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The Shoeshine Column: No bonanza for Fletcher Energy

Friday 16th June 2000

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Trying to put a value on last Friday's High Court judgment in the Fletcher Energy versus Genesis case is an exercise of the purest crystal ball-gazing

The market tried this on Monday. At one point - assuming the judgment was the only thing driving the share price - Energy shares were up 26c, implying the gas supply contract the company had succeeded in enforcing was worth $89 million, or $5.2 million a year over the contract's 17-year life, in bottom-line earnings.

By the end of the day a more cautious tone had prevailed. The stock closed up 10c, indicating $34 million, or $2 million a year.

The real figure, of course, won't be known until 2017.

In part that's because the market doesn't know the contract prices, which have been kept firmly under wraps.

Justice John Wild's decision has the gross value of the gas in question at $1.2 billion to $1.8 billion. Simple division shows the average price over the contract's life is $3.75 to $5.63 a gigajoule.

There's no wholesale gas market - all prices are set by bilateral agreement - but recent data shows the "market" is currently at around $2-$2.50.

So the contract Genesis is now lumbered with is way out of the money by anyone's calculations. In crude terms - multiplying the premium to the market by the 320 petajoules Genesis has to buy - the contract would result in a value transfer from the SOE to Energy of $560 million to $1.2 billion.

Of course those figures have to be discounted for inflation and for the time value of money but they are still big enough to set the alarm bells ringing loudly in Wellington, where the Crown - that is, the taxpayer - will be footing the bill.

Genesis is the shakiest of the three "baby ECs" born of the split-up of ECNZ in April last year. At the December 31 balance date it had total assets of only $708 million.

In fact ministers probably shouldn't get overexcited.

For one thing, the country's largest gas field, Maui, is expected to be depleted somewhere around 2009. At that point the contract will still have almost half its life to run. God only knows what the gas price will be after that - if explorers haven't found very substantial new production fields by then Genesis' contract could well be in the money, offsetting or even reversing earlier losses.

For another Genesis is almost certain to appeal the decision and to keep appealing, unless Energy settles the matter on terms less generous to itself.

Bet on this option. It's not in either sides' interest to keep feeding its lawyers for years to come.

The effect on Genesis is unlikely to be severe. In the December half-year, which includes the coldest months, it made a net profit of $15.6 million.

All the same, taxpayers should be asking how Genesis' predecessor, ECNZ, came to sign such a contract in the first place. It didn't - that's what the court case was, ostensibly, all about.

Gas-supply negotiations between ECNZ and Energy began in late 1995. At that time ECNZ was worried about the Maui field running out and what that might mean for its gas-fired stations - notably Huntly.

There was some interesting argy-bargy when Energy learned ECNZ was also in the bidding for Western Mining's 40% interest in the Kupe exploration field. In the end they agreed not to bid against each other and Energy got the stake.

The two signed a heads of agreement (HoA) for the supply of 320 petajoules of gas up until 2017 in February 1997. But by June ECNZ realised the market was changing. The wholesale electricity price had sunk and was forecast to stay low for five years.

It began asking itself whether, in Justice Wild's words, any "reshaping" of the principal terms of the HoA should be contemplated.

There was also argument about whether Energy should be allowed to contract to supply gas after 2011 only if that was economic.

Negotiations on a comprehensive sale and purchase agreement finally broke down in January 1998.

Energy filed action to bind ECNZ to the HoA. ECNZ said the HoA wasn't binding.

The HoA stipulated Energy and ECNZ must "use all reasonable endeavours" to agree a full sale and purchase agreement within three months. Energy claimed ECNZ made a deliberate decision not to reach agreement because the HoA no longer suited it under the changed market conditions. Justice Wild agreed.

His wisdom is likely to have an unintended beneficiary - Contact Energy.

Genesis uses its gas predominantly to fire the 1000MW Huntly station it inherited from ECNZ. At present Huntly competes with cheap "base load" stations such as Contact's Otahuhu B and TransAlta's Stratford.

But the gas input prices indicated in this deal will make its power more expensive, pushing it down the "dispatch queue" of stations that come on stream when demand sends wholesale prices higher.

Instead of competing with Otahuhu B it will tend to compete with less efficient single-cycle stations like Contact's at New Plymouth. The price shift is hardly one Contact will neglect to exploit.

But Contact shareholders, of whom Shoeshine is one, shouldn't expect huge profits. The Energy contract provides only about two-thirds of the annual gas consumption of one of Huntly's four generation units.

If Fletcher Energy and Genesis settle their case, the Mad Gas Contracts episode will - unless Shoeshine's spies have been deficient in their duties - have come to an end. As one senior industry figure delicately put it. "There were two CEOs who signed contracts like that. One's dead and the other one hasn't been seen since he ran off with his aerobics instructor."

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