Solid Energy: Elder thrown overboard

CHALKIE
Last updated 05:00 20/03/2013
PIRANHA BAIT: Ex-king coal Don Elder gets a grilling from the select committee. After throwing Elder over the side, politicians have been busy on deck cleaving extra chunks of dripping red meat to lob in after him.
KENT BLECHYNDEN/Fairfax NZ
PIRANHA BAIT: Ex-king coal Don Elder gets a grilling from the select committee. After throwing Elder over the side, politicians have been busy on deck cleaving extra chunks of dripping red meat to lob in after him.

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OPINION: Like piranhas, the media have surrounded former Solid Energy chief executive Don Elder and are nibbling away in a frenzy.

Although he had neither a private jet nor an entourage of underage Moroccan nightclub dancers, the ex-king coal has attracted a remarkable degree of attention. Heavens, he even had hacks hovering outside his house.

Chalkie reckons Elder is far from unique in presiding over a sudden corporate decline - think in the past Fisher & Paykel Appliances, Nuplex, PGG Wrightson, Air New Zealand or any finance company you care to mention.

Over the past dozen years there has been plenty of blood in the water. But maybe what's different here is that after throwing Elder over the side, politicians have been busy on deck cleaving extra chunks of dripping red meat to lob in after him.

Piranhas love that.

We've had John Key talking about Solid Energy's multibillion-dollar ambitions to be a Kiwi version of Petrobras, Brazil's partly state-owned oil giant, and we've had Opposition leader David Shearer talking about government demands in 2009 that Solid Energy increase debt and pay more dividends.

Neither of these revelations should come as much of a surprise.

For example, Solid Energy told Parliament's commerce select committee in December 2009 about its aim to develop New Zealand's "world-class" energy resources.

"Investment planned over the next decade could be as high as $10 billion if all key projects progress," it said. "A significant portion of this investment is likely to be provided by Solid Energy investment partners." That is, presumably, not the Government.

The same presentation gave Solid Energy's now-famous projections of coking coal and oil prices soaring into the future like birds on the wing.

Meanwhile, in April 2009, Finance Minister Bill English and then SOE minister Simon Power summoned SOE bosses to a meeting and told them to sharpen up.

"We've got a recession and we've got a government that wants value for the taxpayers' dollar," English told reporters after the meeting. "They need to get better returns than they've got."

Solid Energy was not singled out for dividend extraction and a dose of debt, but you can see why it might have felt the rebuke more keenly than others.

Chalkie has run the numbers on debt and dividend levels for a bunch of SOEs going back to 2005 and it's clear that Solid Energy was slacking a bit. From 2005 to 2008 its annual dividends were zero, $20 million, zero and zero.

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Such paltry returns are not what you want from a business deploying shareholders' funds of $400m or so. No wonder English and Power wanted more.

We'll come back to what Solid Energy did with its money in a mo, but it's worth noting that the Government's rev-up didn't make a difference to all SOEs.

Comparing the four years from 2009 to 2012 with the previous four years, average dividends actually declined at Meridian and TVNZ, stayed roughly the same at Genesis Energy, while big dividend lifts were apparent at Mighty River Power and Landcorp.

Debt levels were also not universally increased after English and Power's crackdown. Landcorp's borrowing stayed in the same ballpark while TVNZ's fell considerably.

The point here is not that debt and dividends at those companies should have been different, only that the outcomes support the view that decisions on these matters were ultimately made by individual SOE boards.

Chalkie reckons the Government's position in 2009 was only what you'd expect from a shareholder and how boards responded to that pressure, rightly or wrongly, was down to their judgment of what was best for the business.

Solid Energy's judgment was that debt could be substantially increased, from $33m in 2008, to $62m in 2009, to $212m in 2010.

By June 2012 debt was $295m, which sounds like a lot but on a crude measure of gearing - debt/total assets - at 25 per cent it was well within the bounds of normal, around 50 per cent.

A better measure may be interest payments, which were also no obvious grounds for alarm. In the year to June 2012, Solid Energy had operating cashflow of $142m - a measure of basic business profitability - representing considerable headroom for its interest bill that year of $14.8m.

So where was all the money going?

Looking at cashflows going back to 2005, Solid Energy was making decent money every year, even when coal prices were relatively low.

According to stats on coking coal prices compiled by BP, the average import price for Japan, where Solid Energy sells a lot of coal, was below US$100 a tonne in 2005, 2006 and 2007. In those years Solid Energy made operating cash of $35m, $94m and $114m.

The price then doubled, but Solid Energy's profits didn't.

Chalkie reckons the reason can be traced to the big money it was reinvesting in mining assets, production equipment and staff costs.

In the figures since 2005, that investment regularly exceeded what Solid Energy was making from operations in what was effectively an all-in bet on ever-rising coal and oil prices.

As is clear from Solid Energy's 2009 presentation, the company strongly believed the world had shifted into a new phase.

"In 2008 for the first time since oil was discovered, oil and energy . . . demand exceeded supply . . . and as a result prices reached US$150 a barrel," it said.

The recession released the pressure, but "we do not expect this balance to remain as demand quickly increases, based on a recovering world economy".

With 90 per cent of the world just starting up the prosperity ladder, the company said, there was only one way oil prices - and therefore coal prices, which are strongly correlated - would go.

In its best-case scenario Solid Energy saw coking coal prices at US$400 a tonne by 2020 and US$600 by 2030.

So what should an energy business do if it sees soaring demand and high prices into the future?

If you believed prices were going sky high, you might invest in more coal production, you might invest in coal seam gas and underground coal gasification.

If you believed in world energy hunger, you might invest in alternative energy sources such as wood pellets, biodiesel and lignite briquettes.

If you believed in ever-tighter oil markets and you were an ambitious, patriotic Kiwi energy company, you might want to secure big chunks of oil exploration real estate.

So in a sense, Solid Energy's strategy in pouring so many millions into these projects had a sort of logic to it.

But only if you believed the price projection.

The Government's release of papers on Solid Energy's National Resource Company proposal shows how far out of whack the company's ideas were.

The Treasury's assessment of the NRC scheme advised: "It is not clear why the Crown would wish to take such an exposure in commodity price movements based on price path analysis not shared by other experts." The NRC idea got the brush-off from the Government, quite rightly.

But Solid Energy isn't struggling today because it thought about getting into oil exploration. It is in trouble because a lot of the money it did invest turned out to be wasted when energy prices didn't behave as it thought they would.

The Government was smart enough to see the implausibility of Solid Energy's forecasts when it came to the NRC, but not when it came to wood pellets, underground coal gasification, lignite, Spring Creek, biodiesel and all the other things soaking up the company's resources.

While all that was going on, the Government shareholder was busy getting Solid Energy to fill in its boiler-plate questionnaires seeking answers about how many credit cards it gives employees, how many staff have mobile devices and what it spent on office refurbishments.

If we wondered why state-owned businesses tend to under-deliver, just think about committees of MPs and bureaucrats poring earnestly over executive mobile phone bills. For all the good it does they might as well flag it and and go to the pub.

Chalkie reckons the Government is well aware its lack of oversight helped Solid Energy get out of hand and is doing its best to make Elder the fall guy.

That's not to say Elder shouldn't have gone - he should. But to Chalkie the main responsibility lies with Solid Energy's board, which reviewed and endorsed the company's strategy year after year. The Government, meanwhile, was well aware of Solid Energy's approach but didn't pay it much attention - complaining about it now is just hypocritical.

Overall, Chalkie see this as another example of why SOEs are a bad business model. It's just a shame the debacle means Solid Energy will remain 100 per cent state-owned for even longer.

- Chalkie is written by Fairfax Business Bureau deputy editor Tim Hunter.

- BusinessDay.co.nz

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