Tax on coal, gas and new investment

The Private equity company EIG Global Energy Partners is betting big money on gas, offering $18.4b for Origin Energy is which was a ~55% premium relative to its last close price. This premium suggests EIG Global Energy Partners believes gas will set price as the Chairman of EIG stated, “it is willing to ignore government threats of export controls and price caps and invest in Australia for the next 20 years because it believes the nation’s gas resources will play a crucial role in the transition to clean energy”.

As federal politics look to potentially intervene in the domestic coal and gas markets, the investors do not appear to be concerned. It seems the thought process is that gas is a sound investment for the next 20 years as we transition to renewables. No doubt they will be keeping an eye on the regulatory environment but with a track record of investments in the UK and German markets where market inventions are currently enabled, they are in a good position to understand the risks and rewards.

As Origin owns a fleet of gas generators that traditionally operate over the periods where electricity prices are at their highest, it puts them in a position to take advantage of the market, producing and selling electricity at high market prices securing a nice profit.

As entry to the industry and source project finance is difficult, Origin’s gas turbines will have time to continue to produce electricity and make money at these heightened energy prices. With new investment being stalled due to funding constraints pressure on electricity prices will continue to occur.

The question for investors, politicians and the public is, do you view gas as the transitional fuel to renewables? While investors may see a distinction between gas and coal, do the end users of electricity hold similar assumptions?

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ORIGIN STILL IN THE RED

More bad news for electricity retailers with Origin Energy announcing an impairment of $1.6B after further writing down the value of its generation assets and reducing the value of its renewable energy contracts.

In a statement, Origin said the write downs were a result of falling wholesale prices, mostly driven by the influx of new wind and solar projects. High gas prices also reduced the returns from their fleet of gas-powered generation.

Origin owns the largest coal fired generation unit in the NEM, so the market pressures weighed heavily on the balance sheet. Origins large exposure to the non-renewable segment of the market through its Eraring coal fired power station which resulted in a $583M post-tax impairment. This comes because of Origin’s assumption of a lower outlook for wholesale electricity prices driven by new supply expected to come online, including both renewable and dispatchable capacity, impacting the valuation of the generation fleet, particularly Eraring Power Station.

Eraring is expected to be the cause of much of the impairment, but the gas-powered generation (GPG) units did not fair much better. The GPG were affected due to the increased cost of gas and the decrease in the spot and contract electricity market price.

Strategically Origin has chosen to source renewable energy through PPA rather than build physical generation so are not exposed to the physical renewable market. Origin was an early mover in the renewable PPA space so the PPA’s on their books are very expensive compared to what the market offers are today. This has resulted in Origin writing down some of the value of these existing PPAs.

Origin says it will write down $995M in value of goodwill for these renewable PPA’s and the gas contracts that are out of the money. Origin expects the spot market price to be up to $20/MWh below where they previously anticipated the price to be.

Origin expect their FY2022 profits to be lower than expected at $450- 600M which will again be largely supported by the LNG export part of the business.

On a positive front, Origin expects the market to recover in FY2023 where earnings are expected to increase by $150-250M on the back of a material rebound in energy market earnings.