Infigen Energy CEO tells Climate Spectator editor Giles Parkinson:

– Why costs of power sale generation have been falling, while power prices have been rising;

– Why there’s been a very weak-to-no signal for new renewable energy investment in Australia over the last year;

– That demand for renewable energy will soar from 2016, but that the industry is not preparing to satisfy that demand at the moment because the price signals and the willingness to contract aren’t there;

– That solar PV will probably become competitive with wind within a 5-10 year timeframe; and

– That it is a concern that arbitrary setbacks for wind farms are being contemplated – and implemented in the case of Victoria – because they don’t address the real issues.

Giles Parkinson: Most Australians have experienced electricity price rises in the last year or so, but generators such as yours have actually been experiencing electricity price falls. Can you explain what's been happening?

Miles George: Sure. The retail price of electricity delivered to domestic households comprises components of generation which are probably around about 40 per cent of the total poles-and-wires cost of getting electricity to the home and then margins and other costs associated with retailing of the electricity. So the generation component is a small component or 40 per cent of the total delivered price. The increases that have been experienced over the past year at the retail level have been primarily due to increases in network charges; in other words, the costs of those poles and wires businesses being passed through to consumers. They haven’t been due to the costs of pole sale generation, which in fact have been low.

GP: And why have they been low?

MG: A number of factors: reduced economic activity; low gas prices, because there’s quite a bit of surplus gas around in anticipation of the development and establishment of LNG facilities in Queensland. We had a lot of rain and so there was a lot of hydro electric capacity fed in to the system. I think they’re the key drivers.

GP: Ok.

MG: Oh, and mild weather as well. You know, average electricity prices in the wholesale market are affected, in particular, by extreme weather. There were fewer really hot days, really high prices then are typical.

GP: And so what’s it meant for your profits, then, because you’ve actually managed to get higher production and you’ve had some new assets come on stream and, I’m just thinking of Australia here, but that’s been largely offset by those lower prices, I suppose?

MG: Well, in Australia, 58 per cent of our output is contracted, so our current exposure for the other 42 per cent of our output, so a lot of electricity prices for that portion of our output have affected profitability. And then the other main contributor to revenue is from the sale of renewable energy certificates, and we are still working our way through the surplus of small-scale scheme certificates and, as a result, REC prices have been fairly weak over the last 12 months.

GP: Going to the prices, the combination of those low prices has meant it has been very hard to either raise the finance to build wind farms or to lend the contracts to get power purchase agreements. How do you see that unfolding over the next 12 to 18 months?

MG: Look, largely as a result of the surplus of small-scale scheme RECs is still being absorbed, there really hasn’t been an incentive for obligated parties under the legislation, so I’m talking about the big electricity retailers; Origin, AGL, TRU and others. There hasn’t been a big incentive for them to contract long term to acquire renewable energy certificates when they can pick them up cheaply from this surplus. So because they’re not willing to contract long term, and because a long-term contract is really required to underpin investment certainty for finance for new wind farms, there’s been a very weak-to-no signal, really, for new renewable energy investment in Australia over the last 12 months or so.

GP: Do you see that changing anytime soon?

MG: We do see that changing. We’re noting in particular that the surplus is declining rapidly. And if you look at announcements made by AGL, Origin and Tru for FY11, they have acquired very large amounts, roughly $500 million-worth of RECs from that surplus in the last year, and they acquired a similar, or slightly lower, amount in the previous year. So that surplus is rapidly being eaten away and our view is that by 2014 it will certainly be gone altogether. Then you have, going a bit further out, from 2016 onwards the target for, under the legislation, increases in the annual target. It’s not just a 20 per cent by 2020 target. It’s actually an annual target; increases more rapidly beyond 2016. That leaves a large, unsatisfied demand for RECs, particularly beyond 2016, and in total the requirement is roughly six times the current installed operating capacity of wind farms in Australia. So, there’s a very large demand there that’s going to come through from 2016 and at the moment the industry is not preparing to satisfy that demand because the price signals and the willingness to contract aren’t there.

GP: So, for your next stage of developments, are you planning any, and what’s going to be the trigger? Are you going to go on a merchant contract or are you waiting for the ability to negotiate a power purchase agreement? And when do you think that might happen, or when will these decisions be made?

MG: What we’re doing with our development portfolio is the best projects in the pipeline are being progressed, so that they’re ready for investment when the market turns around. And the balance of the pipeline of projects that we have is being preserved in value by maintaining things like lease payments and so on. It’s really that the willingness of the market to contract will in fact provide the means to then finance these projects, as we did for Woodlawn. As you know, it’s a merchant plant, and we’ve been able to achieve separate financing from our global debt facility for that project and there is provision in that facility to increase the amount available, when and if we contract a portion of the output from that wind farm. Similarly, when the market turns around and contracts become available, the potential would be for further project financing of new projects in Australia – and that’s the mechanism that we would propose to use to fund further growth when that market signal is there.

GP: You’ve got 1500MW of projects in the pipeline, but you talk about a mixture of wind and solar. Is it about half and half, or how much in wind projects do you have, and how much in solar, and where?

MG: The great majority of our pipeline of projects is in wind farm projects.

GP: In which state?

MG: Well, those projects are predominantly in NSW, South Australia, Western Australia and, to a lesser extent, Queensland and very little in Victoria. In terms of solar; we have a solar development pipeline now, as well, following the work that we did in relation to the solar flagships program, and we have three very suitable and approved sites in NSW for that totaling a 150MW, at the moment, of development potential. And we have other sites that we’ve secured that are in appropriate areas that satisfy the requirements for solar, some of which are similar to wind farm developments and that is, you know, you’ve got to be near a strong point in the grid, you have to have community acceptance, and of course you have to have good solar radiation, but that applies to a fairly large part of NSW.

GP: And how do you see that being deployed in the future? When do you think those costs will come down to match those of wind?

MG: I guess our view is that it’s probably a five to 10 year timeframe for solar PV to become competitive with wind and that’s based on an assessment of the rate of decline of costs per megawatt hour of output from solar. So that cost has been coming down rapidly as the efficiency of solar panels has increased, and the cost of producing them has reduced, particularly through production of the panels in China. The cost of wind energy production is also coming down, but not as rapidly as solar is, and hence our view that the crossover point where solar actually becomes competitive could be somewhere in that five to 10 year timeframe. But currently it’s more than double the cost of wind.

And so, the main focus of our development pipeline is wind, but for solar, as with the solar flagships program, the Australian government is now looking to also promote the development of a solar industry in Australia, much the same way as the wind industry grew, I guess, from about 10 years ago here. So we see it as early days for the solar PV industry here, but certainly a technology sector that we want to be involved in, and that’s why we’ve got our development projects in solar PV in our pipeline.

GP: And you mentioned before, also, that it could balance quite nicely with wind production for the national electricity market.

MG: Yeah, that’s true. So, the profile of generation from solar PV installations complements the generation profile of wind. Clearly, the profile of solar generation is daylight hours, which is, you know, fundamentally more aligned with demand in the NEM. But it turns out that it’s actually quite useful, not only from that perspective, but also in a way to help firm a portfolio of renewable energy generation that would include, for example, wind and solar generation in the same market region like NSW.

GP: Ok. Now, what about the renewable energy 20 per cent target. There’s been some discussion about it recently. Do you think Australia will be able to meet that target, because an awful lot of wind turbines are going to have to be built very quickly to get there?

MG: Well, a couple of things to say about that: The target legislation has been amended a number of times previously and I think the main point I would make about the legislation for the renewable energy target is it’s essential that it’s not further adjusted or changed or any threat of amendment to it because we really need that investment certainty and we need certainty for the obligated parties to be willing to contract under it.

In terms of being able to satisfy it, the fact is that we are not. We are going to be starting late and we’re starting late because the surplus from the small scale scheme has really made it not necessary for the obligated parties to contract under the scheme. They’ve been able to pick up cheap RECs from the surplus. So, starting late is not good obviously. It’s not good for the whole industry, really, because the potential is that there has to be a much more rapid development of wind farms over a shorter timeframe, and that results in increased construction costs and general inefficiency. So in our view it would be helpful if the projects could get started earlier than currently seems to be the case. So, I do think there’s going to be a difficult environment meeting that target. Having said that, our development pipeline includes projects which are very well advanced and, you know, as soon as the price signal is there, we are ready to go.

GP: Most of these projects, presumably, are in NSW and South Australia. Are you concerned by the Victorian decision announced this week that they are cracking down on some of the wind farm planning regulations, and whether this might be sort of contagious in other states?

MG: From Infigen’s point of view, we actually don’t have a lot of development projects in Victoria, so there’s not an immediate impact on us. But for the industry as a whole I think it’s unfortunate that the Victorian government has gone with a completely arbitrary target for setbacks. The approach that we’ve adopted, and the industry has adopted generally, is that a better approach to considering setbacks is to actually measure impacts, in particular noise impacts from wind farms, rather than just setting an arbitrary 2km, because that doesn’t take into account topography, you know, trees, whatever else might be in between – valleys, mountains – in between a particular wind farm and a particular residence. So, I don’t think it’s a good development. It’s not scientifically based, but as I said we’re not particularly exposed to that.

GP: Are you concerned that the same thing might happen in NSW?

MG: We are. We are concerned that a similar approach could be taken in NSW. It certainly restricts, significantly, the sites that are available for new development. In another way, I guess it benefits projects that are already established. It probably increases the value of them. But from a new project development perspective, it is a concern that arbitrary setbacks,, for example, are being contemplated because they don’t really address the real issues.

GP: And what about in South Australia? Because it’s got the highest penetration of anywhere in the world, practically, apart from Denmark maybe. Are they reaching capacity there? And what sort of things need to be done to alleviate that, because you’ve actually had to switch off your turbines down there, on occasions, this year because just too many electrons and not enough users?

MG: That’s right, Giles. So, South Australia effectively has already reached the national target of 20 per cent by 2020 and there have been some fantastic benefits for South Australia arising from that; both in terms of regional investment, but also in terms of electricity costs and carbon emissions reductions for South Australia. One of the consequences, though, as you rightly say, is that the level of penetration of wind in South Australia is such that the network, which is a very old network that is poorly connected into Victoria, suffers at times of low demand, so typically, you know, late at night, for example, and high wind.

When those two things occur at the same time, in fact there can be problems with the grid caused by the weakness of the grid. And the key thing to fix this – and it’s been well known for probably a decade, and it’s not just in relation to wind energy generation in South Australia, but the key to also being able to export wind energy out of South Australia – is to improve the connection with Victoria. The interconnect between Victoria and South Australia is the limiting factor. That’s what’s preventing the lower-cost, carbon-free wind energy that’s being generated in South Australia to be used in Victoria, because the connection doesn’t work.

GP: And why hasn’t that been upgraded if it’s been known for so long?

MG: That’s a good question. You know, in transmission network augmentation around the country that would have to be the most critical interconnector that’s been known to be weak for a long time and nothing has really been done about it. I don’t know why something hasn’t been done about it. We’ve certainly argued for a long time that something should be done about it, but it hasn’t to date.

GP: You mentioned in your report that you wanted to focus on value recognition of Infigen. I presume that was a reference to the fact that the share price is probably low, lower than what you’d want it. How do you go about that?

MG: Well, we’ve really addressed what the market has told us over the last 12 months or so. The market has pointed out a number of challenges for new investors in to our stock and we’ve tried to address them, both in terms of our slide presentation today, but that’s really just referring to the sort of actions that we’ve been taking. One is, I think, being very clear about what the actual position of our global debt facility is and the fact that we did meet the leverage ratio covenant comfortably in FY11 both before or after the sale of Germany and that based on reasonable assumptions we fully expect to meet that leverage ratio covenant right through the life of the facility including the periods of step downs in that covenant ratio which occur in 2016 and 2019.

There seems to have been a poor market understanding of our actual covenant position and we’ve tried to address that this time around with our result. We’ve also tried to explain the position in relation to refinancing the global facility, which is tied to the way that the US business is financed. In relation to the global facility, we make the point that there is no requirement, and nor is there any intention, to refinance the facility in the short term. We think that the optimum time to refinance the facility is probably in around the 2014, 2015 timeframe, but we note that, in the meantime, the facility is actually what we’ve called covenant-light. It was put in place in 2007 at the height market for borrowers, has a low margin, a long tenure and no prescribed repayments. So, we tried to sort of highlight that; what are the positive features of the global debt facility.

I think that one of the key areas, though, that the market wanted us to focus attention on and explain better, was the position in relation to our operating costs after wind farms come off warranty. And so we have explained that, we think; certainly in a lot more detail in the presentation this time around with our result. But essentially, what we’ve described are the actions that we’ve taken during the year to limit the post-warranty operating cost increases to better than the forecasts that we provided and to note that we are striving for the most competitive outcome in, particularly in the US, where the post-warranty service market is becoming more competitive, we’re getting better outcomes. We’re getting better results from the preventative maintenance and predictive maintenance and component parts supply-chain management that we do to achieve operating costs that are at the lower end of the forecast range.

GP: And given the debt levels that you do have, and given the share price that you’re experiencing, are there any impediments to your development ambitions over the next couple of years?

MG: Well, I’d certainly say that the price signal has to come first. So, at the moment, financing considerations are not the constraint for our growth. It’s the market considerations that are the constraint. When those market conditions improve, we believe there are a number of avenues where we can source funding to participate in that growth based on the very strong pipeline that we’ve got and they include, as I mentioned briefly before, project financing, for example, in Australia, where we’ve already established that there is funding available for well-developed renewable energy projects in this country.

GP: Terrific. Thanks very much, Miles.

MG: Ok. Thanks, Giles.