Untangling the knots of network ownership

BY PATTRICK SMELLIE

Vector chief executive Simon Mackenzie wants to talk about ultra-fast broadband.

As the biggest partner in the Regional Fibre Group's bid for a chunk of the Government's $1.5 billion broadband roll-out fund, Vector has a lot at stake.

As the sixth-largest NZX-listed company by market capitalisation, it is already a behemoth in the electricity and gas distribution businesses, where its monopoly networks deliver the usual two-edged sword of any regulated industry: a guaranteed steady income, but limited opportunities for growth or self-determination.

The UFB highway will also probably be a regulated monopoly, so Vector figures it knows the business, and can use its existing electricity and gas network corridors to lay new fibre.

In other words, UFB could be a natural extension of Vector's business and a place where it would be willing to fling "hundreds of millions of dollars" over the life of a UFB roll-out, in pursuit of a more diversified future, says Mr Mackenzie.

Today, however, a less exciting, more valuable part of the business is crowding out the sexy stuff.

Across town in Auckland's Heritage Hotel, a Gas Industry Company workshop is wrapping up and the few hardy souls who understand this stuff have just witnessed a game-changing event in an industry dispute over access to Vector's Auckland gas transmission network.

GIC has just told a roomful of defensive Vector-ites, occasionally angry Auckland gas users, and their suppliers that the uncompetitive gas market in Auckland "cannot be endured" and that existing gas users' transmission rights, which are preventing cheaper gas getting to Auckland, will have to be broken.

As Vector owns the pipes, this is only any of Vector's business because it leads to people blaming Mr Mackenzie for under-building – a claim he disputes. Mr Mackenzie has been defending the property rights of existing contract holders, so the 49 year-old networks industry veteran huffs and puffs a bit when told GIC has just deemed those rights anti-competitive and therefore changeable.

But it's the way of the man to take it on board and move on, where another CEO might jump straight on the phone.

Gluten-intolerant, he carefully checks the menu in a chic eatery down the road from Vector's head office by the Auckland Domain. Eventually, a small portion of something with mushrooms turns up.

This is a good choice. Mr Mackenzie's a talker, and he can hardly get a mouthful in, trying as he is to conduct an interview as well as eat a meal.

For this phlegmatic native of Dannevirke, who came up through the ranks of the old New Zealand Electricity Department, gaining tertiary qualifications on the way, it hardly looks a filling meal or, for that matter, as red-blooded a meal as you might expect.

After all, this guy reports to one of the country's legendary corporate tough nuts, Michael Stiassny, who chairs the Vector board and saw off the last chief executive, Mark Franklin, who found they couldn't work together.

"You seem like far too nice a guy to report to Michael Stiassny," I venture. It's the only time Mackenzie colours, but he comes right back. "A lot of what is said about Michael is unfair," he parries.

"We have a good working relationship. He's extremely focused and challenging. Where there are differences of opinion, we disagree where appropriate, but we haven't had any dust-ups that have got out of control or anything.

"You can't afford to be in these roles if you aren't reasonably thick-skinned."

He's OK with robust discussion and strong opinions respectfully held. An aide looks quietly amused.

For Mr Mackenzie, both the gas transmission and the UFB issues represent the classic network owner's problems: if you build it, will they come?

In the gas market, the over-supply currently driving price cuts will last maybe another two years, but transmission pipes take that long to build, and take a generation to pay for. There's no long-term gas supply outlook that would justify the expense.

And while the gas network is a steady earner, it only does that if the regulator sets rates of return that allow Vector to milk the $1.8 billion it has tied up in the pipes. The same issues, with bells on, apply to regulated returns on Vector's $3.2b in electricity assets, and Mr Mackenzie gets exercised about what he sees as the muddled theory coming from the Commerce Commission's work to re-set regulated rates of return for electricity networks.

Even at 8.82 per cent, the high end of the recently proposed band of potential returns, Mr Mackenzie says there's "little recognition of the need to attract offshore capital", while the proposal is "at least 50 basis points below Australian regulation, when we would expect New Zealand weighted average cost of capital to be higher than in Australia. This must be addressed."

In the UFB field, however, the Government is the network owner's friend – at least for the next decade.

"The Government doesn't want to be a retailer, but there's a transition where the economics aren't practical, so the uptake risk is taken through the Government with its funding mechanism," Mr Mackenzie says. "We can build coverage throughout Auckland, the Government pays us the bill per street, and when a customer connects, we buy that connection." On top of this, Communications Minister Steven Joyce has also signalled a period of "regulatory forbearance" until 2019, during which regulated prices will remain stable, even if they end up dropping when they're eventually reviewed.

In other words, some of the key commercial risks are taken care of. All the Government wants is partners who can spur fast uptake, because if it's slow, there's no way it will reach its policy goal of stringing fibre past the front gate of 75 per cent of New Zealand in the next decade.

And this is where, for Vector, it gets trickier.

For a start, it has perhaps 1000 kilometres of open access cable laid around Auckland. Telecom has far more, although its PR boast of 25,000km counts a lot of cable that's fully used and available only to Telecom.

Perhaps more importantly, Vector is not yet a mass market customer service business in the way that Telecom is, albeit that the only way for Telecom to play in the Government initiative is to split its fibre division, Chorus, from the rest of the customer-rich empire.

While Mr Mackenzie sees long-term opportunity in aggregating networked services, where UFB enables better use of the traditional energy networks, among other things, that is for the future.

"Retailers may want to be able to offer flexible tariffs, while as a network owner, I may be looking at how to shift load," he says. "The customer owns the load, has the right to choose how to make their load available – clearly there's an opportunity to have a differentiated line charge."

Aggregated utilities billing, home security, remote home management and a host of other services the web-enabled citizen of five years' time will be starting to expect could be added. But it hasn't begun yet.

For those who suggest Vector can't afford the roll-out, Mr Mackenzie has this reply.

"We don't constrain ourselves to 100 per cent ownership. It's more about a working capital requirement building the network, and then when it's up and running, we see that as attractive because there's open access and a revenue stream. That's fundable."

He concedes capital constraints would arise only if there's "a very high, unexpected level of uptake" that limits Vector's other investment opportunities.

"We could invest in new gas transmission, but we are not obligated to, so we might look at that and say we could do that, or we could invest in fibre. Where's the best return?"

He stresses this doesn't mean diminished commitment to maintaining the infrastructure networks Vector already owns.

"The baseline of security and reliability is maintained, but new investment is discretionary. That's the reality."

All of which ignores the elephant in the room. The chief executive at Chorus, Mark Ratcliffe, is on record that getting all of Auckland is an integral part of its bid. So does Mr Mackenzie think Auckland can be shared, so that Vector gets a look in too?

"Yeah, clearly," he says, citing the North Shore versus "the rest" split that used to apply under the old electric power boards. "You could separate them out. That may be an outcome that makes sense from a Government perspective, but equally we're happy to build all of Auckland ourselves."

It's a brave hope. Unless it puts Telecom's Chorus in the tent, the Government runs risks with UFB it will dearly want to avoid. Whether that leaves Vector and its Regional Fibre Group as fully participating partners or picking up the crumbs remains to be seen. BusinessDesk

- BusinessDesk