Brian Fallow: Meridian political risk takes shine off power

In the recently renegotiated contract with Meridian Energy, Tiwai Pt aluminium smelter's owners secured the right to shed 30 per cent of its load in 2015. Photo / Richard Robinson

People contemplating investment in Meridian Energy shares need to think long and hard about political risk. They need to weigh the risk of radical change to the way the electricity industry is organised following a change of government and the impact it would have on the value of electricity generators in general, and Meridian in particular.

"Don't worry, it will never happen. It's too daft an idea," seems to be a widespread view.

But that is naive to the point of delusion.

So is the idea that the political risk is already priced in.

It is true that the plans, albeit sketchy, of Labour and the Greens to essentially scrap the wholesale electricity market and replace it with a single buyer, NZ Power, have been around since April, and the sharemarket has had plenty of time to factor it into power companies' share prices, including indicative prices for Meridian.

But is the market good at estimating this kind of risk?

As evidence to the contrary consider a recent, and otherwise illuminating, analyst's report on the Meridian offer from First NZ Capital.

It estimates that if the proposal went ahead it would reduce the value of Meridian, on a discounted cashflow basis, by a third. It sees a similar impact on Mighty River Power, but it sees only a 10 per cent chance that this will happen.

It is not that it believes the Opposition will abandon the policy. It is right about that.

Nor is it in the camp that contends the policy would prove just too hard to implement.

Rather, "the risk relates to the likelihood of the Opposition winning the next election and managing to implement the policy".

Well, good luck finding a pollster or political pundit who would put the odds on a change of government next year that low.

It makes no economic or commercial sense to base wholesale electricity prices on some, probably pretty debatable, historic valuation of what generating assets were worth at the time ECNZ was broken up, or to penalise generators for using a renewable fuel rather than fossil carbon.

But this is all about politics.

The number of voters who would rather have a lower power bill vastly exceeds the number of people impressed by, or even aware of, the case against the proposal.

It is sometimes asserted that this is a case of Labour being led by the nose by the Greens.

It is true that this is an area where the two parties see eye to eye and some common ground is essential in forming a coalition.

But this is very much David Parker's policy and he has clearly won the Labour caucus over to it, to the point that it is now as committed to it as National is to the mixed ownership model, and for a similar reason: the policies play well with their respective political bases.

Never mind that if the concern is really about energy poverty, there are much more targeted ways of addressing that.

It is too easy for a generic aversion to the idea that whatever the problem, the solution is a market, to become a tendency to see market failure at every turn.

Parker, when he was Minister of Energy, got officials to look closely at the single buyer model. They counselled against it and he reluctantly concurred.

But that was then and this is now.

He thinks there is now enough spare capacity in the system to withstand an investment strike during the transition to the model he prefers.

"At that time we had transmission constraints and generation margins [a buffer of spare capacity] that were so tight that we had weekly reviews in Cabinet. At that point the absolute priority was energy security margins and therefore we didn't want to do anything that might cause an investor strike," he has told the Herald.

"Security of supply is paramount. It is not that we were comfortable with the profits that were being extracted under the long-run marginal cost model.

"Now New Zealand's electricity generation margins are better than they have been for a long time, so if there was ever a time you could actually do this it is now. During that period of transition will generators be slower to invest in new kit? Yes."

It is sometimes argued that while there is a comfortable surplus of generating capacity and weak growth in demand for electricity now, as time goes by that window of opportunity for radical change will close, especially as it would take years to implement.

The counter-argument to that is called Tiwai Point.

In the recently renegotiated contract with Meridian the aluminium smelter's owners secured the right to shed 30 per cent of its load in 2015. That alone could free up more than 4 per cent of the country's electricity production for other uses.

And the rest of Tiwai's load could go in 2017, if world aluminium prices have not risen and the exchange rate fallen sufficiently in the interim to put it back in the black.

Another argument going around is that the Labour/Greens policy is confiscatory and would invite a legal challenge from investors, especially those in Contact Energy and TrustPower who arguably, unlike those investing in Mighty River, Meridian or Genesis, have not had fair warning of such a change.

It is not for your humble columnist to offer a legal opinion but it is a role of the courts to interpret the will of Parliament, not to countermand it.

Labour's new leader, David Cunliffe, appears to see the policy as comparable to what he did to Telecom while Minister of Communications.

In any case he seems intent on positioning Labour further to the left, to want to disabuse the public of the idea that the two major parties are Tweedledum and Tweedledee, and to be making a pitch for the disaffected lost tribe who didn't vote for anyone at the last election.

All of which suggests that the Meridian float, instead of simply being an opportunity to invest in the jewel in electricity system's crown for a nice secure dividend yield, has become a variety of sports betting, a way of taking a punt on the outcome of the next election.

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