Australia | Apr 12 2017
-Value in Origin's flexible generation is being exposed in the current electricity market
-Limited gas supply is reducing competitive pressure
-Upside case rests on tighter-than-expected wholesale electricity market
By Eva Brocklehurst
The outlook for energy markets continues to strengthen and brokers take a closer look at Origin Energy ((ORG)), as the company is set to benefit from the next phase of higher electricity prices. The past summer has revealed the electricity generation market is much tighter than previously believed and this is compounding the effect of higher fuel costs.
Origin is able to offset higher wholesale prices through increased output from its generation assets. These assets have been generating around 27TWh annualised since the start of 2017, 35% above the 20TWh generated in FY16. This level of output did not occur in the December half of 2016 because of an extended outage at the Eraring power station (NSW).
Electricity And Gas Prices
Citi believes the current level of electricity prices is partly a function of the limited gas supply that is reducing competitive pressure within the electricity market. This provides a choice for the company between monetising its gas within the electricity markets or the gas markets. The broker currently estimates a 50% capacity factor at Eraring, with each additional 10% adding around 5% per annum to earnings (EBIT).
The arbitrage between electricity prices and the cost of generating additional electricity from spot coal prices, the broker assesses, provides incentives for the company to use Eraring harder to capture this arbitrage. Closing this coal to electricity price arbitrage by the generators is another reason why the broker believes that current electricity prices are peaking and likely to head lower.
In the near term, Origin Energy is in a sweet spot for its gas book and the value of its gas peaking power stations. Citi observes the recent deal with Engie is monetising the best gas book in the market, upgrading to Neutral from Sell.
While the broker believes there is value in the stock and energy markets are in a position of strength, the medium-term outlook is more difficult to ascertain, given expectations for a US$65/bbl long-term oil price and the belief that spot LNG prices will be materially weaker by mid year and affect market sentiment.
The value in the company's flexible generation portfolio is being exposed as the electricity market evolves to higher peak prices and volatility. Credit Suisse suspects there is upside to its estimates as the market appears to carry a higher valuation for oil & gas assets, on which basis energy markets appear cheaper.
A rebound in output from the Eraring power station in the March quarter also points to around $50m in operating earnings (EBITDA) upside versus the previous corresponding quarter and the broker's FY17 estimates. This could mean the company is trading at or above the top end of its FY17 energy markets guidance.
With market dynamics continuing to play into Origin's hands and strong APLNG project operations, for now at least, optimism from the market is not without merit, in the broker's view, nor is the upside being tapped.