The Shoeshine Column: Little time left for Fletcher Challenge's Plan B

Friday 20th October 2000

If Shoeshine were a gambling man he wouldn't put a lot of money on Royal Dutch/Shell's chances of persuading the Commerce Commission to let it buy Fletcher Challenge's Energy division.

Last week's clearance refusal capped off a very frustrating few days for FCL chairman Rod Deane. That FCL was caught completely off- balance by events was evident from its incomprehensible decision to trumpet the deal in national newspaper advertising.

This cliche-ridden exercise ("you have had a glimpse of the future and it is bright") is estimated to have cost around $77,000.

You'd really have thought, as FCL has been in the commission's gunsight for years and is even now in court with it over the Kupe acquisition, that the directors would have had a pretty realistic idea which way the decision would go.

One tale doing the rounds has it Deane called commission chairman John Belgrave just before the FCL break-up announcement and got the go-ahead. Nonsense, Belgrave assures.

Sharemarket analysts were quick to announce the decision was no surprise. Given the run-up in Fletcher Energy's share price after the break-up announcement it would be interesting to know how many of them advised their clients not to buy into Fletcher Energy ahead of the commission's decision.

Now some are warning against undue pessimism.

The decision, they argue, amounts to less than an outright "no." There's still plenty of room for Shell to negotiate. Didn't Southern Cross succeed in buying Aetna Healthcare on the third application?

The comparison is a little thin. In Aetna's case the commission's concerns related only to one market - medical insurance - and Southern Cross was primarily after Aetna's superior computer systems and its First Health and PrimeHealth public sector contracting businesses.

Southern Cross was, if not happy, at least prepared to ditch Aetna's insurance portfolio to keep the deal alive.

It's hard to see what Shell could ditch to satisfy the commission over Fletcher Energy.

The deal has hit three strikes on dominance in the current and post-2009 gas production markets and in the LPG production market.

Were the merger to go ahead, the commission notes, the combined entity would control almost all New Zealand's gas production.

Until it runs dry, around 2009, the crucial field is Maui which supplies 80% of total gas production. Shell/Fletcher Energy would have nearly 94%.

Some observers have suggested that doesn't matter from a competition viewpoint as all the Maui gas - in fact, most of overall gas production - is committed to long-term contracts.

The commission doesn't agree. Shell/Fletcher Energy might not be able to lift contracted prices but it would be able to influence the free market by manipulating production levels.

Plainly the deal wouldn't be worth doing if Shell undertook to divest Fletcher Energy's Maui interest.

After 2009 the commission estimates Shell/Fletcher Energy would have 75% of likely production and 63% of likely and possible production. The key field would be Pohokura which, with an estimated 825 petajoules of gas, is New Zealand's third-biggest discovery behind Maui and Kapuni. Shell/Fletcher Energy would have 51.6%.

Again, it's hard to see how Shell could give up Pohokura and still consider the deal worth doing.

So what will Shell take to the commission? Shoeshine reckons it will have to be an entirely new proposition, perhaps offering effectively to underwrite competition by guaranteeing to make a significant amount of gas available to another party.

That would be a complex business and the commission would want to know who the other party might be and at what price Shell would part with its gas. On the commission's previous record it's unlikely to be impressed but it's worth a try from Shell's point of view.

In the meantime Dr Deane will be brushing up Plan B.

A second bidder for Fletcher Energy can't be ruled out and a mere transfer of dominance doesn't breach the Commerce Act.

But even if an offshore energy player were interested Fletcher Energy wouldn't be worth nearly as much to them as it is to Shell because it would have no existing operations to which to add the assets.

The neatest solution would be to let the division stand alone, either as is or in conjunction with the sale of the Canadian operations to Apache Corporation.

Under Plan A Apache has offered $US600 million ($1.5 billion) for Canada. Shell was to have provided $US100 million of that in return for a placement of Apache shares.

There's no reason Fletcher Energy could not also take Apache shares as part-payment. It would then have $1.25 billion in cash.

But the division doesn't need money so selling the profitable Canadian operations doesn't make much sense if it is to stand alone.

Fletcher Forests of course needs money by the bucketload and is banking on getting a large chunk of it out of Energy, via the Rubicon roundabout, when Capstone Turbine shares are sold.

Whatever, FCL shareholders need to know the whole picture before they vote on the Forests rights issue in two weeks' time. Once that is under way Energy's commitment to support the issue will presumably be irrevocable.

Building shareholders won't care much.

But if Energy is to stand alone its shareholders might ask why they should swap their interest in proven-technology Capstone shares for, via Rubicon shares, Forests' somewhat vaporous intangible biotech property and a load of trees.

And Forests shareholders might wonder why suffering the massive dilution of the rights issue and placements, and losing their intellectual property, is better than the status quo.

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