Directors Report 3 Yearly Ownership Review

South Canterbury Power Trust: 3 Yearly Ownership Review

The Directors of Alpine Energy are required to report to the South Canterbury Power Trust on a number of matters, in a manner prescribed by the Trust Deed. A summary of the requirements is appended to this report.

 

1.0 Introduction

 

1.1 Industry Reform

 

The last 10 years has seen several waves of legislative reform of the electricity industry, and in particular for the regional retailing and distribution sectors of the industry. The electricity industry is essentially made up of four sectors being:

1. 1. Generation:Production of Electricity in Power Stations
   2. Transmission:Long Distance Transport on National Grid
   3. Distribution:Local Transport by Regional Line Businesses
   4. Retailing:Regional Billing and Customer Services

Generation and Transmission were separated into distinct Government owned companies in 1988 and regional power companies were required to separate into distinct Distribution and Retailing companies by the Electricity Industry Reform Act (EIR Act) 1998.

The EIR Act defined Generation and Retailing as naturally competitive sectors of the industry and were therefore to be largely free of regulation, and defined Transmission and Distribution as natural monopolies. Recently the Government introduced the Commerce Amendment Bill into Parliament with the express purpose of placing the monopoly sectors, Line Businesses and Transpower under price control. Although its passage through a Parliament just a few months out from a General Election is uncertain, it is reasonable to assume that the conceptual intentions of the Bill will flow through to the industry sooner or later as the Opposition also have a desire for greater regulation of the industry.

1.2 Alpine Energy Ltd and it’s Shareholders

Alpine Energy Ltd is the regional lines business for South Canterbury covering the traditional area except for the Hakataramea which is supplied by Waitaki Power through Kurow, and the upper Rangitata which is supplied by Electricity Ashburton through Mayfield.

Alpine Energy Ltd has four shareholders being:

South Canterbury Power Trust 40.0%

Timaru District Holdings Ltd 47.5%

Waimate District Council 7.54%

Mackenzie District Council 4.96%

The shareholding mix reflects the Timaru District Council’s previous sole ownership of Timaru Electricity Limited prior to the merger, the role of a the South Canterbury Power Trust (“Trust”) as a trustee of consumer interests, and the desire for broad community ownership by the allocation of shares to Waimate and Mackenzie District Councils. In 1993 it was anticipated that the Trust (and its potential successor) would have a maximum combined existence of 15 years. This is structured in a Trust Deed which requires the Trust to either distribute its assets by 14 July 2002, or resettle into a new Trust which will have a maximum life of six years.

1.3 The Recent Performance of Alpine Energy Limited

There are three key measures of performance for an electricity lines business being reliability, price of services and profit.

The Ministry of Commerce (MOC) have devised several reliability measures, some related to length, type or voltage of lines, and others related to customer service. The need for any business to focus on customer service is paramount and so the best performance parameters to consider are SAIDI and SAIFI, being respectively the System Average Interruption Duration/Frequency Indices. These give outages in terms of minutes and events per year. Alpine Energy continues to be a reliability leader with amongst the best internal statistics in New Zealand.

Unfortunately the reliability delivered to the Alpine Network by Transpower is very poor with 55% of the outages in the following table caused by Transpower compared to a national average of less than 20%. With this correction Alpine’s ranking for its own internal reliability performance climbs several places with a typical ranking of 3rd best reliability in New Zealand.

Year Ending 31 March	SAIDI		SAIFI
	Minutes p.a.	NZ Ranking	Events p.a.	NZ Ranking
1996	182	13th	2.6	15th
1997	86	5th	2.6	14th
1998	150	9th	2.7	14th
1998 excl Tpwr	63	3rd	1.0	6th

Alpine’s price of services, especially line charges, continues to be amongst the best in New Zealand, although with different companies having a different mix of fixed and variable charges and different structures for off peak controlled supply, comparisons are difficult. Nevertheless the MOC have published comparisons based on a medium domestic consumption of 12,000 kWh per year with 40% controlled supply for hot water and space heating.

The profitability of the company is a little more difficult to consider because we have the effects of the lines business which is the regulated part of the company, and the wider Alpine Energy Group which includes investments in other companies such as United Electricity (until 1999), Opuha Dam, and the company’s contracting subsidiary PowerCom. Rankings of the lines business part of the company are possible from MOC statistics, however no comparative statistics are available for the Group which is the true extent of the Trust’s investment.

Year Ending 31 March	Lines Business Profit		Group Profit on Shareholder Funds
	Return on Equity (ROE)	Ranking
1996	3.6%	26th	4.8%
1997	4.4%	22nd	4.7%
1998	5.6%	13th	5.6%

On a consolidated comparative basis a number of independent financial analysts have ranked line businesses overall performance using different mixes of a wide range of performance parameters. These show the following performance out of 35 line businesses:-

These reports and the above performance statistics show that Alpine Energy Ltd, despite the disadvantages of a long, low growth network across a sparsely populated provincial region, consistently meets the highest standards of operational and financial performance.

2.0 Continued Trust Ownership

2.1 Strategic Ownership Issues

Alpine Energy, as owner and operator of a regional infrastructure asset, is often under pressure by some groups as a means to achieve a specific agenda. For example it is clear that a percentage of the South Canterbury community is financially disadvantaged and therefore argue that low line charges will help them budget their income. Such a broad brush approach to social needs also means that the better off part of the community also benefits from a social subsidy, and that the discounted cost of electricity prevents other commercial energy sources such as coal, gas (LPG) and firewood from competing on a level playing field.

Alpine Energy Ltd is a strong business entity and puts the sustainable interests of the company and its shareholders ahead of specific agenda and sectional interests. Furthermore it is considered that the restructuring and centralisation of the New Zealand economy has left South Canterbury with few companies with the financial strength and commitment to invest and therefore make a real economic difference to the region as a whole.

Intervention by Government in the electricity industry continues unabated as in addition to the new EIR Act 1998, lengthy information disclosure regulations were promulgated by Order in Council on 29 March 1999. The industry anticipates ongoing legislative and regulatory intervention in the years ahead, and some of this may address the structure and objectives of Power Trusts which continue to have interests in some 80% of the New Zealand line businesses.

Government has also expressed its desire to continue the process of gaining industry efficiencies in order to minimise operating costs, return the full cost of capital to shareholders, enable corporate taxation and thereby create efficient pricing of services.

There are four major options available to Alpine Energy to achieve these goals:-

1. Continue to operate as an efficient stand alone company but recognise there are still some additional overhead costs associated with retaining a local ownership structure.
2. Merge with other regional line businesses and influence strategy as a minority shareholder. This will remove local ownership overheads and be more cost efficient.
3. Contract out management of the network to a larger company and retain ownership. This will retain some local ownership overheads, give little operational control, but retain strategic influence and provide substantial efficiencies.
4. Divest ownership to another line business and allow shareholders such as the Trust to distribute or invest the cash as appropriate.

The first three of these options also mean that continued Trust ownership is probably desirable.

2.2 Advantages of Continued Trust Ownership

The Trust is a single purpose organisation, directly elected by all consumers and representing no specific consumer segment. It is in a unique position to be focussed on the company, its sustainability and performance. While it is possible for a small vocal group to catch the Trustees attention, the 3 yearly election process for Trustees ensures they remain accountable to all consumers, and the needs of the community at large.

The Trustees therefore have a unique opportunity to develop a vision for the future of Alpine Energy that will benefit the whole South Canterbury region and ultimately the consumers. Should the Trust shareholding be distributed it would be more difficult for many individual shareholders to exert such influence over the other major Council shareholders who are perhaps more focussed on a vision for their specific district and ratepayers.

The Trust as a single entity is therefore a strong and influential shareholder able to negotiate equally with the District Council shareholders.

The consequential advantage to the company of continued ownership is that 27,300 beneficial interests in the Trust are co-ordinated by the Trustees into a single strategic vision, rather than many thousands of shareholders having a diverse range of views, and the attendant potential administration costs.

2.3 The Disadvantages of Continued Trust Ownership

The Trust has cost an average of $91,400 p.a. to operate reflecting Trustee fees, administration and 3 yearly election costs. Beneficiaries of the Trust as the future shareholders are unable to arrive at an informed view on whether this cost is matched by value added to the company.

There is a risk that the 3 yearly Trust elections might focus on populist issues and circumvent the genuine legal and commercial responsibilities of the company, as these are much too complex to be represented and comprehended in a public debate. This could create the opportunity for political capture of the legitimate commercial responsibilities of Trustees and the potential for conflict between Directors and Trustees.

This did not happen to the Trustees in the 1997 election. The Trustees have demonstrated a willingness to develop a vision for, and co-operation with the company, allowing the diversity of consumer views to be considered along with the sustainable needs of the region and the company. However the future risk remains.

Some would consider that rather than a common vision, there is a strong case for widespread shareholding and diversified views as this will bring a broader partnership between individual investors and collective bodies such as District Councils. Continuation of the Trust as a single holder of 40% of Alpine Energy’s shares prevents this opportunity from arising.

Continued Trust ownership deprives the individual beneficiaries of the Trust of control and access to their assets. It assumes the individuals in the community cannot manage their personal affairs in a responsible manner.

Since a distribution of Trust assets will occur no later than 2008 in any event, some would say it is better to do it now and give control of assets to the consumers who are most affected.

Administrative disadvantages of continued Trust ownership include the requirement of the Trust to hold dividend income for six months before distribution, and that beneficiaries of the Trust below the highest marginal tax rate might not always receive the full tax imputation credits on dividends paid out by the company.

2.4 Options Arising From This Review

After considering the issues in this review, the Trustees will have a number of options. These include:

• Immediately commence a process of share sale or distribution involving consultation with the public.
• Continue with the status quo until the termination of the present Trust in July 2002, and then make a distribution of shares, or sell the shares and distribute the proceeds.
• Continue with the status quo until the termination of the present Trust in July 2002 and then resettle the assets into a new Trust which will have a maximum life of 6 years.

The Trust in reaching its decision on the preferred option will need to consider the issues outlined above and in addition, a number of further issues including:

1. The ongoing change in the regulatory environment for line businesses makes sustainable decision making uncertain if the best interests of the consumers are to be preserved.
2. A possible change in Government may see legislation that supports a Government or a Private/Members Bill to allow a change to the termination provisions of the Trust Deed. The Opposition Member for Aoraki has recently signalled his party’s willingness to be guided by consumers on this matter.
3. Local Government Reform is requiring Local Bodies such as District Councils to operate their commercial investments in an increasingly transparent manner. This places the wish of individual Councillors to meet social goals through the pricing of electricity line services in conflict with the corporate responsibility of Councils to avoid cross subsidies.
4. The high level of misunderstanding in the wider community about the intent and form of the industry reforms makes it difficult for consumers to make informed decisions on their personal options.
5. An early share distribution would likely see widespread cashing up by consumers and dissipation of the community wealth accumulated by the Company and Trust.
6. Alpine Energy Ltd, which under the requirements of the Energy Companies Act 1992 operates as a successful business, is well equipped and positioned to make informed commercial decisions on expansion and development investments, and brings to those decisions a financial ability to ensure they proceed.
7. A distribution of shares by the Trust would easily enable Timaru District Holdings/Council achieve its target 51% shareholding as outlined in its 1999 Draft Annual Plan by purchasing freely traded shares.
8. Successive Local Government Reforms, and the spectrum of views on commercial development amongst elected members of the Council would tend to prevent Alpine Energy operating as a normal business with a normal commercial risk profile. Local Government demands tend to ensure elected Councillors operate in a risk averse environment.
9. Opportunities to add value to the business by reducing operating and management costs are better investigated and implemented by commercial directors who are able to consult fully with owner representatives who have a detailed knowledge of a very technical industry.
10. When a distribution of Trust shares occurs it is better to be done as a single event rather than a progressive trickle. This will ensure that any selling shareholders are able to maximise sale price and value through the creation of an active market for resale of shares.
11. The sale of shares as a block may realise a “control” premium which would be reflected in the subsequent cash distribution to shareholders.
12. The share distribution should, when it occurs, follow the following process:-

This proposal gives preference to ongoing local share ownership in the medium term and ensures the company retains shareholder loyalty through strong performance.

13. The current Trust dividend distribution policy reflects the level of line charges paid, and therefore the contribution of the various consumer groups to the profit and accumulated value of the company.

It needs to be noted, however, that the traditional political arguments for community ownership and control are not easily justified as it is considered there are appropriate protections against abuse of the natural monopoly. The traditional arguments that should not be accepted as relevant to the debate on Trust ownership include:

1. That a share distribution will lead to foreign control and therefore irresponsible management of prices and reliability.
2. Collective ownership with zero profit targets solely in order to avoid taxation is a proper use of community assets.
3. Low prices through low profit will encourage economic development in the region. There is however, a widely held view that low prices generated by business efficiency and reasonable company profits are helpful in assisting economic growth.

3.0 Options for Company Development

3.1 Water Supply & Irrigation

Alpine Energy at present has most of its assets in the electricity network and support services covering South Canterbury, together with investments in Opuha Dam (50%) and Alpine Gas (50%).

These external investments have demonstrated that there are business growth opportunities in South Canterbury that can lead to economic growth and energy choices in the region.,

Electricity network growth is entirely demand driven and will not readily occur in South Canterbury. To create growth we need a vision of the future and of opportunities such as investment in water supply and irrigation as demonstrated by the Opuha Dam project.

The opportunity to invest in other small hydro generation projects in South Canterbury is no longer available to the Company because of the provisions of the EIR Act in spite of several strong prospects having been identified.

3.2 Line Business Growth

Government pressures to merge smaller line companies are rising using the Australian model where NSW with a population of some 6 million has only 5 local network companies. However it is understood that these local companies also provide retail services, and therefore are not prevented from entering competitive activities as is the case in New Zealand. While clearly there are economies of scale to be had, it is essential that we do not lose the efficiency of local focus in the process.

Studies by Alpine Energy have indicated that economies of scale can be achieved without losing small scale focus with a size growth of 2-3 times the present size if there are contiguous operations. Therefore gaining these benefits could only occur with a like minded approach by our neighbours.

4.0 Recommendations

After considering the main outcomes of the above discussions being:

• Valuation of shares.
• Identification of and notification to Trust beneficiaries of their entitlement value.
• Trust beneficiaries elect to receive shares or cash.
• Trust beneficiaries and existing shareholders can elect to preferentially purchase more shares from the pool created by those electing the cash option.
• Based on the size of the pool the then shareholders should consider whether the company buys the remaining shares or offers them for sale to the market at large.

The following recommendation is made:

That the Directors of Alpine Energy recommend that the South Canterbury Power Trust continues with its current shareholding in Alpine Energy Limited, and continue to support the company’s initiatives to invest in projects and developments which bring profitable returns to the company and economic growth to the region.

Acknowledgement

The author would like to thank the Directors of Alpine Energy and Trustees of the South Canterbury Power Trust for their individual contributions to this report.

No external professional advice has been obtained in respect of the preparation of this report.

The directors have given regard to the views expressed in the twice yearly survey of the public carried out by the company.

W Hart

Chief Executive

Alpine Energy Limited

Attachment

• Reporting Requirements of the Trust Deed of South Canterbury Power Trust

South Canterbury Power Trust Review

Terms of Reference

The Trust Deed requires the Directors to prepare a report considering proposals and available options for the future ownership of the shares owned by the Trust.

The Trust Deed gives the Trustees three (broad) options:

• retain the shares in the Trust; or

• dispose of a portion of the shares including any resettlement of the shares on Trust and retain the remainder of the Trust; or

• dispose of all of the shares including resettlement of the shares on Trust

The report is to contain:

1. an analysis of the performance of the Company to the date of the report;

2. a discussion of the advantages and disadvantages of continued Trust ownership;

3. if a distribution of shares is recommended, a draft Share Allocation Plan detailing:

• the manner in which and the Consumers to whom the shares (if any) and assets constituting the Trust Fund are to be distributed and such shares and assets may be distributed to a greater or lesser extent to some or all of the Consumers;

• the manner in which and the Consumers to whom the proceeds of the sale of shares (if any) received as a result of a disposal of shares are to be distributed and such proceeds may be distributed to a greater or lesser extent to some or all of the Consumers;

• if the shares (if any) are to be resettled on Trust, the terms and conditions of such Trust.

4. a summary of the professional advice (if any) obtained in respect of the preparation of the report.

5. a statement as to whether or not the directors have had regard to any views expressed by the public with respect to ownership.

The Trustees shall comment on the report to the Directors and upon completion of their review of the report, the Trustees shall make the report available to the public together with a summary of their comments. [‘available to the public’ means making the information available for inspection at any office of the Trust or any office of the Company or at any other place in the District on normal business hours on any business day, after giving 3 days notice of the place(s) and times in a newspaper].

The Trustees and the Directors shall in respect of the report and no later than 1 month after the date of the report, implement the Special Consultative Procedure (as attached) outlined in Schedule 2 of the Trust Deed.

Following completion of the Special Consultative Procedure and not later than 6 months after the report date, The Trustees and the Directors shall meet and, after taking due account of the view expressed by the public and the Directors, the Trustees shall decide whether to:

• retain the shares in the Trust; or

• dispose of a portion of the shares including any resettlement of the shares on Trust and retain the remainder of the Trust; or

• dispose of all of the shares including resettlement of the shares on Trust

If the shares are to be retained by the Trust, the Trustees shall notify the public by making the information available for inspection at any office of the Trust or any office of the Company or at any other place in the District on normal business hours on any business day, after giving 3 days notice of the place(s) and times in a newspaper.

If the shares or any portion of them are to be distributed, the Trustees shall prepare a Share Allocation Plan in terms of Schedule 3 of the Trust Deed (attached).