Southern hydro lakes expected to hit Contact earnings

A low inflow of water is expected to hit earnings. File Photo / 123rf

Low inflows of water into the South Island's hydro-electricity storage lakes are expected to knock Contact Energy's earnings in the second half of the current financial year but should boost prices for electricity to residential, commercial and industrial users next year, says analysis from investment firm First New Zealand Capital.

"South Island hydrology has shifted gear from flood to trickle," wrote analyst Nevill Gluyas in a research note dated May 23. "Storage in southern lakes has fallen to now reach the 1 percent risk level, ie, one previously observed extreme hydro sequence could result in future shortfall."

New Zealand has experienced periodic winter electricity savings campaigns in the 1990s and 2000s, caused by so-called 'dry winters' in the eastern South Island catchments, which account for around 80 per cent of the country's relatively limited hydro storage capacity in an electricity system where 70-to-80 per cent of all electricity is generated from renewable sources, primarily hydro.

In recent years inflows have been normal or above average while the combination of falling electricity demand and major investments in new wind and geothermal power stations have seen wholesale electricity prices sag and kept pressure off prices to consumers.

While Gluyas notes that inflows "could bounce back at any time", the current low inflow sequence "has restored tension in 2018 financial year forward prices, lifting our FY18 earnings before interest, tax, depreciation, amortisation and movements in the value of financial instruments (ebitdaf) by 1.5 per cent to $533 million".

"Price tension and reversion to mean inflows mean our FY18 outlook improves, ... benefiting not only Contact's merchant outlook, but also bringing favourable pressure on retail and commercial/industrial sales and pricing."

FNZC's detailed forecasts show Contact earning an average $49.40 per Megwatt hour for wholesale electricity in the current financial year, down on last year's actual average of $59.60 per MWh. In the next financial year, it forecasts a jump to an average of $75.30 per MWh, before rising to above $80 per MWh in FY2021.

In the current financial year, however, higher wholesale electricity input costs along with a $4m cost to switch from the FlyBuys to the AA Smartfuel scheme and an expected increase in the price Contact pays for LPG is estimated to knock 2 per cent off ebitdaf, which FNZC now estimates at $518m.

It continues to rate Contact stock at 'outperform', raising its target price per share by 2 cents to $5.90, compared with $5.05 in trading on the NZX this morning.

The shares last traded above $6 apiece in June 2015, were at $5.46 a year ago and fell as low as $4.35 in November before recovering to current levels.

Gluyas noted that the electricity system operator, managed by national grid owner Transpower, is currently doing daily monitoring of the generation mix, with more use of gas and coal-fired power stations in the North Island and increased water conservation in the southern catchments controlled by Contact and fellow generator-retailers Meridian Energy and Genesis Energy.

The Transpower website this morning shows that while South Island hydro generation capacity of 3749 Megawatts is available, only about half of that is in use, with southern hydro generation running at 1947MW.