APA a big winner from energy crunch

The nation’s energy crunch is playing out on equity markets in many ways, with obvious winners emerging.

APA Group CEO Mick McCormack. Picture: Hollie Adams

The nation’s energy crunch is playing out on equity markets in many ways, with obvious winners emerging — the owners of legacy energy assets, with AGL and Origin being two — while industrial users such as BlueScope, Orica and Incitec Pivot are facing double-digit rises in a significant chunk of their fixed cost base.

Indeed, in August the chief executive of food processor Inghams Group, Mick McMahon, declared skyrocketing energy bills across his business were a symptom of “market failure”.

One of the lower-profile winners from the energy blowout has been Australian Pipeline Group. Few people have heard of the infrastructure operator APA, but chances are the gas you use on the east coast has travelled through one of its pipelines.

Under chief executive Mick McCormack over the past 12 years, APA has been steadily acquiring and developing key gas pipeline infrastructure to emerge as a $10 billion juggernaut. To put that in context, it’s not far behind the two dominant east coast generators AGL and Origin, which are both capitalised at about $16bn each.

APA oversees more than 15,000km of pipeline assets, from the core Moomba field to Sydney and Roma to Brisbane, as well as Victoria’s regulated pipeline network.

While the bulk of APA’s revenue comes from fixed-priced contracts, demand for gas is escalating — and not only from the huge LNG exporters in Queensland, but domestically, as gas is increasingly being used in power stations as older coal-fired plants are closed down. Gas accounts for about 40 per cent of power generation capacity in the National Electricity Market and this proportion will quickly grow.

In September, the Australian Competition & Consumer Commission noted there would be insufficient gas production in NSW and Victoria to meet forecast domestic demand.

This means the gas users, from industry to retailers, will be relying on gas produced in Queensland to be sent down the increasingly congested APA pipelines into the southern states. For its part, the ACCC says the transportation and shortages will add an additional $2 a gigajoule and as much as $4 for users. APA maintains its fees represent between 5 to 10 per cent of the end cost for users.

Despite its utility-like assets, APA has all the characteristics of a growth stock and shareholders have done well.

Over the past five years, APA has delivered an annualised total shareholder return (share price growth and dividends) of 19.9 per cent. This has easily outpaced the returns of the S&P/ASX 100 of 12.2 per cent per annum over the same period.

Even so, this year is shaping up as a testing one for the operator with a plan to spend $1.2bn in the near term — more than half of it this year — as it becomes a player in green energy. The investment spans 260MW of capacity from a wind and solar farm in Western Australia, a solar farm in Queensland, and in Victoria APA will overhaul and refurbish a small mothballed gas processing plant in Orbost in the state’s east to process natural gas from Cooper Energy’s Sole gasfield in Bass Strait. If all goes to plan that’s more gas down APA’s pipes and potentially more into the tight gas market.

The spending program is APA’s biggest capital investment and needs to be closely managed for cost overruns as investors like the hefty 5 per cent-plus dividend yield APA has become known for.

But it’s not all blue sky for drummer and part-time farmer McCormack.

Controlling the pipes that the gas runs through delivers significant market power. A big customer has little choice but to pay the tariff. All this has captured the attention of the ACCC in recent years and APA is going to face a battle getting any price rises through in the current climate.

New rules on pipeline tariff negotiations give a lot more power to industrial customers when it comes to striking a pricing deal. Since August, APA and other pipeline operators are now subject to tough contract rules.

So when APA sits down with a big gas user it is required to disclose additional information to customers (both prospective and those undergoing recontracting) such as pricing methodology, what prices others are paying and what costs are being incurred. This level of disclosure would make any business in any industry uncomfortable.

At the same time if negotiations break down, an independent arbitrator can be chosen to determine a “fair price”. Since the new rules began, APA has negotiated little more than half a dozen contracts without the need to go to such arbitration.

Given the predictability of cash flows, shortly before Christmas APA forecast a first-half dividend of 21c per share, which is up 27 per cent on the same time last year. Full-year guidance is sitting at 45c per share, giving it an almost locked-in yield of 5.4 per cent based on yesterday’s close.

To sustain its “growth” APA is thinking offshore. It has opened an office in downtown Houston, Texas. It’s a small step, with just two staffers who have the job of kicking the tyres for potential acquisitions there.

Ultimately this means APA will soon have to weigh up whether the Australian growth opportunities (and our fractured energy market) are starting to diminish, with better returns elsewhere.

John Durie is on leave.