Former Economics Editor of the NZ Herald

Brian Fallow: Going on with asset sales risky business

Toxic interaction between the policies of the Government and the Opposition is destroying value.

Power would be sold at a regulated price under the Opposition's plan. Photo / NZPA
Power would be sold at a regulated price under the Opposition's plan. Photo / NZPA

Looking at the impending float of Meridian Energy it is hard to say which side of the House of Representatives is serving the public interest worse.

There is a sort of toxic interaction between the policies of the Government and the Opposition.

The net effect is value destruction and the only questions are how large that loss will be and how it will be apportioned between taxpayers and investors.

Some of the gung-ho commentary we have heard from capital markets players about the float since it was confirmed on Budget day displays a sort of cognitive dissonance, a resolute ignoring of the rhinoceros in the room, which is the plans of Labour and the Greens to radically change the industry structure and scrap the market as the means whereby wholesale electricity prices are set.

Ignore it and it will go away isn't much of a plan. Instead of an opportunity to invest in the jewel in the electricity system's crown for a nice secure dividend yield, the Meridian float has become a variety of sports betting, a way of taking a punt on the outcome of the next election.

Meridian is the company which would lose most value under the Labour/Greens policy. They would say that's because Meridian is the one extracting the fattest super-profits under the status quo.

The idea seems to have emerged that this will never happen, or if it does it will be so far down the track it's not worth worrying about. Any such notion is deluded. Opposition parties are every bit as serious about this policy as National is about selling down the SOEs.

The policy will no doubt get modified and refined but not abandoned. The merits or otherwise of the policy have little to do with it.

Like the Government's partial privatisation agenda, it's a policy that appeals to their political base. It's about ideology and branding.

Meridian is the country's largest electricity generator. All its generation is from renewable sources, the great majority from hydro schemes built decades ago.

Under the Labour/Greens model, it would have to sell its power at regulated prices that cover operating costs (which are low because the fuel is free) and its cost of capital. The latter would be based on historical costs probably, but not necessarily, adjusted for inflation.

This is not a particularly sensible way of thinking about the cost of capital.

It costs the Government money to continue to own Meridian, namely the opportunity cost. That is what the Government could get if it sold it and used the proceeds to reduce its debt and its interest bill.

It is anchored in what the assets are worth to a buyer now, not what the Crown paid Bechtel and other contractors to build the Manapouri hydro scheme back in the 1960s.

But what the assets are worth now depends on the future path of electricity prices and the effect that has on the company's cashflows.

It's hard enough to figure that out under the existing industry structure and market model. Trying to estimate it under a very different system, with a single buyer setting wholesale prices, structural separation (at least) of the generation and retail arms, and tenders for new generation, is at this stage just impossible.

Then there is the perverse effect of the Labour/Greens announcement on the negotiations still going on between Meridian and the owners of the Tiwai Pt aluminium smelter. Half Meridian's generation, or 14 per cent of the national total, is committed to the smelter but currently on terms its owners say threaten its survival.

If the object of the exercise is to lower household power bills the last thing you'd want is to stand in the way of an orderly phasing out of the smelter.

The Labour/Greens policy completely undermines Meridian's negotiating position, which is presumably all about the opportunity cost to it of committing the equivalent of Manapouri's output to the smelter rather than making it available to the rest of the country.

But that is predicated on the existing market and industry structure, whose future is now uncertain.

The smelter's owners now have every reason to hang in there in the expectation of a more congenial environment (from their point of view) down the track.

And as if the Opposition parties hadn't done enough, the Government has further strengthened the smelter owners' hand by putting pressure on to get its future squared away so that it doesn't overshadow the float.

As a Southlander I'm reasonably happy about this, but as an electricity consumer I have not been well served.

In these circumstances for the Government to press ahead with the selldown of the SOEs turns a policy that was merely kind of pointless - a solution in search of a problem - to one that is either cynical or bloody-minded.

The Government runs three arguments to justify partial privatisation.

One is that it needs to reduce its debt and free up capital; the second is that the state is no good at running businesses; and the third is that it would beef up New Zealand's rather puny sharemarket.

It is desirable for the Government to reduce its debt, though with unemployment as high as it is and bond yields as low as they are it need not be as much of a priority as it currently is.

But it needs to be done the hard, old-fashioned way by reining in spending and running surpluses.

Merely shrinking both sides of the balance sheet and both sides of the operating accounts by more or less the same amount achieves nothing.

Secondly, "the state" is an abstraction and doesn't run anything. It is people who run these enterprises, people who have a solemn statutory obligation to run them as if they were investor-owned.

In the case of the SOE generator/retailers, where is the evidence they have failed in that duty?

Granted, Solid Energy is no poster child for the SOE model, but let's remember that the Bank of New Zealand, Air New Zealand and New Zealand Rail all had to be renationalised, so ruinously lousy were their managements and boards at running them after they were privatised.

As for bolstering the sharemarket by encouraging first-time investors to buy into the power company floats, there is now a real risk that will backfire.

The risk is Meridian and Genesis will be listed, but the shares mispriced. In other words, the Government will sell the shares at prices that don't reflect the political risk and potential value destruction to come.

As more clarity emerges about the magnitude and timing of the Labour/Greens plans for electricity and their impact on the value of power companies, a lot of "Mum and Dad" investors will want to sell. But sell to whom?

New Zealand institutions won't want to go big in power company shares, when the whole sharemarket will be top-heavy in the electricity sector (Contact, Vector and Trustpower are already listed).

That leaves offshore buyers. It will only reinforce the perception that the New Zealand sharemarket is just a low-rent motel on the road from state ownership to foreign ownership.

- NZ Herald

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Former Economics Editor of the NZ Herald

Brian Fallow is a former economics editor for the New Zealand Herald. A Southlander happily transplanted to Wellington, he has been a journalist since 1984 and has covered the economy and related areas of public policy for the Herald since 1995. Why the economy? Because it is where we all live and because the forces at work in it can really mess up people's lives if we are not careful.

Read more by Brian Fallow

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