Is splitting AGL into two viable entities possible? The architect of the master plan has resigned, and now a new champion must convince the market that it is a good plan. The Transfer Price Agreement is the key; but it will be contentious.
Introduction
AGL's CEO Brett Redman championed the proposal to split the company into two businesses, namely PrimeCo which will own the coal power generation assets with a development pipeline, and New AGL which will become "Australia's largest multi-product energy retailer" transitioning to a low carbon future, says AGL.
Last week, Brett Redman resigned as CEO because he could not commit for another 5-year CEO stint to lead one of the proposed split entities. Consequently, the AGL Board appointed the Chairman (Graeme Hunt) as interim CEO, and Non-Executive Director (Peter Botten) stepped up to Chair the Board.
The stock market was rattled by the shock resignation of the chief architect and proponent champion to split the 180-year old company. It seems that the Transfer Price Agreement will be contentious as it sets out the hedging price, scale, structure, conditions and tenure between the two entities.
New AGL is too big to not have a physical hedge to manage the price risk of the portfolio which is why AGL battled against the ACCC to acquire a minority stake in the Victorian Loy Yang Power in 2003, and then fully acquired the business in 2012. And then again battled the ACCC to take ownership of NSW Bayswater and Liddell power stations in 2014. By doing so, AGL accumulated the largest coal fired generation assets in the market under the leadership of former CEO Michael Fraser.
The proposed AGL split is yet to be supported by large investors who are now working through the detail. The key is that each entity must be financially viable and earnings accretive to shareholders.
PrimeCo
PrimeCo will face significant market pressure with the next 3-years of the wholesale forward market prices being the lowest in Victoria since 2005, and the lowest in NSW since 2014. Spot prices for Q1-21 was the lowest in 9 years for Vic and the lowest in 6 years for NSW. Looking forward, the wholesale market is undergoing significant change with competition increasing, not decreasing. Prices during dark hours and days of calm wind or cloud cover will dictate a base load generator's livelihood.
There is persistent market speculation supported by market modelling that many of the coal-fired generators will retire early, driven by market conditions rather than an Australian climate policy. Meanwhile State Government's 2030 Renewable Energy Targets are also adding to the driving force for early closures, especially in Queensland. Energy Australia has already announced that the Victorian brown coal Yallourn power station will close in 2028 rather than the planned 2032.
How does PrimeCo manage this risk of significant downward pressure on market prices and protect its future? It must be through the Transfer Price Agreement.
PrimeCo will seek a hedging agreement between itself and New AGL that is of sufficient price level, scale and tenure to deliver a reasonable risk-adjusted return to its shareholders. From PrimeCo’s perspective, the higher the Transfer Price the better.
PrimeCo will also need to deal with a few challenges including:
- Investing in high carbon emitting businesses has become unpopular with many investment funds and some Banks; so PrimeCo with the 1,600MW wind farm pipeline and the prospect of transitioning existing generation sites into energy hubs, will need to have a strong re-positioning strategy
- The rehabilitation cost of Liddell, Bayswater and Loy Yang A power stations at the end of their life, remembering Hazelwood power station rehabilitation cost has been estimated at $743m
New AGL
New AGL will not wish to be saddled with burdensome hedging agreements that cause New AGL to carry an uncompetitive cost base. AGL has already issued a write-down of previous renewable Power Purchase Agreements off-take deals struck years ago. The shareholders of New AGL will not want history to be repeated causing shareholder value erosion. New AGL will want the lowest Transfer Price possible with the right tenure.
NewAGL will not want PrimeCo to become the ‘enemy’ by pushing up market prices if New AGL is under-hedged, when its large competitors are protected through their vertical integration. Although New AGL will reportedly house 2,100MW of flexible generation and storage assets to help manage peak demand events, it will also need the Transfer Price Agreement to reasonably protect the entire position.
This dilemma between creating value for both PrimeCo and New AGL centres on the Transfer Price Agreement.
AGL’s share price has eroded heavily over recent years, which happens to coincide with Brett Redman’s tenure. The strategist Brett Redman attempted to transform AGL through the $3bn acquisition of telco Vocus in 2019 but eventually withdrew from the race. The good old days have passed when former CEO Michael Fraser built a strong vertically integrated business, and then Andy Vesey the next former CEO had the benefit of riding the wave of strong market prices.
Competition on the ‘Big 3’ vertically integrated gentailers is increasing from more agile retailers, renewable generation, energy storage systems and the consumer led behind-the-meter revolution. Hydrogen transition is also on the horizon.
New AGL also needs to ensure that its balance sheet has significant hard assets, otherwise the business will draw a poor credit rating. Stand-alone retail businesses with insufficient hard assets always face a poor credit risk rating, which leads to higher interest rates for any borrowings, limited borrowing capacity and restricted wholesale trading capability due to limited counter-parties.
Conclusion
We are not surprised to learn that key shareholders are seeking further information on the business case of the AGL split. We are intrigued to observe the new champion carrying on with the job to convince the market that it is a good plan. It is not guaranteed that the AGL split is a done deal … but reversing the decision, is an unlikely viable option for the AGL Board.
