NZ supply fears will keep power prices up, analysts say

Monday 25th May 2009

Electricity security fears will keep power prices high and cushion ongoing profits at so-called gentailers such as Contact Energy and Trustpower, say research reports from brokerages Forsyth Barr and Goldman Sachs JBWere.

While regulatory risk was now greater for listed utilities Contact and TrustPower, no significant change to current electricity market arrangements is expected.

Any large changes could result in under-investment in new generation, which is ultimately a greater political risk than high power prices, the broking houses argue.

Both firms reassessed electricity stocks following a multi-year study by US academic and electricity markets expert, Professor Frank Wolak, released by the Commerce Commission last week and alleging $4.3 billion of "over-charging" by power companies during the dry winters of 2001, 2003, and 2006.

"We do not believe the case of over-charging has been proved," said Andrew Harvey-Green, an analyst at Forsyth Barr.

Using its own modelling, Forsyth Barr put sector returns at 7.2% over the six and a half years covered by the Wolak report, well below its 9.0% weighted average cost of capital assessment for generator-retailers, known as gentailers. Once the alleged over-charging was removed, sector returns fell to 3.1%.

"It is hard to argue that the sector as a whole has been making excessive returns,” Harvey-Green said. "If wholesale prices are 18% higher than they should be, then we would have expected more generation projects to have emerged and we would not have expected the (Genesis) e3p project to require government support to go ahead."

Goldman Sachs said it maintained a neutral view on Contact and TrustPower, expecting:

Flat earnings over the next year due to weak wholesale prices and political restraints on retail tariff growth;
Continued regulatory "noise"; and
A preference for cyclical exposures in an improving macro environment.

The two firms regarded Energy Minister Gerry Brownlee's comments in response to the Commerce Commission report as the most concerning element of the announcements.

Goldman Sachs’ analyst Matt Henry said strong statements by (Brownlee) against electricity price increases “represent a negative risk to our view.”

"We may be underestimating the political desire to stem electricity price increases and/or have a fundamentally different opinion on what defines an efficient outcome," Henry said.

Goldman Sachs rates Contact and TrustPower as "hold", while Forsyth Barr has an “accumulate” rating, though it downgraded Contact to a recommendation with "negative bias" as the utility struggled to deal effectively with the impacts of recent transmission constraints.

Heavy-handed regulation was estimated to knock 13% off Contact's market value, and 8% off TrustPower's.

Contact fell 0.2% to $5.84 today and has shed a fifth of its market value this year. TrustPower climbed 1.3% to $7.75 and is up 3.8% this year. Infratil Ltd. which owns a controlling stake in Trustpower, was unchanged at $1.61

Businesswire.co.nz

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