Contact Energy - CEN Chart

[Snoopy]

Gearing does vary a bit over the business cycle. Contact has indicated that they are currently in a 'pay down debt' part of the curve. But there was a time this decade, dating back to the 2011 capital raising, that Contact had a chance to optimize it's gearing.

The main stated purpose of the June 2011 Capital raising was to build the planned Te Mihi power station that was due for completion in 'mid 2013'. In fact it was May 2014 before this new geothermal station was finally commissioned. So the project didn't quite go to plan. But Contact management would know all about expected cashflows and make adjustments accordingly. So I think the June 30th 2014 balance sheet position is a fair window into what balance sheet position that Contact management wanted to achieve.

The Contact Group position at FY2014 balance sheet date was as follows:

(Total Liabilities) / (Total Assets) = $2,601m / $6,183m = 42.1%

Meanwhile 'down the road' Mighty River Power (now Mercury) had their own geothermal power station under development. The Ngatimariki power station was completed in September 2013. There was no rights issue. But Mercury were given considerable freedom over previous years in the dividends they were required to pay to the government to make sure their capital position was optimized. The closest balance date to this was June 2013.

The Mercury Group position at FY2013 balance sheet date was as follows:

(Total Liabilities) / (Total Assets) = $2,620m / $5,802m = 45.1%

The two gearing figures are pretty close. Perhaps one could argue that the gearing at Contact should be slightly less due to the higher proportion of thermal generation assets in the portfolio that are 'lesser quality assets' to borrow against? Yet generally the similarity between the two companies is not something that requires much imagination to see.

SNOOPY

[Jantar]

Jantar, I wonder if you would clarify something on 'Wairakei' for me, if you can help!

'Wairakei' I think has two meanings in this context. Firstly there is the Wairakei 'power station'. Secondly there is the Wairakei 'steam field'. The Wairakei steam field actually powers three of Contact's power stations: Wairakei, Poihipi and Te Mihi. The newest of those. Te Mihi was commissioned principally because Contact has permission to take more steam from the Wairakei steam field then they were using. Te Mihi was a neat way to take up all of their consented steam. However the net gain was not expected to be 116MW. The trade off was that some of the steam that used to go into the old Wairakei power station was to be shuffled off to operate the new more efficient Te Mihi. However, once Te Mihi was commissioned, the capacity the original Wairakei power station apparently was not reduced.

Is it possible to run all three stations that feed on the Wairakei steam field (Wairakei, Poihipi and Te Mihi) together generating a combined 132MW +65MW + 166MW= 363MW? Or is the combined generating capacity of all three rather less than this?

TIA

SNOOPY

You are mainly correct. The original Wairakei geothermal station was commissioned in 1958 as a 200 MW power station, although it never generated much more than 190 MW after transformer losses etc were taken into consideration. The station had a design life of 25 years before refurbishment with a maximum life of 50 years. That time has now been well surpassed. Its steam was extracted from a large steam field to the west of the station.

Popihipi was originally built as a joint venture by t6he McLachlan family and MIghty river (now Mercury) and took its steam from the south western edge of the Wairakei field. Resource consent limitations meant that it could only generate a fraction of its design 55 MW output, and the station was sold to Contact, and renamed Poihipi, in the late 1990s. Contact then applied to combine the consents from Wairakei and Poihipi on the grounds that they were using a common steam source. By this time the output from Wairakei had declined to around 116 MW (from memory, so this figure may not be correct), and two new heat exchange generator sets were installed at Wairakei to bring its output back up to over 145 MW.

Te Mihi was constructed using steam from the far western edge of the Wairakei Steam field, and using a much more efficient plant design.

So, yes they do all take steam from the same field, but from different parts of it, and some steam can be diverted between Te Mihi and Poihipi as required. The limiting factor is the consented annual Mass Steam Take. Although in theory they can all operate at close to full load all the time, if they did so, then they would exceed their annual permitted steam take.

[Jantar]

Thanks for that. Although small in absolute terms, it seemed to me like a no brainier, when mentioned in the 2011 capital raising prospectus, that it would go ahead. It is part of the feeder system that ultimately ends up in the Clyde dam after all. Since the Hawea dam already exists, I woudl have thought there would be little extra incremental cost to sticking a turbine in there. Can you offer any insight as to why the project was put on ice?

The full reason may be commercially sensitive, but let's just say that the quotes received were higher than the budget. A modified version is under investigation.

Thanks for that. I notice on the Contact website:

https://contact.co.nz/aboutus/our-st...-powerstations

that Clyde is still listed as having a generation capacity of 432MW. If what you say is correct, it is very poor that the website has not been updated when Contact have had ten years to do so! There is possibly more hidden value here than I suspected!

I do not know why the website hasn't been updated, although the team that manage PR are not the operations or trading teams.

It is sufficiently long ago now that I can relate a slightly embarrassing tale about how the 464 MW value was obtained. When the new resource consents were confirmed, the dispatcher on duty at Clyde got a gleam in his eye and said to his manager, "Right, lets see what these babies can do." It is like driving a high powered sports car on the Waikato expressway and being told there are no longer any speed limits.

The turbines at Clyde were opened to 100% and Roxburgh was backed off to maintain the same total output from the Clutha stations. Immediately the 4 machines at Clyde shot up to 476 MW, but as the extra water raised the tailrace level the output dropped over the next 30 minutes to 464 MW. It then stayed there consistently for the following 30 minutes, hence the Max output was tested at 464 MW continuously for 30 minutes.

4 weeks later the reconciliation team in Wellington rang Clyde to see if we knew of any reason for the HVDC charge to Transpower suddenly increasing by almost $2 million. . We did explain to Transpower that it was as a result of a test, so the charge did not stick. However as a result of that we did some further investigation into how the HVDC charge was applied, and ended up reducing the maximum output from Clyde to 395 MW. Generation above that figure meant that we were paying more for the HVDC charge than we were receiving for the energy. Meridian caught on and also reduced their maximum output at Benmore and Manapouri. 2 years ago Transpower began the process of moving away from a peak based charge towards a MWh charge, and that move allowed us to once again offer up to the station maximum. My annual bonus was severely at risk that year.

I notice on the Contact website link above, the capacity of Ohaaki has been omitted!

On page 23 of the international presentation dated April 2017,

https://contact.co.nz/-/media/contac...53870CBBC16D06

the capacity of Ohaaki was listed as 50MW. That was a year ago, so has Ohaaki declined even further? Is three no drilling program that can hope to restore generation capacity to close to the 100MW design capacity?

SNOOPY

No. The required reinjection has quenched the field and cooled the geothermal fluid. Output will continue to decline slowly over the life of the station.

[Snoopy]

Jantar kindly identified some errors in my first version of this table. Time to put in his corrections

Mercury Energy Hydro	Station Generation Capacity	Mercury Notes	Contact Energy Hydro	Station Generation Capacity
Aratiatia	78MW	Upgrade by FY2020
Atiamuri	74MW		Clyde	464MW
Waipapa	51MW		Roxburgh	320MW
Ohakuri	112MW
Whakamaru	100MW	Upgrade to 124MW by FY2020
Arapuni	196MW	Received 12MW upgrade in FY2011
Maraetai 1 & 2	352MW
Karapiro	96MW
Total	1059MW		Total	784MW

Mercury Energy Geothermal	Station Generation Capacity	Mercury Notes	Contact Energy Geothermal	Station Generation Capacity	Contact Notes
Kawerau	100MW		Ohaaki	48MW
Mokai (25% owned)	112MW		Te Huaka	28MW	Completed FY2010
Rotokawa	34MW	Refurbished FY2015	Wairakei	145MW
Nga Awa Purua (65% owned)	138MW	Completed FY2010	Poihipi	65MW
Ngatimariki	82MW	Completed FY2014	Te Mihi	166MW	Completed FY2014
Total	466MW		Total	452MW

The first purpose of this comparison is to show how similar the renewable generation of each company is.

The second purpose of this comparison is to come up with a 'quantitative factor' that shows how we can estimate any undeclared 'thin air capital' on the Contact balance sheet. Competitor Mercury are very forthcoming with their 'thin air capital', regularly upgrading the value of their generation assets on an annual basis. Contact do not follow this policy, but that doesn't mean that no thin air capital is accumulating at Contact. It just means they are not trumpeting it in the annual accounts. Sniffing out hidden value is this hound dog's specialty, so this is why I remain 'on the case'.

I was a bit disturbed by Jantar's opinion that there is no fix for Contact's Ohaaki. The required water re injection rate quenching the field looks to be a long term death sentence for Ohaaki, and no doubt would require an annual write down in the value of that station should Contact adopt the policy of revaluing their generation assets each year. There is also a 'field risk' with most of the rest of the Contact geothermal portfolio all plugged into the Wairakei field. It is still possible that long term wholesale price increases over the geothermal portfolio will cancel out any production deterioration at Ohaaki though. Given this, I would suggest that for 'valuation purposes' we should assume that it is only the South Island hydro assets that are accumulating thin air capital. But even then with climate change changing the snow melt in the South, there could be some long term valuation adjustments to be made as a result.

Clearly there is not as much 'thin air capital' being accumulated at Contact than is being accumulated at Mercury. Also. I don't believe it is prudent that in a market with electricity wholesale prices largely flat, that we can assume any thin air capital accumulated in the past is a pointer to more of the same happening in the future. I do believe we investors can bank the thin air capital that has already been accumulated though, even if it hasn't been recorded in Contact's books.

Mercury has already calculated how much thin air capital they have accumulated over the last few years. I think it is a fair assumption that if we take this figure for any time period, then multiply it by a factor of:

784/1059 = 0.74

Or if you consider that the Mercury Geothermal power stations have increased in value over time, unlike their Contact counterparts, the multiplication factor might be:

784/(1059+466) = 0.51

One of those fractions will allow us to make an approximation of how much thin air capital has been accumulated by Contact over the same period. Once we know that figure, we can work out what size new power station that Contact can build, without going back to shareholders for more capital.

SNOOPY

[Snoopy]

Mercury has already calculated how much thin air capital they have accumulated over the last few years. I think it is a fair assumption that if we take this figure for any time period, then multiply it by a factor of:

784/1059 = 0.74

Or if you consider that the Mercury Geothermal power stations have increased in value over time, unlike their Contact counterparts, teh multiplication factor might be:

784/(1059+466) = 0.51

One of those fractions will allow us to make an approximation of how much thin air capital has been accumulated by Contact over the same period. Once we know that figure, we can work out what size new power station that Contact can build, without going back to shareholders for more capital.

My post on the Mercury thread, post 1076, gives the background information required for this calculation. Sadly with the balance sheet of Contact 'optimised' at the FY2014 balance date, we probably should only consider the thin air capital created over FY2015, FY2016 and FY2017 when assessing how much hidden value has accumulated within Contact's Generation Portfolio. For comparative purposes, I list the relevant Mercury figures, grabbed from Mercury posts 1003 and 1076, below:

Mercury Energy	Total Revaluation ($m)	Pre Tax Revaluation ($m)
FY2015	356	497
FY2016	100	137
FY2017	38	52
Total	494	686

Observant readers will note that in the case of Mercury I subsequently took off all the special dividends paid. This is because I judged the Mercury special dividends were being paid to optimise the capital structure of Mercury. Contact shareholders will remember that they were paid a special dividend of 50cps just before Origin Energy quit its Contact stake. However, that payment was made for quite different reasons, to utilise imputation credits that would otherwise be lost. Since the Contact special dividend was not a capital structure optimization exercise, I propose to make no capital optimisation adjustment for that!

Using the scaling factor I derived in post 1514, we can now work out the 'thin air capital' that should now be 'off the books' at Contact Energy:

$494m x 0.74 = $366m

If we assume 45% gearing then Contact could borrow 0.45 x $366m = $165m against that sum.

This means the the money available to construct a new power station, using Contact's off balance sheet funds, is:

$165m + $366m = $531m

SNOOPY

[horus1]

These revaluations are based on the fact that prices increase as does the cost of new generation. With new tech ,solar and batteries that is no longer the case and it is becoming cheaper to put in your own solar than pay the price of grod power ,hence the valuations will stop. That is why the electricity industry hates solar and is trying to put customers of it.

[Snoopy]

These revaluations are based on the fact that prices increase as does the cost of new generation. With new tech ,solar and batteries that is no longer the case and it is becoming cheaper to put in your own solar than pay the price of grid power ,hence the valuations will stop.

I agree what you say is a possibility Horus. That is why I am only using past valuation increases in this exercise. I think it would be unwise, from an investor's perspective, to assume that these past power station revaluations will continue at anything like the past pace into the future.

SNOOPY

[fish]

I agree what you say is a possibility Horus. That is why I am only using past valuation increases in this exercise. I think it would be unwise, from an investor's perspective, to assume that these past power station revaluations will continue at anything like the past pace into the future.

SNOOPY

Nobody Knows but I believe population growth will lead to increased demand.
Solar doesnt work every day and night summer and winter and I cannot see it making a big change-it will be gradual and slow.
Thermal will eventually go-maybe the odd peaker will stay.
Geothermal and hydro will always be our main source

[percy]

Electric vehicles will not run on fresh air.
They may need electricity.
So perhaps the projected numbers of electric vehicles,may help us work out future power demands.?
I would expect 1 million electric vehicles plugged into the grid overnight could lead to power black outs.
I would also expect an electric bus/train would require a lot more power than a small Toyota.
I am noticing a growing number of battery bikes on the roads too.

[LAC]

We just need a large business to start selling these electric cars, offer special type of insurances as well as finance the loans, electric cars do cost a little more than the gas guzzlers.