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Edited Transcript of MCY.NZ earnings conference call or presentation 19-Aug-19 11:00pm GMT

Full Year 2019 Mercury NZ Ltd Earnings Call

Auckland Aug 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Mercury NZ Ltd earnings conference call or presentation Monday, August 19, 2019 at 11:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Fraser Whineray

Mercury NZ Limited - CEO

* William Meek

Mercury NZ Limited - CFO

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Conference Call Participants

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* Aaron Ibbotson

UBS Investment Bank, Research Division - Director & Research Analyst

* Andrew Rupert Pelham Harvey-Green

Forsyth Barr Group Ltd., Research Division - Director & Senior Analyst of New Zealand Equities

* Grant Swanepoel

Craigs Investment Partners Limited, Research Division - Director & Head of Research

* Nevill Gluyas

Jarden Limited, Research Division - Director of Equity Research

* Stephen Hudson

Macquarie Research - Head of Research

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Mercury annual results analyst briefing. (Operator Instructions) Please be advised that today's conference is being recorded.

I would now like to hand the conference over to our first speaker today, Mr. Fraser Whineray, Chief Executive. Thank you, sir. Please go ahead.

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Fraser Whineray, Mercury NZ Limited - CEO [2]

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Thank you. (foreign language) Welcome investors, analysts, media, and also in the room, a substantial part of the executive and others from Mercury. I'm joined here by William Meek, the Chief Financial Officer. And it's our pleasure on behalf of the company and the Board to take you through this quarterly look today about the FY '19 full year financial results.

We have published materials on the Internet this morning, which we will click through on the slides here and I assume that it comes up on the screens you're watching as well or you have copies in front of you. The -- this year, we've had to work much harder for the outcome. Last year, we enjoyed some tremendous or record inflows into the Waikato Catchment and that flowed through to a record hydro generation and a record result. We executed on a lot of things last year. This year actually, we had to work much harder for the financial result, and many multi-year items have reached key milestones. So this is the year that we are particularly proud of. I'll just go through a couple of highlights, and then William and I will work back and forth through the slide deck, and then we'll come to Q&A at the end.

So the financial result of $505 million of EBITDAF, that was achieved through -- there we go -- a disclaimer, right. The financial results of $505 million of EBITDAF was achieved through mean or average hydrology, though, there was a great illusion across the 12-month period of mean or average because it was very strong in the first 2 months of the year, which followed 2 years of very strong inflows into the catchment, and then went to second percentile inflows from September through to May, which was quite an extended period. Offsetting that was some record geothermal generation with availability at pretty much 98%, and that was very valuable in contributing an extra sort of $10 million or so with those record spot prices to our overall result of $505 million. The $505 million was also achieved with a part year loss of Metrix, and William will touch on some of those normalization aspects shortly.

The market conditions, moving across to the second box there, market thesis, and that is a slide you'll see later in the deck, which we've been talking to since August 2016, 3 years ago. The market thesis is being realized through supply and demand coming more into balance. Though, it was exacerbated strongly this year by thermal fuel and thermal plant constraints. And now we are increasingly seeing the impact of elevated gas pricing coming through to dispatch decisions for those parties that own thermal plants, and also investment decisions for those parties that can see a bit of counterfactual in renewable fuel rather than purchasing gas. And there is a sense of déjà vu from about 15 years ago when that happened last time. With gas prices elevating, we saw wind go from about 0% to 6% of the national grid and geothermal go from 7% to 17% of the national grid at the expense of baseload thermal fuel, whether it was coal or gas. So there's a bit of Back to the Future there and I'm sure we'll talk more about that market thesis as we go through.

I think this year, and it's not on this page, but I want to highlight it. And third spot to talk to is this year has seen a tipping point, I think, in recognition of New Zealand's renewable electricity advantage for the country being recognized for what it does today, and what it will deliver into the future in terms of energy sovereignty, structural costs in the economy, and the opportunity, which is now inevitable, around the intersection of wind turbine technology with the wind fuel resources here and transport technology becoming electrified. Both those global activities are receiving tremendous amounts of R&D, production scale economies, one is a few years ahead of the other one, but they almost face an inevitable marriage here in [Alterra], and I think there's no herculean technological assumptions you need to believe for that now to roll out.

Now that recognition came through in a number of reports, the Interim Climate Change Committee report, MBIE's reset its forecasts, the Productivity Commission, IEA reports, et cetera. And they think, broadly, we're looking at sort of going from 40 terawatt hours to 60 terawatt hours over the next 30 years per annum of electricity through those things I discussed. And just to put that into context, that is a Turitea wind farm every 9 months delivered by the sector to achieve that. So that is quite a change to how it's been certainly since about 2008 when demand went flat. Now William will talk to demand later on, but I'm just talking more to the medium and long-term activities and the outlook for the sector and the country.

The dividend, the final dividend, I'll leave many other financial metrics to William to talk to, of $0.093 per share goes to $0.155 for the year. The point I want to emphasize here is that, that is the 11th year of ordinary dividend growth. And I'll challenge any analyst, I'm sure they'll be able to whip it up before the end of this call, to tell me the names of the companies on the NZX that have actually done more than 11 years of ordinary dividend growth consecutively and are still on that path, they haven't fallen off it. I think that is testament to taking long-term views, and again, you can only create long-term ordinary dividend growth by having long-term ordinary earnings growth. And that's why we must continue to think about capital reallocation out of things that we don't think are going to produce that growth and into things that we think will and are a core part of our future.

Customer value has been very important to us. We'll -- I'm sure we'll talk about this more. We are focusing, as we've said, our 3 customer promises, make it easy, reward and inspire. And we are focusing on rewarding that loyalty by keeping the economics and the proposition as favorable to existing customers as we can. We haven't shifted headline prices to core customers since April 2018 -- and from April 2018, and we have reduced acquisition activity in this retail market as we try to bring on more customers on headline rates using other non-price attributes than simply deep discounting for which we cannot get the [maths] to go around on.

Capital reallocation, just talking of that out of Metrix $272 million after owning that business since 1999 and turning it into a smart meter business from a legacy meter business. We've put more growth capital supporting Tilt on its Dundonnell wind farm in Victoria, and we've committed to the first large scale wind farm or electricity generation build in New Zealand since 2014 with Turitea. Combined with our original investment in Tilt, that represents over $700 million of capital reallocation within the business and we -- those are multiple year projects, which we are pleased to have done. Reinvestments continued, hydro, Whakamaru and Aratiatia, geothermal, IT systems and also, this year, a 4-year project concluded or reached the end of its big milestone of getting 3 offices in Auckland consolidated into 1 here in Newmarket along with a complete change in ways of working, which is resonating well with staff and productivity.

So I'll now hand over to William to talk through some of those key financials year-on-year.

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William Meek, Mercury NZ Limited - CFO [3]

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Thank you, Fraser, and welcome everyone, again, on the call. We're on Slide 4 now. It sounds like the CEO has done me out of a job and described most of the variances here anyway. So I'll just skip through quickly. Energy margin dropping to $667 million for the financial year largely driven by 800-gigawatt hour reduction in generation volumes. Hydro, trending out at [main] but certainly quite a different journey from wet-to-dry through the financial year.

Operating expenditure is just under $200 million for the year at $199 million, down $6 million. Again IFRS 15 and 16 adjustments through there for revenue recognition and for leases, the delta really flat on the prior year after adjusting for the divestment of Metrix.

EBITDAF, I will bridge more fully in the next slide. And skip NPAT, a record at $357 million largely attributable to the Metrix gain on sale of $177 million, which happened in March.

Underlying earnings down $37 million to $161 million, again largely bridged by the reductions of $60-odd-million in EBITDA offset by lower interest and tax. So certainly, we're seeing those -- the effects of those 10-year swaps rolling off certainly lowering both interest expense and cash interest payments for Mercury.

Our free cash flow down to $237 million, again, driven by most of those EBITDA and tax interest movements previously, also CapEx, which is down to $89 million or down $23 million, again, driven largely by the refurbishments on Whakamaru and Aratiatia but also investments into IT. So at [Commerce Harbor], which is certainly improving our customer experience for those on the Mercury brand.

Growth, $81 million, really driven by just 2 things: last payments on Turitea and $55 million into the Dundonnell capital raise for Tilt renewables. Our dividend is up $4 million, 11th year running, to $211 million, so fully imputed at $0.155, and no buyback this year assuming in FY '18 we did $15 million buyback at $3.21, which seems on a long way back from where the share price is today.

Just bridging more fulsomely the EBITDA on Slide 5. You can see here generation volumes worth about a $74 million difference downwards. That explains a lot of the bridge between this year and last year. Price effects that we saw record high prices through FY '19. So jumping up to around $140 a megawatt hour. And you can see the effect of the vertical integration and hedging across the firm with a $356 million price effect there. So positive to our generation business, the longs obviously benefiting from higher spot prices offset by, essentially, decreases in EBITDA in our mass -- our fixed price variable volumes. So that's from C&I right through to mass markets, physical sales, derivative settlements of $60 million and with end users and in other derivatives also $45 million. So those 3 summing to $354 million, basically the same number as $356 million in terms of generation. So the longs and shorts essentially offsetting each other. And so the bridge, the [74 GWh] essentially reducing net by [about 10 GWh] to give you that $505 million at the end in terms of an outcome for EBITDA.

Back to Fraser.

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Fraser Whineray, Mercury NZ Limited - CEO [4]

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Guiding a lot of our activity in the business, ones we've also enjoyed over the last few years, 5 key pillars. And you can kind of think of these as almost forms of capital. And the way we consider them is, if in 15, 20, 30 years' time any of those is impaired or absent, then the business will either be atrophied or struggle to even exist. And so that's why these 5 pillars we -- they are same 5 pillars as the group KPIs. You'll see, in the extensive remuneration section of the annual report, how the group KPIs have these -- have percentages against these. And we have to make sure as a company, we are bringing forward these and investing in these each year as we head towards longer-term goals. This year, in our business planning, we wanted to define what those longer-term goals look like. And so we have put on some 10-year success statements. We also have some 3-year goals and then they flow back through to the stuff that we are actually going to get on with in FY '20, which ends up aiming towards the long-term goals that are established there. And so we just wanted to make sure we'd shared those with you.

We think it's important that you understand how we're trying to make sure that the company is enhanced over the long term, what ingredients are necessary for that enhancement because, talking in analyst and investor language, if your terminal value is 0, I bet you your current market cap is a lot lower. And sustainability of cash flows is primary, and growing those cash flows is also important against that dividend track record that I talked about earlier. But there's a lot of volatility out there globally in a whole range of areas, whether it's technology, human capital, geopolitics, the capital markets, et cetera. And we just certainly want to make sure that the business is in a strong shape into the future long-term because that's good for value.

In terms of key performance indicators against those pillars, we're just continuing to work out what the best sets of KPIs are to report against those. There's a range of them there for each of customer partnerships, Kaitiaki people and commercial. I'll just touch on a couple, the Mercury brand trader churn. This has gone adverse to where it was. It is an intensely competitive market. We have eased back slightly on our acquisition activity by dropping the deep discounting in most instances. So -- and the Auckland market it is a very competitive place, where we happen to have a significant customer base. So that churn is now at around 7.4% for trader churn. On total churn, we've still got a significant advantage to the market.

The other thing I'll just point out is the 0 high-severity health and safety incidents. I know people can look at TRIFR a lot, total recordable injury frequency rate, that deals with medical treatment injuries and lost time injuries or reduced work situations. It's avoiding extremely low-probability but extremely high-consequence events. That is a very big focus for this company, and I'm delighted that we had another year with 0 high-severity health and safety incidents. Unlike many other KPIs, which you can reasonably forecast as you're heading into 30 June, you don't get to tick this one off until you're past 30 June. And it's kind of never ticked off anyway because you just have to keep getting up the next day and making sure people stay safe. As I talked about on the first slide.

Moving to Slide 8 now. New Zealand's renewable advantage has received substantial press during the year from the Interim Climate Change Committee, which is an extremely well constituted group, which actually turned around and said we think we've been asked the wrong question. And then focused on a different question, not how to get to a 100% renewable electricity by 2035 but what would be a good percentage of renewability to optimize low carbon outcomes for energy in total, remembering, of course, that electricity, on an end-user basis, is only half of the energy market. And it's that other half that I mentioned earlier which we see as coming more towards electricity as it grows from 40 to 60 terawatt hours over the next 30 years. So that was a very good report. We've seen the government's response to that. And we [can mean] that pragmatism that actually going for a 100% doesn't make sense because electricity is the solution to decarbonize the balance of the energy system. It also recognized the value of hydro generation, both for deep energy storage and for peaking capability, as more uncontrolled renewables are brought into the New Zealand market.

MBIE revised its energy -- electricity demand and generation scenarios just last month. The Productivity Commission came out to the low emissions economy report that was from the previous government's targets that came out in August -- that came out last year. And that also supports electricity -- renewable electricity as a key enabler of the transition. And we've also -- have submissions closing today on Minister Genter's feebate arrangements with respect to low-emissions light vehicles for implementation in 2021. We support that. I think it will end up being temporary in the end. Because electric vehicles are going to be a lay down misere for consumer choice in probably 5 to 10 years anyway for most applications, and therefore, they won't need any sort of tilting. So therefore, why is it important in the meantime? It's important in the meantime because I -- we believe that upstream supply chains are going to become constrained as vehicle manufacturers turn towards electrification of their cars. And if you're not serious as a country about it, I don't think the allocations of those vehicles will be forthcoming, and that's a structural disadvantage against New Zealand's competitive advantage in renewable power.

You've also seen not just in cars but heavier transport coming to fray as well as for electrification. Waste Management is converting 800 of its trucks, including rubbish trucks. We're seeing activity around electrification of ferries in multiple places. Ports of Auckland just announced it's buying the world's first electric tug, which will match the power of its current largest tug. And of course, and New Zealand is -- and others are thinking about electrification of planes as well. So all the transport bases seem like they're getting covered.

Coming up, though, on Slide 9, we still need to see the outcome of the electricity pricing review. We look forward to that. We think the focus on vulnerable customers is important. Within that we think dropping the low fixed charge tariff is important. We think addressing the issue that some retailers have with excluding vulnerable customers because of the payment methodologies and the way they service customers, fixing debt is important as well. And there are many other of the options contemplated there, which we support. So we look forward to seeing that. And there's more on transmission pricing and tax and national policy statements, the last 2 with respect to fuel, namely hydro fuel and also indigenous biodiversity as an unintended potential consequence of that national policy statement on geothermal, which we believe will be satisfactorily addressed.

William, to the market.

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William Meek, Mercury NZ Limited - CFO [5]

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Thank you, Fraser. This should be a familiar chart to those that have been following these decks over recent years. It's -- quite clearly you can see here where we graph both South Island storage on a basis of deviation from average for every month from '99 through to 2019 for both North Island and South Island. So we can certainly see, against the trend lines, which have been rebates, which include the certainly higher prices we observed in 2019. We can certainly see a breakout there, where, actually, small deviations from average storage levels in the South Island are leading to much, much higher prices. Again, most of us on the call should be familiar with the -- both the gas constraints and, basically, the thermal constraints also during 2019, which persist into 2020. So you can see, certainly, in the legend there prices at $59 in 2017 rising to $87 in 2018.

So that's a delta of $28. They then get to $143 in 2019, which just so happens to be twice the difference from the year before. So hopefully, we haven't got a geometric series there and staring it at a $171 price in 2020 if that trend is continuing. So you certainly -- certainly a breakout there from trend that is persisting through into futures prices and really goes to the thesis we had about the market 3 years ago that certainly the supply-demand balance is tightening, mostly, I think, on the supply side and in, certainly, thermal fuels, and that is leading to, certainly, over the medium term an elevated spot and wholesale market environment for market participants.

So we'll step through onto Slide 11. And this is really just looking at the Taupo Catchment now. The -- it's just graphing, [frequently], lake level across the financial year. The gray band really represents the range of storage or lake levels. You can see full is notionally just below 600 gigawatt hours, about 580 gigs is the full Lake Taupo level. And you can that history since Mercury has operated that catchment from '99 through to the current day. So typically, when we look at this, we're [once a peak in] catchment. We, on average, expect wet conditions through the July-September period. The driest part of the year is January through April. And you can certainly see that reflected in terms of the mean, which builds essentially up through to the Christmas period, New Year and then you see it falling back through April.

And that really reflecting the underlying hydrology of starting wet, moving to dry in terms of an expectation basis. So what you can see there in the ranges is, through Q4 calendar, so that is the period from October through December, you've got a tendency to drive the lake towards the fuller end of the range. That's in anticipation of the dry period that happens through summer. As we all go -- a lot of us still go down to Lake Taupo and certainly enjoy that Lake when it warms up. And you see the, particularly, storage drawn down typically over that summer and early autumn period. So that's a phenomenon that typically we look to optimize so that the lake level is protected from hitting that 0 level, which we fortunately have not done in the 20 years of operation that we have enjoyed. So that is a -- really just working through that dynamic.

You can see the wet conditions that persisted through July and August in the table. July, August and September there above average, which really was a continuation of bonanza hydro we experienced through '18, and then quite a rapid turn where you see negative inflows occurring quite strongly through that October to May period. So we were sitting in the very low percentiles, sort of in the bottom 2 or 3 sequences we've observed since records began in 1927 for the catchment.

Then turning to spot prices, you can see 7th of October, the world changed for the market. The gas outages -- but -- and we saw October prices spike to $300, hold up around $200 and then have trended somewhere in the sort of low $100 -- low to mid-hundreds thereafter from December through July and that continues. August we're tracking at the moment around $145. So we're still seeing those high prices in the spot persisting. And then you look at the futures prices at the bottom of that table and see how they have moved. So you had a tendency there to track around the sort of $70, $80 range on a monthly basis and then you certainly seeing those step up into quite high numbers. I think the interesting -- one of the interesting things to observe in this table is it took the market some time before it realized that the effects of October and November weren't just temporary. And that they were actually going to persist in terms of actually tightening in the thermal generation, and that has continued.

So that takes us through to the thesis, which is a slide on Page 12, which, again, working through, the supply and demand has rebalanced, while demand growth has been pretty staid. So we're really looking at flat demand, which will talk to you next. Certainly, we have seen a supply contraction. So if you look at gas constraints and pricing and in thermal availability, you are seeing quite a profound effect from April this year between the Huntly side and TCC down in New Plymouth. You've probably got a capacity there of north of 1,100 megawatts baseload. And those stations there are struggling to hit 700 megawatts average on a monthly basis. So you're certainly seeing lower gas generation, which is feeding into those higher prices. Spot gas is trending at about $12 a gigajoule. So again, almost double where we potentially were 18 months ago. So you're certainly seeing some effects there into the thermal market, difficult to see those abating in the short-to-medium term.

So I think gen development, and certainly you have seen an acceleration there not only by ourselves but also from some of our peers in terms of bringing new power stations to market. That didn't happen overnight. So we're potentially in an environment where you are looking at elevated wholesale pricing for at least the next couple of years. The conducive demand growth, if you take a longer term view, certainly, based on the reports from ICCC, MBIE, Productivity Commission, certainly expecting to see that fuel substitution from -- in transport and industrial process, energy to renewable electricity, which is certainly positive.

So potential for a reasonably significant demand growth through time. We have seen increased volatility in pricing, Monday, we saw prices again going into multi-hundreds. Futures prices have increased, and we've got a chart on that next. C&I pricing is happening now. Those renewing at this point in time, they are looking at pricing lifts of at least $20 a megawatt hour from the prices they enjoyed a year ago. So that is happening relatively rapidly. We have not seen a reduction in retail churn at all, so that is just -- retail churn has continued unabated in the low 20s. And so -- and as of yet, we still haven't seen significant upward pressure on retail prices.

So certainly when we look at what this means from our portfolio for Mercury, we do decide to -- particularly, we're vertically integrated. We make a decision how we will sell our output. These are really 3 choices. You can sell spot, you can sell to the C&I market or you can sell through to mass markets. And certainly, given these outlooks, spot and C&I looks like a better return than mass markets at this point. So that really flows through the final point that we are surprised you are still seeing very aggressive acquisition offers out in the market, which Fraser will touch on shortly. And our view is those offers are out of the money, based on a 2- to 3-year view of energy costs.

To demand, pretty straightforward chart here. You've got -- again, it's always a tug of war. Certainly Tiwai potline 4 starting up late last calendar year has been helpful, though, that's not running -- it's not really flowing through into an overall lift in demand. So you are seeing certainly industrials. So certainly industrials appear to be responding to the higher prices by slightly reducing their demands. So really you've got industrial volumes excluding Tiwai down and the other sectors flat to slightly rising giving us a basically flat curve year-on-year.

Finally, touching on those futures prices. So the line chart on the left on Slide 14, you can see a period of very low volatility in sort of medium-term futures prices. So prices in Auckland trending in a very narrow range of $75 to $80 a megawatt hour. And essentially, from January 19, a significant repricing really up to sort of low 100s. So a big, big step up. As discussed, that is feeding through into commercial and industrial renewal pricing. And you can certainly see those effects are persisting through FY '20 and FY '21. So that's certainly interesting. Mercury's view is we can't see other than very wet conditions that, that supply-demand dynamic is going to alter significantly over the medium term.

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Fraser Whineray, Mercury NZ Limited - CEO [6]

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Thanks, William. Just turning now to Slide 15 on retail competition. We touched on this, you are well aware of the proportion of our book that is retail, which is circa sort of 40% of sales and the value that, that contributes, which probably slightly less than 10% of the business at an EBITDAF level.

These churn rates are shown there where Mercury has, on trader switches, come much closer to the market. The last data point pushed up by a change to a Fonterra Farm Source contract. I'll touch on that shortly, but it is very competitive, particularly in Auckland. The neat numbers that people quote on churn, whether you're going forward or backwards by 1,000, of course, hide the iceberg of the 3,000 to 5,000 that every large generator retailer is losing every month in terms of customers [worth] looking for, I guess, in some instances, a matching or greater gain. So the core thing is to focus very hard on the in pipe and the out pipe to your retail customer base and think very carefully about the ones you're targeting and the ones you're trying to retain. And that certainly a lot of investment on IT systems throughout the year is helping us focus much harder on customer lifetime value and do the best for our loyal customers.

There's a lot of, as William touched on, competitive offers out there in the market. I think the challenging on realistic assumptions of churn to make work at the moment relative to other channels of spot and C&I. And as such, a slight relaxation in our portfolio from committed sales is where we're biasing it this time. And that was also as we look to link them slightly on average hydrology given the dynamics in the market are not too benevolent when it comes to running short positions.

On Slide 16, we just talk a bit more to the points I made earlier about trying to attract customers on headline pricing rather than discounted pricing and certainly reducing the depth of those discounts with our offered retention, and also we haven't touched our headline pricing since April 2018. So as a retailer, facing that large lift in futures prices, whether you're vertically integrated or not, you can think about do I increase my headline to deal with that cost impasse or do I deal with the fact that there's a whole bunch of acquisition pricing going on to actually compensate for yield overall. And you can see our position there. Just touching on Fonterra Farm Source, that's going to -- I think, going to be slightly north of 10,000 ICPs that come out with that. We used to have a partnership running there. That's a multiple sort of a panel approach that Fonterra Farm Source runs. And in the competitive market that it is, we did not renew that and -- which we're happy with. We were -- the farm accounts team to have quite significant load in Q4 calendar and Q1 calendar, and that's a key time. As William mentioned, when -- actually, we'd prefer Lake Taupo to be hitting slightly higher to deal with the autumn runoff there. So those pair of accounts are giving us a little more flexibility but not having them in Q4 and Q1. And of the 2,000 ICPs last month that we lost, probably selling for slightly less than $100 on energy yield, they're yielding us, as I speak, $185 by selling that power into spot market. And so that's a reasonable outcome. Capital allocation has been important.

I'll just hand over to William to talk about that.

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William Meek, Mercury NZ Limited - CFO [7]

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So we're now on Slide 17. Pretty simple histogram there really bridging operating cash flow and then uses of funds. So around $90 million or so in business CapEx, which we've already discussed, around hydro refurbishments, IT, et cetera. Ordinary dividends, $211 million; and then growth CapEx of $81 million being into Dundonnell and Turitea. So that -- those sum to $381 million against operating cash flow of $326 million, giving us a negative [doubter] of $55 million. We did divest our Metrix business for 200 -- giving us $270 million and debt repayments of $215 million. Certainly, Turitea, as we steer forward over the next 2 years, project costs there, $256 million.

Looking at the other uses of capital. Tilt Renewables, you may be aware, is looking to sell its interest in Snowtown II. Certainly, that looks like it should clear most of their core debt. So we're not expecting to see necessarily significant capital contributions required in the medium term in terms of Tilt to continue to invest in both New Zealand and Australia, which Fraser will touch on more shortly.

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Fraser Whineray, Mercury NZ Limited - CEO [8]

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So as I mentioned, 11 years of ordinary dividend growth and to take that out to say 20 years, you've got to keep on pursuing commercially responsible growth that is also aligned with the other 4 pillars that we run, as mentioned earlier.

So we made the commitment to the Turitea wind farm on the northern zone. It has got a wonderful intra-island alignment with the Waikato Hydro Scheme, which is [neat long] capacity with a peaking power of 1,050 megawatts and an average utilization of about 450. So that is a very nice coordination to put more energy against that long capacity system. But I note that, that coordination, in terms of co-optimization, isn't part of the business case -- it wasn't part of the business case for that, but we're certainly expecting some good benefits from leveraging that capacity in the Waikato Hydro Scheme, which we're reinvesting in further.

We think, as we've touched on earlier, the issues with upstream thermal supply or plant reliability and certainly the pricing of gas at the moment means -- and the ability to get gas commitments at the moment, means that many parties are looking at renewables as a cheaper counterfactual to provide not necessarily firm energy but certainly energy which they may be able to co-optimize with other assets. And that's an interesting dynamic, which is, as I might have mentioned, is a sort of a back-to-the-future moment.

The investment in Tilt Renewables significantly in the money, so it's going fine. We have governance representation now on the Board so that's good. And as I said, which is outlined in the first bullet there, we said this would be an active investment and it has been. Every sort of 5 or 6 months, there's something material happening. And I expect that we will continue to look actively at that investment to maximize the value that we get from it. We're pleased to see how the Tilt management and Tilt Board are going with adding value via -- in a fairly interesting Australian market. And I think it's helpful that it's a bit of interesting over there because that means that you've really got to be committed and disciplined and skilled to be able to create development margin.

Just turning now to the guidance. We've bridged it out there in terms of EBITDAF going through to $485 million. So taking about $10 million off for generation adjustment. That's largely due to geothermal. We've got some outages this year -- planned outages this year, which we didn't have last year. We lose the earnings from the Metrix divestment, and we've got a slight uptick in OpEx because we do have some of those additional outages this year in geothermal compared to last year. We've got quite a heavy program. And then we have a further growth in the core business taking us through to our guidance of $485 million on main hydro and geothermal generation, which is listed there.

The guidance on dividend, up 2%. That will be our 12th year in a row, so at $0.158 -- on growth, it's $0.158 per share. Stay-in business CapEx, $105 million. We've got a couple of wells going on which makes it a bit lumpier this year. And we also have 3 hydropower stations at various phases of refurbishment, Aratiatia and Whakamaru getting your last units and pre-work going on at Karapiro before we start taking units out there in FY '22 through to FY '24.

Before moving to Q&A, I just want to certainly mention the huge effort that's gone on from the people at Mercury and our partners this year and also you for your support and guidance as investors and analysts. It has been a very satisfying year but also a very challenging one for many of the reasons that we've already covered on this call.

I also, before going to the Q&A, just want to acknowledge our Chair, Joan Withers, who actually isn't in the room here today as is normally the case for the investor call. She's not normally here. Joan is completing a decade tenure as chair at the September ASM. She's shown a huge amount of courage, works harder than just about, I believe, any director in New Zealand at understanding everything, reading everything and thinking right across the business from customers to assets to partners and all of the pillars which we hold dear for our long-term value and sustainability of the company and has shown great courage and provided great support to the Board and the business throughout that period.

So we acknowledge Joan's tenure there. Those 10 years also happen to be the same 10 years which forms the trend for the ordinary dividend growth. Prue is -- Prue Flacks is going to be our new Chair. Prue has been on the Board of Directors since 2010, has strong knowledge of the business, a strong belief in the company and strong alignment with the directions we are going with having had good ownership of everything from the 5 pillars, the rebrand that we did in -- 3 years ago. And what the company is trying to do to continue to succeed. So I'd just note those governance changes and certainly acknowledge Joan's contribution over that period, as I'm sure you will do as well.

So with that, I'm happy to hand over to Q&A. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question today comes from the line of Grant Swanepoel from Craigs.

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Grant Swanepoel, Craigs Investment Partners Limited, Research Division - Director & Head of Research [2]

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Just a couple of questions. On your OpEx, so flat year-on-year. Do we assume that organic OpEx, excluding the geothermal outages, is going to continue in flat in nominal terms? Or can we look for improvements on that end? And then just my final question, just talking about your guidance bridge. Should I assume that a $485 million normalized if you take -- didn't have the geothermal outages, you can add back the $5 million OpEx and the $10 million generation adjustments? Actually, now you've got a $500 million normalized number. And in that context, if I recall, the start of FY '19, you were looking at an average hydro year and predicting or forecasting a $500 million EBITDA. Take off Metrix, you're at $472 million. So in effect, that $472 million now to $500 million, that's phenomenal growth. Or am I missing something?

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William Meek, Mercury NZ Limited - CFO [3]

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Okay. Thanks, Grant. I think I've got that. So I can answer that pretty simply. Around geothermal maintenance timings, so we are working through in terms of those timing. And historically, we've had -- it's been a little bit lumpy in terms of being sort of 3 stations versus 1. So we're looking to [frequently] smooth those through. So you either get 2 out one year and the other 2 out the following year. Sometimes, we may be able to push those to 3 depending on where we are around conditional or statutory inspections. So you -- this year is impacted by higher maintenance on those geothermals. But it's -- you're still going to end up with some volatility through time when you're talking -- but you're talking sort of small millions.

OpEx. In terms of base OpEx, at the moment, our forecast, I am expecting to see OpEx lift $5 million year-on-year. And then on a normalized guidance, in terms of getting to $500 million in terms of steady state, that would be a phenomenal lift. So you'll bridge there from last year. If we take last year's number guidance, this time of the year was $515 million, which included 200 gigawatt hours above main hydro, which should take you back to $500 million. And then you pull Metrix out which gets you, as you said, back to $472 million. We're currently steering at $485 million. So you have got an improvement in the core, which is that $15 million in the EBITDA bridge. But as soon as we look -- as you look forward, obviously, pricing ongoing efficiencies, but as a normalized number, $500 million, that would be -- in 2020, that would be large even with normalized geothermal maintenance.

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Operator [4]

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Your next question comes from the line of Aaron Ibbotson from UBS.

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Aaron Ibbotson, UBS Investment Bank, Research Division - Director & Research Analyst [5]

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So I have basically got one question. But I will split it into two. And that's slightly longer term on Turitea and on Tilt. So first on Turitea, I just wanted to know if you've had any reason to change any of your assumptions or if you're still thinking $30 million for the EBITDAF impact? And am I right in assuming that this is for FY '22 and that we should see maybe half of that in FY '21? So that's my first question.

The second question, which is Tilt and Turitea and dividend, is you've obviously highlighted that, in order to have progressive dividend policy, you need progressive earnings policy. So I'm a little bit curious to know how you want to guide us or how you want us to think about both Turitea and, in particular, Tilt when it comes to contributing to your dividend capacities. So with Turitea for starters, if I use your 70% to 75% -- 70% to 85% range, we could get anything from 0 to 100% of that, except $30 million in dividend. And when it comes to Tilt, I basically don't really understand when we're going to see anything of that $250 million capital tied up contributing to dividends but keen to hear your thoughts.

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William Meek, Mercury NZ Limited - CFO [6]

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Yes. So I'll respond Turitea. So assuming the phasing on Turitea hasn't altered, we're still on track for commencing commissioning late 2020. So that's where we are. Obviously, the EBITDA guidance was predicated on numbers that were probably more in the $80 range than the $100 range they're currently trending. So potentially at the front end, you've got some uptick there on a $20 price delta. But we'll see when we get there, who knows?

But certainly, the way things are pricing at the moment, you'd expect to see that revenue contributions will lift if prices persists because Turitea should be the first generation development project to complete commissioning. So there's no changes there in terms of where we're expecting Turitea to land. Certainly, given price outlooks at the moment, and we're resolving in the ongoing issues on gas and thermal generation, certainly the market prices are indicating there generation development is required. So -- and we're continuing to look about what that means for the southern zone and for Puketoi.

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Fraser Whineray, Mercury NZ Limited - CEO [7]

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Yes. So just on Turitea and Tilt, Aaron, that was a good question. When does money actually fly? Well, the cool thing with renewables, as you're well aware, is -- and you've done some great research on this, is that it consumes a lot of capital at the start for which you'd either need the equity or debt or a mix of and then you slightly dig your way out of that over time with the biggest mortgage on day 2. So whether it's Turitea or Tilt, it's kind of a similar thing. It's just that the Tilt investment is bundled up in a vehicle, which, if it grows, it will continue to reinvest and ultimately then that grows value that way. But against that value then, it also gives us probably better ability or better comfort to think about how our ordinary shareholders are remunerated from that.

And if it doesn't grow, it will have a lot of yield. Because like a Turitea investment would, which you wholly own, and there can be combinations in between, such as capital recycling, which is currently mooted, that Snowtown is under its strategic review. So either way, renewables do consume capital, which I know is a core part of your consideration of the investment thesis in the sector here, particularly if there is going to be some significant investment in renewable capital. But we think, through our own investments, that, that can be supported for growing dividends over time. And through Tilt, well, it's active. We said it would be active. And I still think there's a wide range of choices out there for value to be created beyond what the good management and Board of Tilt are actually doing.

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William Meek, Mercury NZ Limited - CFO [8]

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Sorry. But I think one of the questions was what does Turitea mean for dividend? So insofar as Turitea is lifting EBITDA and that's therefore lifting free cash flow, you would expect to seeing under the dividend policy that would flow through it in terms of the 75% to 85% of free cash flow. So I'd expect you'll get half of that appearing in FY '21 given a late 2020 commissioning and then you'll get a full year in '22.

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Aaron Ibbotson, UBS Investment Bank, Research Division - Director & Research Analyst [9]

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Okay. I guess I'll just spell it out my question then on Turitea. Because obviously, shareholders or whatever you want to call it are contributing to you building out wind. I personally had expected you to grow your dividend slightly faster than the sort of inflationary 2%. So my question basically is do you think you're likely to signal to the market that you don't have to wait 10 years for the sort of wind EBITDA to show up in the dividend? And within your 70% to 85% range, you obviously have the flexibility to do nothing or to do quite a lot with the dividend. So just to clarify, should we expect 70% to 85% then of that additional $30 million to show up in dividend? Or will it be consumed by your range? That is my question.

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William Meek, Mercury NZ Limited - CFO [10]

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Yes, sorry. Our expectation is that the increase in earnings from Turitea will flow down -- will flow into an increased ordinary dividend payment because you are going to get a step-change in earnings.

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Aaron Ibbotson, UBS Investment Bank, Research Division - Director & Research Analyst [11]

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That is crystal clear.

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Operator [12]

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Your next question comes from the line of Andrew Harvey-Green from Barr.

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Andrew Rupert Pelham Harvey-Green, Forsyth Barr Group Ltd., Research Division - Director & Senior Analyst of New Zealand Equities [13]

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A couple of questions from me. First one is just around the, I guess, the customer side and the retail side. Look, it looks to me that, I mean, you're certainly pulling back your EBITDA, I guess, on mass market space. And if you can just maybe, I guess, comment on the C&I sort of margins you're seeing and how they're that much higher than -- or are they than the retail margins you're getting?

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Fraser Whineray, Mercury NZ Limited - CEO [14]

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Yes. I could answer that. The C&I is largely, when it renews, is largely repriced off of where the ASX curve is or there or thereabouts. You're starting to see a little bit of a premium come back, I think, in the FPVV rather than CfD, which it should have a premium in it because the optionality that it presents to the buyer, and that got discounted away a while ago. So there's a bit more in that. So you don't really have margins on CfDs. Of course, it's, just to [further that], what it is, is a function of timing as to when you sell. So the yield is the yield in C&I, if you go and sell a contract today, would be superior to retail certainly -- acquired retail absolutely.

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William Meek, Mercury NZ Limited - CFO [15]

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Andrew, I think it all comes back to what's your view of forward price. And as far as I said, the futures price for commercial/industrial pricing is a good indicator. But certainly, all retailers can make their decision themselves. But if you're sitting there with forward price trending at $100, then a residential customer in Auckland is going to have an energy cost of about $115 a megawatt hour. That's just the energy cost before you even overlay cost to serve. And that's the challenge. And based on the offers we can see, we're just not seeing acquisition pricing delivering a yield that's anywhere near that number for residential.

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Andrew Rupert Pelham Harvey-Green, Forsyth Barr Group Ltd., Research Division - Director & Senior Analyst of New Zealand Equities [16]

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Yes. I guess the residential side is somewhat of a longer-term game, though. So I mean, how do you, I guess, kind of factor that thinking in? And I guess the numbers have been falling back there, the volumes have been falling back quite a bit. And it is quite expensive to get back into it, if you do want to get back into it in a bigger way. So I mean how do you think about it from that sort of long-term perspective?

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Fraser Whineray, Mercury NZ Limited - CEO [17]

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Well, the cost of getting back into it and the cost of getting out of it is -- remember that it's a net thing. Everyone is spinning their tires on swapping 4,000 customers a month. So you can get back into it if you want to get back into it and chase volume. And I know it's a long-term game on average with your book. But it's not with an acquired customer because you create a moment of truth when the acquisition pricing runs out 2 years later and half of those customers will leave you. And so then you're looking at 2 lots of having cost of acquisition plus the discounted cost to serve in the meantime when you're under water on buying on that power of spot or hedge markets, if you're looking at a true counterfactual.

And then you try and put the [mark], in terms of pricing, to some sort of normal pricing to match what your existing customers would pay. And you find that it won't stack up. So you can actually get back into this when you want. What we're focused on is, if you look at the overall total yield of that book, there's 2 ways to adjust it. You can look at your headline pricing or you can look at discounts, which don't actually go to your existing customers and so against our 3 customer promises and thinking about the pressure that's come under the spot and wholesale markets. Particularly, the last year, I think the spot market averaged, what, $140, $150. Every sale was under water against that. Then we're confident, if we need to push play on that, we will.

But at the moment -- so I think everyone gets quite obsessed with net numbers. I think it's probably better that everyone publishes gross numbers because then I think then we'd get a better focus as to just how much money is being spent acquiring a whole bunch of customers. And a lot of that money isn't, as you know, Andrew, turning up in OpEx, it's getting capitalized, not here, but it's -- to any great extent, but there's a lot of stuff on balance sheets which is masking that dynamic. And any salesperson, even in your shop or cars or telco, that will add volume. And I think we're in exceptional circumstances here around thermal fuel supply and constraints. And so I'm kind of aligned with William in terms of I'm surprised churn is still running at 20%.

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Operator [18]

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Your next question comes from the line of Stephen Hudson from Macquarie.

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Stephen Hudson, Macquarie Research - Head of Research [19]

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Mine are sort of iterations on what have been asked, but I'll try and rattle through them and get your response. The 70% to 85% free cash flow payout range, you're obviously higher than that this year and next year, and there's a lot of moving parts. But what's your best guess at the moment as to when you return to the middle of that range, assuming that, that range is still sort of relevant? In terms of geothermal, I think you talked about, pre the maintenance program that you've announced today, sort of a 2,800 gigawatt hour per annum geothermal number. I just wondered if you can give us an idea on when you return to that level and if there could be some efficiency gains. Just in terms of the $15 million growth wedge on your guidance, can you give us an idea of how much of that is pass-through business trading? And then just finally, your NZU cost this year, can you give us that number and what you're expecting that to be next?

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William Meek, Mercury NZ Limited - CFO [20]

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That's a lot of questions. So yes, the dividend this year is slightly outside that range. If you actually take the actual CapEx number on a normalized basis, it falls within. So the policy is on average. So it is smooth. So we're not concerned about certainly that range causing us an issue. And we expect to see earnings growing for a time, so not just from [G&D] but in terms of yield and in financial performance of the firm. But that's a work in progress.

The $15 million growth in the bridge, I mean, that's just a combination of a whole lot of factors. It's just small improvements everywhere. Certainly, yield is a chunk of that. But it's just better performance across our core business. Some of that will be in trading, some of that will be in mass markets, it's just everywhere, lift in C&I prices, et cetera, et cetera. NZU costs, we've got long-term forestry contracts that are in the sort of -- certainly below the cap of $25 but in the sort of $20, $25 range.

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Stephen Hudson, Macquarie Research - Head of Research [21]

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And the 2,800 gigawatt hour geothermal number, is that the right number? And when do you think you will return to that?

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William Meek, Mercury NZ Limited - CFO [22]

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Yes. So that's -- on a normalized basis, 2,800 is correct, yes.

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Stephen Hudson, Macquarie Research - Head of Research [23]

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And sorry, will it be below that level for the next 5 years?

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William Meek, Mercury NZ Limited - CFO [24]

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No.

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Stephen Hudson, Macquarie Research - Head of Research [25]

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But I think you've guided for 2,600.

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William Meek, Mercury NZ Limited - CFO [26]

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So you may -- yes, you see when you look at the operating stats, our 25% stake in Tuaropaki Power Company is worth 200 gigs. So that doesn't obviously impact EBITDA because it's below the line and because it's equity accounted. So 2,600 gigawatt hours would be the normal range for our normal accounted or our owned geothermal.

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Stephen Hudson, Macquarie Research - Head of Research [27]

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So it's on a consolidated basis.

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William Meek, Mercury NZ Limited - CFO [28]

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Yes. If you take everything, you add another 200 for TPC.

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Operator [29]

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Your next question comes from the line of Nevill Gluyas from Jarden Limited.

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Nevill Gluyas, Jarden Limited, Research Division - Director of Equity Research [30]

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Easy question for me, I guess. You've talked about the growth, which in the guidance, I guess, we would expect, if you believe the ASX forward curve for year 2, year 3 ahead, you would still get some continued gains in the C&I book, particularly if you start biasing your sales that way for year 2, year 3. And I was just wondering if you sort of could give some order of magnitude on that. As a sort of a side question, maybe to clarify, what have you assumed in terms of ASX or forward pricing in the guidance you've given?

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Fraser Whineray, Mercury NZ Limited - CEO [31]

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Well, a lot of the year-ahead stuff on the next financial year is largely squared away. So years 2 and 3 and kind of year 4 as we roll through this year, we'll start to look at pricing stuff for '21, '22, '23 unless something comes up now which has got a significant forward start because we're trying to ease a bit of our portfolio linked through to the commissioning of Turitea when we get another sort of 470 gigawatt hours of energy in net length. So there is a -- so in the guidance we've given, that's largely in the book. That's not really relying on any renewable assumptions for C&I.

And we'll be largely looking at ASX pricing and looking at our internal spot price and wholesale price views for working out what we have beyond those years. But yes, it does roll through. Apart from a very significant long or quite substantial long-term contract of about 700 gigawatt hours, the balance rolls about every 3 years. So you will -- if those prices remain at $100, $110, then you'll see that flow through into the C&I book. The C&I book is about...

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William Meek, Mercury NZ Limited - CFO [32]

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2,500 gigs.

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Fraser Whineray, Mercury NZ Limited - CEO [33]

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2,500 gigs, excluding that large contract. And so 2,500 times $10 is $25 million.

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Operator [34]

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There are no further questions at this time. I would now like to hand the conference back to today's presenters. Please continue.

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Fraser Whineray, Mercury NZ Limited - CEO [35]

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Right. Well, look, thank you once again for joining us for the FY '19 Mercury Annual Results Investor Call. We appreciate the questions and the engagement and looking forward to catching up with many of you over the coming weeks both here and also in Australia and then, for any of those further afield, in November to December for other jurisdictions. If you've got any other questions and comments, please don't hesitate to get in touch with Tim Thompson, who is our Head of Treasury and Investor Relations. And we wish you a good day. And thanks very much for your time. (foreign language)