CLIMATE SPECTATOR: Is Origin's luck about to run out?

Grant King successfully turned Origin into one of Australia's 20 largest listed companies with smart calls and an ounce of luck. But his decision to stay out of wind could soon come back to bite.

Climate Spectator

Grant King has done an exceptional job running Origin Energy. He has taken it from an unwanted little LPG offshoot of Boral, into a company that now far surpasses its parent in terms of size and financial returns.

As an electricity retailer it has been by far the most innovative. In spite of more established competitors, it skilfully employed such things as Greenpower and its offshoot green products such as solar PV and solar hot water to differentiate itself from competitors and grow a valuable residential customer base.

And just recently it was the first to market with an intuitive energy usage information web portal (‘Origin Smart’) for its customers that finally delivers on the promise from Victoria’s smart meter roll-out. Based on interactions with Origin staff, I expect it will also be the leader in any roll out of other demand-management energy services.

King also wisely steered clear of overpaying for Victorian brown coal generators – unlike TRUenergy and International Power – conscious that a future carbon price could undermine their value.

He also recognised that the value in electricity was to be captured through vertical integration backwards into gas supply, which ultimately led to a massive Liquefied Natural Gas export pay-off. He successfully rebuffed a takeover offer from BG Group, getting Conoco-Phillips to buy into its Queensland coal seam methane interests at a noticeable premium over prior transactions while maintaining Origin’s exposure to further upside. This delivered a multi-billion dollar windfall to shareholders. And King, in combination with Conoco-Phillips, then delivered on the upside through successfully closing financing on not just one but two LNG trains, with the second significantly more profitable than the first.

But like any successful businessman he has had his fair share of luck.

His vertical integration into gas supply was originally not about LNG, but power generation. Through the implementation of a carbon price, King expected the domestic market for gas would grow at the expense of coal, and with this growth would come profits. If it wasn’t for the unexpected emergence of LNG, this strategy would now look extremely unwise. A major drop-off in electricity demand growth means Australia is now substantially oversupplied with power generation. And while Origin managed to successfully argue the case for a carbon price, what has been implemented barely makes a dent in the cost competitiveness of coal-fired power.

In terms of renewable energy, Origin was left badly short in 2007. At the time there was an about face in government policy and both the Coalition and Labor elected to substantially increase the level of the renewable energy target. Origin made a very conscious decision to stay out of wind power project development and focus investments on gas with secondary, small, speculative bets on geothermal and solar PV.

But its bet on geothermal has come to little and is unlikely to help at all in meeting its RET obligations. In addition the RET will completely cannibalise any market for combined cycle gas baseload power plants over the next decade. While Origin did buy into a small wind development company a few years ago, the consensus view of experienced players is that the project portfolio was poor.

However Origin’s lack of investment into wind is yet to hurt. This is because rather than driving large uptake in wind as most people expected, tweaks to the RET legislation actually drove an entirely unexpected surge in solar PV renewable energy certificate creation. Origin was in the box seat for this solar PV boom, as its experimental solar PV play enabled it to become the largest installer of solar PV in the country. It also offered a very large pool of extremely cheap renewable energy certificates to meet an obligation it had lobbied against.

Because of this huge overhang of surplus solar PV RECs, Origin has held the upper hand in power purchase agreement negotiations with wind power developers. Yet Origin hasn’t really thoroughly exploited this opportunity to contract well in advance, and consequently its shortfall in RECs grows extremely rapidly from 2016 onwards.

This failure to contract in advance is probably because Origin wanted to make one last lobbying push to water-down the RET to help its fossil-fuel power generation business. This might pay-off handsomely, but it could also blow-up in their faces.

There is a reasonably good probability the current review of the RET by the Climate Change Authority will rule in favour of no change. After all it seems incredible that the review could recommend that the best way to meet the legislation’s objectives – of which the first and foremost one is to encourage additional renewable electricity – is by dramatically reducing the level of the target.

Based on quite explicit public statements from Labor’s Greg Combet and the Liberal’s Greg Hunt, it would then seem likely they’d accept the recommendation from the Review for no change.

At this point Origin will find itself at a noticeable competitive disadvantage to AGL. Since 2005 with the purchase of Southern Hydro, AGL has assiduously built up a large, high quality wind development pipeline through a range of acquisitions.

Origin will probably find it harder than it has in the past to contract with wind farm developers. Developers will be in a much stronger negotiating power as the supply of RECs becomes increasingly short within the next two years. Also Origin will have to battle it out with TRUenergy, which also has a very large shortfall in RECs. In addition a number of renewable energy developers are establishing their own electricity retailing arms such as Pacific Hydro, Meridian Energy and even smaller players like Diamond Energy, as an outlet for monetising their RECs.

Origin Energy is full of clever, well motivated staff, good at making their own luck. So they may find a way to overcome the substantial competitive edge AGL has over them on wind power. But it’s not evident right now.

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