Gagging on power plan

YOUR PORTFOLIO - TIM HUNTER
Last updated 05:00 28/04/2013

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OPINION: Like Kids with a stink bomb, David Shearer and Russel Norman have charged into the National Party staff room and set off an appalling stench.

Supporters of the Mighty River Power share offer have rallied round frantically fanning the air with prospectuses and opening windows, but the surprise attack has sent investors rushing outside, gagging on the overpowering political odour. The question is, will they return as the gas clears, or will they hang back, wary of lingering smells?

Having said two weeks ago I planned to buy shares in the float, I'm one of those who must come up with an answer.

Frankly, this is a curly one.

As Labour and the Greens no doubt intended, their announcement has amplified the sense of risk around Mighty River Power's partial privatisation. My initial reaction was to place my order for shares on hold until I got my head around it and there were probably many who did the same.

The Labour and Green policies are not identical, but they are close enough to suggest what might happen if the two were to form a coalition in the next government. The common factor involves radical change to the electricity market involving a single government-owned buyer at wholesale level, called NZ Power, which aims to drive down prices and pass on savings to consumers.

How it would do that is a major bone of contention. Labour says NZ Power would pay generators a price to cover costs and a fair return on capital, while the Greens say it would use its negotiating power to contract supplies at close to average cost rather than the higher marginal cost under the present system.

You can argue until the cows come home about the feasibility of these options but their intention is to slash power costs to consumers by a collective $500-$700m, or a cut in the average household power bill 0f $230-$330 a year.

If people believe this can be achieved, the policy could attract support - there have been complaints about excessive electricity price rises for more than a decade and there is a wealth of data to support a sense of grievance.

Personally, I have long been convinced the electricity market is not properly competitive at wholesale or retail level and arguments trotted out to justify retail price hikes are often bogus. The favourite - that retail customers were cross-subsidised by commercial and prices had to be rebalanced - is not consistent with the data.

You have to go back to the early 1990s to find average commercial prices higher than retail, which means we have now had almost two decades of synchronised "rebalancing" from all power companies - even if you accept that energy costs should be higher for households, which is a dubious assumption in itself.

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The upshot is that the probability of Labour and the Greens having a chance to implement their ideas is more than zero. Investors must therefore try to estimate the downside for Mighty River shares, which is far from easy. Indeed, there is a woeful lack of advice on the matter from the financial sector.

Most of the big players are so conflicted by the share offer - they get 1 per cent of the money from retail investors whose subscriptions bear their stamp - that they can say nothing about Mighty River Power at all.

The Government's supplementary disclosure was unable to quantify the effect, which isn't much help, but justifiably said its 2014 financial forecasts were still good because any market changes would take time to implement.

I've seen only two analyst reports attempting to put a price on Mighty River since the policy bombshell, one from Wellington boutique Woodward Partners and one from Morningstar.

Woodward analyst Nick Lewis suggested the regulatory risk translated to a 10 per cent price discount, reducing the indicative range from $2.35-$2.80 to $2.12-$2.52 a share.

Morningstar analyst Nachiket Moghe said the shares were probably worth $2.70, but as long as the price was in the $2.35-$2.80 range they were worth buying.

Other analysts have restricted themselves to rating Contact Energy and Trustpower.

Jason Lindsay of First NZ Capital sliced 7.7 and 5.6 per cent off his respective valuations and rated both companies neutral in terms of their investment attractiveness.

Grant Swanepoel of Craigs Investment Partners reduced his target price for Contact by 7 per cent to $5.91 but maintained a "buy" rating on the stock with the market price at $5.39.

Andrew Harvey-Green of Forsyth Barr reduced his target prices for Contact and Trustpower by about 5 per cent to $6 and $8.35 respectively, "however, we believe both companies are good investments and have upgraded our TPW recommendation to ‘buy' and maintained our ‘buy' recommendation on CEN."

The implication here is that Mighty River shares should be cheaper than they would have been without the Labour/Green announcement.

The offer structure means retail investors like me won't know exactly how much we will pay, but I think the institutional book-build will put downward pressure on the price.

Several fund managers are on record saying the increased regulatory risk requires them to pay less for the shares.

In the end, for me this isn't a deal-breaker. I can tolerate the extra risk because I have a portfolio approach and I think there is some corresponding upside from a lower offer price.

As for the wider policy issue, I think state ownership of two thirds of the electricity industry has been a major factor in the failure of successive governments to fix the market's flaws.

Mixed ownership is not the whole solution, but it is progress. Beyond that, responsible politicians should consider reform of such an important and complex sector based on careful analysis and consultation rather than a hydrogen sulphide blitzkrieg.

Gas is an imprecise weapon prone to blow-back.

- Tim Hunter is deputy editor of the Fairfax Business Bureau.

- Sunday Star Times

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