Appointment of directors: Mixed ownership model ‘gentailers’ and principal/agent problems: what will we see?
Now that Mighty River Power and Meridian Energy, two New Zealand state owned enterprises and major generators and retailers of electricity (‘gentailers’) have been partially privatised with the Government retaining a controlling 51% shareholding interest and Genesis (the third gentailer state owned enterprise) is on track for partial privatisiation next year, the issue of the appointment of new directors arises.
Company law to one extent or another tackles the principal/agent problem or agency dilemma (which concerns the difficulties in motivating one party to act in the best interests of another rather than in his own interests) between, first, shareholders and management, second, the majority shareholder and minority shareholders, and third, the company and non-shareholder stakeholders.
Where the company is wholly owned by a single shareholder (e.g. the Government), securing the accountability of management (the directors) to the 100% shareholder through traditional company law mechanisms is not be difficult. In particular, under the state owned enterprises model, the Shareholding Ministers have a statutory right of appointment and removal of the directors.
Where the shareholding of the company is diversified, the principal/agent problem between shareholders and management becomes more meaningful. Where a shareholder has a 51% controlling interest, securing the accountability of management (the directors) to the shareholders (at least the controlling shareholder) through traditional company law mechanisms should likewise not be difficult. After all, the 51%controlling shareholder can, at the general meeting of shareholders, determine the appointment and removal of directors. However, one does have the principal/agent problem between the 51% controlling shareholder and minority shareholders; how does the minority shareholders influence the 51% controlling shareholder to have regard to their interests? Normally, one might expect that the interests of the 51% controlling shareholder and the minority shareholders to be aligned, especially where all the shareholders are traditional investors, so that there should be no problem. But is this the case where the 51% controlling shareholder is the Government which is, while an investor, open to other influences?
To the extent that there a principal/agent problem between the Government 51% controlling shareholder and the minority shareholders in the context of the appointment of directors, how will the problem be resolved?
The simple company law answer is that the shareholders at or represented at the general meeting of shareholders will appoint and remove directors and the Government as the 51% controlling shareholder will determine the matter as it chooses. However, the reality will be different.
Take two scenarios.
Under the first scenario the Government (the Shareholder Ministers) sits back and lets the Chair and the remaining directors of the particular mixed ownership model (MOM) gentailer (perhaps via a board nominations subcommittee) select candidates for appointment as a new director and consult the Shareholding Ministers as to whether one or more of the candidates would attract the Government’s 51% vote in favour. Under this scenario, it is the existing directors of the MOM gentailer that select the candidates and in doing so would (one assumes) have regard to the interests of all shareholders (both the Government as 51% shareholder and the minority shareholders).
Under the second scenario, the Government Shareholding Ministers (via their advisers) select candidates for appointment as a new director and consult with the directors (via the Chair) of the particular MOM gentailer as to the suitability of the candidates. Under this scenario the Shareholding Ministers would (one assumes) have regard to the interests of all shareholders (both the Government as 51% shareholder and the minority shareholders). Given that the Government is an investor but open to other influences, it might have some extra regard to its interest as the controlling 51% shareholder but (as a counterbalance) be open to views of the MOM gentailer directors as to the impact of the selection on the interests of minority shareholders.
What happens in the case of another MOM, Air New Zealand? The directors are responsible for nominating directors and for filling vacancies that may occur between annual meetings. In considering potential directors to commend to shareholders (both the Government as controlling shareholder and minority shareholders), the directors seeks to identify candidates with appropriate skills, knowledge and experience to contribute to effective direction of the company, and who can exercise an independent and informed judgement: see www.airnewzealand.co.nz/board. In other words, the first scenario is what happens.
What happens in the case of another listed gentailer, say, Contact Energy? Contact Energy is listed on the New Zealand stock exchange. Origin Energy, through its subsidiary companies, has a majority shareholding in Contact of around 52-53%. Retail and institutional investors own the rest of Contact’s shares. From what I can gather, this is another instance of the first scenario. The board of directors has a nominations subcommittee the membership of which is the chair – the Chairman of the board (Grant King, Managing Director of Origin Energy), and two non-executive independent directors.
I suspect that the Government Shareholding Ministers of the new MOM gentailers will be content with appointment of directors as per the first scenario but behind the scenes there will be elements similar to the second scenario to address the principal/agent problem between management (the directors) and the Government 51% controlling shareholder.
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Bryan Gundersen, Barrister, New Zealand.
www.bryangundersen.com
The operator is responsible for conducting the joint operations subject to the control of the operating committee. The Joint Operating Agreement (JOA) will provide how information is to be provided to the operating committee so it can do this. However, the primary means of control by the operating committee is the approval of programmes and budgets.
This is because the operator cannot conduct any joint operations without a programme and budget approved by the operating committee. A JOA for exploration, development and production operations will provide for approval of exploration, appraisal, development and production programmes and budgets (although the exploration and appraisal programmes and budgets are often combined). The operator will submit the programme and budget to the operating committee which may approve, in the end or rejected. The operator is obliged and authorised to proceed with the operations as approved.
There can be differences in the programmes and budgets for the different stages: what should the control freaks look out for?
There must be an annual exploration programme budget which covers the minimum exploration work requirements under the relevant exploration payment. Look for provisions which deal with the situation where the operating committee cannot agree on what is to be done to comply with the permit work obligations e.g. should the operators proposals prevail or that of the joint venture parties with the largest participating interest?
There must be a programme and budget (which should be annual so as to coincide with internal budgets) for an appraisal of a discovery. Some parties like to have an annual programme and budget for both exploration and appraisal operations. However, control freaks should look out for this and consider how it impacts on its ability to undertake a sole risk appraisal operation.
If a discovery is made, there must be a development programme and budget for all operations required to bring the discovery on stream. Make sure that the operator may only propose the programme and budget if required by the operating committee as its preparation is a major and expensive exercise. The key points for control freaks are to first, ensure that the period for consideration of the proposed programme budget can be extended, if required, and secondly, ensure that there are rights of non-consent (not to participate in an approved programme and budget) and sole risk (to proceed notwithstanding it is not approved), and thirdly, endeavour to ensure that the procedures for approval and decision making on non-consent and sole risk can be undertaken in a manner consistent with internal processes. JOAs can be complex with tortuous procedures for approval and exercise rights of non-consent and sole risk. But a balance between complexity to achieve commercial perfection (such complexity leading to non-compliance) and simplicity (which maximises compliance) is required.
There should be an annual programme in budget for production which the operator is required to submit. The control freaks should ensure that the JOA provides for the circumstances where further development work is required during production operations. Also one has to bear in mind that parties who are developing or in a production stage, may also be exploring in another part of the permit area. Hence, there is a need for separate programmes and budgets and control freaks should ensure that the JOA is clear in that regard.
There is also the abandonment stage but that is another story.
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Single-buyer model and farmout agreements. How about that!
It was great to see that my blog published in Energy News www.energynews.co.nz on the single-buyer model stimulated some comment. I agree with many of the comments including the risk or inevitability of direct or indirect political interference.
Before the blog on the single-buyer model I had been blogging on farmouts and I have now asked myself whether contracting by NZ Power as the single buyer and contacting by the farmor had anything in common?
To state the obvious, they both involve long term contracts e.g. NZ Power would contract for the consenting, development and operation of the generation plant and in exchange the generator would get paid; the farmor will contract for a contribution to the funding of or performance of the whole or part of the permit work programme (and/or cash) and in exchange the farminee will obtain an interest in the permit for its full term with which it can deal subject to the terms of the JOA and the Minister of Energy’s consent. Hence, the traditional long term contracting risks of security of reserves/ feedstock, non-completion, sub optimal operation, force majeure, political interference/changes in law and change in market (price) conditions have to be identified and allocated with appropriate contractual mechanisms to the extent practicable.
What about the risk of political interference?
A contract can address the risk of political interference by way of change in law in various ways e.g. in the case where the counterparty is the Government or a Government related party, by allocating the risk to that party by way of an indemnity perhaps limited to changes in law which discriminate against the contract or the non-government contracting party and/or, where a certain revenue flow has been promised, changes to the fiscal regime which impact on that revenue flow; and, in the case where the contracting parties are independent of the Government, by the risk being shared with each party having to bear any associated costs unless or until there is a material adverse impact and/or by having reciprocal rights of termination of the contract.
However, in the case of the single-buyer model, the concerns are more directed to political interference in the decision making by NZ Power. I suggest that the same issue can arise in the case of the farmout, or other contracts between private parties, in that the farminee or the counter party can be the subject of interference by its ultimate parent company. Also the farminee or counterparty might have significant market power which gives rise to concerns similar to that when contracting with the Government or a Government monopoly (as NZ Power would be)
In case of decision making independent of the contract (i.e. not pursuant to a power conferred by the contract), NZ Power would probably be exercising a statutory power of decision which would be subject to judicial review but such, generally speaking, goes only to the decision making process rather than the merits of decision itself but this may to some degree restrain the extent of influence. The farminee or other contracting party with market power would only be restrained by the general law e.g. perhaps to some extent, by the trade practices provisions of the Commerce Act. Hence, recourse to the law as a means to mitigate the risk of interference in this decision making is limited.
More can be achieved in the case of decision making under the contract i.e. pursuant to a power conferred by the contract. First, the contract can be prescriptive as to outcomes and performance levels which limit the scope for influence. Secondly, the contract can provide for legal sanction so as to, in effect, enable judicial review of the decision making process and the merits of the decision itself e.g. provisions that the exercise of a discretionary power must be made after disclosure of relevant information, consultation and in good faith and/or in accordance with a prescribed criteria and that the decision itself must be reasonable.
Hence, contracting by NZ Power as the single buyer and contacting by the farmor have points in common in that decision making under the contract, whether the subject of influence or not, can be the subject of legal sanctions. In the case of decision making outside the contract, the law can only provide limited protection against interference by those with political or market power and, therefore, the nature of the beast (NZ Power in the case of the single buyer model and the farminee in the case of the farmout) becomes critical.
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Is a16.44% regulated return on equity of interest to anyone?
The Philippines Energy Regulatory Commission approved recently a Power Sale Agreement under which the seller is to construct a 119MW coal fired power plant for an approved US$220.36 million and obtain a pre-tax WACC of 12.30% (post tax 8.61%) and a 16.44% cost of equity (based on70/30 debt/equity funding)..
The circumstances are interesting and are attractive to investors.
The seller is a Philippines based generator and the buyer is an Electric Cooperative which has a franchise to distribute and supply electricity to consumers in the Philippines city of Zamboanga on the island of Mindanao.
Electric Cooperative are non-profit cooperatives recognised by the Philippines legislation as authorised and having a mandate to supply power to its connected consumers in defined impoverished areas of the country. In this case the Electric Cooperative buyer is connected to the Mindanao grid. Mindanao is the second largest and southernmost major island in the Philippines with a population of 22 million plus. Many areas in Mindanao suffer rolling 12-hour blackouts due to the island’s woefully inadequate power supply. Given the special needs of Mindanao, the Mindanao grid is excluded from the Philippines WESM (the deregulated and competitive wholesale market) and the industry on the island is regulated at all functional levels by the Energy Regulatory Commission.
The Electric cooperative buyer is unable to meet the demand of its consumers but is required to ensure that the demand is covered by new supply contracts from new generators given that the traditional supplier, the state-owned generator, is not allowed to construct new capacity. This is part of the grand scheme to privatize the industry as set out in my previous blog item. Thus, the Energy Regulatory Commission accepted that there was a clear need for the proposed power plant and the power supply agreement. Indeed, the seller generator is only one on many looking to invest. The Manila Electric Company (Meralco), the largest power distributor in the Philippines, and Global Business Power Corp. also a major provider, have announced plans to enter Mindanao for the first time to establish solutions for the power problems within the island.
The Power Supply Agreement contemplates the construction of a circulating fluidized bed combuster boiler coal fired power plant with an installed capacity of 119 MW and a net dependable capacity of 105 MW (the capacity guaranteed by the EPC contractor) and supply for buyer’s baselaod requirements up to a contracted capacity of 85 MW for a term of 25 years at different rates for commissioning and commercial operations. The tariff or rate structure is as follows:
• A Capital Recovery Fee to recover seller’s capital (debt and equity) and rate of return
• A Fixed Operation and Maintenance Fee to cover the operating and maintenance costs of the power plant
• A Variable Operation and Maintenance Fee to cover the cost of consumables, spare parts and other items directly related to production
• Actual Fuel Cost being a pass through of the actual cost of the coal feedstock
• Start-Up Costs to cover the cost of starting up the plant after any period of shut down for any reason attributable to the buyer
• A Replacement Capacity and Energy Charge to cover the cost to seller in obtaining replacement electricity during any allowed outages
• A Back-up Capacity and Energy charge to cover the cost to seller in obtaining replacement electricity during any forced outages (those outside the allowed limits)
• An Interconnection Capital Recovery Fee to cover the capital costs of grid connection (divided into components to reflect the portions capital cost funded by foreign capital and domestic capital)
The tariff or rate structure and the methodology for the calculation of the amounts payable were reviewed by the Regulator but the major focus was on the WACC recovered by the Capital Recovery Fee.
The essential elements of the Regulator’s approval was as follows:
• The capital cost of the power plant was approved by reference to the EPC contract and other estimated project costs
• The 70:30 debt-equity ratio was approved by reference to sellers actual debt—equity funding for the project
• The cost of debt (7.50% pre-tax and 5.25 post-tax) was adopted as being the actual cost of debt as per the terms and conditions of seller’s loan facility negotiated with the lenders (a syndicate of Philippines based banks)
• Seller’s proposed cost of equity of 19.40% was rejected but 16.44% was approved, it being the Regulator’s established practice to accept this as being a reasonable cost of equity. Not bad, eh!
The result: a Capital Recovery Fee which recovers a pre-tax WACC of 12.30% (8.61% post-tax).
No wonder other participants in the Philippine’s electricity industry are starting to line up to invest in Mindanao to to establish solutions for the power problems within the island, especially given that such is consistent with the political objectives of a relatively stable and ‘pro-privatization’ administration of the Republic of Philippines.
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Is a16.44% regulated return on equity of any interest?
The Philippines Energy Regulatory Commission approved recently a Power Sale Agreement under which the seller is to construct a 119MW coal fired power plant for an approved US$220.36 million and obtain a pre-tax WACC of 12.30% (post tax 8.61%) and a 16.44% cost of equity (based on70/30 debt/equity funding)..
The circumstances are interesting and do attract investors.
The seller is a Philippines based generator and the buyer is an Electric Cooperative which has a franchise to distribute and supply electricity to consumers in the Philippines City of Zamboanga.
Electric Cooperative are non-profit cooperatives recognised by the Philippines legislation as authorised and having a mandate to supply power to its connected consumers. In this case the Electric Cooperative buyer is connected to the Mindanao grid. Mindanao is the second largest and southernmost major island in the Philippines with a population of 22 million plus. Many areas in Mindanao suffer rolling 12-hour blackouts due to the island’s woefully inadequate power supply. Given the special needs of Mindanao, the Mindanao grid is excluded from the Philippines WESM (the deregulated and competitive wholesale market) and the industry on the island is regulated at all functional levels by the Energy Regulatory Commission.
The Electric cooperative buyer is unable to meet the demand for of its consumers and is required to ensure that the demand is covered by supply contracts. Thus the Energy Regulatory Commission accepted that there was a clear need for the proposed power plant and the power supply agreement. Indeed the seller generator is only one on many looking to invest. The Manila Electric Company (Meralco), the largest power distributor in the Philippines, and Global Business Power Corp (GBPC), also a major provider, have announced plans to enter Mindanao for the first time to establish solutions for the power problems within the island.
The Power Supply Agreement contemplates the construction of a circulating fluidized bed combuster boiler coal fired power plant with an installed capacity of 119 MW and a net dependable capacity of 105 MW (the capacity guaranteed by the EPC contractor) and supply for buyer’s baselaod requirements up to a contracted capacity of 85 MW for a term of 25 years a different rates for commissioning and commercial operations. The tariff or rate structure is as follows:
A Capital Recovery Fee to recover seller’s capital (debt and equity) and rate of return
A Fixed Operation and Maintenance Fee to cover the operating and maintenance costs of the power plant
A Variable Operation and Maintenance Fee to cover the cost of consumables, spare parts and other items directly related to production
Actual Fuel Cost being a pass through of the actual cost of the coal feedstock
Start-Up Costs to cover the cost of starting up the plant after any period of shut down for any reason attributable to the buyer
A Replacement Capacity and Energy Charge to cover the cost to seller in obtaining replacement electricity during any allowed outages
A Back-up Capacity and Energy charge to cover the cost to seller in obtaining replacement electricity during any forced outages (those outside the allowed limits)
An Interconnection Capital Recovery Fee to cover the capital costs of grid connection (divided into components to reflect the portions capital cost funded by foreign capital and domestic capital)
The tariff or rate structure was reviewd by the
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