Australia | Apr 02 2020
How will Australia's electricity providers fare during the coming recession?
-Electricity demand in several states now approaching the lowest on record
-Lower gas prices could also have a material impact on wholesale power prices
-Volatility in the oil market adds another layer of complexity for Origin Energy
By Eva Brocklehurst
What does sharply reduced economic activity mean for Australia's electricity market? After a summer of high demand and fears of shortages, the outlook has turned around quickly. Usually, Morgans assesses, electricity retailers would be good defensive assets but in this instance the sector is not facing typical problems.
Demand is down by -6.3% in March in south-east Queensland, the lowest level since March 2014 - when electricity demand from the resources industry started increasing.
Meanwhile, demand in NSW is down -6.6%, the lowest March in the history of the National Electricity Market (NEM), and Victoria is down -6.8%, the lowest since 1999. Again, South Australia demand is down -11.1%, the lowest on record.
Morgans suggests larger falls in demand could happen if Australia's grid-connected heavy industry, normally running 24/7, reduces activity. What does this mean from a company perspective?
While there is likely to be higher demand from consumers during this period of the crisis, because more are working from home, margin gains from the consumer segment could be offset by higher bad debt provisions (businesses & households).
While household demand for electricity should be resilient, bad debts are still likely to increase, as a number of households struggle to pay their bills when jobs are lost. The increased customer investment by both companies is positive, nevertheless, Morgan Stanley believes, as both have scale advantage compared with their competitors.
The broker envisages the losses will be reflected more in the lower-margin commercial and industrial segments for both AGL Energy ((AGL)) and Origin Energy ((ORG)).
A similar pattern is expected for gas. Gas prices are falling, contributing to the weakness in electricity emanating from softer demand, but as books are principally contracted forward, the effects will be felt in FY21, Macquarie assesses. Hence, the main impact in the short term for energy retailers, in the broker's view, will be the bad debt provisioning that reflects the oncoming recession.
Still, gas supply is the marginal price-setter of electricity to the NEM and lower gas prices could have a material impact on wholesale power prices. And the key issue for investors is the wholesale price and its impact, Morgan Stanley asserts. FY21 baseload futures for Victoria and NSW have fallen below $60/megawatt-hour and large-scale generation certificate prices are below $30/megawatt-hour.
UBS calculates a -$10/MWh drop in wholesale electricity price forecasts could pass on a -20% reduction to FY21 net profit estimates for AGL Energy, which has the highest exposure across its utilities sector coverage to changes in wholesale electricity prices.
This stems from the nature of the generation base, as AGL Energy is net long generation, i.e. generating more energy than its own portfolio requires. The broker expects an NEM weighted average wholesale electricity price of $70/megawatt-hour by the end of 2021, supported by committed new renewable projects. However, this cannot occur with renewables alone and the other key contributing factor will be lower domestic gas prices.
UBS revises forecasts for AGL Energy, extending FY21-21 debtors working capital and bad debt provisions, and reducing segment demand for small-medium enterprises by -25%.
AGL Energy is considered over-exposed to falling wholesale electricity prices and securing value-accretive growth is challenging. Still, the broker acknowledges the share price could be supported by demand for defensive income stocks and upgrades to Neutral from Sell. Morgans disagrees and downgrades to Hold, concerned about the downside in demand and increasing bad debts from retail customers.