Origin Energy sticks to strategy

In early 2021, Origin Energy broadcasted to the market that their NSW coal-fired Eraring Power Station would be deployed differently, and in the words of CEO Frank Calibri, "I think it's actually going to be a pretty messy period of time, and I think you will see us running our generation less at Eraring"  

Despite a unit outage since August, Origin Energy is sticking with the strategy which has impacted NSW Q4-21 and Q1-22 spot prices, while forward prices have soared.

Eraring Power Station Outage

Unit 4 major upgrade began in August 2021, and then returned-to-service briefly in November, before going offline again. Paul McArdle from WattClarity has kindly advised the unit is due back on 25 January.

Looking at the NSW Eraring offers from Origin Energy since January last year, there is a significant capacity only offered for spot prices above $5,000/MWh. Furthermore, despite the unit 4 outage, Origin Energy has stuck with the strategy. The red coloured tones in the chart below represent the average capacity above $5,000/MWh offered by Eraring for each month.

Put another way, so far in January 2022 nearly one-third of the average capacity offered is only for prices above $5,000/MWh, well above any previous month, despite the reduced capacity due to the unit outage.

Average Spot Prices

The NSW average spot prices for Q4 last year resided in our top quartile of our price forecast, a reflection of the Unit 4 outage accompanied by the capacity offering strategy. Although it is early days, the quarter-to-date average prices for Q1 is tracking at similar levels as Q4, and once again in the top quartile of our spot forecast.

Is this strategy announcement a precedent?

From my recollection, there have 2 other times in the market's history that a market participant has broadcasted their energy trading strategy publicly.

Queensland Government

In June 2017, the Queensland Government directed Stanwell Corporation to place "downward pressure" on power prices by directing Stanwell to change its pricing policy, which lasted for 2-years. This direction was also accompanied with the return-to-service order for the mothballed gas-fired Swanbank E power station.

Macquarie Generation

In the late 1990's, Macquarie Generation walked the streets to forewarn the market that their 8-unit power stations (Bayswater and Liddell) would soon operate as 6-units, given the significant over-supply of baseload generation. Subsequently, the crushed spot prices experienced an off-peak led recovery beginning May 1998.

It would be unheard of today and a breach of Insider Trading rules, of forewarning participants in a face-to-face meeting (remember those days), rather than making a broadcast message for all to hear simultaneously.

Such a strategy was very mature, as it addresses the issue as to what is best for the organisation, and not be paralysed by the nagging truism of free-rider benefits. After all, like competitors will benefit without any contribution.

It was proven possible to earn at least the same margin, by running less leading to a reduction in coal burnt and emissions.

Who are the winners?

In the short term, Origin Energy is not a likely winner. Foregoing short-term cash for longer term benefits requires a very mature organisation, and a patient shareholder. The Macquarie Generation strategy of 1998 and the Origin Energy strategy of 2021 are both from the same unwritten lesson book perhaps titled "Managing Co-competition in the NEM". Perhaps it is no coincidence that the head of trading at Origin Energy, served his energy trading apprenticeship at Macquarie Generation?

It is reasonable to speculate that Origin received a windfall from the mid-year Callide C catastrophic failure, and perhaps this favourable cash injection has made the organisation more resilient to continue with the strategy? The Eraring spot revenue soared over the May through to July period, and given Origin was already running with this strategy of reserving a significant proportion of capacity for high prices, it would have likely had uncontracted capacity. Consequently, a significant amount of the spot revenue would likely have been retained, and not paid out in hedging agreements.

The NSW forward prices of Cal-22 to Cal-25 have been rising since March 2021, and since mid-November during the Unit 4 outage, forward prices have been surging upward. Origin Energy (and others) will benefit from the strengthening of the forward prices as it will flow through to Deemed Market Offers for residential and small businesses, as well as Commercial and Industrial sector pricing. Customers will be on the wrong side of this outcome.

Conclusion

When undertaking strategy projects over the years, I often conclude it is better to be bold than placid, after considering and where possible mitigating the risks. Bold however, does not mean being stupid.

To Origin Energy's credit, it has been bold in facing up to the challenges before the business, and has been sufficiently mature to develop and implement a suitable strategy.

However, this is only one of the chapters in the renewable energy transition which at times will deliver pain and joy, although these emotions will not be evenly distributed. This chapter may have been favourable for Origin Energy, but previous chapters have not been so kind, leading to write-downs and profit warnings.  There is more to come.