy appears to be to generate less than base line one year and then try and get above it the next year.
Of course with REC prices being very high, the REC bank having run down the pressure on Snowy to get over 5TWh a year will be quite strong. Recently generation shows an increasing trend and is now above the baseline which we think is calculated on a calendar year basis.
David Leitch was a Utility Analyst for leading investment banks over the past 30 years. The views expressed are his own.