Brian Gaynor 's Opinion

Investment columnist for the NZ Herald

Brian Gaynor: Refining shareholder faces unequal battle

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Chairman of Refining NZ David Jackson has been highly critical of Bryan Halliwell's resolution to change the 30 per cent/70 per cent gain sharing arrangement. Photo / APN
Chairman of Refining NZ David Jackson has been highly critical of Bryan Halliwell's resolution to change the 30 per cent/70 per cent gain sharing arrangement. Photo / APN

A hopelessly one-sided conflict will be renewed in Ruakaka, Northland, on Thursday.

The small player is Bryan Halliwell, a Refining New Zealand shareholder and former BP employee, and his opponent is the refining company chairman, David Jackson.

The dispute, which will be continued at Thursday's Refining NZ annual meeting, is about the processing fees charged to the big oil companies, which are also Refining NZ's largest shareholders.

This dispute is one-sided because the oil companies own 72.7 per cent of the refining company with BP holding 23.7 per cent, Mobil 19.2 per cent, Z Energy 17.1 per cent and Chevron 12.7 per cent. In addition, eight of the 10 directors are representatives of these three oil giants and the NZX-listed Z Energy.

The oil companies haven't become big and powerful by looking after the interests of non-related parties, particularly minority shareholders of organisations they effectively control.

With this in mind an individual has to be extremely persistent - and just a little bit naive - to take on the oil giants and expect any degree of success.

The dispute goes back to 1995 when Refining NZ changed the processing fee it charges to its main shareholders from one based on a combination of a fixed, variable and market-related costs to one that is totally market-related.

This market-related fee is effectively based on 70 per cent of Singapore refinery fees with a minimum and maximum fee, the latter being US$9 ($10.40) a barrel. Effectively 70 per cent of the refinery margin goes to Refining NZ with the remaining 30 per cent rebated back to the oil company shareholders.

The 1995 independent appraisal report, which was issued in conjunction with the fee changes, stated that "the allocation of 30 per cent to the user companies together with their indirect interest (shareholding) should provide a sufficient incentive for them to optimise their use of Refining NZ's capacity".

This report, as with most independent reports, concluded that "the terms and conditions of the processing arrangements are fair" to minority shareholders.

The report contained forecasts of total processing fees of $900.7 million over the first five years of the new formula. The actual fees were $666.1 million over this five-year period, 26 per cent below the forecast at the time of the fee change.

Halliwell first brought the issue before shareholders at the 2010 annual meeting when he proposed a motion asking the board "to arrange for Hale and Toomey to carry out a study" on the processing fee.

Chairman David Jackson told the meeting that "the board has agreed that in future the independent directors will play a more significant and defined role" in relation to the processing fee. He went on to say that international oil consultant Purvin and Gertz had undertaken an additional independent review of the processing fee in 2009 and confirmed that "the processing fee based on 70 per cent of the refiner's margin remained fair". Halliwell's motion was soundly defeated as he received support from only 1.11 per cent of the votes cast.

Refining's chief financial officer, Denise Jensen, emailed this column a week before the April 2010 annual meeting with the following points:

• The 30 per cent discount granted to the oil users was not a "loyalty discount". She wrote that the 30 per cent discount reflects "the fact that Refining NZ's customers bear the risks and associated costs of crude purchasing; finance and currency costs; risks associated with maintaining crude feedstock and product inventory; shipping and demurrage risks; and guaranteeing a minimum processing fee".

• Refining would only release a summary of the 2009 Purvin and Gertz report because the full study "is very detailed and includes certain proprietary information of Purvin and Gertz".

• The company had taken legal advice regarding the right of the oil company shareholders to vote on issues relating to the processing fee and this advice determined that "under general company law, shareholders are entitled to vote at a shareholders' meeting even if they are 'interested' in the proposed resolution".

Halliwell was back at the 2013 annual meeting with three resolutions. The main one was, "That the shareholders disagree with the present 30 per cent/70 per cent gain sharing arrangement" in relation to the processing fee.

Jackson was highly critical of Halliwell's resolution.

He said that Halliwell's 2010 motion received only 1.1 per cent support and another resolution was proposed in 2011 but was withdrawn by Halliwell before the annual meeting.

The chairman said that the independent directors and management had invested considerable time and effort on correspondence and meeting Halliwell. The matters repeatedly raised by him were diverting management away from running the company. He urged shareholders to vote against Halliwell's resolution and only 0.61 per cent of the votes cast supported the shareholder's resolution.

Halliwell has proposed the following resolution at next week's annual meeting: "I move that, in view of their continued support for the user companies' invalid, pre-costs, "gain sharing" discounts ... shareholders have no confidence in the willingness of the directors, and the chief executive" to act in the best interests of the company ...

Halliwell wrote in the notice of meeting that the "refinery operates close to 100 per cent capacity, for 24 hours/365 days. But in 2013 (December 31 year) it lost 0.5 cents on each of the 6.4 billion litres it produced. Meanwhile, the users received invalid discounts, of about $300 million".

Jackson wrote to shareholders this week that Halliwell "fails to appreciate that Refining NZ no longer operates in a government-regulated environment, does not enjoy price protection as a result, and cannot set its pricing at will, as it must remain price competitive with overseas refineries from which its customers import fuels".

Halliwell is persistent but the big problem is that the oil companies don't have to use the Ruakaka refinery, they can source product from cheaper refineries.

Z Energy confirmed this point during the week when chief executive Mike Bennetts said that his company had sourced product from a South Korean refinery.

The Halliwell/Refining NZ dispute is an important issue as is Refining NZ's inability to achieve its revenue and share price projections.

For example, Jackson told last year's annual meeting that the company expected to achieve "strong revenue generation" even though business conditions remained volatile and difficult.

The actual outcome was a decline in revenue from $277.5 million in the December 2012 year to $221.9 million in 2013 and a loss of $5 million compared with a 2012 year profit of $31.1 million.

Chief executive Sjoerd Post also told the 2013 meeting that the company aimed to achieve "first quartile NZX50 returns for shareholders".

In the 12 months since the 2013 annual meeting, Refining NZ has produced negative gross sharemarket returns of 31 per cent - compared with a positive 11.9 per cent for the NZX50 Gross Index - making it one of the worst performing large NZX companies.

In addition, the recent refinery shutdown was 22 days longer than planned and this will have an impact on December 2014 revenue and earnings.

The simple issue with Refining NZ is that the four big oil company shareholders receive a 30 per cent discount on their refinery processing fee while the remaining 3600 minority shareholders receive well below average sharemarket returns.

Shareholders really need Jackson to give a realistic view of Refining's long-term future and whether the independent directors have made any attempt to renegotiate the all-important processing fee.

• Brian Gaynor is an executive director of Milford Asset Management.

- NZ Herald

Brian Gaynor

Investment columnist for the NZ Herald

Brian Gaynor has written a weekly investment column for the Weekend Herald since April 1997. He has a particular passion for the NZX and its regulation. He has experienced - and suffered through - the non-regulated period prior to the establishment of the Securities Commission in 1978 and the Commission’s weak stewardship until it was replaced by the FMA in 2011. He is also a Portfolio Manager at Milford Asset Management.

Read more by Brian Gaynor

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