Contact Energy - CEN Chart

[Snoopy]

That is not correct. G. Grilli did some work for Electrocorp back in the late 1990s that showed an incremental cost for the Waikato stations at around $2:00 per MW. That was 20 years ago. Next add on Transpowers HVDC cost of close to $9.00 per MW for all south Island generation, then add to that the cost of every circuit breaker operation at around $110 and there are measurable costs. Granted they are still very small compared to a thermal station.

But. and a BIG but, here is the difference. Thermal stations are cheap to build and expensive to operate. Hydro stations are expensive to build and cheap to operate. When selling energy from a hydro station, if it is simply the incremental cost (SRMC) that is being recovered then the company will quickly go broke.

I am not suggesting that external sales are made at anything less than the spot market price.

Base load hydro needs to be priced at close to its long run marginal cost (LRMC), and the transfer price may reflect that.
Additional generation could be offered to the market at SRMC. but why would anyone sell to the market at a lower price than to their own customers?

I could cook a gourmet dinner myself, sell it to myself for $100 then spend the next day complaining about why I had paid so much for my dinner the previous night, despite it being 'gourmet good'. But what would be the point of such a charge in the first place?

SNOOPY

[Jantar]

I am not suggesting that external sales are made at anything less than the spot market price.....

But aren't retail sales "external" as well?

Your gourmet dinner example is flawed as you are consuming it yourself. How about you cook a gourmet dinner, sell it to your self for the $100 worth of ingredients, gas, electricity, cleaning products etc., then sell it to a customer for $110. Are you then complaining about the cost of that dinner?

[Snoopy]

But aren't retail sales "external" as well?

The general understanding is that 'retail' sales mean external sales to customers, yes.

Your gourmet dinner example is flawed as you are consuming it yourself.

I see you get my point, even though I think you are looking at what I said from a different angle.

The way I see it is this:

1/ Contact are buying electricity from their 'generation unit', selling it to their 'retail unit' who then sells it to the end line customer.
2/ But since the electricity market is highly competitive it is not the retail price that the customer pays that determines Contact's profitability. Profitability of 'Contact Retail' is affected far more greatly by 'input costs'.
3/ Most of 'Contact Retail' electricity is bought from 'Contact Generation'. So the profit from 'Contact Retail' is determined by what price 'Contact Generation' wants to supply electricity at. The hydro energy from 'Contact Generation' never makes it onto the market because it is all spoken for.
4/ SO 'Contact Generation' can, at least in theory, charge 'whatever price they like' to 'Contact Retail', depending on how profitable they want 'Contact Retail' to be and how much profit they want to retain inside the 'Contact Generation' business unit.

The gourmet dinner example that I gave about cooking my own dinner and then charging myself for it is exactly analogous, because this is exactly what Contact are doing. They are 'cooking up' their electricity in 'Contact Generation' and consuming it in 'Contact Retail': the transaction is entirely internal.

Of course to shareholders none of this matters, because we own both 'Contact Generation' and 'Contact Retail'. So it doesn't matter to us what business unit, be it 'Contact Generation' or 'Contact Retail', is generating the profits.

SNOOPY

[Snoopy]

I was very surprised when CEN SP rose on what was really a very poor annual result.

One thing we have to remember about annual results is that they are historical. While I agree the annual result for FY2017 was not good, is this a pointer to the annual result being not good in FY2018?

If we look at EBITDAF for the first and second halves of the year just gone, the two figures are $261m (1HY2017) and $233m (2HY2017).

If you go back nine years, that first half figure was the second best (only beaten in 1HY2014: $261m) and the second half figure was below that achieved in any of the previous five years. So my way of looking at this is that we had a year of two halves (or maybe even 'three good quarters' and 'one bad one': p12 of FY2017 result presentation shows under 550GWh Contact hydro generated in Q4 vs 900GWh in Q3).

Wet weather is not good for 'external' hydro sales, because the market price for hydro-energy is at its lowest when plenty of water is in the Clutha catchment (from a Contact perspective). This shouldn't matter to Contact because normally they seem to be able to sell all of their hydro energy to their own customers. In the fourth quarter the Clutha catchment suddenly changed from having an above average reservoir of water inside it to a well below average level. So Contact 'ran their gas generation units' hard, with the 'cost of energy' similarly spiking. If Contact budget on normal customer demand being 125% of renewable load, a 40% reduction in 'normal' hydro generating capacity must have hurt them.

60% of 125% is 75%. So Contact hydro generation in that last quarter would only be supplying 75% of budgeted customer demand. That means a substantial proportion of Contact's thermal generation must have been needed to supply their own customers, blowing out their fuel bill in the fourth quarter. I am looking at the poor second half for FY2017 from Contact as more a 'weather driven' rather than a 'management incompetence' event. It is true that management must allow for a variation of 'expected inflows' into their catchments. But they will still be caught out by extreme variations which is what Contact saw into their own catchments in Q4.

I am not happy with the FY2017 performance. But I am prepared to look through it as an 'exceptional weather event', and not a potent of what is to come in FY2018 and beyond.

SNOOPY

[Snoopy]

Looking at p13 of the Annual Results for 2017 presentation, it does appear as though Contact are able to price themselves into an electricity market sweet spot.

https://www.nzx.com/files/attachments/263317.pdf

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1/"Contact’s hydro inflows typically peak during summer."

2/"Traditionally, wholesale and futures prices are lowest between October and February."

3/"Contact seeks to maximise the value of its renewable assets by selling all renewable generation at a fixed price."

4/ "Flexible thermal generation, limited hydro storage, gas storage and hedges allows us to “firm” the renewable variability"
"Over the past 3 years this has enabled fixed priced sales at 125% of mean renewable generation, in contrast to integrated renewable generation only peers who sell between 70-85%"

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It looks like my first interpretation of the above referenced p13 was not quite right. There is still something that irks me though.

While selling all your renewable energy at what is a relatively high price sounds good, it is only possible to do this if you don't have a surplus of hydro energy to sell. And if you don't have a surplus of hydro energy, that opens up the prospect of having to 'make up the difference' in times of shortage by purchasing energy 'on market' or firing up your own thermal stations. Since both of these are more expensive that hydro, it looks like being 'top of the class' in selling hydro has a consequence of much higher power purchase costs in times of power shortage. So is “firming” the renewable variability really a thing to boast about?

"Keeping our hedge level in line with peers at 70-85%, would have resulted in an annual average of 1-2 TWh per annum of renewable generation being sold into the spot / futures market at $60-70/MWh"

Doesn't 'keeping our hedge level in line with peers at 70-85%', mean selling a lot more power than you can generate to retail customers? How can that mean selling more power on the spot market, when you don't have the capacity to generate that power in the first place? ,(from hydro)

SNOOPY

[Jantar]

It looks like my first interpretation of the above referenced p13 was not quite right. There is still something that irks me though.

While selling all your renewable energy at what is a relatively high price sounds good, it is only possible to do this if you don't have a surplus of hydro energy to sell. And if you don't have a surplus of hydro energy, that opens up the prospect of having to 'make up the difference' in times of shortage by purchasing energy 'on market' or firing up your own thermal stations. Since both of these are more expensive that hydro, it looks like being 'top of the class' in selling hydro has a consequence of much higher power purchase costs in times of power shortage. So is “firming” the renewable variability really a thing to boast about?.....

And this is where the whole question of pricing Hydro comes into force. If hydro was only ever sold at SRMC then no hydro generation would ever be profitable. Similarly if it was only ever offered at LRMC then there are very few times that it would ever be dispatched. But way back in the late 1930s early power systems text books explained about hydro pricing to fit in with other types of generation.

The basic principle is to say that if your hydro storage is full then the water is worth nothing nothing. If it isn't used then it will be spilled and wasted.

If your hydro storage is so close to empty, then that last MWh of storage must be priced higher than the most expensive other generation available, so that it will be dispatched prior to that last MWh of your hydro.

In between those two stages of full and empty will be steps at which the price will excced some other forms of generation, but not others. Thus there will be times that hydro will replace other cheap forms of thermal generation and there will be times that other thermal plant will be dispatched to firm up the hydro position.

Further complicating this position in NZ is that we have quite of lot of other types of renewable generation other than Hydro:
Wind, that is intermittant, and up till now is always dispatched ahead of all other types of generation. The EA have just published a discussion document, (I believe driven by NWF), that will address this issue and allow wind to offer into the market in a similar manner to all other generators.
Geothermal which operates as base load and is always dispatched ahead of all other generators except wind.
Solar, that is never dispatched but is simply treated as negative demand.

[Jantar]

...
Doesn't 'keeping our hedge level in line with peers at 70-85%', mean selling a lot more power than you can generate to retail customers? How can that mean selling more power on the spot market, when you don't have the capacity to generate that power in the first place? ,(from hydro)

SNOOPY

I need to careful here that I don't give away comercially sensitive information....

Our company, and at least one of our competitors, tend to offer renewable generation first, but priced as I described in my previous post. If we see that we have more renewable generation than we need, or that the NZX, and/or forcast prices are higher than the cost of generating with our non renewable plant, then we will offer to sell hedges to the other companies at a price that we would see as profitable. If other companies did not want to pay our asking price then we would sellany excess on spot.

If we appear to be short on our position, then we will seek to buy hedges at a price that would would be cheaper than starting our thermal plant.

If there are no favourable heges available and the price expectation was high, then we would start our thermal plant to cover our own postion and sell some at spot.

[Snoopy]

If hydro was only ever sold at SRMC then no hydro generation would ever be profitable. Similarly if it was only ever offered at LRMC then there are very few times that it would ever be dispatched.

For those who are not 'au fait' with all the electricity industry 'buzz abbreviations (and that includes me!)':

SRMC means 'Short run marginal cost' and
LRMC means 'Long run marginal cost'

SNOOPY

[Snoopy]

Wind, that is intermittent, and up till now is always dispatched ahead of all other types of generation. The EA have just published a discussion document, (I believe driven by NWF), that will address this issue and allow wind to offer into the market in a similar manner to all other generators.

At the risk of going 'off topic' (because Contact Energy currently doesn't operate any wind farms) but staying on topic (because Contact dispatches energy into the same market to their competitor wind farms), how can a generator not dispatch wind generated energy immediately? I thought that I understood that wind energy cannot be stored. Or has battery technology, and more particularly battery purchase and storage costs, now changed so that storing wind energy is now economically viable?

SNOOPY

[BlackPeter]

At the risk of going 'off topic' (because Contact Energy currently doesn't operate any wind farms) but staying on topic (because Contact dispatches energy into the same market to their competitor wind farms), how can a generator not dispatch wind generated energy immediately? I thought that I understood that wind energy cannot be stored. Or has battery technology, and more particularly battery purchase and storage costs, now changed so that storing wind energy is now economically viable?

SNOOPY

Still difficult to store wind energy - however, it does make a lot of sense for wind generators to stop their generators when the power price is too low. At current they tend to run losses when their cost (due to maintenance and wear) are higher than the price paid.