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South Island Interim Development Group

1 December 1998

Table of Contents

• Introduction
• Business Goals
• SISOE Organisation
• Market Environment
• Environment and Community
• Generation
• Future Opportunities
• Financial Plan
• Projected Balance Sheet ($m)
• Projected Income Statement ($m)
• Capital Expenditure Plan ($m)

Other South Island IDG Documents

• Certification Report
• Financial Viability and Competitiveness Report
• Environmental Report
• Legal Report
• Establishment Plan
• Draft Statement of Corporate Intent

Introduction

SISOE is the largest of the Government's three new energy sector State Owned Enterprises (SOE). It has approximately 30% of New Zealand's generating capacity.

SISOE's power stations have a total capacity of 2,323 MW and over the past three years averaged over 12,500 GWh pa of generation. SISOE has acquired the ECNZ interests in South Island hydro development opportunities, research and development investments in superconductor and fuel cell technologies and wind generation opportunities.

SISOE has a number of contract obligations and benefits; a portion of ECNZ's hedge book on a back to back arrangement, the Comalco contracts, and the retail companies ECNZ purchases before 1 April 1999. It also acquires three major projects currently underway:

• The construction of the second tail-race tunnel at Manapouri.
• The re-runnering of Aviemore.
• Automation and remote control (ARC) of Manapouri and the Waitaki stations.

Business Goals

1. Being the best in the business at managing the physical and financial markets during the transition period;
2. Focusing on risk optimisation. Developing internal performance to be best in the market;
3. Vertically integrate the retail business with the generation business, through development of horizontal core business processes;
4. Leveraging existing competencies in asset management and outsourcing to develop value adding investment opportunities.
5. Matching the operating performance of generating assets to the requirements of the trading position;
6. Energising and investing in key competencies in SISOE's people;
7. Earning a reputation for environmental stewardship;
8. Creating a public image of trust and commitment.

SISOE Organisation

SISOE will have a small number of high quality staff, recruited for their core competencies as well as their technical competencies.

The people will be flexible, changing roles as the market requires. Keeping the team small and highly motivated will be the challenge. To do this SOE 3 will use contractors and consultants for work that is not core to the organisation and where there is no danger of the intellectual property being lost.

SISOE's retail subsidiaries include Northpower, CHB Power, ScanPower and Waitaki Power. In total these represent a customer base of 70,000, most located in the North Island.

Dam Safety Assurance is of vital importance to SISOE. A Dam Safety Assurance subsidiary will contract its services to the Huntly and Waikato SOEs and seek to expand its delivery of niche service beyond those bounds.

SISOE will have South Island offices in Twizel and Christchurch and an office in Wellington.

Market Environment

A competitive environment is assumed, with wholesale, spot and hedge markets more competitive than in the past, wholesale prices falling and major competitors likely to be vertically integrated companies hedging generation with retail.

SISOE expects to operate in a dynamic marketplace and will work closely and in partnership with its customers, suppliers and other counterparties to achieve optimum efficiency and maximum business performance.

The new environment and market volatility after 1 April 1999 is uncertain and it is difficult to predict the behaviour of market participants. SISOE will act competitively while working within the bounds of its resource consents and the law.

SISOE has the ability to manage hydrology risk through a combination of modelling and by entering into commercial arrangements with counter-parties. SISOE accepts that there will be no shareholder support in the event of a dry year.

Environment and Community

The operations of Manapouri power station, the Waitaki hydro scheme and the Wellington wind turbine generator are governed by conditions on their existing resource consents that set out a number of conditions to be complied with. SISOE will inherit an established pattern of environmental management and performance including community involvement and stakeholder relationships.

SISOE will develop, maintain and enhance these relationships with key stakeholders as well as continuing the ECNZ sponsorship contract with NZ Ballet.

Generation

SISOE will need to be a flexible operator to compete effectively. The main driver of generation is the way competitors behave and hydrology in dry years.

Changing market conditions will make it necessary to optimise maintenance and availability levels as part of a rolling forward-looking process. Signals will be developed as to the appropriate timing through the day for outages. This will require capability in modelling and measurement of market behaviour.

Generating assets will earn value through interaction with the market. This requires that the asset management process is integrated with the rest of the business processes, and that real time market knowledge is used in asset management for quality decision making.

The maintenance effort is totally outsourced. Assurance of sustainability to the outsourcing and alignment of contractors' goals with SISOE Generation goals will be essential.

Generating assets have in the past been managed on a minimum life cycle cost basis. The focus in the future will be market value, maximum life cycle productivity (market value). Plant improvements will be driven by maximum life cycle profitability and maintaining statutory compliance until the market environment changes to a lower surplus and higher prices.

A significant plant improvement currently underway is the automation and remote control (ARC) of the Waitaki stations and Manapouri. Its benefits include; more responsive and flexible control from a single control point, automated loading capability, efficiency optimisation and the collection and management of plant operations knowledge which will be able to be used as leverage for market oriented generation and minimising cost.

SISOE takes ownership of Cobb hydro station on 1 April 1999, continuing its sale process for the Crown. If it remains unsold at 30 September 2000, SISOE will retain ownership of it. Highbank small hydro station is expected to be sold by ECNZ before 1 April 1999.

Future Opportunities

Current over-supply, anticipated to last some five years, means that opportunities in complementary markets need be investigated to utilise the asset management skills and systems. Through its Wellington wind turbine and other strategic wind farm interests, SISOE is well placed for future investments in renewable generation.

SISOE will participate in research and development, particularly in the area of distributed generation and utility solutions. SISOE has international interests in fuel cell technology through Ceramic Fuel Cells Ltd and in superconductor technology through Superlink Developments Ltd.

Financial Plan

Projected Balance Sheet ($m)

The opening balance sheet as at 1 April 1999:

• Excludes any initial allocations of cash and working capital from ECNZ.
• Includes $233.0 million of work in progress and capitalised interest relating to the Manapouri second tailrace tunnel, Waitaki ARC and other projects.
• Includes $24.5 million of fixed assets and goodwill relating to the acquisition of retail businesses.
• Includes an initial allocation of debt from ECNZ of $527.4 million.

Projected Income Statement ($m)

SISOE will pay total dividends equal to 75% of NPAT, split 50:50 between interim and final dividends. No dividend will be paid in respect of the three-month period to 30 June 1999.

Capital Expenditure Plan ($m)