TransAlta Corp (TAC) Q3 2020 Earnings Call Transcript

TransAlta Corp  (TSE: TAC) Q3 2020 earnings call dated Nov. 04, 2020

Corporate Participants:

Chiara Valentini — Managing Director, Strategic Finance and Investor Relations

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Todd Stack — Chief Financial Officer

Brett Gellner — Chief Development Officer

John Kousinioris — Chief Operating Officer & President of TransAlta Renewables Inc.

Analysts:

Maurice Choy — RBC Capital Markets — Analyst

Rob Hope — Scotiabank — Analyst

Mark Jarvi — CIBC Capital Markets — Analyst

Ben Pham — BMO — Analyst

Andrew Kuske — Credit Suisse — Analyst

John Mould — TD Securities — Analyst

Dariusz Lozny — Bank of America — Analyst

Dan Healing — Canadian Press — Analyst

Naji Baydoun — Industrial Alliance — Analyst

Presentation:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the TransAlta Corporation Third Quarter 2020 Results Conference Call.

[Operator Instructions]

I would now like to hand the conference over to your speaker today, Chiara Valentini, Managing Director, Investor Relations. Thank you. Please go ahead.

Chiara Valentini — Managing Director, Strategic Finance and Investor Relations

Thank you, Mariana, and good morning everyone and welcome to TransAlta’s third quarter 2020 conference call. With me today are Dawn Farrell, President and Chief Executive Officer; Todd Stack, Chief Financial Officer; John Kousinioris, Chief Operating Officer; Brett Gellner, Chief Development Officer and Kerry O’Reilly Wilks, Chief Legal, Regulatory and External Affairs Officer.

Today’s call is webcast and I invite those listening on the phone to view the supporting slides that are posted on websites. A replay of the call will be available later today and the transcript will be posted to our website shortly thereafter. All the information provided during this conference call is subject to the forward-looking statement qualification set out here on Slide 2, further details in our MD&A and incorporated in full for the purposes of today’s call. All amounts referenced during the call are in Canadian currency, unless otherwise stated. The non-IFRS terminology used, including comparable EBITDA, funds from operations and free cash flow are also reconciled in the MD&A for your reference.

On today’s call, Dawn and Todd will provide an overview of the quarter’s results, along with expectations for balance of the year. And after these prepared remarks, we will open the call for questions. With that, let me turn the call over to Dawn.

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Good morning everyone and thanks for joining us on our third quarter call here in 2020. We have some great third quarter and year-to-date results to report. And as well, we have a number of very key and important updates and accomplishments on our strategy of becoming Canada’s leading clean electricity provider. I’m going to start with our strategic updates and then I’m going to turn it over to Todd for the numbers. During the quarter, the Board and management of TransAlta made several key decisions that we announced this morning. They’ve included that we’ve determined we can now close the Alberta Highvale Mine effective December 31, 2021. This decision advances our goal of being off thermal coal in Canada by four years, originally 2025 but now by the end of 2021. All Alberta power plants will now run only on natural gas, starting January 1, 2022. Our only coal plant after the end of next year will be Centralia, which has a long-term contract supporting this cash flow, and we have a transition agreement on greenhouse gases in Washington State until the end of its life in 2025. In Q3, we also made the final investment decision on Sundance Unit 5 repowering. This 730-megawatt project is estimated to cost between CAD800 million and CAD825 million and will come online in Alberta in the fourth quarter of 2023. The team has advanced the project substantially throughout the year and we’ve received Board approval to build the project and I’m pleased to tell you today that we’re on track.

Our gas conversions are also on track with Sun 6 in its final stages of testing. Everything is proceeding extremely well. We’ll be completely — we will complete the full commissioning by mid-November, in just a couple of weeks. The Q2 — the K2 and K3 conversions are on deck to be completed next year. On our ESG front, our greenhouse gas emissions will be under 11.5 million tonnes by the end of 2022, down almost 70% from 2005. I want to be very clear TransAlta has more than met its fair share of the Paris Agreement. To date, we alone have delivered 10% of Canada’s goal of a 220 million tonne reduction for Canadians by 2030. We’ll begin the conversation today about our plans for additional reductions as we work with customers to help them achieve their ambitions to reduce their own greenhouse gases. And due to the outstanding work by our finance team to raise project debt at South Hedland, we have created even more strength in our liquidity, which has never been stronger, all this at a time when there is great uncertainty due to COVID. This sets us apart as a company in which to invest. We are positioned with the cash we need to continue to grow RNW and to fund our growth at TransAlta. We have positioned several assets as potential dropdowns to RNW and hope to make an announcement in the coming months. We also — we will also provide further updates to on our project pipeline and what’s next on the growth side.

On gas supply, two important milestones were met. We and Tidewater entered into agreement with ATCO to sell Pioneer Pipeline for CAD255 million. The transaction is expected to close in the second quarter of 2021. The TC team also received regulatory approval for the NGTL 2021 Expansion Project, which expands our supply options and helps us manage future pricing volatility. TransAlta Corporation has been a leader in the deployment of innovative renewable technologies for decades. We were a pioneer in Canada in the deployment of wind power generation and we’re now growing our renewables’ fleet with commercial — with a new addition of a commercial operation of our wind charger battery storage system. This is Alberta’s first utility scale battery storage project and it’s a truly renewable system as it’s powered by the Summerview wind farm. The Board also approved a diversity and inclusion pledge, which has developed — which was developed by our frontline Diversity and Inclusion Council. Great work by that team to get us point — clearly pointed at the future and set the foundation for our goal to have 40% of our workforce female by 2030. Finally, but just as importantly, we delivered excellent financial results that demonstrate our continued drive to generate free cash flow for investors. I think this is the third quarter in a row which we’ve been over CAD100 million of free cash flow. So congratulations to the hard working TransAlta team that made that so [Phonetic]. By the end of the call, it will be very clear TransAlta is a leader in clean electricity and should be a sought after investment by those who are interested in companies that deliver on economics and ESG. We call it E-ESG or E squared SG and we’re very proud of the work we’ve all done to get us here today. Our work to convert our Alberta fleet to gas, our ownership in Hydro, our ownership in RNW, our innovative work with customers and the clear advantages we have with our marketing and trading team have created a strong and diversified portfolio of investments that have held up through a pretty interesting 2020. Frankly, the team at TransAlta hasn’t missed a beat.

Now, I know the investment community is familiar with most of the projects that we’re investing in. So I won’t go through them line by line, but I want to provide you with a couple of updates. Our Skookumchuck Wind Project is close to completion and we expect commercial operation to be imminent. Our 49% ownership option will be executed shortly thereafter. Construction on Windrise, our contracted wind facility here in Alberta is 45% complete and we began receiving wind turbine generators on-site in mid-October. We’re advanced on the Kaybob Cogen project. And as I said earlier, for Sun 5, we received approval to proceed and are targeting commercial operation by fourth quarter 2023. Now we’re typically pretty conservative in terms of what we tell you about what’s in the development pipeline and we often only tell you of our projects once they’re signed, sealed and delivered. But we thought today that we — because we have a lot of development potential at TransAlta behind the scenes, that we’d highlight some of that. We have over 500 megawatts of growth projects that are in various stages of development. This is a great amount of growth potential and our business development efforts set us up well to generate growing returns for the considerable future. This is the first time we’ve provided details on many of these projects. We have a dedicated development staff that continues to advance, all of our prospects from PPAs, wind studies, permitting to transmission access and our goal continues to be to target to 200 megawatts to 400 megawatts of development projects per year and we have the cash and the financial capability to achieve this goal.

Now as I summarized earlier today, we announced that we will be entirely running on natural gas in Canada by the end of 2021. This is a tremendous milestone for us and a major step forward in delivering on our Clean Energy Investment Plan. This decision is the concluding chapter of our thermal coal legacy here in Alberta and further demonstrates our commitment to our Alberta customers that their electricity is moving towards carbon-neutral. Recent and upcoming milestones on this journey include retiring Sundance Unit 3 on July 31, 2020, completing the boiler conversion of Sun 6 with full gas firing and which is currently in testing in commissioning mode. Our boiler conversions next year for Keephills units 2 and 3, gas firing Sundance Unit 4 and Keephills Unit 1 in 2022, although these units will be derate [Phonetic] to run fully on gas, we have sufficient ability in our portfolio, which is a flex [Phonetic] to all of our capacity to ensure that we can fully optimize the fleet and serve the market here in Alberta and finally, of course the repowering of Sundance Unit 5.

Now, as you can see from this slide, TransAlta has made tremendous progress as an organization in reducing our greenhouse gas emissions, especially in comparison to international agreements, compared to our peers here in Canada and to the rest of Canada, I’m sorry, to our peers here in Alberta and to the peers in the rest of Canada. By the end of 2022, we will have achieved 32 million tonne reduction in greenhouse gas emissions from the 2005 levels across our worldwide fleet. Of that, 21 million tonnes have been reduced in our Canadian operations. As I said earlier, overall, we’ve contributed 10% to the Paris target set by the Canadian government. We are among a very few companies in Canada to achieve such significant reductions and in doing so, we are a clear leader in supporting candidates’ commitment to the Paris Agreement. We are outpacing the rest of the province and the country by significant margins and we’re not done yet. The pace of change in renewable energy technology is accelerating at an unprecedented level. We know that we can be long-term partners with our customers to provide green electricity and help integrate these new and leading technologies into their power supply. This roadmap describes how we’re conceptualizing the delivery of these technologies and implementing them with our customers. We are working with customers like BHP in Western Australia where our recent contract replacement and extension at Southern Cross energy recognizes the value and the need for integrating renewables to supplement base load requirements that industrial customers need for their operations. As we look at the mid 2020s, we’re dusting off our prior work on carbon capture and storage that we’ll be using to understand its potential value and supporting a future renewables build-out here in Alberta. We’re also relooking at the economics of Brazeau pump storage. It’s a potential 900-megawatt battery that has the potential to start wind and solar here in Alberta and provide firm green electricity. We are currently working with customers who may be interested in buying firm green electricity from Brazeau in the future. And we have a team that works directly with flow battery companies and we expect to make investments there in the coming years.

There are many technologies in various states of commercial readiness and we stand ready to make necessary investments as they become more commercial for our customers. On hydrogen, many players are going to invest substantial dollars in creating hydrogen, we’d like to be one of the first power companies to plan hydrogen into our facilities and we’re working with potential partners today to see what opportunities may now be available.

Before I turn over the call to Todd., I want to take a moment to summarize the key takeaways from this call. We are moving our corporate transition forward on an E squared SG principle, E for economics, E for environment, S for socially responsible and G for governance. TransAlta’s track record on greenhouse gas reduction is indisputable. ESG investors should be looking carefully at TransAlta for their portfolios. We are moving into an ESG focused investment space and are set to continue to deliver impressive emissions reductions in the country. We are one of Canada’s largest suppliers of renewable electricity and our new goal is to focus on firm green electricity supply which will take us a decade to achieve a great long-term goal for the team. We have a proven track record of commercializing new and innovative technology and we’ll continue to be a trusted partner for our customers. And finally, we’re committed to building a strong and modern organization free from discrimination and systemic barriers.

So now let me turn it over to Todd, who will give you more color on the numbers.

Todd Stack — Chief Financial Officer

Thanks Dawn, and good morning everyone. Before I jump into the details, I just wanted to echo your comment that our portfolio delivered great performance both in Q3 and on a year-to-date basis. The company is in a very strong financial position and we’re on track to deliver free cash flow near the high end of our guidance range.

Looking at Slide 13. The charts include several of our key metrics. For those listening, you may recall that last year in the third quarter, we received the residual PPA termination payment of CAD56 million that was awarded to us for the Sundance Units 3 to 6 arbitration. In order to provide a more accurate comparison of relative performance, the figures that I’m going to reference on our call will exclude the PPA termination payment.

During the quarter, we generated incredibly strong EBITDA and free cash flow due to contributions from all our business segments and were indicative of the resilience of our operations, our hedging and energy-marketing capability and our portfolio diversification. EBITDA of CAD256 million in the quarter was up 3% versus 2019 at free cash flow was also very strong at CAD106 million. Year to date, we’ve generated CAD306 million of free cash flow, which is almost CAD50 million better than 2019 on a comparable basis. Free cash flow per share is at CAD1.11, which is a 22% increase over 2019s nine-month performance. All in all, a very strong performance from the business so far in 2020.

On Slide 14, we’ve laid out our Q3 and year-to-date performance by segment. As you can see, we had strong performance across the fleet and total segment cash flows were in line with last year for the quarter and significantly ahead for year-to-date performance. This strong performance was primarily a result of the following. The Centralia segment performed very well, and more than made up for weakness here in Alberta, again, showing that diversity of regions, contracts and technologies can provide overall stable cash flows. Our 2019 investments in Big Level and Antrim as well as the recent acquisition of Ada are delivering cash flows as expected in the wind and solar segment and in the North American gas segment. I would like to congratulate our Energy Marketing team on their outstanding performance in Q3. The investments we’ve made in this business over the past 20 years has positioned us to capture opportunities across all power markets in North America. Their results in Q3 were fantastic. Their ability to capitalize on their energy-marketing capabilities is a major asset to the company. This strong performance was partially offset by expected lower cash flow from the Alberta thermal fleet. Segment cash flow decreased by CAD47 million and was partially due to higher sustaining capital spend during the gas conversion at Sundance Unit 6, which is expected to wrap up later this month. The fleet delivered strong realized prices consistent with last year. However, we are seeing gross margin pressures in the Alberta thermal business as we transition to shut down the mine. As we move towards the last phase of our mining operations, we will see continued pressure on our per ton coal costs as our mine delivers fewer and fewer tons of coal across the fixed cost base of the mine. At the same time, we expect to see increasing cash from working capital as our remaining coal inventories get utilized.

Our corporate segment was flat quarter-over-quarter, but up CAD9 million on a year-to-date basis due to the realized net gains in 2019 from the total return swap. Adjusting for the total return swap impact, our corporate costs were down almost 10% on a year-to-date basis. I’m pleased with our ongoing cost reduction efforts across the company and our ability to take on new assets with no impacts to corporate overhead. Slide 15 summarizes the current financial strength of the company and highlights just how much free cash flow the business generates. At CAD306 million of free cash flow to date, we are tracking to deliver towards the high end of our guidance range. Liquidity was strong at quarter end at CAD1.6 billion and we added significantly to this in Q4.

In October we closed the second tranche of the Brookfield investment for CAD400 million and we also closed the CAD800 million Australian dollar financing from the South Hedland Power Station. This sets us up extremely well to fund our gas transitions, deliver on our renewables growth plan and return capital to shareholders through the share buyback program. As you can see on the chart on the bottom right, over the past few years, we’ve been focused on reducing our corporate senior recourse debt levels in preparation for a fully merchant market. We are on track to meet this goal and have significant cash available to repay the bond maturity in November.

On Slide 16, you can see that spot market prices in the quarter averaged CAD44 a megawatt versus CAD47 in 2019. As I outlined last quarter, our base load generation was fully hedged for the Q3 and the team was able to optimize dispatching around those hedges. We continue to see slightly lower load demand in Q4 due to the ongoing impact of COVID and are highly hedged for the balance of the year. Looking ahead to 2021, we continue to see constructive factors for Alberta power prices as compared to 2020. First, with the end of the Alberta PPAs, roughly 2,400 megawatts of thermal capacity reverts to the asset owners on January 1. As you know, in order to recover capacity costs, we anticipate plant owners will structure their energy offers accordingly to reflect the recovery — for the return of and the return on capital as there is no other mechanism outside the price of energy to do so. In addition to the end of the PPAs, we expect price support from three other factors. First, we expect some additional demand recovery in 2021. Second, we expect higher scarcity pricing due to a significant number of facility outages and coal to gas conversions. And finally, we expect the provincial carbon tax to increase to CAD40 per tonne to remain in line with the federal program. This raises the cost of production and must be recovered through higher power prices. Over the past quarter, we’ve seen the 2021 forward curve strengthen about 10% from CAD51 a megawatt to CAD56 a megawatt. In particular, we see stronger prices in Q1 at over CAD62 with some peak hours priced above CAD70.

Moving to Slide 17, we provided our update on hedge levels. And based on prices strengthening for Q4 and Q1, we’ve added on to our hedge positions. For the balance of the year, our Alberta thermal base load generation is now hedged for Q4 at approximately 90% at CAD53 a megawatt hour. For the first quarter of 2021, our hedge levels are now over 40% and an average hedge price of CAD60. I know I’ve spoken at length on the Alberta market, but I want to reiterate that we see strength in the forward market prices and are well positioned to capture increasing margin in periods of tightening market supply and increased price volatility.

To close of our presentation, I want to highlight what I think makes TransAlta a highly attractive investment and a great value opportunity. First, as Dawn pointed out, we are a leader in GHG emissions reductions underpinned by a high quality and highly diversified portfolio. We have the largest hydro fleet in Alberta and we’ve been operating for over a century. We are well positioned to capture market upside post PPA. The business is supported by a highly contracted renewable portfolio that is complemented by our world-class energy marketing capabilities. The company has a very strong financial foundation. Our balance sheet is in great shape, we have ample liquidity, we’ve continued to maintain capital discipline in our growth investments and the company has a track record of generating strong free cash flow. We believe the company is at an exciting milestone and we are well positioned for the future as a leader in clean electricity production.

With that, I’ll turn the call back to Chiara.

Chiara Valentini — Managing Director, Strategic Finance and Investor Relations

Thank you, Todd. Mariana, would you please open the call for questions from analysts?

Questions and Answers:

Operator

[Operator Instructions]

Your first question comes from Maurice Choy with RBC Capital Markets. Your line is open.

Maurice Choy — RBC Capital Markets — Analyst

Thanks and good morning. My first question is on, I guess the guidance, you just had a very strong Q3 results, yet also reaffirmed your guidance for this year. Can you discuss as Q3 was in line or better than your expectations and depending on that response, are there any things that you are keeping a close eye on for Q4 that motivated you to reconfirm your guidance range?

Todd Stack — Chief Financial Officer

Yes. Maurice, I think clearly our guidance range for free cash flow was CAD325 million to CAD375 million, and sitting at CAD306 million, we’re very bullish on coming in at the high end of that program. We do still have a significant amount of capital, sustaining capital, Sun 6 turnaround and conversion is still ongoing. There’s still money to be spent in Q4 on that. So we do have a high capital spend. That’s something that’s definitely laying into our forecast for the balance of the year. And on top of that, we did have some use, our sustaining capital guidance go down, a lot of those just shifting when we move the K2 and the K3 conversions slightly next year, delay them by a month or two each, it moved a bit of the capital into 2021. So that was part of the reason for that. Not just reducing and rationalizing sustaining capital. It was a bit of a timing delay on those as well. So I think capital, we’re paying attention to. As I mentioned, we’re highly hedged in the Alberta market, but really looking for opportunities to generate some upside potential in the Alberta business.

Maurice Choy — RBC Capital Markets — Analyst

Makes sense. And my final question is about, I guess, capital allocation and opportunities, particularly given that you have the CAD2.7 billion liquidity. It sounds like you’re also going to be able to introduce some drop-downs in the coming months. You’ve introduced an extra E to ESG and Slide 10 has a number of attractive opportunities for you to improve your ESG profile. Wonder if you could discuss broadly the costs of returns, potential partners for some of these opportunities and if there is a preference for contracted versus merchant cash flows?

Todd Stack — Chief Financial Officer

I just wanted to touch on liquidity there. Maurice, you mentioned the CAD2.7 billion which we do — keep in mind, we do have the CAD400 million bond maturity coming up here in November. So I don’t want you think will be at CAD2.7 billion at the end of the year and we are looking for the Skookumchuck project to complete, which will also be a capital expenditure in the balance of Q4 here.

Dawn Farrell — President, Chief Executive Officer and Corporate Director

So Maurice, I’m going to start and then I’m going to let John and Brett also chime in here, because I think it’s an important question. So the reason I’m going to give the extra E, I’m going to give that credit to Mac Van Wielingen over at ARC Financial. He’s written a number of papers on that and I wrote him last night and said, I’m stealing your idea, which I wanted to do because I do think it’s important as people reinvest cash into the future that’s coming, which there is a lot of talk about this net zero by 2050. It is important that there is economic cash flows to be reinvested into that future and there’s just not enough money available in the world to not do that in a very sustainable and economic way. We would all else being equal, this team tends to go after contracted assets. We are very bullish on Sun 5 mostly because we also have a good hedge there [Indecipherable]. So we tend to always favor that overall. And so, what I’ll do is I’ll maybe turn to Brett on how he is thinking — how he has seen returns on the growth side and then John, any comments that you would have.

Brett Gellner — Chief Development Officer

Yes. Thanks. Yes, we’re seeing a number of opportunities out there especially as people focus on the ESG as Dawn pointed on the customer side. So not just here in Alberta and rest of Canada, but United States in terms of looking for renewable projects. And so we do see good opportunities. Now again we’re going to continue to be disciplined like we’ve been in the past. We’re not going to chase low returns. And the contracted tenure tends to range between that seven and 15 to 20-year period. So again is there a portion of merchant or post-PPA risk that we have to factor in, we do, but we then factor that into the return expectations of the project. I think if you’re looking at Cogen projects, generally those are well contracted. There might be a component of merchant associated. But as you know they have steam and electricity components to them. So generally that’s how we approach those projects. And again, we like those kind of projects because of our position. The bigger projects that are further out like Brazeau, clearly we’ll be looking to contract up to initiate those. Those are big, big projects, but we think very important projects. So it’s a mix, but I echo what Dawn says. Generally we’re focused on contracted-type projects.

John Kousinioris — Chief Operating Officer & President of TransAlta Renewables Inc.

Yes. I don’t really have a lot more to add to that, Maurice. The one thing I would say is when talking about partners, we’re not against bringing other partners into our projects. We tend to do it alone. But when I think of partners, I think of our customers as being partners and the one area that we didn’t talk much about is just the potential growth that we’re seeing in Western Australia, our relationship with BHP. We do see them as a partner and our ability to do a bit of solar for them and potentially work to renew some gas and steamers for them is very, very important to us as we move forward. So when we think of growth, we do think of it in terms of partnerships with our customers.

Maurice Choy — RBC Capital Markets — Analyst

Great. Thank you very much.

Operator

Your next question comes from Rob Hope with Scotiabank. Your line is open.

Rob Hope — Scotiabank — Analyst

Good morning, everyone. Just a clarification on Maurice’s question. The MD&A says the midpoint of free cash flow guidance and I think you highlighted the upper end. I just want to confirm that?

Todd Stack — Chief Financial Officer

Yes. I do see between the midpoint and the upper end, I’m actually seeing towards — closer towards the high end now.

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Yes. And I just think — just to add one thing. We do have two big outages next year again with K2 and K3. And there’s always an opportunity potentially, especially with COVID. The team may want to do a little more pre-buying in Q4 and spend a little more capital just to make sure that everything that we need is ready to go. So I think, the team is looking at a little bit of flexibility on the capital side there as we go into Q4.

Rob Hope — Scotiabank — Analyst

Okay. And actually that’s a good segue to the capital side. So with the Hedland financing which arguably would be more than the market would have anticipated maybe even yourselves, the pioneer sale and potential future dropdowns, you look a little overcapitalized here. So, how do you think about investing in future projects versus some capital drag in the near-term here versus share buybacks?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Yes. It’s a good question. I mean, for sure TransAlta is really going to — has really got some great opportunities ahead of it here. And our investment path at TransAlta is really well known. I mean, you know what we’re doing on K2 and K3. I think, you know what we’re doing on Sundance Unit 5. So really the team, as it looks at — there’s a couple of considerations on that. If you look at the way the company is set up, I mean, we are fundamentally going to be a gas and renewables company by the end of next year. And if you look at the kinds of projects that we look at, some of them fit. We see very clearly projects that we look at that fit very well into RNW and some other projects potentially fit into TransAlta, because we have tax benefits and other things in TransAlta as well that we want to use up. So we’ll be looking at that. But broadly, with the amount of capital that we’ve brought in, it does — it means that we’ll have to consider more carefully our capital allocation relative to dividend growth at TransAlta and share buybacks. So I think you’re on the right track in terms of thinking about that Rob.

Rob Hope — Scotiabank — Analyst

All right. And then just one final one. Just layering on some hedges, good to see the additional disclosure on the hedges in the early part of 2021. But hedging does kind of fall off in the balance of the year. Is that just a view that you want to see the forward curve kind of move up in the balance of the year to reflect, what your view of the fundamental power price should be?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Yes. It’s kind of two things that go on. I’ll set it up and people can add here. So first of all, it is Alberta. And frankly hedges — the liquidity of hedging in Alberta only really opens up a quarter maybe a quarter-and-half ahead of a quarter. So when you see them dropping off, it’s because really the liquidity in the three quarters after the first quarter is pretty low and there’s not a lot of transactions that take place there. That’s number one. And then number two, absolutely for sure, we think as price formation goes through the year there’s more opportunity. So the team — our team is very good at figuring out when to take some hedges off the table. I don’t know anybody, wants to add?

John Kousinioris — Chief Operating Officer & President of TransAlta Renewables Inc.

No. I mean, I think that’s right. We’ve seen liquidity sort of recover and be constructive for Q1, which is why we’re layering hedges that are now, I think Dawn, we’re around 45% hedged for Q1 of next year. And we are noticing that liquidity for the second quarter is beginning to ramp up as well. And we’re just being pretty disciplined from a price perspective. It’s quite a big change that’s happening in the market next year, and there’s no point from our perspective given where we think fundamentals are. Todd touched on all the things that he thinks will impact the market next year to rush ahead and hedge a position at prices that we don’t think would be appropriate.

Rob Hope — Scotiabank — Analyst

All right. Appreciate the color. Thank you.

Operator

Your next question comes from Mark Jarvi with CIBC Capital Markets. Your line is open.

Mark Jarvi — CIBC Capital Markets — Analyst

Yes. Good morning, everyone. Just with the Keephills 1 and Sundance 4 moving to gas only and the derate, how much of those units have to run to actually breakeven current fuel costs and power prices? Like, is this essentially a quasi mothball or do you actually think that those units will be quite active?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Yes. I mean, frankly we don’t really break it down unit by unit. We run it as a portfolio. So it’s really the optionality of those units in the portfolio. So, as the asset optimizers look at how to set-up for the various weeks days, hours, they’ll have different strategies in terms of whether or not they’ll have those units on or off, on standby. But currently, they’ve determined that having them in that state on gas is beneficial to the portfolio.

Mark Jarvi — CIBC Capital Markets — Analyst

Okay. And then, you just talk about power price hedges and whatnot. What’s the current perspective and you talked about your gas transportation, where are you guys on any fuel cost hedges for next year?

John Kousinioris — Chief Operating Officer & President of TransAlta Renewables Inc.

So in terms of next year, I think we are pretty much entirely hedged for the first quarter. It then drops off a bit I think for quarters two through four. We’re at about 60% hedge level there Mark. And then in terms of prices, I would say that our prices sort of for the first quarter would be roughly in that CAD290 million [Phonetic] range. And then for the balance of the year they’re kind bouncing around that kind of CAD250 million, CAD260 million range.

Mark Jarvi — CIBC Capital Markets — Analyst

Okay. That’s very helpful. And then, maybe sort of a broader question. With the repowering that you are doing, a couple of part time [Phonetic] repowering, maybe the Cascade plant coming in, they’re all quite efficient low emissions intensity. The chance that there actually won’t be a lot of carbon tax revenue generated from the fossil fuel fleet in Alberta. Do you think that sets up that they’ll have to revisit the Tier scheme and the best gas standard? Or do you think the standard was set up to impact you guys to make these decisions? So maybe just your views on any of the changes in what people are doing impacts? How the Tier is set up?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

I don’t know. That’s a big question. I mean that’s a big policy question between the Alberta government and the federal government. And I think as we go forward over the next decade and environmental policy changes around the Tier, the carbon pricing, the clean fuel standard, I think there’s a lot of moving parts in there. And effectively, we continue to like to have a portfolio rather than a single plant investment or a single strategy because we do think that on average our portfolio will perform. And I think Brett there’s some nuances too in terms of the peakers — the coal-to-gas peakers have the ability to run more than just regular peaker than that.

Brett Gellner — Chief Development Officer

Yes. I mean there’s a few things. Clearly if it does change, which again would be speculation on our part that everybody is impacted by that. And anybody still on solar coal firing, gas and coal would be impacted more than what our units would be impacted by, but it would impact all gas units in the province. In terms of Dawn’s point, any new peaker is limited because they can’t meet the 0.37 to only running I believe at 30% in a year. So new peakers are challenging to build going forward. So our converted — boiler converted units are really like peakers and they’ll operate accordingly. Some of them will run more baseload and mid merit than others but certainly echo — again back to the points we made that it’s a fleet, it’s a diversified fleet. And we kind of are managing it in that way Mark.

Mark Jarvi — CIBC Capital Markets — Analyst

Okay. Fair enough. I know it’s a tricky question, but I appreciate the answer. And the last one, any updated discussions with your partners on shares and what the plans are for those?

Brett Gellner — Chief Development Officer

No updates. [Indecipherable] and no change there.

Todd Stack — Chief Financial Officer

Yes. That’s right.

Mark Jarvi — CIBC Capital Markets — Analyst

Okay. Thank you.

Operator

Your next question comes from Ben Pham with BMO. Your line is open.

Ben Pham — BMO — Analyst

Hi. Thanks. Good morning. I wanted to follow-up on some of the repowering questions and you effectively pinned down your entire Alberta portfolio and where that’s going and the transition. Could you comment on your decision to not move to repowering that I can think of why but just wanted to walk through the process with you. And then on the derating, I would assume there’s still optionality to move up capacity assuming you can procure gas from pipe, is that correct?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Okay. So just I want you start over again. We’re not quite sure what the question is. Now you’re breaking up, sorry.

Chiara Valentini — Managing Director, Strategic Finance and Investor Relations

Ben, a bit on your first question, so maybe try that again for us.

Ben Pham — BMO — Analyst

Yes, sure. Yes. So there is — there was a thought of repowering two coal units at one point of time and you move with one and you were trying to figure out what do you do with the second. There’s a bunch of EBITDA scenarios you provided. So I was curious more what led you to one? And then the second question, I wasn’t sure you heard that which is you’ve opted to derate. And I’m wondering I think there’s product options for you to move that capacity higher assuming you get to — you can get more gas to the facilities?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Right. All right. Okay. So let’s — I want to be clyster clear on the second question and the first question. So first of all, on the second question, we’re derating those units not because of gas supply but because of the ability of those units to just run on gas…

John Kousinioris — Chief Operating Officer & President of TransAlta Renewables Inc.

Physically, yes.

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Physically, because they haven’t been converted to gas. Next year we’ll do additional studies 4K — for Sundance Unit 4 and for K1 to determine if they are candidates for gas conversion, simple boiler conversions. We don’t see them needed in that capacity fully in 2022, but they may be needed in 2023, 2024. So we’ll do those studies next year. There’s some optionality there. In terms of the second, they’ll also be looked at and the whole fleet will be looked at in terms of the second repowering. There is definitely a potential for a second repowering in our fleet. These are very, very attractive repowerings as you’re seeing from us. What we want to do though is also very much assess climate change policy around that second repowering because if we get much more aggressive climate targets, there’s a very good chance that second repowering would also have to have some sort of carbon capture and storage associated with it. And it goes back to our comments around green firm power. We just think it’s going to get — as you go through the decade, there’ll be a requirement we think for more and more cleaner power which can be achieved by blending some hydrogen in at the plants by CCS. So when we look at our second repowering we’re very much thinking about how do you make those megawatt-hours less greenhouse gas-intensive. So it’s definitely not off the table. It is off the table for 2025. We originally, I think had thought maybe by 2025, we’d have a second repowering. So for sure we’ve slipped out of that 2025 period probably in 2026, 2027 in there. We’ll make those — we’ll do that analysis all of next year but we’ll be doing that analysis also thinking very carefully about how to ensure that we can meet environmental standards going forward over the next 20 years. Does that make sense?

Ben Pham — BMO — Analyst

Yes, absolutely. And maybe just on the topic of crystal clear [Phonetic], maybe question on the free cash flow guidance, Todd. I just want to make sure I got the messaging right. So your formal guidance is still the midpoint in your MD&A package. And so you’re sticking with that but you’re just saying that it looks like there’s a possibility to succeed or be at the higher end. And if you do hit the midpoint don’t penalize us for it or are you actually saying it ignored MD&A and our new guidance is at the upper end. I just wanted to make sure I understood really your positioning on that?

Todd Stack — Chief Financial Officer

Yes. I definitely see it moving above the midpoint and we are planning and driving the business to deliver towards the high end of that goal.

Ben Pham — BMO — Analyst

Okay. All right. Thank you.

Operator

Your next question comes from Andrew Kuske with Credit Suisse. Your line is open.

Andrew Kuske — Credit Suisse — Analyst

Thank you. Good morning. I guess, 20 years ago we started the PPAs and there were some uncertainty going into it. Now we’re finishing them and there’s uncertainty as they finish. So I guess just in that context, you talked a little bit about the lack of liquidity in the hedging market. But ideally, as things stabilize and we’ve got a better view on bidding behavior, what level of hedging do you think you want to have in the Alberta market specifically for your portfolio? And then how does that triangulate with these credit rating metrics?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Yes. So Andrew, I think that’s an important question. And I do think, I’ve been predicting and it will take some time to see if I actually can be right about this. But as the PPAs roll off and as people in Alberta are completely unhedged in a spot market, I do think there is going to be a whole bunch more contracts than vehicles for hedging that are going to emerge. And we do — we’ve got a team of people working very closely with customers to see what can be done there as well because I think the PPAs have muted — provided a sort of muting to the market. And once it is a full spot market for sure financial contracts should emerge and there should be — there should over time be a much more transparent signal in terms of what some of the pricing might look like. So for example, even today we’re talking to some customers about even three and seven year hedges that kind of thing. Now early, early days, people really need to see what the market looks like. They need to assess the risk of it. But as you know in all markets, that should emerge.

In terms of the — our hedge values, it completely depends. So, if we’re sitting in a market where it pays nothing for us to hedge because prices are low or prices are weak, we’re not going to hedge up then. And if prices get really spicy for whatever reason, we’ll probably hedge up more at that point. So our hedge volumes will move sort of from year-to-year. We will disclose where we’re at and what our thoughts are, as we’re going into the market. We’ll probably get a lot better at that, as we go through 2020 and see how the market shapes up and see how some of these customer discussions emerge. But I think it will start to look very much like some of the things you see in other commodity markets, where there’ll be times when it does not pay off to continue to hedge. We can’t blindly set a level on hedge is another way to say it. We’ll have to really be on top of it with our asset optimization — optimizer. Does that make sense? Am I being clear?

Andrew Kuske — Credit Suisse — Analyst

Yes. No that’s very helpful. And maybe a follow-up to it is do you anticipate evolution to your financial reporting and just a change to that given the fact that you’ve got a marketing group now? But you’re really operating the PPAs, marketing group does some other things on optimization basis. But as you go into full energy-only market, the functions kind of changed? And should the reporting change around that too?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Yes. So there’s — I mean, we’ve — for the last 10 years we’ve reported on fuel type because fuel type tended to have different levels of capital. Coal was a big capital user and it made some sense for the market to see, especially as we were growing the portfolio with more gas and renewables, you could start to see that just the shape of the way the company reinvested capital was changing. There is an argument and we’ll be doing the work on it for having sort of the more of an Alberta portfolio because we do operate it as a portfolio and we have to think about in terms of what the asset optimizers do and how we manage those units here. And frankly, we make electricity and electricity is electricity no matter how it’s made. So we are thinking about that. We haven’t made any decisions on that at all. But certainly you may expect to see something as we go through next year.

Andrew Kuske — Credit Suisse — Analyst

Okay. That’s very helpful. Thank you.

Operator

Your next question comes from John Mould with TD Securities. Your line is open.

John Mould — TD Securities — Analyst

Thanks. Good morning. I’d just like to start with great results for energy marketing in the context of California volatility. But I’d like to focus on opportunities to potentially provide firm supply in the Pacific Northwest. You’ll have one operating unit at Centralia through 2025. And just in the context of some of the other coal retirements coming in that region, what opportunities could you have to provide from supply in that market, whether it’s a potential gas conversion in Centralia or other investments there?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

That’s a good question. So, what we know about that region is that, there will be a number of RFPs in the region for the next five years from a number of the players looking for a way to replace all of the coal that’s being shut down. And we know that those RFPs will start with looking for more green and accepting more intermittent power. And of course, there’s opportunities there with our land with solar and potentially some interesting opportunities on wind. But we know that the region is very, very nervous about, as they go forward and all the coal shuts down, what are they going to do about firm supply. We also know because, we’ve worked very closely with the environmentalists in that region that they do see some sort of gas transition at least till 2040 because, frankly nobody can conceptualize even though, we’re all trying to do it desperately, nobody can conceptualize yet, how to get the kind of supply that you need to create green baseload. It’s just not feasible yet. So we’ve been encouraged by the local customers and local utilities there to think about how to submit into those RFPs and it could even be something frankly where we provide operating reserve or something like that. So, at this point, it looks like the RFPs in that area will be green to start with in the 2020, 2021, 2022 time frame. And then they’ll be focusing on how to get some baseload. So, we continue to look at it and it could be even — you think could it be a coal-to-gas conversion which is actually pretty big in that region. It takes a lot of gas and that region doesn’t have as much gas as you think but it might be putting a peaking unit back in — remember we’ve got that BHP plant there that we pretty well sold everything out of. But putting a small LM6000 in there might win a competition if we can get it amortized to 2040. So, those are the kinds of things that are going on. Very, very early days on that, but something the team will be looking at as we go forward.

John Mould — TD Securities — Analyst

Okay. Thanks for that. And then, maybe just circling back on sheerness and the dual fuel plans there and maybe to ask Mark’s question in a different way. Will you be able to provide any color on just the future coal versus gas fueling there and how carbon emissions and broader ESG considerations feed into the thinking of the owners regarding the future of coal at that — of those units? Or how you think about TA cogen stake in sheerness?

John Kousinioris — Chief Operating Officer & President of TransAlta Renewables Inc.

Yes. John, it’s John. On — with respect to sort of TA, I’ll try to answer your question in reverse. With respect to TA cogen’s interest in the sheerness facilities, we haven’t had any discussions in terms of changing the ownership that we have there with our partners CKI. So, right now, we — the status quo is effectively what we’re seeing there. In terms of dual fuel, I think all I can say is that, I think the folks at Heartland are pretty much focused on trying to increase and really transition towards a gas-fired facility there. That will be their focus. Will we see some dual fuel burning over the course of 2021? I do expect that. But as time goes by, our expectation would be, is that, it would be predominantly run on natural gas.

John Mould — TD Securities — Analyst

Okay. Great. And then, maybe just lastly on Brazeau. You’ve talked before the ability pump storage just to be clear. You’ve talked before about the ability to maybe build that in stages. I’m just wondering, how much of that project output would need to be contracted before you really felt like you could start to move forward with that? And maybe, how its ancillary value to the broader market kind of plays into that need to contract up the facility before deciding to move ahead?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Yes. I mean, I think you got to get it contracted into that 70%, 80% range to take a risk on that size of investment for us. Now, potentially, if we had a partner that maybe could take more merchant risk than we could, you can change some of that. But for sure, as you look at sort of the ESG world of investing and you look at some of the demands to reduce carbon. There’s a lot of companies now that have to really focus on their scope two emissions, which is the emissions that come from their power supply and you can see some opportunities. It’s actually a very interesting project because most — it’s less about the power hedging, it’s more about the environmental permits that come out of it and the recs and really figuring out how to attract capital into that side of it. So, it’s — so as we do more work on that, we’ll talk about that, but it’s actually hedging the greenhouse gas side of it more than the power side.

John Mould — TD Securities — Analyst

Okay. Very much appreciate those contexts. Those are my questions, thanks.

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Thank you.

Operator

Your next question comes from Julien Dumoulin-Smith with Bank of America. Your line is open.

Dariusz Lozny — Bank of America — Analyst

Hey good morning. It’s Dariusz Lozny on for Julien. Just wanted to ask one quick question on the R&W side and it has to do with your re-contracting efforts. It sounds like there was some progress made in Southern Cross in the last quarter. And I was wondering, as we kind of look ahead to Sarnia and that contract, what the next milestones that we should watch for would be, as far as that re-contracting?

John Kousinioris — Chief Operating Officer & President of TransAlta Renewables Inc.

Dariusz, thanks for the question. You’re right. We’re pretty excited about, the extension of the contract at Southern Cross. And that extends the length by, 15 years there. With respect to Sarnia, I think, the next milestone for us would be and I think we’ve been pretty transparent about it, it’s just all the re-contracting efforts that we have with the customers there that are behind the fence. Our sense is that they’re advancing well. Our facility does a good job in serving their needs. And we’re presently expecting and hopeful that those arrangements would be finalized pretty much across the board in the first half of next year.

Dariusz Lozny — Bank of America — Analyst

Great. Thank you very much.

Operator

Your next question comes from Dan Healing with the Canadian Press. Your line is open.

Dan Healing — Canadian Press — Analyst

Hello. Thanks for taking my question. Dawn, I just want you take a step forward — step back and just kind of go through the strategic rationale for moving up the coal retirements. Is it related to the Brookfield investment of a year or so ago?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

No, not at all. I mean, I think it’s really related to, kind of overall the economics of producing power in Alberta on coal, with the carbon tax. If you look at Alberta, we’ve currently got a CAD30 carbon tax, it will be CAD40 by next year, CAD50 the year after. Coal plants get less economic and they’re less flexible, in a merchant market. So when you — we’re doing a conversion right now to gas that plant, when it comes back will be highly flexible and will be highly flexible and will be much easier to run in a market that has more volatility. John, did you want to add something?

John Kousinioris — Chief Operating Officer & President of TransAlta Renewables Inc.

Yes. I mean the only thing is the other thing you have to remember is, when the climate leadership plan came in from the previous government and even with the federal government, 2029 was the date that they set for the coal-fired generation to end. So really it resulted in the company just refocusing the way it would run its portfolio.

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Right.

Dan Healing — Canadian Press — Analyst

Okay. And then I also had a question about what the impact on employees will be as you close down that coal mine and elsewhere in the operation?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Listen, that is the bittersweet, sad part of the story.

John Kousinioris — Chief Operating Officer & President of TransAlta Renewables Inc.

That’s the number one thing.

Dawn Farrell — President, Chief Executive Officer and Corporate Director

At the height of TransAlta, we had 1,500 people, working out there. By the end of next year, we’ll have 40 or 50 working on reclamation. Now they’ll have good reclamation jobs for about 20 years, which is great. But it is — those people have given their heart and soul to this company. They are some of the best families in the province. And our number one thing is,to make sure that they continue to work with us till the end of next year. I’d — having family members, who work in that business. I do know that, having the certainty is actually helpful to them because they can make plans. But, we’ll be working really hard to make sure they all continue to work all through next year. And we’ll be throwing them a party for all the work they did for the last 50 years for this province.

Dan Healing — Canadian Press — Analyst

Okay. Sounds good. Thanks very much.

Operator

Your next question comes from Naji Baydoun with Industrial Alliance. Your line is open.

Naji Baydoun — Industrial Alliance — Analyst

Hi. Good morning. Just a couple of questions. Just going back to the Centralia asset. Now that you won’t have any coal-fired facilities in Canada as of 2022, just wondering if you can give us your latest thoughts on Centralia? And I guess the question is what would it take to completely remove all coal from your portfolio?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

Well, we — I mean we’d have to probably sell Centralia to a private buyer. But the interesting thing about Centralia is we have a 360-megawatt hedge on that plant that’s very strong, and it helps create the cash flows till the end of 2025. And as well, when we negotiated that contract, so if you have to go back to 2011, we worked with governor in 2011. And we basically made an agreement that if they would get us some hedges that we would guarantee that we would shut the plant down at the end of its life. So we guarantee that we’d shut Unit 1 down at the end of this year, which we are doing, and that we’d shut Unit 2 down at the end of 2025. And in return we don’t have an environmental liability for that because of the work we did with the state there. So I mean, it’s really a net present value discussion. But in the meantime, the cash flows are strong in that plant and we can use them to reinvest in our green strategy. And having cash to reinvest is an important part of our E-ESG, how we’re visualizing that.

Naji Baydoun — Industrial Alliance — Analyst

Yes. That makes sense. Thank you Dawn for that. And I guess more of a broader question was related to RNW. As more of your assets are converted to gas, does that change at all your drop-down strategy for TransAlta Renewables? Would you be looking to have or move more of your contracted assets into RNW and sort of keeping the majority of merchant exposure within TransAlta Corp? Like is there a minimum contracted profile that you would like to maintain at the TA level?

Dawn Farrell — President, Chief Executive Officer and Corporate Director

That’s a tough question to answer, because when you — there’s a number of benefits that work in both portfolios. So there’s — we’ll look at a project, and it might have certain tax attributes that work better in TransAlta and another project that has the same sort of green attributes might work better in RNW. So as we now have brought the strategies pretty close together and we’re really aiming at that ESG world, we will have to do a little bit more work I think to show investors what our investors — what our investment policy is for both companies. We need a bit more time to do that. But clearly, as we look at a number of portfolios that are coming up for sale in the market or looking at developing different projects, there are projects that work for both portfolios, and we’ll want to make sure we allocate the capital to the right project in the right portfolio to get all the economic benefits that we can. Again, E-ESG Economic-ESG. And so, we’re really looking at how to put that — wrap that around both companies together.

Naji Baydoun — Industrial Alliance — Analyst

Okay. Thank you for that detail.

Operator

There are no further questions at this time. I will now turn the call back over to the presenters.

Chiara Valentini — Managing Director, Strategic Finance and Investor Relations

Great. Thank you everyone. That concludes our call for today. If you have any further questions, please don’t hesitate to reach out to the Investor Relations team here at TransAlta.

Operator

[Operator Closing Remarks]