TRANSALTA CORP. FACES NEW ERA OF UNCERTAINTY
TransAlta’s message to shareholders at Friday’s annual meeting could have borrowed a line from the Rolling Stones’ 1966 hit Mother’s Little Helper: “Things are different today. …”
In the coal-fired power world, that’s a gross understatement.
As TransAlta chairman Gordon Giffin said in his opening remarks, no one could have predicted what has taken place during the past year.
“The economy in Alberta, as you well know, where the majority of our assets are situated, has experienced a precipitous deterioration due in large part to the decline in world oil prices,” said Giffin, a former U.S. ambassador to Canada. “This reduction in economic activity in the province, among other factors, both dampened demand for electricity and depressed prices for power.”
“Depressed” is a nice way to describe it.
Companies that aren’t hedged are likely in the challenging position of being able to cover their variable costs — and not much more. The impact of low oil prices on Alberta’s economy wasn’t the only topic of discussion at the meeting Friday.
The second elephant in the room was the impact of climate change plans — both provincial and federal — on Alberta’s electricity generators, in particular those with coal-fired assets.
The public policy changes, which upended provincial regulations that companies like TransAlta relied upon to make multi-decade investments means the long-term economics associated with its coal-fired assets have been fundamentally altered, Giffin said.
This has imposed “novel and material uncertainty on the business,” he said.
“The uncertainty continues, with PPA (power purchase arrangement) buyers most recently relinquishing their long-term contracts and the outcome of discussions regarding potentially stranded investments due to policy changes remain unclear,” Giffin said.
He was referring to the number of PPA buyers that have returned contracts to the provincial Balancing Pool because they are no longer economic relative to the original price.
These decisions stem from a combination of the higher price for carbon and excess supply in the power market.
Along with the need to clarify the transition off coal, this means there is nothing resembling a market signal that would cause a company or investor group to commit capital to replace the 6,200 megawatts of installed coal-fired power in Alberta with gas or renewables any time soon.
According to TransAlta’s estimates, $15 billion — at the low end — would be needed to do this, and that’s just for generation.
There will also be costs associated to add transmission capacity.
An eye-opening comment TransAlta chief executive Dawn Farrell made after the AGM no doubt mirrors what many in the electricity sector are thinking about investment.
“We certainly would not have invested in Keephills 3 — we would not have invested a dime in Keephills 3 — if we thought we were going to have shut a brand-new super-critical coal plant down in 2030,” she said. “We could have never foreseen that the carbon debate would become so big that coal would be shut down.”
That means the price of cer- tainty is much higher here than in other provinces.
Whatever agreement recently appointed provincial negotiator Terry Boston arrives at will have to come with some fairly strong guarantees, not to mention compensation, before the power players step up and invest in new capacity.
“Future investment in new capacity will require confidence in investors, in the ability to earn a return and confidence in the long-term stability of the regulatory framework,” Giffin said.
Meanwhile, TransAlta has taken a number of measures to lower its cost structure, diversify its asset base and shift its financial strategy to better address the current market.
Like TransCanada and Enbridge, it has engaged in ‘dropdown’ transactions to strengthen its balance sheet. Last December, it monetized more than 1,000 megawatts of assets in Eastern Canada by transferring them to TransAlta Renewables (RNW) for $540 million.
It also sold an eight-per-cent stake in RNW to the Alberta Investment Management Corporation for $200 million.
It used the net proceeds of $372.5 million to pay down outstanding debt.
“Over time, what I want is less debt in the corporate structure where there is more merchant risk and have the right leverage in TransAlta Renewables where there is more contracted plants,” Farrell said.
Despite all these moves, TransAlta’s share price remains under pressure. Its shares have plummeted from a 52-week high of $12.50 this time last year to Friday’s close of $6.29.
That’s up significantly from a low of $3.60 last January but a long way from the $39 per share bid made by Luminus Management in 2008.
Farrell said all the uncertainty is causing the market to undervalue TransAlta, although she isn’t concerned about an unwanted takeover bid. On that, she is probably right. As things sit today, the current conditions are effectively acting as a poison pill for a potential acquirer as well as deterring the investment in new, gas-fired and renewable capacity.
Farrell said she is confident Boston, with his rich experience in the U.S. power sector, has the knowledge and expertise to arrive at an agreement that ultimately benefits all stakeholders — companies, consumers and investors — who could be impacted by the impending shutdown of coal-fired plants.
The consequences of not doing that means Alberta doesn’t attract the capital it needs to achieve the goals the government has set to ‘green up the grid’ because companies will keep one (modified) adage top of mind as they assess the risks and benefits of investing in the province: Once stranded, twice shy.
These are the complicated waters Dawn Farrell is navigating.