Monday 30th September 2013
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The main elements of the Labour and Green parties' policies to reform the electricity market could be in place within a year or two, although ironing out the detail would take considerably longer, says First NZ Capital in a report on the Meridian Energy share float.
The report values Meridian at $2 a share on a discounted cashflow basis, but says if Contact Energy and MightyRiverPower shares are a guide, Meridian shares would be likely to trade in a range between $1.43 to $1.60, reflecting investor fears about the potential for the Labour-Greens policy to wipe value from the sector.
First NZ Capital identifies the policy as the single largest risk to Meridian, valuing its impact at 61 cents a share from its $2 valuation. That price includes discounts for "a low probability of Labour-Greens policy change and a slightly higher chance of Tiwai smelter closure."
While First NZ Capital believes the Labour-Greens policy has only a 10 percent chance of occurring, it says the consensus among equity investors appears to expect a 70 percent probability of implementation, based on prices for MRP and Contact.
However, the investment bank says the impact of the Rio Tinto-controlled aluminium smelter at Tiwai Point closing only shaves 2 cents a share off Meridian's value, because renegotiated contracts for the smelter have been priced at a level where Meridian is "indifferent" to its closure.
First NZ Capital estimates that at current exchange rates of around 83 US cents to the New Zealand dollar, the metal price would need to rise to US$2,000 a tonne from just under US$1,800 today for the smelter to break even. Either that, or the New Zealand dollar would need to fall to 70 US cents.
"Our forecasts currently pick aluminium to remain below US$2,000 per tonne and the New Zealand dollar to depreciate no further than 75 US cents in the next two years," the research report says. "If the smelter closes, we believe it is likely to have a large impact on electricity prices", with falls of between $10 and $15 per Megawatt hour for retail electricity tariffs.
However, for as long as the smelter remains open, First NZ Capital believes the new smelter supply contract would shelter Meridian from some of the impact of the Labour-Greens policy. The policy would seek to reprice all power station output, based on the historic cost of construction rather than the current system, which pushes prices towards the price required for the next unit of generation to be built.
"If the smelter threatens to leave in 2017, we would not expect Meridian to offer further discounts to keep the smelter open," First NZ Capital says.
The report also suggests Meridian could make savings worth $20 million a year by reducing headcount, noting its total staff today is 827, compared 365 seven years ago, yet its operations are roughly the same size today as they were in 2006.
First NZ Capital suggests implementation of the NZPower single buyer policy could be swiftly achieved by retaining current electricity market processes.
As a first step, hydro generators would be "compelled by legislation to sign fixed sum annual contracts in return for all their future hydro revenue", with control of hydro water passing to the System Operator, currently part of Transpower.
NZPower would then write contracts to limit its exposure to high wholesale electricity market prices and allow prices for retail customers to be reset over a one to two year period.
"Financial impacts on gentailers would now largely be in place" and several more years could be taken to "build all the other processes and structures necessary to operate the model," says First NZ Capital.
The report comes on the opening day of registrations by would-be shareholders of Meridian.
Finance and State-Owned Enterprises ministers Bill English and Tony Ryall say a call for expressions of interest from domestic sharebrokers has seen bids submitted for 45 percent of the shares on offer, indicating "strong demand" for the shares.
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