COMMENT: No capex for Solid Energy's next big adventures just yet

Friday 31st August 2012

Comment by Pattrick Smellie

Solid Energy may have said it's going to develop its carbon-rich lignite fields and get into underground coal gasification, but nothing in its apocalyptic announcements this week say the state-owned coal miner will be allowed to.

As Don Elder, Solid's chief executive of the past 12 years, tells it, the global coal market went so pear-shaped in the space of a week in June that the board and management spun on a dime, reversing massive investments in underground mining operations at Spring Creek, near Greymouth, and Huntly East.

Some $200 million has been spent developing Spring Creek for further mining, yet now it looks likely to close indefinitely, unless there's a spike in coal prices like the one that sustained a boom in demand for high-grade coking coal, used in steel making, fed largely by exploding Asian growth.

Neither Elder nor John Palmer, his chairman of the past six years, believe that's going to happen. Like a lot of exporting companies in this latest reporting season, there are real grizzles about the strength of the New Zealand dollar.

But as Elder also points out, the global coal and metals sectors are in crisis at present. Solid Energy is hardly alone in being caught out. In fact, the implications for world growth rates are serious.

Local harbingers are BHP Billiton's cancellation of Olympic Dam, the largest mining project ever conceived in Australia, earlier this month, and news that Rio Tinto wants to renegotiate its electricity contracts at the Bluff aluminium smelter, which has lost money for the last two years and is for sale.

Elder says also there are players in world coal markets who will compete to the bottom on a "last man standing" basis. Solid Energy has neither the appetite nor the mandate to do that. In cyclical commodity businesses, there can be great upswings but big downswings as well.

In the case of mining, the human cost can be very substantial. As many as 370 of Solid Energy's current staff will lose their jobs, from a workforce of roughly 1,400.

Palmer sought to turn Solid Energy's mess to advantage in the partial privatisation debate, arguing it showed why the Crown shouldn't bear the risk of owning 100 percent of a coal company. Nice try, but there are other questions to answer here.

There is no doubt that the underground mines are hard, and for now too hard, to make profitable. Spring Creek is a deep mine, which makes it above averagely expensive to operate, while Huntly East is a mine in search of a customer, as New Zealand Steel has turned to Indonesian suppliers.

Elder gave a breakeven price for Spring Creek coal of $220 a tonne, compared with current prices for semi-soft coal of around $150 a tonne. You can't argue with that.

Palmer also intimated several times that the true cost of meeting the health and safety challenges thrown into sharp relief by the Pike River disaster have also been weighing on the cost of mining underground in New Zealand's complex geology. Opencast mining is not only cheaper, but safer by a huge order of magnitude.

Elsewhere, however, Palmer and Elder have been cleaning house of some misconceived diversification adventures in renewable energy, while also claiming a mandate to pursue what could simply be larger versions.

The Nature's Flame wood pellets product works well, but its business value has been written down by almost a third from $37.5 million to $13 million, and has only recently become cash-neutral. Others had mothballed such plant before it even opened and Solid Energy "would have derived more value" from Nature's Flame had it done the same thing.

Its bio-diesel business, which was always going to struggle when government subsidies ended, has been written down by $9 million to $8.7 million and is for sale. In retrospect, the bio-fuels play was "mistaken," Palmer says.

Also written down to zero from $18.5 million was Solid's experimental underground coal gasification (UCG) unit in the Waikato. However, this investment was apparently a success.

So much so, that UCG is one of the new adventures that Elder, never one to undersell an idea he's in love with, is pitching as the next phase of a refined corporate strategy in which Solid ditches renewables, stays above ground, and starts developing new technologies.

While the Waikato proved not to have commercially viable gas flows, Elder says the company gained international attention for its "world-leading" capabilities in UCG. It will now look to implement a UCG strategy in tenements it holds in the more prospective Taranaki region.

Tellingly, however, there is no capex committed for anything to do with new UCG expansion this year, and Elder concedes there's a multi-year glut in the New Zealand gas market, and that Solid Energy would look for capital from joint venture partners rather than its own to get such a project going.

The other big leg to this refocused strategy is the pursuit of value from the vast lignite resources available to Solid Energy in Southland.

The first lignite project is in fact in commissioning now - a $25 million demonstration-scale flammable briquette plant at Mataura.

On the basis of the recent track record for creating value from bold innovations, it would be a brave punter who says this plant will have maintained that value in five years' time.

In fact, as with UCG, there is no commitment yet to spending capital on lignite developments beyond this one.

Plans will go to the board later this year for consideration, under a new chairman, Mark Ford, in an environment where maximising capital value on a recovery track for partial privatisation will be the imperative.

That makes Palmer's disclosure about the potential for substantial land sales, once the scope of lignite activity is known, all the more interesting.

In other words, it's far from clear whether Solid Energy's remaining ambitions, especially the politically and environmentally contentious lignite proposals, will ever get off the ground now or whether we are watching Solid Energy turn back into a company that does opencast coal mining and not much else.

BusinessDesk.co.nz

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