Brian Gaynor: Labour-Greens proposal creates dilemma

The partial privatisation of Mighty River Power has the potential to invigorate the NZX. Photo / APN

Policy makes Mighty River Power sell-down more attractive for taxpayers and less so for investors

The Labour-Greens' proposal on the electricity industry has created a major dilemma for potential Mighty River Power (MRP) investors.

Should they invest in a company that could be subject to major regulatory change, including a dramatic adjustment to its business model?

How can individuals invest in MRP when the IPO price is set after applications close and the indicative $2.35 to $2.80 a share price range hasn't been adjusted even though the company's potential long-term outlook has dramatically changed?

How do new sharemarket investors decide whether they invest or not when most of them are unable to obtain qualified investment advice?

The basic problem is that the country's electricity sector has never worked flawlessly, nor has it had widespread consumer support, and the Labour-Greens blockbuster announcement has created huge uncertainty for investors.

The country's first high-voltage electricity transmission line was built in 1886 between Skippers Canyon in Central Otago and a mining company 6km away.

Two years later Reefton, another mining town, was the first in the southern hemisphere to have a public electricity supply.

In 1903 the Water Act empowered the Crown to use water to generate electricity and 11 years later the first major state-owned hydro scheme was completed at Coleridge.

Electricity generation and transmission came under the jurisdiction of the New Zealand Electricity Division (NZED) of the Ministry of Energy but there were numerous outages, power cuts and requests for "voluntary" savings under this regime.

A 1985 Treasury report was highly critical of NZED because of high electricity prices, over-investment, cost overruns and inefficiencies.

This kick-started a number of reforms which all pledged to deliver lower prices but have failed to deliver on these promises.

These reforms included:

• In 1987 NZED was corporatised to form the Electricity Corporation of New Zealand (ECNZ).

• Six years later ECNZ's transmission business was split off into Transpower.

• ECNZ was split again in 1996 with the formation of Contact Energy, a new generation business.

• In 1999 Contact Energy was privatised and listed on the NZX while ECNZ's remaining assets were split into Mighty River Power, Genesis and Meridian Energy.

• The Electricity Commission was formed in 2003 to manage the domestic electricity market.

• The commission was replaced by the Electricity Authority in 2010 and one of the latter's major roles was to create more competition in the sector.

ECNZ initially held prices in real terms to deter new market entrants.

But water shortages in 1991, 2001 and 2003 resulted in water heating cuts, the partial closure of the Tiwai Point aluminium smelter and electricity conservation campaigns.

One of the problems with hydro electricity is that output declines during water shortages and this can create significant problems during cold winters.

Power supply can be a major problem during peak winter residential demand periods - between 5pm and 10pm - if generation is restricted because of low water levels in the hydro dams. Consumers are more concerned about the security of supply when there are electricity blackouts but prices become more important during more stable periods.

An independent committee established by the Government after the 1992 power crisis recommended the removal of electricity price caps. One of the reasons for this was to encourage investment in generation capacity to avoid future blackouts.

New Zealand's electricity market has never worked perfectly because it hasn't achieved the appropriate mix between a monopoly structure and competition or between security of supply and pricing.

The Labour-Greens proposal will transform the country's electricity generation from a semi-competitive sector to a government-controlled purchasing monopoly and the proposals are more about electricity prices than the security of supply.

Labour's policy paper notes that: "Owners of hydro-electric generation are taking the nation's free water resource and turning it into super profits. This is a multi-billion dollar transfer of wealth to generators paid by consumers."

The sharemarket performance of Contact Energy, which has substantially underperformed the NZX average over the past five years, doesn't indicate any "super-profits" while the generators have delivered much better supply security in recent years.

There is no dispute that residential electricity prices have risen substantially since 1978, the starting point of Labour's analysis. But prices were exceptionally low 35 years ago because household electricity was heavily subsidised and there has been a substantial increase in other costs over the same period.

For example, residential customers paid $3.38 billion for electricity in 2011, a 17 times increase over the $200 million paid in 1978.

Over the same 35-year period government spending on social welfare expenditure has increased 14 fold, health spending rose 18 fold and spending on education has risen 14 times.

The link between government spending and electricity prices is that the Crown owns three of the four large generators and politicians have encouraged them to pay higher dividends in order to fund the huge increase in government expenditure.

The Labour-Greens proposal claims that the electricity generators are producing "super-profits" but what is to stop future governments from demanding "super-dividends" from the generators, particularly as this will be easier to achieve under the purchasing monopoly structure proposed by the opposition parties?

However, the main concern of this column is the potential impact of the proposed Labour-Greens reforms on Mighty River Power and its NZX listing.

New Zealand investors have had a terrible experience with a number of government privatisations, including Bank of New Zealand, Telecom, TranzRail and Air New Zealand.

Confidence in the NZX has suffered badly, partly as a result of these four privatisations, and this is reflected in the accompanying figures on the value of the country's housing stock and the NZX. The figures also show the massive increase in household debt and the country's overseas debt since 1978.

Residential property values, which have surged 25 times since 1978, had a total value of $615 billion at the end of 2011, according to Reserve Bank figures, compared with the NZX's total value of just $55.9 billion.

The productive and innovative sector has been starved of capital because of the poor performance of the NZX as New Zealanders' preferred investment strategy has been to borrow extensively, mainly from offshore, and invest in residential property.

That is not the way to create long-term economic prosperity.

This column supports the partial privatisation of Mighty River Power because it has the potential to invigorate the NZX by attracting, and keeping, new investors who have a positive experience.

The Labour/Greens proposal has the potential to turn the MRP float into a big negative as far as the NZX is concerned, particularly if a large number of new investors experience investment losses.

During the week the Government released an extraordinary Supplementary Disclosure Statement which gives investors the right to withdraw their application.

This statement is a strong warning that the risks associated with Mighty River Power have increased dramatically.

It is unfortunate that this statement was not more specific, particularly as far as the $2.35 to $2.80 indicative price range is concerned.

The failure to comment on the indicative price range is a concern because many first time investors have been attracted by the Government's positive advertising campaign.

The timing of the Labour proposal is dreadful as far as Mighty River Power and the NZX is concerned. It demonstrates that investors have to be extremely careful about investing in MRP because of the massive political and regulatory risks associated with the Labour-Greens proposals.

Ironically, the MRP sell down is now a more attractive proposition for taxpayers - and a less appealing opportunity for investors - because under the opposition parties' proposals the company will probably have to reduce its dividend.

Brian Gaynor is an executive director of Milford Asset Management.