State Owned Enterprises And The Way Ahead

Good morning. I am pleased to be able to talk to you today on the subject of State Owned Enterprises and the way ahead.

For the first time in over 100 years of electricity generation in this country, New Zealand households have at last had their first taste of real competition in the electricity market.

The first signs of competition they saw were the major discounts offered under the blue and orange livery of First Electric and the black and white logo of Contact Energy. Since then, existing retail electricity companies have countered with the first significant price reductions to electricity their customers will have ever seen.

It is no accident that the companies that forced this competition, First Electric and Contact Energy, are both State Owned Enterprises.

Having at last been given the freedom to chose, New Zealanders have responded in droves. In just three weeks, 40,000 people have called First Electric's service number for further information. Substantial numbers have also called Contact.

Already, over 7,500 people have dropped their existing electricity supplier in favour of First Electric, creating for the first time a broad-based retail electricity market.

Next month, the Government will take the final decision to proceed with the split of the state owned electricity generator ECNZ into three competing SOEs. This represents a major realignment of the Crown's portfolio of electricity SOEs.

At the moment, the new SOEs are in the design phase. Three Interim Development Groups have been appointed to prepare business plans and develop organisational design and corporate structures. The new SOEs will be based on electricity generation assets in Waikato, Huntly and the South Island.

The Government is scheduled to consider the results of this work in December when the final decision on the formation of the three new SOEs will be made. This decision is conditional on satisfactory progress with Treaty of Waitangi, environmental and security of supply issues.

I would also note that it is conditional on the agreement of satisfactory interim transmission arrangements with Transpower.

Already, we know from the September 15 report of the Electricity Reform Transition Unit that each of the three new SOEs will be commercially viable under a wide range of market conditions, that they will not require an equity injection by the Crown, and neither will there be a write-down in the value of the assets below the current book value of ECNZ.

With a month to go until final decisions are made, I would like to take you through a profile of what we know about the three new companies.

WAIKATO SOE

The Waikato SOE has been allocated the eight hydro stations on the Waikato river, a total capacity of 1040 megawatts, equivalent to 13% of New Zealand's generation capacity.

The Waikato river system can ramp from low to maximum output very quickly, giving the SOE the ability to capture peak generation opportunities. These low operational costs and high operational flexibility will give the Waikato SOE a strong competitive position.

The Waikato SOE has also been allocated the First Electric retail energy business, and a range of smaller projects including Mokai geothermal, Marsden B and an Indonesian geothermal project.

With Lake Karapiro and its facilities in the Waikato providing New Zealand's premier rowing venue, the Waikato SOE will provide a natural home for ECNZ's Rowing NZ sponsorship.

The company profile is for a hydro company with very low operating costs and a sound balance sheet. Opening asset value is $729 million, the Waikato SOE will initially carry a 55% gearing.

The principal operating activities of the Waikato SOE will continue to be managed from the existing Hamilton offices. In addition, the Waikato SOE will establish a small corporate support office in Auckland.

HUNTLY SOE

The Huntly SOE will comprise the Huntly station and the Tongariro hydro system. This SOE has also been allocated ECNZ's interests in the Kinleith co-generation project, the Meremere A and B sites, and ECNZ's 25.75% interest in the Kupe gas field.

The Huntly SOE will own around 17% of the country's electricity generation capacity, with assets of $432 million and gearing initially at 13%.

ECNZ's Science Fair sponsorship will be picked up by the Huntly SOE.

The company profile is for a smaller, robust and competitive energy business looking forward to the new challenges of the marketplace. The operations office will continue to be run out of Huntly and a small corporate office will be established in Manukau City.

SOUTH ISLAND SOE

The South Island SOE will be the largest of the Government's three new State Owned Enterprises with assets of over $1.9 billion. Comprising the eight Waitaki hydro stations and Manapouri, the South Island SOE will have a total capacity of 2,323 megawatts - around 30% of New Zealand's generation capacity.

The Comalco contract will be assigned to this SOE and it will have a retail marketing presence arising from ECNZ's purchase of the Waitaki, Northpower and Central Hawkes Bay retail businesses.

Even though its capacity will be mostly in the South Island, this SOE will impose a strong discipline on the North Island companies by transferring electricity northwards on the Cook Strait cable.

And for those of you who know Wellington, the landmark wind turbine will fall under the responsibility of this SOE, as will ECNZ's sponsorship of the Royal New Zealand Ballet.

The company profile is for a hydro-based generation company with a substantial water storage capacity. The SOE will be initially geared at 27%.

The majority of staff will remain in the operational base in Twizel. South Island headquarters will be established in Christchurch to manage the SOE's South Island retail and customer interests.

The chief executive may be based in Wellington along with 25-30 staff to maintain and build relationships with the SOE's single largest customer, Comalco, and with Transpower, its largest supplier.

RESIDUAL ECNZ ENTITY

Following the split, a number of assets, liabilities and functions will be retained in ECNZ as a residual entity.

Of key interest to the industry, ECNZ's existing hedge contracts will remain with the residual ECNZ entity whose performance will be guaranteed by a third party, most likely the Crown.

Companies with existing hedge contracts with ECNZ will continue to pay ECNZ, which in turn will make payments to the new SOEs through offsetting contracts. Similarly, payments due to companies with hedge contracts will be funded by the new SOEs through ECNZ.

These payments from ECNZ's existing hedge portfolio will provide a substantial firm cashflow during the initial years of operation for each of the new SOEs. As ECNZ's hedge profile decays, the new SOEs will sell their own hedge products.

The residual ECNZ entity will also meet obligations to creditors, taxation liabilities and, unless it is completed by the transfer date, the balance of the small hydros sales process.

The residual ECNZ will operate as an SOE and will continue to comply with the Companies Act. Reporting and accountability requirements will be met but the principal objective to operate as a successful business will no longer be appropriate and will be removed by Order in Council, as envisaged in the Electricity Reform Act.

AFTER THE REFORMS ARE IMPLEMENTED

The generation sector reforms will create an industry with four major companies and at least two medium sized companies with generation and retail. None of the new SOEs will be dominant in the market and each will have strong incentives to compete.

The SOE model will continue to deliver results in the form of lean, responsive and successful businesses. Just as Contact has moved swiftly to diversify its risk base, the Government fully expects the three new SOEs to seek out new energy investments both in New Zealand and overseas.

Recently, the Government had to reach a view on whether it was desirable for SOEs to extend this involvement into the domestic electricity market through the purchase of the retail portion of energy companies. We concluded that it was.

SOEs form a key part of the industry and are required to operate as successful businesses in their own right. As shareholder, the Government expects them to be proactive as industry developments unfold and would be concerned if their value eroded because of a failure to adapt. Nor do we wish to impede competition in the retail electricity market by holding them back.

Having said that, the SOEs do not have a blank cheque to buy existing retail operations. SOE boards must ensure that full commercial investment criteria are met when bidding for retail interests by competitive tender and we will not allow an SOE to develop a dominant market position through acquisitions in retail electricity.

The entry of SOEs into the retail electricity market has accelerated the reform process and delivered benefits to consumers as much as a year ahead of expectations. Here in Wellington, residents can now choose between Contact Energy, First Electric and TransAlta. Prices have been placed under substantial pressure and consumers have clearly benefited. That degree of benefit would not have been delivered at the speed it has been without SOE involvement.

The three new SOEs will have no privileged position in the market, nor will they have any particular disadvantage. They will have to work hard to compete against each other and private sector players to fight for market share and market advantage.

At times this will result in vigorous disputes, that's to be expected. I personally will take that as a sign of the level of competition in the market and the firmness with which the new SOEs are contesting it.

I have discussed so far the establishment of the three new electricity SOEs. You will also be aware that the Government has commissioned a report to examine the sale of Contact Energy Limited.

Commercial advisers are at the moment conducting a detailed review of the company, considering issues that may affect a sale, and an assessment of the best timing for a sale. These advisors have also been asked to assess sale options that would ensure widespread public ownership.

Given the success of the float of Auckland Airport shares and strong interest in the current float of Capital Properties New Zealand, we want to provide further opportunity for New Zealanders to invest in a high quality utility business.

Introducing a private sector company to compete with the three new SOE generators will make those SOE's more competitive and deliver lower prices to New Zealanders. Proceeds from any sale will go towards reducing public debt. The savings in interest costs will free up valuable funds for higher priority spending such as health and education.

The Government is likely to consider the implications of the scoping study by Christmas.

This Government has no plans to address its ownership interests in the three new SOEs, our concern is to ensure they are established and operating as successful businesses in their own right.

I would like to conclude with the Government's shareholder monitoring arrangements. Taxpayers' equity investment in the three new SOEs will total more than $2.3 billion, or 42% of the equity value of the SOE portfolio.

Under the State Owned Enterprises Act, the shareholding ministers for ECNZ are the Minister for State Owned Enterprises and the Minister of Finance.

As you know, a new ministerial position, the Minister Responsible for Contact Energy, was created when Contact was separated from ECNZ.

As well as having separate responsible ministers, separate monitoring arrangements were also put in place. The Treasury has responsibility for advising Ministers on ECNZ and CCMAU was given the role of advising and monitoring on Contact.

This structure has reduced the risk of possible conflicts of interest on competition issues.

The Government is now reconsidering these monitoring arrangements as we prepare for the establishment of the three new SOEs.

It has been put to me that there could be value in the Government contracting in some of the monitoring responsibilities from private sector expertise, rather than relying solely on our traditional sources.

The management and audit of commercial businesses is an area in which the private sector tends to be superior to the public sector. This is recognised in the State Owned Enterprise model, where directors are appointed from the private sector.

Obviously, any such contracting would need to be carefully managed and the impartiality of advice and possible conflicts of interest would need to be addressed.

This is an idea that I consider worthwhile pursuing and I would like to conclude by inviting participants at this conference, and the wider business community, to offer the Government your views on the merits of this proposal.