Isra-Mart srl: Uncertainty in a challenging environment

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Vector's Simon Mackenzie says infrastructure companies like his own face a range of challenges ranging from uncertainty over the regulatory and emissions trading environments to rethinking network resilience in the wake of the Christchurch earthquakes.

"The uncertainty has got worse - not better," says Mackenzie, pointing to the recent Commerce Commission decision which overturned the basis on which most lines companies set their prices.

The gas and electricity distributor is seeking a legal review of the mechanism by which the commission regulates pricing for monopoly network owners. Analysts like Goldman Sachs' Matt Henry, who slammed the moves as "material but seemingly arbitrary", saying the proposed removal of a tolerance band on the network's cost of capital substantially increases Vector's downside risk, believe it will reduce the company's profitability by 3 to 5 per cent. MacKenzie argues the resultant return on capital of 7.78 per cent is simply too low to maintain and upgrade the networks. "These guys are saying you are better to go and invest in Australia because the regulator gives you more returns and less uncertainty."

Mackenzie believes his company will experience even more uncertainty as the Government prepares to float down shares in the three state-owned power generators and review the emissions trading scheme.

At issue is the resultant over-weighting of the NZX with energy stocks. "If a fund manager offshore is looking to New Zealand they will see our index is already reasonably highly weighted with infrastructure companies." says the Vector chief. "Add three generators and Solid Energy and suddenly it is overweight in infrastructure. They have to have balance ... maybe 15 per cent or something. This will result in a huge over-dominance of infrastructure in the exchange at the top end."

He expects there will be a rub-off effect on other energy companies like Trustpower or Contact Energy.

Mackenzie is also concerned at political uncertainty, questioning the impact if Labour indicates it will rescind the SOE sell-down at a future date in the same fashion it has said it will pull the plug on Telecom's ultra-fast broadband deal.

And he questions what slowing down the ETS means for a company like Vector which has to buy carbon credits. "This all creates uncertainty."

Add to this some fundamental rethinking of the impact of a series of recent natural disasters on the capacity of "lifeline" businesses to deliver energy, water and sewage to customers and it is clear the Vector boss has a challenging time ahead.

The major impact of the earthquakes is the way they have forced networks businesses to stand back and question how they can achieve resilient cost-efficient infrastructures that are able to respond to such events. It's not just the impact of earthquakes which have made it hard to access and repair underground networks but also the impact of hurricanes and tornadoes on overhead networks.

"The real issue is do we go overhead or do we go underground," says Mackenzie. "We've got a full review of that for us now."

"There's been a fundamental mental shift away from underground to overhead networks. From a cost perspective, overhead is about a quarter of the cost to fund. But some find overhead aesthetically challenging."

Another major issue in the energy space is where to locate critical data centres. He cites one organisation which did a lot of work on seismic strengthening its Christchurch data centre before the February 22 quake. "Had they not done that there would have been huge damage to multiple operations ... a centre of activity like a data centre can potentially take down a whole country."

Mackenzie was disappointed Vector did not get a slice of the Government's ultra-fast broadband rollout.

But analysts suggest the company has the ability to leverage the greater awareness among Auckland businesses, in particular of the benefits ultra-fast broadband can deliver them.

Mackenzie will not comment directly on Vector's own competitive response. But he says that before the initiative was floated his company had a fibre business competing against a vertically integrated monopoly. Customer demand was slow as there was not enough awareness around fibre and retailers were not pushing product to the market.

Now retailers will be able to compete against the structurally separated entity. "There is a lot of retail demand out there and a lot of retail solution providers. We look at 18 months of extensive research and detail built across Auckland. It might be attractive to a retailer that wants to access our networks and expand. It could be a pyrrhic victory for Vector."