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AGL bid puts spotlight on wholesale electricity prices: Charts of the week

Lewis Jackson  |  22 Feb 2022Text size  Decrease  Increase  |  
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AGL Energy’s board is at loggerheads with its suitors. A $5 billion bid from tech billionaire Mike Cannon-Brookes and Canadian asset manager Brookfield materially undervalued the company, the energy retailer and generator said as it rebuffed the offer on Monday.

Part of why management and the suitors disagree lies with the future of electricity prices. Coal plant economics requires constant generation, a problem when cheap renewable energy frequently sends electricity prices below zero during daylight hours. AGL’s earnings and share price plummeted alongside wholesale electricity prices through 2019 and 2020 as wind and solar generation increased. But backers argue the business is being undervalued because electricity prices are rising, and earnings will follow.

Bulls point to a jump in wholesale prices in the last quarter of 2021. Plant outages, volatile renewable energy generation and higher prices for gas and black coal saw average prices rise from $39 per megawatt-hour (MWh) in October to $75/MWh by December, according to the Australian Energy Market Operator (AEMO). Measured across the quarter, prices were 13% lower compared to the September quarter but up 31% versus the year before.

Markets cheered the improved outlook and higher prices tracked a revival in AGL shares. From a trough of $5.10 in November 2021, prices rose 40% to $7.18 on Friday, the last day of trading prior to the Brookes-Brookfield bid.

“Electricity prices have already risen. The market hasn’t factored that in fully yet and AGL’s management rightly argues the business is being undervalued,” says Morningstar senior equity analyst Adrian Atkins, who has a fair value of $13.30 for the stock. He supported management’s decision to reject the bid, arguing any sale should wait until earnings recovered and AGL completed the demerger of its coal assets, planned for a shareholder vote in mid-June.

A flood of cheaper renewable generation entering the grid has weighed on wholesale electricity prices in recent years. Wholesale electricity prices were zero or negative just over 16% of the time between October and December of last year, according to AEMO. Clean energy accounted for roughly a third of generation across the quarter.

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Trading in energy futures markets suggests participants believe higher prices will continue into this year and next. In New South Wales, where AGL has two coal plants and cheap long-term coal supply contracts, base load futures for 2023 changed hands at $90/MWh on Monday, compared to around $48/MWh a year earlier. Prices in Victoria rose from around $33MWh to $50/MWh over the same period.

Markets are reacting to supply uncertainty ahead of the closure of AGL’s Liddell plant in 2023 as well as uncertainty over global commodity prices given tensions in the Ukraine, says Tony Wood, energy program director at the Grattan Institute.

“Overall, you probably see a little more pressure upwards,” he says. “No one is making money when prices are that low, even renewables.”

AGL doesn’t automatically reap the full benefit from higher wholesale prices, notes Wood. The energy regulator will decide how much of the higher prices it can pass through to retail customers. Many of AGL’s energy-heavy industrial customers are insulated from changes in spot prices due to long-term contracts, adds Atkins.

Longer term, renewable energy will weigh on wholesale energy prices, says Professor Ariel Liebman, director at the Monash University Energy Institute. The accelerated closure of Origin Energy’s Eraring power plant in 2025, seven years ahead of schedule, could bring forward renewable supply, he adds.

“Over the next five years, prices will converge on whatever the long-run cost of wind, solar and batteries is. That’s going to be cheaper than running a current coal fired power station,” he says.

Markets appear to believe a marginally higher bid for AGL is possible. Shares closed on Tuesday at $7.85, above the bid price of $7.50. Bid leader Brookfield indicated it is willing to go hostile and approach big investors regardless of the board’s decision, in an interview with the Financial Times on Monday. Negotiations look set to continue

is a reporter and data journalist with Morningstar. Tweet him @lewjackk or get in touch via email

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