Agenda of Regional Council Meeting

Follow-ups from Previous Regional Council Meetings

Attachment 1

Follow-ups from previous Regional Council Meetings

Meeting Held 30 April 2014

	Agenda Item	Action	Responsible	Due Date	Status Comment
1	Conflict of Interest Declarations	Threshold for declaration of shareholdings and clarification of non-pecuniary interest	L Hooper	Immed	Email (attached following) sent 1/5/2014
2	Affixing Common Seal	Explanation of how freeholding of leasehold properties affects ACC cashflow payments	E Lambert	Immed	Email (attached following) sent 1/5/2014
3

From: Leeanne Hooper
Sent: Thursday, 1 May 2014 12:21 p.m.
To: Alan Dick; Christine Scott; Dave Pipe; Debbie Hewitt; Fenton Wilson; mmohi@doc.govt.nz; Peter Beaven; Rex Graham; Rick Barker; Tom Belford
Cc: Liz Lambert
Subject: Follow-ups from Meeting yesterday

Good morning,

Some follow-up information from yesterday’s meeting for you …

Members’ Interests (Guidance from Auditor General)

http://www.oag.govt.nz/2010/lamia/docs/local-authorities-members-interests-act.pdf

From Part 3 re shareholdings:

Interest in a company

3.24 If either you or your spouse or partner is involved in a company that has a pecuniary interest in a matter before the authority, you are deemed for the purposes of the Act to have the same interest (as the company) only if:

• you or your spouse or partner, singly or together, own 10% or more of the shares in:

– the company; or

– another company that controls it; or

• either you or your spouse or partner is a shareholder of the company, or another company that controls it; and either of you is the managing director or general manager (by whatever name you are actually called) of the company or the controlling company; or

• either you or your spouse or partner is the managing director or general manager (by whatever name you or they are actually called) of the company, and either of you is a shareholder of another company that controls it.

Part 5: Other conflict of interest issues states:

“5.1 Having a pecuniary interest in a matter before the local authority, as discussed in Part 3, is one type of conflict of interest. However, quite apart from the Act, there are legal rules about conflicts of interest more generally, which apply to both pecuniary and non-pecuniary conflicts of interest.

Conflicts of interest generally

5.5 A conflict of interest exists where two different interests intersect – in other words, where your responsibilities as a member of the local authority could be affected by some other separate interest or duty that you may have in relation to a particular matter. That other interest or duty might exist because of:

• your own financial affairs;

• a relationship or role that you have; or

• something you have said or done.

Situations where a risk of bias may exist

5.18 The most common risks of non-pecuniary bias are where:

• your statements or conduct indicate that you have predetermined the matter before hearing all relevant information; or

• you have a close relationship or involvement with an individual or organisation affected by the matter.

What is predetermination?

5.26 You could also create a legal risk to the authority’s decision if you participate in the authority’s consideration of a matter and you have made a formal submission to the authority in your personal capacity to support or oppose a particular proposal as part of a public submissions process. There may be rare situations where you may still be able to consider such matters. However, as a potential decision-maker, to avoid creating legal risk for the authority’s decision, it is advisable to avoid making submissions on matters that will come before your authority for decision – doing so will usually compromise your ability to participate in the decision making process.”

Bias, Predetermination, Relationship with other persons or organisations (including membership of other organisations) and ‘What to do?’ are all covered in Part 5 – available via the link provided above

ACC & Leasehold Cashflows (excerpts from 14 August 2013 Regional Council public excluded agenda item 7)

I realise that this paper was considered by the previous Council, so if any of you want a full copy of it let me know and I will send a ‘red paper’ version to you.

1. In the event a leaseholder purchases the freehold of his/her/their property from HBRC during the fifty year period, the purchase price paid by the leaseholder to HBRC will be allocated as follows:

1.1. First, to pay to ACC the net present value of the expected future rents which would have been received by HBRC if the sale of the freehold had not proceeded, calculated at the same discount rate as used in the purchase price paid by ACC, and,

1.2. Second to share any difference between the price paid by the leaseholder and the net present value of potential future rents between ACC and HBRC.

Benefits and Costs

2. The benefits of the final proposed deal are outlined below:

2.1. HBRC receives a single lump sum of $xx for investment in key regional initiatives that cannot be achieved from any other way of dealing with these assets because of the constraints of the HBELEA.

2.2. As a result of the sale, HBRC’s revenue is estimated to improve to the extent that the sales proceeds can be invested and earn interest in excess of the leasehold rentals. These improvements in revenue are around $310,000pa for the 2013/2014 financial year $340,000 in the 2014/2015 financial year and $290,000 in the 2015/2016 financial prior to reinvestment. The following table illustrates these calculations using current market interest rates.

2.3. The HBRC will share, along with ACC, in the potential upside to future rents which increase at a greater rate than 1.5% pa projected for the cash flows sold. This means where rents do increase beyond projected levels in future HBRC will receive a share of the higher rents which will in turn increase its operating revenues.

2.4. HBRC continues to own the underlying properties, and will continue to manage them in accordance with existing lease terms between HBRC and leaseholders.

2.5. Leaseholder’s rights and obligations in terms of their leases and the HBELEA are unaffected.

2.6. At the end of the fifty year term (i.e. in 2063), all cash flows derived from rentals paid by then leaseholders will return to HBRC in full.

2.7. Management costs will be funded for HBRC by deduction from gross rents before net rents are transferred to the investors. The effect of this arrangement is to reduce HBRC’s operating costs correspondingly.

3. If the cash flows are not sold and the funds needed for RWSS are borrowed at current market rates, the cumulative additional cost to the HBRC over the period of the LTP will be around $3.9m.

If you have any further questions or this email hasn’t answered the questions properly, as expected, please let me know J

Cheers,

Leeanne Hooper
Governance & Corporate Administration Manager

HAWKE’S BAY REGIONAL COUNCIL

Wednesday 28 May 2014

SUBJECT: Deloitte Peer Review of HBRIC Ltd RWSS Business Case

Reason for Report

1. Deloitte has completed its Business Case Peer Review report and this report will be presented at this Council meeting by Alan Dent and David Morgan from Deloitte’s.

Background

2. To assist Council with the decision making process surrounding the possible investment in the Ruataniwha Water Storage Scheme, Deloitte was appointed by HBRC in January 2014 to undertake an independent peer review of the Business and Investment Case presented by HBRIC Ltd to HBRC.

3. The independent peer review of the business case is an important part of the overall assessment process for HBRC and has relevance for the assessment of:

3.1. Financial feasibility – is the Council’s investment supported by a sound business case? What are the strengths and weaknesses of the business case?

3.2. Returns on investment – what financial returns can the Council expect from its investment and over what time period are these expected to occur?

3.3. Business Risks – what risks does the company face and how will these be managed or mitigated?

4. The Peer Review is in the nature of an “audit” of the HBRIC Ltd prepared business case and Deloitte was tasked, in particular, with addressing:

4.1. Whether HBRC can have comfort that its exposure to calls on capital can be limited to its current funding envelope of $60-80million

4.2. The circumstances under which HBRC may be required to contribute additional capital and where possible the quantity of those potential calls and the risks that such calls could eventuate

4.3. The extent to which HBRC can have comfort that the projected returns on its investment have been accurately calculated and are based on reasonable assumptions

4.4. How investment returns could vary under different scenarios

4.5. Any other matters that Deloitte considers ought to be brought to HBRC’s attention in connection with its assessment of the business case.

Deloitte Interim Report

5. In its interim report presented to Council’s Corporate and Strategic Committee meeting on 16 April 2014, Deloitte identified the key interlocking components of the business case from a financial perspective as being:

5.1. The up-front capital investment in the physical infrastructure of the RWSS

5.2. The business model which drives the operating cash flows necessary to provide the investor returns

5.3. The ownership model and related investment structure that allocates capital, risk and return to the different investor

5.4. Fundamentally however the critical factor is demand – how long it takes to get to full uptake and the profile of this uptake.

6. In assessing these factors as the core building blocks of the project, Deloitte satisfied itself as to the reasonableness of the assumptions supporting these building blocks and the way the financial model has been constructed and returns calculated within the HBRIC Ltd business case. They then used the model to:

6.1. Assess the overall return on capital from the project under different uptake scenarios

6.2. Demonstrate how the internal rate of returns have been calculated

6.3. Use sensitivity analysis to identify which assumptions matter and which are immaterial in terms of the financial case

6.4. Identify the implications for HBRC capital requirements and returns under different scenarios.

7. The key risk to the project as identified by Deloitte is how long the project takes to get to full uptake of water. This is important for two reasons:

7.1. If the level and pace of uptake are lower and slower respectively than the base case then there is a risk that HBRC will be called upon for additional capital (together with all other investors)

7.2. There is a risk that HBRC’s rate of return may be lower than that estimated in the business case e.g. the business case assumes a rate of return of 6.9% at full uptake, but this could range between 6.4% and 7.4% depending on the level and speed of uptake.

8. Deloitte is confident that the risks from any overruns in capital costs during construction are well covered by the fixed price, fixed time contract and will not impact upon HBRC.

Final Report and Findings

9. Attachment 1 to this paper is the final report of the review of the HBRIC Business Case from Deloitte’s. Their conclusion is part of the executive summary of this report which considers the base scenario presented in the Business Case.

10. Deloitte notes that the three major moving parts of the proposal, namely the construction contract, the required level of initial contracted water and the capital structure, have yet to be finalised. They also state that is it not unusual for projects of this nature to have a degree of uncertainty right up to the point of financial close. Given this situation it would be appropriate for Council to retain their services to undertake a final assessment of the proposal should there be any material change between the base case and the situation at financial close.

Decision Making Process

11. Council is required to make a decision in accordance with the requirements of the Local Government Act 2002 (the Act). Staff have assessed the requirements contained in Part 6 Sub Part 1 of the Act in relation to this item and have concluded the following:

11.1. The decision does not significantly alter the service provision or affect a strategic asset.

11.2. The use of the special consultative procedure is not prescribed by legislation.

11.3. The decision does not fall within the definition of Council’s policy on significance.

11.4. The persons affected by this decision are the public of Hawke’s Bay

11.5. Options that have been considered include not receiving the report, although Council specifically commissioned Deloitte to undertake an independent per review.

11.6. The decision is not inconsistent with an existing policy or plan.

11.7. Given the nature and significance of the issue to be considered and decided, and also the persons likely to be affected by, or have an interest in the decisions made, Council can exercise its discretion and make a decision without consulting directly with the community or others having an interest in this specific decision as public consultation is occurring on the overall investment proposition.

Recommendations

That Council:

1. Agrees that the decisions to be made are not significant under the criteria contained in Council’s adopted policy on significance and that Council can exercise its discretion under Sections 79(1)(a) and 82(3) of the Local Government Act 2002 and make decisions on this issue without conferring directly with the community and persons likely to be affected by or to have an interest in the decision due to the nature and significance of the issue to be considered and decided.

2. Receives the report titled “Peer Review of the Ruataniwha Water Storage Scheme Business Case” prepared by Deloitte; and

3. Notes that a further report will be required from Deloitte when the final RWSS business case, including the capital structure, has been finalised by HBRIC Ltd.

Paul Drury

Group Manager

Corporate Services

Liz Lambert

Chief Executive

Attachment/s

Peer Review of the Ruataniwha Water Storage Scheme Business Case

Abbreviation	Definition
ACoT	Avoided Cost of Transmission	INZ	Irrigation New Zealand
ASX	Australian Securities Exchange	IRR	Internal Rate of Return
BNZ Advisory	An independent division of Bank of New Zealand, a subsidiary of National Australia Bank	Macfarlane	Macfarlane Rural Business Limited
BOI	The Board of Inquiry process under the management of the Environmental Protection Agency	$m	Millions of dollars
BOOT	Build Own Operate Transfer	M³	1 cubic metre of water
Butcher	Butcher Partners Limited	M m³	1 million cubic metres of water
Castalia	Castalia Limited	MW	Megawatt
CIIL	Crown Irrigation Investments Limited	O&M	Operations and Maintenance
Concession Period	The 70 year period from the beginning of construction to the transfer back to the Community of the Scheme	PWC	PricewaterhouseCoopers
D&C	Design and Construct	RFP	Request for Proposal
DSRA	Debt service reserve account	ROA	Return on Assets
EOI	Expressions of Interest	RPA	Ramp-up proceeds account
EPA	Environmental Protection Agency	RWSS / Scheme	Ruataniwha Water Storage Scheme
FEMP	Farm Environmental Management Plan	RWSS LP	Ruataniwha Water Limited Partnership
FY	Financial year	SMEC	SMEC Holdings Limited (formerly Snowy Mountain Engineering Company)
GDP	Gross Domestic Product	SPV	Special Purpose Vehicle
HBRC	Hawke’s Bay Regional Council	Trigger date	The point at which there is full uptake
HBRIC	Hawke’s Bay Regional Investment Company Limited	WUA	Water User Agreement

Introduction

Hawke’s Bay Regional Council (“HBRC”) is considering investing up to $80 million the Ruataniwha Water Storage Scheme (“RWSS”, the “Scheme”). HBRC’s subsidiary company, Hawke’s Bay Regional Investment Company Limited (“HBRIC”), has prepared a business case in support of this investment. Deloitte has been engaged to peer review this business case.

The RWSS is a proposed long-term sustainable water storage solution for the Tukituki catchment in Hawkes Bay. Through the construction of a dam on the upper Makaroro River and associated distribution system the RWSS will store high winter flows for irrigation use during summer when pressure on the water resource in the Tukituki catchment is greatest. The motivation behind the Scheme is the capturing of environmental, economic and social value.

A new company will be established to build and own the dam and reservoir to be used to collect, store and distribute water to farmers and other stakeholders on the Ruataniwha Plains on commercial terms. It is important to note that the proposed procurement structure is under a build, own, operate and transfer (“BOOT”) structure which will see ownership transfer back to HBRIC^{^[1]} at the end of a 70 year^{^[2]} concession period.

The scale of the RWSS and the multiple objectives make this a far more complex investment proposition than has been the case with other large scale irrigation schemes which have primarily been commercially motivated, subject to compliance with environmental and other regulatory constraints. In the case of the RWSS environmental and wider economic development and social considerations are major drivers of the case for investment and the reason why the Scheme cannot be funded on a wholly commercial basis from the outset.

The RWSS will comprise an 83 m high dam capable of managing outflows of approximately 200 million cubic metres (“M m³”) per year on average and a primary (canal and pipeline) and secondary distribution network (pipelines, pumps and property-off-takes). The costed Scheme Design is based on a hypothetical secondary distribution layout which:

· Provides for full uptake of 104 M m³ of water per annum;

· Provides full workable pressure to 35 m head; and

· Accounts for approximately 44 M m³ of water as signed up in irrigator expressions of interest (“EOI’s”).

Based on the forecast water volumes and distribution layout the RWSS has the potential to increase farm productivity and allow higher value farming through irrigating approximately 25,000^{^[3]} hectares (and an additional 17,000 hectare direct area of influence giving a total influence area of circa 42,000 hectares) on the Ruataniwha Plains and down through the Tukituki catchment. In addition to the 104 M m³ of water available to be contracted for irrigation purposes a further 43.3 M m³ of water will be available for environmental purposes (residual flows and flushing flows) and 52.3 M m³ for other purposes including being sold as spot water and providing an additional buffer of water available for managing environmental conditions.

In undertaking our peer review we have directed our work at addressing the following matters in particular:

· Whether HBRC can have comfort that its exposure to calls on capital can be limited to its current funding envelope of up to $80 million;

· The circumstances under which HBRC may be required to contribute additional capital and where possible the quantity of those potential calls and the risks that such calls could eventuate;

· The extent to which HBRC can have comfort that the projected returns on its investment have been accurately calculated and are based on reasonable assumptions;

· How investment returns could vary under different scenarios; and

· Those other matters that we consider ought to be brought to HBRC’s attention in connection with its assessment of the business case.

In undertaking our peer review we have identified the key interlocking components of the business case from a financial perspective as being:

· The up-front capital investment in the physical infrastructure of the RWSS;

· The business model which drives the operating cash flows necessary to provide the investor returns; and

· The ownership model and related investment structure that allocates capital, risk and return to the different investor categories.

The interplay between these three components underpins the financial case for the RWSS.

Design & Construction

HBRIC has run a competitive process for the selection of its preferred construction contractor. The process was structured as a request for expressions of interest followed by a shortlisting and request for proposal. The HBRIC process attracted a number of quality bidding consortia. Following a shortlisting to two consortia a full Request for Proposal (“RFP”) process was undertaken. At the conclusion of this process OHL-Hawkins was selected as the preferred bidder.

The bid was requested as a fixed price for design and construct (“D&C”). This is normal practice where the required performance and scope of the project can be adequately specified. It also eliminates the interface between designer and constructor which, if managed as separate contracts by the investor or owner, can create additional risk through unclear accountability in the event of problems with the project or its eventual performance.

One of the difficulties with the Scheme is that the full extent of initial irrigation water uptake and the location of the offtake points are currently unknown. The location of the initial offtake points is likely to be spread throughout the total area to be irrigated and it is extremely difficult to design a distribution system which meets only this initial demand and can be readily expanded in stages as demand grows. In order to deal with this challenge the project team has negotiated a contract price structured as follows:

Table 1: Contract Price Structure

Price Element	Price	Pricing basis
Dam and electricity generation	$120.6 million	Fixed price and scope
Primary distribution	$63.0 million	Measure and value allowing flexibility to build less or a different layout^{^[4]}
Secondary distribution	$59.4 million	Measure and value allowing flexibility to build less or a different layout
Total OHL-Hawkins contract	$243.0 million	Fixed price and scope (absolute cap on price assuming full scheme is built)

The combination of a fixed price and scope pricing for the dam and electricity generation elements of the Scheme and a measure and value approach for the primary and secondary distribution elements significantly reduces the risk of the equity investors being required to fund material capital cost overruns. The risk to the investors arising from delays in Scheme completion or Scheme performance issues are limited by damages provisions in the contract.

In addition to costs associated with the build of the physical infrastructure additional other costs also need to be funded as part of the up-front investment in the Scheme. These are:

Table 2: Other Up-front Investment Costs

Construction Component	Price	Party responsible
OHL-Hawkins (dam, generation, distribution)	$243.0 million	OHL-Hawkins
Construction period operating costs	$11.7 million	RWSS Partnership
Development costs, Land, Ancillary Roading & Surveying	$21.8 million	Incurred or negotiated prior to FC
Total capital cost	$276.5 million

Business Model

The business model for the RWSS is based on users (farmers) contracting for water on a take or pay basis for a period aligned with the first 35 year resource consent period. Unlike other similar schemes RWSS is not being structured as a farmer co-operative. Therefore, while farmers have an opportunity to invest in the RWSS this is not a requirement of their accessing water. As a consequence the financial viability of the RWSS is fundamentally dependent on farmers being willing to contract for water. The validity of assumptions made in this regard is therefore critical to any financial case for investment. A primary factor in determining the proposed ownership structure, with HBRIC and Crown Irrigation Investments Limited (“CIIL”) as being cornerstone funders, is the positive economic and environmental externalities. If the Scheme was being undertaken solely for the benefit of irrigators it would be reasonable to assume the majority of the funding would be provided from a co-operative structure but it would be very unlikely the same scale of project would be achievable.

The economic assumptions underpinning the business model are supported by an independent farm profitability study undertaken in September 2012 by agribusiness consultant Macfarlane Rural Business Limited (“Macfarlane”), an independent demand and uptake analysis undertaken by infrastructure advisor, Castalia Limited (“Castalia”), and also an internal process undertaken by HBRIC and its legal and financial advisors to collate EOIs.

Demand for irrigation water is premised on the assumption that irrigation will facilitate increased farming profitability and reduced weather risk. The Macfarlane study provided an analysis of the direct financial benefits that may result from the RWSS. This study informed the Castalia demand study, originally completed in September 2012 and updated in November 2013, which sought to forecast the phased uptake profile for irrigation water. The EOI process undertaken in 2013, which ran from early March until the end of August, has provided further confirmatory analysis and broadly reinforced the findings of the Macfarlane farm profitability and the Castalia demand studies.

Macfarlane consider that land use under irrigation will change towards more intensive and profitable farming systems. A high proportion is assumed to be dairying and arable farming depending on soil type. Land use will be determined by relative profitability and soil type, moderated by the farmers own preference. Macfarlane consider that farm productivity for farms who take up water after the Scheme is commissioned will trend toward the top 20% for reasons of modern irrigation technology, higher debt servicing, greater motivation and improved technical skills. More fundamentally reliable irrigation water provides farmers with the confidence to increase stocking and planting levels without the concern that dry conditions may impact on their investment.

Effectively, the Macfarlane farm profitability study provided an ‘end state’ or rational basis for utilising irrigation to intensify farming systems as a means of increasing profitability. The forecast rate of uptake was based on an assessment of farmer sentiment and other modelled factors related to the decision making processes of incumbent and new entrant farmers. Fundamentally this will involve farmers weighing up the capital costs necessary to effect a change in land use against long run expected returns on this marginal capital. While capital costs can be estimated with a high degree of precision long run returns on capital are harder to predict and will be fundamentally be determined by commodity prices and productivity improvements. While long run trends in commodity prices can be estimated these are not certain. Further, in the short term prices can be volatile relative to this long run trend and this volatility can influence investment decision making.

Castalia undertook a survey to gauge farmer views in relation to irrigation uptake and also the likely impact on land sale (turnover rates). The survey, conducted anomalously, (online, by phone and also in written form) had a response rate of around 50% of the RWSS catchment land area. The Survey responses covered a wide range of farming types, soil types and farmer demographics. Survey information was used as a key input in a demand model, which also included amongst other parameters, milk pay-out, the cost of water and the rate at which land turned over.

HBRIC has advised that a condition precedent for financial close for the Scheme is to have 40 M m³ or 38.5% of water contracted by 30 June 2014. This has now been pushed out to 30 September 2014. The Base Case financial projections for RWSS assume 52% of contracted water by the time construction is completed which assumes additional 13.5 M m³ of water users sign up over the 3.5 years construction period. We had considered a timeline requiring nearly 40% of water to be contracted by 30 June to be extremely tight given the material contractual commitment that farmers are being required to enter into, the extension to 30 September should give some headroom.

Capital Structure

The final capital structure is yet to be locked down but is expected to be provided from a combination of arm’s length sources (institutional investors and bank debt), related parties (farmers, local investors and local Iwi) and discounted capital (CIIL and HBRIC). The Base Case financial projections assume the following capital structure:

Table 3: Base Case Capital Structure

Financing Sources	Indicative Investment
HBRIC Ltd	Up to $80m
Institutional Investors	>$50 million
Crown Irrigation Investments Ltd	TBD
Tukituki Investments LP / He Toa Takitini	> $10 million
Total funding sources	$276 million

Current projections assume that HBRIC achieves a less than commercial return on its investment until the point at which full uptake is achieved at which time it will receive the same returns as other equity investors. The cost of CIIL funding is heavily discounted, but this capital is required to be refinanced as farmer uptake ramps up.

In our view, in the absence of subsidised capital from HBRIC and CIIL the RWSS is not viable under the current uptake scenario. However, the Scheme is also critically dependent on capital from parties seeking a commercial return on this investment. We note that if full uptake (or at least a significant portion of uptake) was contracted at financial close we would expect a reasonable proportion of the funding to be provided by bank debt. This is the case with the more recent co-operative schemes in the South Island and large scale infrastructure projects where a significant portion of the revenue is contracted.

We asked BNZ Advisory to consider a scenario which had 100% uptake at day 1 of operations. Under this scenario a reasonable commercial capital structure is considered to be 75% bank debt gearing via project finance and the balance funded by institutional investors solely (that is, no public funding).

This scenario results in an institutional investor IRR that would be within an acceptable range of returns for institutional investors for such a project (70 year concession with no uptake risk).

The requirement to balance the needs of commercial investors and the providers of subsidised capital adds significant complexity to the capital structure both in terms of the quantum of capital needed from the different sources and how the terms of such investment are balanced out to make sure that the objectives of each party are met and aligned. While the inclusion of different investor classes in the capital structure adds complexity there are benefits also. In particular the involvement of institutional investors brings additional scrutiny and financial and governance disciplines. In addition such investors can also bring additional technical competencies. In this regard we note that while Trustpower has recently decided not to invest in the RWSS it did play a significant role in the process for selecting the preferred construction partner and in validating key assumptions that have been incorporated in the financial models developed by BNZ Advisory for the purposes of the RWSS business case.

The capital structure for RWSS requires operating cash flows to be shared between investors on quite different bases. We have undertaken extensive scenario analysis to satisfy ourselves that there are no circumstances whereby HBRIC is required to commit additional capital to fund the payment of returns to other equity investors. However, we note that the final capital structure and who the investors will be have yet to be finalised. Similarly, the terms under which funds will be provided are still subject to negotiation and the agreement of final terms and these could vary from what is currently being modelled.

Financial Projections

The base case financial projections show HBRIC achieving a sub-commercial internal rate of return (“IRR”) on its investment up to the point of full uptake which the Base Case assumes is June 2028 (the “Trigger Date”) with an IRR reflective of Brownfield investor returns (approximately 10% per annum) beyond that point. We are satisfied that the IRRs have been correctly calculated but note that a number of factors influence these calculations and in particular assumptions as to:

· Uptake

· The quantum and timing of the introduction of debt

· Interest rate assumptions

· The assessed value of HBRIC’s investment at full uptake

· Refinancing

The Base Case IRRs are sensitive to changes in key assumptions such as the rate of uptake and increases in capital expenditure. We note however that the proposed structure of the CIIL capital significantly mitigates the risk to HBRIC of a lower than projected uptake in the period up to the Trigger Date.

Risks and Mitigants

In broad terms the risks are allocated as follows:

· Design and construction risks are borne by the D&C contractor. These include cost over runs and timing delays (where there is no scope change initiated by the Scheme).

· Demand and uptake risk is borne by HBRIC and the portion of the institutional investors’ return which is not met by an investor fee. CIIL provides a timing buffer through the repayment mechanism which depresses the repayment while uptake remains low thereby making a higher proportion of cash flows available to HBRIC and institutional investors than would otherwise be the case. If uptake was very slow then it would also be likely to impact institutional investors’ investor fee.

· Operating costs and performance is largely met by all parties in the post trigger date period, however in the ramp up period this risk is borne by HBRIC and the proportion of institutional investor returns not accounted for in the investor fee.

· Regulatory risk is borne by all investors equally, assuming that the trigger date is reached prior to the end of the first consent period.

Board of Inquiry

The RWSS is intended to be a key component of the integrated management of the Tukituki catchment. Increasing minimum flows and setting appropriate nutrient levels are expected to improve environmental and cultural outcomes. Tukituki Plan Change 6 (a land and water management plan) was developed to achieve these benefits and has been subject to a Board of Inquiry (“BOI”) process under the management of the Environmental Protection Agency (“EPA”). The BOI released its draft determination on 15th April. We have not examined this determination in detail but understand that while this does provide the necessary consents for the RWSS to proceed, it also requires stricter limitations on nitrogen than were requested in Plan Change 6. We understand the absolute levels required under the BoIs draft decision are very stringent noting there is apparently some ambiguity throughout the draft decision. This requirement as it is currently framed is likely to affect land use options for farmers. A final decision is now anticipated no later than June 28 at which point the economic impacts will need to be fully assessed.

Conditions Precedent

The business case summarises the key conditions precedent that must be met prior to financial close. These are identified as being:

· Satisfactory EPA resource consent conditions for the RWSS infrastructure and operations;

· A concession deed for the RWSS entered into by HBRC and the Ruataniwha Water LP (“RWSS LP”) becoming unconditional, including in respect of the required resource consents;

· A project agreement entered into between HBRIC and RWSS LP becoming unconditional;

· A D&C agreement entered into between the RWSS LP and the OHL-Hawkins consortium; and

· Receipt of commitments to purchase a sufficient volume of irrigation water, as determined by agreement between HBRIC and other investors. HBRIC has set its requirement at 40 M m³.

Conclusion

The business case for the RWSS for the Hawkes Bay region is now at a critical stage. The draft determination of the BOI has effectively given consent to the Scheme albeit with restrictive terms in relation to the management of nitrogen. However, the three major moving parts of the proposal – the construction contract, the required level of initial contracted water and the capital structure – have yet to be finalised. It is not unusual for projects of this nature to have a degree of uncertainty right up to the point of financial close. However, in our view there is a significant amount still to be achieved before financial close. In this context we understand that the targeted contractual close has been moved out by 3 months to 30 September 2014 with the expectation that water user uptake will be well advanced by this time

Our review has been directed at the business case for the RWSS as it currently stands. As note there are still material elements of the RWSS proposition that have yet to be finalised. It is likely that the final proposition will differ from that set out in the current business case. Once the RWSS proposition is finalised there may be benefit in a further review to confirm that HBRIC’s portion has not altered materially.

Given the importance of the RWSS and the significant effort and investment made in getting the Scheme to its current state we believe that a decision to extend the financial close date is sensible provided that there is a reasonable expectation that the conditions precedent to financial close can be met within the extended timeframe.

Construction Component	Price	%	Party responsible
OHL-Hawkins (dam, generation, distribution)	$243.0 million	87.9%	OHL-Hawkins
Development costs, Land, Ancillary Roading & Surveying	$21.8 million	7.9%	Incurred or negotiated prior to FC
Construction period operating costs	$11.7 million	4.2%	RWSS Partnership
Total capital cost	$276.5 million	100%

Introduction

In this section we consider the risks generally associated with major capital projects and the challenges specific to the RWSS. We consider the approach taken by the development team to specifying and tendering the Scheme construction contract to date and assess the proposed approach to contracting for the construction of the Scheme and the effectiveness of this in managing the primary risks to which investors will be exposed. We then consider the residual risks which investors will carry.

Financial risks in major capital projects

Most major capital projects contain three generic risks which expose investors in the projects to the risk of financial loss. These are:

· Capital cost – the risk that the final project cost is more than that expected at the point at which the investment commitment is made. The investor then needs to make up the shortfall which impacts on the investors’ returns and potentially the viability of the project.

· Delays – the risk that the project takes longer to reach operation than expected meaning that revenues and other benefits are delayed and returns to investors are delayed and/or reduced.

· Performance – the project fails to perform at the expected level reducing the level of revenues generated and potentially requiring additional capital to restore the project to an adequate level of performance. Again, investor returns are reduced and, if the performance shortfall is sufficiently large, the viability of the project may be compromised.

These risks are allocated between the investors and the construction contractor through the terms of the construction contract signed between them with the financial consequences resting with one or other under certain defined circumstances depending upon the detail of the terms agreed.

The tendering process by which a contractor is selected will determine the competitiveness of the price for the construction contract and hence the value and returns to investors. A competitive process with multiple parties tendering should deliver the lowest market price for a given scope of work and best value to the investors.

Ruataniwha procurement process

HBRIC invited expressions of interest from contractors for the combined design and construction of the Scheme in February 2013. The process attracted five bidding consortia which registered interest. This was reduced to a shortlist of two which were invited to submit a full design and construct proposal. The successful shortlisted consortia were:

· Bouygues Construction Australia Pty Ltd – the Australian subsidiary of Bouygues SA, a listed global construction company with headquarters in France; and

· OHL-Hawkins – 50/50 Joint Venture. OHL is a listed Spanish construction company with international operations and Hawkins Infrastructure Ltd a New Zealand owned construction company.

The shortlisted parties were provided with an owner’s requirements document specifying the performance requirements and scope of the Scheme with which bids were required to comply. RFP’s were submitted by both parties in August 2013 and both proceeded to a full detailed evaluation. The owners requirements document was updated on 16 April 2014, primarily in relation to the performance requirements for the irrigation system.

The evaluation was undertaken by an evaluation team comprising HBRIC, Trustpower (Investors), National Australia Bank (financial advisor and debt specialist), SMEC Holdings Limited (“SMEC”) (technical/engineering advisor), and an independent technical procurement advisor. The panel was supported by other subject matter experts.

Following the evaluation process OHL-Hawkins was selected as the preferred contractor however the bid price exceeded the affordability threshold. The evaluation team and its advisors entered into a value engineering process with OHL-Hawkins and identified alterations to scope and other changes which resulted in the design and construct price being reduced to $240 million to $245 million.

Scheme construction scope

The business case provided to Council in March 2014 contained the following summary of the OHL-Hawkins scope of supply:

OHL-Hawkins Dam and Associated Works Design Summary

· Central core rock fill dam (CCRD), approximately 83m above existing river bed level, with a crest width of 7.0m at RL 475.30m.

· Free overflow (ungated) Spillway located on the left abutment with a sill level at RL 469.5m capable of passing the Probable Maximum Flood of 775 cubic meters (“m³”) per second and downstream plunge pool.

· A 4.5m D-shaped diversion tunnel constructed by drill and blast methods and approximately 480m in length.

· Inclined reinforced concrete Intake Structure with six distinct intake gates constructed with inverts between 462.95m RL to 414.7m.

· Outlet Works comprising 2200mm diameter outlet pipe (penstock) and 600mm diameter environmental flow pipe, fixed cone valves and stilling basin.

· Hydropower Station consisting of a Powerhouse with installed turbine capacity of the order of 6.5 megawatts (“MW”).

OHL-Hawkins Distribution Design Summary

· Three screened and flow controlled river intake structures located along the Waipawa River to supply water to Zone A, Zones B-D, and Zone M, respectively.

· Primary Distribution System consisting of approximately 16km of canal and 17km of pipeline length.

· A new outfall from the canal on the Upper Tukituki River to supply Zone M and other downstream irrigators.

· Secondary Distribution Network consisting of approximately 200km of pipeline length, 180 property-off-takes (with water metering, isolation, and telemetry), and pump stations to provide a fully pressurised system at 35m of head pressure (35 bar) at the farm gate.

Design and Construction Contract – Transmission System

· In addition to the OHL-Hawkins contract RWSS LP is currently negotiating a contract with Centralines for the provision of electricity transmission to the dam site. While still in negotiation the current proposal includes:

· A dedicated 33kV sub transmission feeder to the new power station from the Transpower Waipawa GXP at Ongaonga;

· Five dedicated 11kV feeders to supply the RWSS pumping stations;

· An upgrade to the Centralines existing substation assets at Ongaonga, Takapau and Waipawa and Transpower assets necessary to meet the projected loads (6.5MVA) and generation (6.5MW); and

· Fibre telecommunications infrastructure between all RWSS load/generation locations.

Discussion of approach taken

The construction contract tender process is not yet complete. OHL-Hawkins has been identified as the preferred contractor and a revised scope negotiated. The contract has been further updated on 16 April 2014 with more detail added in relation to the commercial details including liquidated damages, however the construction contract has yet to be finalised. To date the contract comprises the draft provided to the contractor during the RFP process which has been updated with some of the content from the contractor’s RFP response. We were advised during discussions with management that the contract has been “left to one side” whilst the value engineering exercise was completed. Our comments on the approach are made in this context and are focussed on how the three major risks above have been dealt with and how any specific challenges of this Scheme have been addressed.

Price certainty

The bid was requested as a fixed price for design and construct. This is normal practice where the required performance and scope of the Scheme can be adequately specified. It also eliminates the interface between designer and constructor which, if managed as separate contracts by the investor or owner, can create additional risk through unclear accountability in the event of problems with the Scheme or its eventual performance.

One of the difficulties with the Scheme is that the full extent of initial irrigation water take-up and the location of the offtake points are currently unknown. The location of the initial offtake points is likely to be spread throughout the total area to be irrigated and it is extremely difficult to design a distribution system which meets only this initial demand and can be readily expanded in stages as demand grows. In order to deal with this challenge the project team has negotiated a contract price structured as follows:

Table 5: Contract Price Structure

Price Element	Price	Pricing basis
Dam and electricity generation	$120.6 million	Fixed price and scope
Primary distribution	$63.0 million	Fixed price and scope ^{^[6]}
Secondary distribution	$59.4 million	Measure and value allowing flexibility to build less or a different layout
Total OHL-Hawkins contract	$243.0 million	Fixed price and scope (absolute cap on price assuming full scheme is built)

A measure and value approach is generally used where changes in scope are anticipated and exposes investors to additional costs where these are made. This exposure has been dealt with by the project team by specifying a capped price for the construction of the full primary and secondary distribution system. If this is incorporated into the final construction contract, and the costs of constructing the full system as specified exceeds that bid by the contractor, then the additional costs will be required to be met by the contractor.

If a subsequent decision is made to reduce the scope of the distribution system once the location of initial offtake points is known, it may be possible to reduce the secondary distribution system cost. The draft contract specifies a formula of how the price will reduce to scope reductions and a less extensive system. Any scope reduction would need to be a business decision made by the RWSS GP and its investors at the time balancing the benefits and costs associated with capex deferral; although we understand that preliminary work is being undertaken in this regard.

Land acquisitions are underway with one farm acquisition already completed. The management team advises that the land owners approached to date are willing to sell their properties however final purchase prices have not yet been negotiated. HBRIC anticipates having conditional contracts for these purchases by 30 September but this is not a condition precedent.

A fixed price construction contract typically has a number of conditions specified by the contractor which need to prevail in order for the fixed price to hold. The current draft of the construction contract provides a very limited range of circumstances under which the contractor can increase its price. These relate primarily to force majeure provisions for natural events such as floods, earthquakes etc. and for variations to scope requested by investors in the project.

One of the major risks faced on large construction projects is geotechnical or ground condition risks. This is the risk that underground conditions are not as expected requiring further excavation or more extensive foundation works for the project. This is normally mitigated by carrying out borehole and other underground investigations to confirm the nature of the ground on which the project will be built. HBRIC has carried out its own geotechnical surveys and OHL-Hawkins has carried out further work. On the basis of this work OHL-Hawkins has indicated it is willing to take on all geotechnical risks. This is reflected in the current draft contract and confirmation of this in the final construction contract will eliminate a major construction cost risk for investors.

Time certainty

OHL-Hawkins has specified a completion date for the construction and commissioning of the dam in its bid. The proposed contract terms require damages to be paid to the Scheme owners in the event that the Scheme is completed later than the specified date. These damages are capped, which normal practice in construction projects but means that if the delay exceeds a certain amount of time the damages sum will not be sufficient to fully compensate the investors for their loss. These damages are underwritten by a performance bond lodged by the contractor which is used to pay investors in the event that damages payments are triggered. Again this is normal construction practice.

The construction period has a specified trigger to set the start date, typically the signature of a final construction contract at financial close. The fixed bid price also typically has a validity period beyond which the contractor is free to increase its price. We note that the Scheme has experienced delays to date and further delays may be encountered in reaching financial close. This creates a risk that the construction price may increase or, if delays are significant, the contractor may withdraw from the bid process.

Performance risk

The Scheme will need to deliver water at a specific pressure to farm boundaries across the full irrigated area. This has been specified as part of the bid process and has been updated in the 16 April update to the owners requirements document. During our discussions with management we were advised that OHL-Hawkins has confirmed that its design will meet these specifications.

The specifications and testing procedures will need to be confirmed in the final construction contract together with the damages payments which the contractor will make in the event that the standards are not met. The draft construction contract currently has no provision for specific liquidated damages in the event that the system fails to meet the performance specification; however it specifies that the owner is not required to accept the works until they have passed a performance test. Consequently the owner should have recourse to damages for delay in the even that performance test are not met or rectification work is required to meet them.

The current performance specifications do not appear to include a maximum coincident demand flow rate or pressure however we understand that the scheme has been modelled assuming that every offtake is running simultaneously at its maximum design flow – (i.e. it has been modelled at peak flow). Further pipes and pumps have been sized to accommodate this peak flow. It is anticipated that the scheme will normally run below the peak design flow due to the large number of shareholders and diverse farming practices throughout the RWSS command area and that peak flow may only be reached 1 or 2 times a year (if at all). The system is however capable of delivering water to every user simultaneously at design flows.

Conclusion

The tender process is complete and a preferred contractor selected. The contractor has provided a fixed price against a scope and performance specified by HBRIC which has also taken professional advice throughout the process to date. The definitive allocation of risk between investors and contractor will however only be confirmed once a final construction contract is signed and we note that the negotiation of this contract is not yet complete. Our overall comments are as follows:

· The tender process has been competitive attracting a wide range of high quality bidders. This is likely to have resulted in a competitive construction price.

· The structure of the RFP, specifically requesting a fixed price for design and construction is good practice and is designed to push price and scope risk back to the contractor.

· The pricing for the secondary distribution has been designed to deal with the nature of the proposed irrigation investment. The capped price for the full system isolates investors from scope and price risk for the construction of the full distribution system but some exposure remains if a less extensive system is eventually built using the current pricing structure. This later issue was covered in the bid documentation with a formula for price reductions but needs to be clarified in the final contract.

· Allocation of geotechnical risk to the contractor removes a significant cost risk to investors.

· Whilst the outcome of the RFP process has, subject to contract negotiations, provided price and programme certainty, other factors in the Scheme could cause the construction cost to increase above the current expected level. Specifically any unexpected consent conditions or further delays to financial close could enable the contractor to seek increases to the price bid.

· The contractors bid price has been based on performance and other specifications developed by HBRIC and its advisors. Should these prove deficient in any way resulting in inadequate performance of the Scheme there is unlikely to be any recourse to the contractor for damages or compensation and investors would need to meet the full cost of any rectification required.

· Operation and maintenance costs are currently only budget estimates while there has been no bid process to confirm these they were developed by an experienced operator and reviewed by HBRIC’s engineering advisor.

Appendix 4 sets out a risk register that summarises the key risks of the RWSS from a capital cost perspective, how these are mitigated and an assessment of the probability of these risks materially impacting on HBRIC.

Introduction

As set out in the business case RWSS LP will carry out the business of designing, constructing and owning the RWSS. Ruataniwha Water GP is the company that governs and operates the Scheme.

The underlying business model is relatively simple. Revenue will be sourced from the sale of water to farmers under long term WUA (the primary source of revenue), the sale of spot water and the sale of surplus electricity. The cost structure will comprise the operating and governance costs of operating the Scheme and financing costs.

The primary business driver is the rate of uptake of water by farmers.

Economic Analysis and Demand Assumptions

The economic assumptions underpinning the business model are supported by an independent farm profitability study undertaken by agribusiness consultant Macfarlane, an independent demand and uptake analysis undertaken by infrastructure advisor, Castalia, and also an internal process undertaken by HBRIC and its legal and financial advisors to collate expression of interests (EOI).

Demand for irrigation water is premised on the assumption that irrigation will facilitate increased farming profitability and reduced weather risk. The Macfarlane Rural Business farm profitability study undertaken in September 2012 provided an analysis of the direct economic benefits that may result from the RWSS. This study informed the Castalia demand study, originally completed in September 2012 and updated in November 2013, which sought to forecast the phased uptake profile for irrigation water. The EOI process undertaken in 2013, which ran from early March until the end of August, has provided further confirmatory analysis and broadly reinforced the findings of the Macfarlane farm profitability and the Castalia demand studies.

Macfarlane Rural Business Farm Profitability Study

The Macfarlane farm profitability study sought to assess the improvement in farming profitability that may result from the RWSS. Specifically, this economic study analysed farm profitability, expressed as EBIT $ per hectare (ha), including the cost of water, and the corresponding return on irrigation, expressed as percentage rate of return on the marginal capital invested. The Macfarlane study included the following parameters and key assumptions:

· Modelling analysis was based on 91M m³ of annual storage water sufficient to irrigate 25,000 ha, which equates to a weighted average 3,741 m³per ha per annum, plus a further 17,000 of farmland influenced by the base irrigated area to give a total area of 42,000 ha affected.

· Land use under irrigation is expected to move towards more intensive and profitable farming systems as driven by relative profitability, soil type and also farm owner’s preferences; and modelling analysis specially assumed 37% of the irrigated area would change to dairying, 32% mixed and intensive arable farming and remaining 31% consisting of mixed finishing farms, dairy support, orchards and vineyards.

· Base case water charges were assumed to be $0.20 per m³longer run average forecast commodity prices were applied, and farm productivity was assumed to be in the top-20% for reasons related to modern irrigation technology, higher debt servicing and associated motivations and improved technical skills and in particular the confidence that irrigation provides to farmers to farm more intensively through – for example – higher stocking rates.

· Analysis assumed an estimated weighted average current farm capital investment valuation of $21,200 per ha or $890 million, weighted average new farm capital investment of $8,779 per ha or $369 million, with a weighted average post investment farm capital valuation of $29,982 per ha or $1.258 billion.

We note that the Macfarlane analysis was not updated for the move to the $0.23 per m³ with a pressurised system now proposed but the EOI process discussed below was based on the higher price and a pressurised system.

Table 6 below summarises the Base Case results of the Macfarlane Rural Business farm profitability analysis expressed as return on assets (“ROA”). This analysis shows that under the Base Case assumptions, ROA are projected to increase from 4.2% to 6.6%, with a return on the marginal capital investment of 12.5%. The following sensitivities are also shown.

· High and low commodity price scenarios^{^[7]}, reflecting a 15% variation in Base Case budgeted gross farm revenues and a corresponding 3% change in farm working expenses.

·
An average production sensitivity was run based on the Ministry of Primary Industry (“MPI”) Farm Monitoring Report which contrasts with the Base Case analysis which assumed farm productivity to be in the top-20%.

Table 6: MacFarlane Rural Business RWSS Farm Profitability Analysis

Other key conclusions of the MacFarlane farm profitability analysis are that EBIT per ha increases by c.$1,000 per ha (124.1%) as a result of the RWSS, with the value of assets per ha also increasing from $21,200 before the RWSS to $30,000k after.

The analysis presented above clearly sets out the importance of the assumption of moving to a farm productivity level in the top 20^th percentile. While the assumption as regards farm productivity is important this expectation is supported by the experience with comparable schemes in the South Island. Long run commodity prices are harder to predict given the variability which inevitably surrounds such prices.

The Macfarlane land use assumptions are set out in Table 7 below.

Table 7: Macfarlane Land Use Assumptions

Fundamentally the investment decision that farmers will face in relation to the RWSS will involve weighing up the capital costs necessary to effect a change in land use against long run expected returns on this marginal capital. We note that while capital costs can be estimated with a high degree of precision long run returns on capital are harder to predict and will be fundamentally be determined by productivity improvements cost structures and commodity prices. While farmers have significant control over productivity improvements and cost structures they have little influence over commodity prices. While long run trends in commodity prices can be estimated these are not certain. Further, in the short term prices can be volatile relative to this long run trend and this volatility can influence investment decision making.

The following analysis sets out a series of price charts which show the basis of the Macfarlane commodity price assumptions set out in Appendix 5 and how certain of these compare against long run trends.

Figure 1: Milk Price ($/kgMS)

Figure 2: Lamb Price ($/kg)

Figure 3: Beef Price ($/kg)

Figure 4: Wool Price ($/kg)

From discussions with Macfarlane we understand that they are wary of using historic prices and trends as a predictor of future prices. Their approach is to develop a forward view of prices based on the fundamentals of the market for each product and trends more generally for primary sector commodities. They also note that the prices that they have adopted may appear with optimistic or pessimistic relative to current prices – but this perception will be influenced by where prices sit at a point in the commodity cycle for that specific product.

Castalia Demand Uptake Analysis

The Castalia demand study sought to forecast the phased uptake profile for irrigation water, or more simply, how many years it is expected to take to sell the available water.

Castalia undertook a survey to gauge farmer views in relation to irrigation uptake and also the likely impact on land sale (turnover rates). The survey, conducted anomalously, (online, by phone and also in written form) had a response rate of around 50% of the RWSS catchment land area. Survey information was used as a key input in a demand model, which also included amongst other parameters, milk pay-out, the cost of water and the rate at which land turned over.

Figure 5 summarises the projected uptake curve for irrigation water for the RWSS. It sets out projected demand under the Base Case as well as under the Low and High scenarios. Under the former, there is an initial influx of demand (which appears to be supported by market data as discussed later), which then grows steadily year-on-year, until it peaks at 97.5% in the financial year ending 31 March 2028. At this point, circa 100 M m³ is being demanded, out of a possible 104 M m³. Uptake is similar under the High scenario, although maximum demand is reached a year earlier, whereas under the Low scenario, it takes 25 years for demand to reach 97.5%.

We understand the updated Castalia report provided in November 2013 provided only a Base Case uptake profile and the low and high case scenarios were put together using the Castalia model by Trustpower and are therefore reflective of an equity investor’s viewpoint. Ultimately there is any number of plausible scenarios. For the purposes of the financial modelling and demonstrating the risks or benefits of low or high scenarios the scenarios have an appropriate range. We have undertaken further sensitivity analysis with a more severe downside case in section 8.

Figure 5: Projected Demand Uptake

As highlighted in Figure 5 above, under the Base Case, and assuming a storage capacity of 104 M m³, uptake from incumbent farmers as at the initial period is forecast to be 52%, and full uptake is forecast to be achieved by year 12. Castalia noted following:

· Uptake between year 2 and 12 is driven by slower adopters, who will over time cautiously evaluate their neighbours’ experiences before electing to either intensify their farming systems or sell their farms.

· Farmers with existing intensive farming operations tended to have a better understanding of the implications of RWSS participation than those farmers who currently had extensive farming operations, who were more likely to adopt a ‘wait and see’ approach.

· Around 40% of survey respondents were older than 65, indicating a need for farm succession and the likely potential increase in farm turnover rates.

· Observed uptake rates based on recent completed Canterbury irrigation schemes do not provide compelling evidence, as uptake rates on these schemes were driven by significantly lower water costs which provided immediate capital gains; whereas the economic benefits of the RWSS are expected to be achieved over a longer investment timeframe.

· Despite this observation for the purposes of comparing the uptake profile in a number of these schemes to the proposed profile for the RWSS, HBRIC has in conjunction with the developers of the schemes prepared the following analysis with an estimate of the initial uptake, current uptake and the time to reach this position. As discussed the ownership structure and pricing structure of these schemes all differ from RWSS but nonetheless it does provide some guidance as to the value that farmers place on water and the relative time taken to reach a reasonable level of uptake.

Table 8: Irrigation Scheme Uptake Timeline

Sensitivity analysis showed a high case forecast uptake at the initial period of 54%, and a forecast full uptake achieved by year 11. A more extreme low case showed forecast uptake at the initial period of 40%, and a forecast full uptake not achieved until 2040 (over 20 years). We understand that the low case was intentionally structured to be disproportionate to ‘moderate’ the high case scenario.

The Figure opposite is sourced from the business case and demonstrates the change in land use anticipated by the base case demand analysis prepared by Castalia.

Figure 6: Existing and Anticipated Land Use

We note that the Castalia analysis results in different expectations of land use change to that assumed by Macfarlane based on their analysis of the most profitable land use.

While there is some divergence between the Macfarlane assessments both parties anticipate very significant land use change and the direction of the change is consistent.

HBRIC EOI Process

In parallel with the above analysis HBRIC has undertaken a process to establish a non-binding EOI for water from the RWSS. The EOI process was run in the middle of 2013 and the responses received indicated that water demand is c.40% of the maximum available water.

The EOI contained key terms and conditions which were expected to form part of a binding WUA which is expected to be available for signing over the coming months. Key terms of the EOI, which were expected to be carried across to the draft Water User Agreement, are as follows:

· The WUA will be a “take-or-pay” agreement with an initial duration of 35 years (1 Concession Period). However, water users will likely be able to supplement their committed water take by purchasing up to an additional 100% of their signed volume on the spot market. Prices have indicatively been estimated at 3 times those under the Agreement.

· The available water under the RWSS will be allocated on a “first-come, first-served” basis, meaning that those who delay signing up run the risk of receiving less water than they want or potentially no water at all.

· The agreed delivery point for water will likely be within 2 kilometres of the Water User’s boundary, at a pressure or no less than 1 bar. The exact delivery location is subject to future negotiations and will depend at least in part on the design of the distribution network.

· The Water User will likely have to comply with certain environmental management plans.

· If the WUA is signed before financial close, the Foundation Water Users will be offered early uptake incentives, which may include a discount on the water price ($0.06 per m³ for the first 4 years of the Concession Period) as well as an opportunity to invest in the water distributor.

· The indicative price range was $0.22 to $0.25 per m³ (in 2013 dollar), less any applicable discounts. The final price of $0.23 per m³has since been selected from this range. In addition, there will also be an energy charge of $0.03 per m³ for delivered water.

· The Water User Agreement is transferable in part, or in full, if the land is sold.

Draft Water User Agreement

We have been provided with a copy of the draft Water User Agreement (“WUA”) that is currently being discussed with farmers. The key terms of the WUA are broadly consistent with those tested through the EOI process. In particular we note the following key terms:

· A volumetric charge of $0.23 m³ take or pay.

· An energy charge of $0.03 m³ for delivered water.

· An initial supply period of 35 years (to 2049).

· A right of renewal for a mutually agreed period of up to 45 years.

· A “Foundation Water User” discount of $0.06 m³ for 4 years.

· Condition Precedent 1 – which requires that the RWSS LP confirms that the distribution network will service one of the nominated delivery points.

· Condition Subsequent 1 which requires the parties to agree the terms of a Farm Environmental Management Plan (FEMP) by the first supply date.

· No liability for delivery failure caused by climatic conditions.

· Payments monthly in advance commencing in June each year 3 months prior to the start of the irrigation season.

· Credit support in the amount of two years contracted water charges.

The WUA requires the farmer to commit to a substantial financial obligation for an extended period. The farmer can only be released from this obligation where the rights and obligations under the agreement are permanently transferred to a party approved by the RWSS LP.

As part of their investment decision process farmers will need to assess the implications of the requirement to commit to a FEMP. The FEMP needs to set out how the farmer intends to comply with the RWSS consents to the extent these apply to each particular farm.

Generation Assumptions

As discussed earlier, revenue derived from hydro-electricity provides an additional revenue stream for the Scheme. We understand that the long-run generation revenue is premised on a number of key assumptions which include the following:

· The RWSS generates 26,000 megawatt hours (“MWh”) per annum in a determined seasonal pattern. Of this approximately half will be used for the schemes own use and the remaining portion sold to generate electricity revenue.

· The long run price is $93.71, although this is offset by a $12.50 discount which is the estimated discount required to achieve a fixed price, variable volume power purchase agreement.

· A downward adjustment of 9% is applied to electricity generated with water delivered under the RWSS to reflect the fact that the hydro station will not be run to optimise the electricity price but rather irrigation needs resulting in sub-optimal intra-day and intra-year generation timing.

· Avoided cost of transmission (“ACoT”) revenues total c.$340,000 per annum^{^[8]}. We note this revenue stream is dependent on the scheme operating at specific times in the year which may be outside of the control of the operator and it is therefore at risk, The revenue only comprises approximately 1.2% of total revenue once full uptake is achieved (or 2.4% in year 1 when uptake is assumed to be 52%) so is not overly material to the financial returns. Further there is a review being undertaken by the Electricity Authority on the ACoT charging regime which may have a negative impact on the availability of these revenues, despite the review only being at an early stage.

Operating Cost Assumptions

Unlike the Design and Construct (“D&C”) Agreement, the Operations and Maintenance (“O&M”) Agreement is not yet agreed. We understand that over the coming months this part of the Scheme will be put to tender. In the interim, the operating costs have been estimated based upon initial values which are escalated over time. The only exceptions to this are the Centralines charges, which also have a non-indexed component, and mitigation costs which follow their own profile. Specifically, operating costs include:

· Pump energy

· Pump and distribution maintenance (aligned with uptake)

· Maintenance dam, generation plan, communications, Centralines charges

· Mitigation costs

· Special Purpose Vehicle (“SPV”) management costs

Peer Review of the Ruataniwha Water Storage Scheme Business Case

Attachment 1

HBRIC LTD (Equity Investment)

It is currently anticipated that HBRIC will invest up to $80 million in the RWSS LP. The final amount invested by HBRIC will be scaled based on the level of securities subscribed to by other investors in the RWSS LP.

HBRIC’s investment will be an ordinary equity security in all respects, other than the share of distributions during the demand uptake period. Equity allows HBRIC to have proportional ownership of the RWSS LP and share in the demand uptake risk to ensure the RWSS proceeds. This includes the right to appoint directors to the board of Ruataniwha Water GP.

Cash flow distribution to HBRIC is based on free cash flow after operating costs, debt servicing (on bank debt and Tukituki Investments LP hybrid security), CIIL coupons and repayments, and Institutional Investors’ investor fee. Free cash flow is then proportionally distributed to HBRIC LTD depending on the level of demand uptake:

· Before demand uptake reaches the Trigger Date (earlier of 95% demand uptake plus two years, or 100% uptake), cash distributed between HBRIC and Institutional Investors (not including Tukituki Investments LP until hybrid security converts to equity); and

· After the Trigger Date, the distribution is pro rata to total equity.

The distributions are such that before the Trigger Date, HBRIC’s target return is a sub-commercial financial return that reflects the positive externalities and public value attributable to the Scheme outside purely financial metrics, and the fact that the majority of assets will transfer back to the Council at the end of the Concession Period. Post-Trigger Date, HBRIC’s return will be the same as other equity investors, with a target return of approximately 10% (a commercial return for similar brownfield investments).

The following description of the key terms of the CIIL, Institutional and Farmer Note funding is all based on the current negotiated positions as set out in the business case. We have not evidenced any draft shareholder agreements which we would expect to set out key investment terms and triggers for certain events. On this basis it would be our expectation that HBRIC will use its discretion to continue to negotiate its position with each respective funder and that the final shareholder agreements will reflect terms at least as favourable as discussed below.

CIIL (Hybrid Security)

CIIL has expressed a strong preference to invest in the scheme as a subordinated debt provider to minimise its exposure to usual equity risks (for which there is commercial appetite), focusing instead on uptake risk.

CIIL’ s funding is particularly important for sharing demand uptake risk with HBRIC LTD. CIIL will share in the demand uptake risk and accept a sub-commercial return in order to facilitate the creation of the Schemes economic benefits, including national GDP growth and employment. Whilst still being negotiated, CIIL’s repayment structure will likely be linked to uptake. As such, if demand uptake takes longer than Base Case model assumptions then repayment of CIIL’s capital will likely be delayed. This benefits both the RWSS economics and HBRIC’s risk profile as a slow uptake profile will result in a slow repayment profile for CIIL.

As CIIL exits, there may be a requirement for cash from investors to fund whatever part of the CIIL debt that cannot be paid down from RWSS operating cash flows or draw-downs of bank debt. This is particularly so in the event of very slow uptake (albeit a phased CIIL exit partially mitigates this).

Tukituki Investments LP (Hybrid Security)

The Preliminary Information Memorandum for the public offer to eligible investors in the Tukituki Investments LP has been released, with expressions of interest due by 30^th April. Eligible investors are defined as persons who:

· Have signed a WUA for water from the RWSS LP;

· Are landowners within the RWSS irrigation footprint; or

· Are Hawke’s Bay resident individuals or businesses; and

· Who are “eligible persons” for purposes of the Securities Act 1978.

The minimum total subscription is for $10 million, but the RWSS LP will accept subscriptions in excess of this. Eligible investors will invest in a hybrid security with a cash paid coupon converting to common equity at the Trigger Date (full or close to full uptake).

The Tukituki Investments LP will be an intermediate investment vehicle to pool eligible investment. Eligible Investors (limited partners) would invest in the Tukituki Investments LP and hold a stapled interest (providing governance but no economic rights) in the general partner of the Tukituki Investments LP. The Tukituki Investments LP would then invest the proceeds of the public offer into RWSS LP. The terms of the Tukituki Investments LP include:

· Investment will be by way of an intermediate Limited Partnership, which will have the sole purpose of investing in the RWSS LP;

· Minimum subscription of $50,000;

· Cash paid coupon of 5.0% per annum;

· Second ranking in the cash flow waterfall, behind bank debt only, this is the intention but may depend on the final negotiation with CIIL regarding the priority of its funding;

· Conversion to common equity once full uptake has been achieved;

· Perpetual ownership in the RWSS assets, beyond the end of the Concession Period;

· Voting rights; and

· Exclusive right to nominate one of the RWSS LP Board’s Independent Directors if subscriptions exceed $25 million in aggregate (other investors will have the right to veto any nominations and ask for another nomination).

The cash paid coupon is expected to be attractive to farmers looking to invest in the RWSS but who require certainty of cash flow to help offset the cost of funding the investment.

He Toa Takitini

The business case notes that there is the possibility that He Toa Takitini (a local Treaty claimant group) may also be a direct investor in the Scheme through their treaty settlement. The structure and quantum of investment is unknown as treaty negotiations are currently in progress.

Institutional Investors (Equity Investment)

It is anticipated that Institutional Investors will subscribe to interests between $50 million to $90 million in the RWSS LP. This will be an ordinary equity security in all respects, but will benefit from an investor fee which is prioritised over distributions.

Investment returns to Institutional Investors are by way of an investor fee and free cash flow distributions. The investor fee is designed to provide a partial shield for Institutional Investors investment during demand uptake by targeting a minimum return, before remaining cash flow is distributed to equity. Through the investor fee mechanism, risk-adjusted return requirements for private capital are below what would otherwise be required. Furthermore, the investor fee allows Institutional Investors to realise returns at the front end of the Concession Period, a requirement given their investment amortises to zero at the back end when the assets are transferred back to the Council.

Importantly if the investor fee it is unable to be paid (i.e. insufficient cash flows) the fixed dividend will capitalise and compound but will not trigger any default. The payment of the fixed amount (including capitalised amounts) will rank ahead of any distributions to HBRIC. The breakeven for the fixed dividend (i.e. where cash flows are sufficient to ensure no capitalisation) is dependent on the overall capital structure and uptake levels. BNZ Advisory have run a scenario which shows under the Base Case the breakeven point for full repayment (no accrual) of the investor fee is approximately 55% to 60% uptake.

Discussion

The capital structure currently proposed reflects the need to balance the requirements of different investor categories and the reality that the RWSS is not a commercially viable Scheme at establishment given the forecast level of pre-sales. We understand that more work is required to confirm the investors, the quantum of capital committed by each and the exact terms under which they will invest. Until these matters are finalised the capital structure – and the implications of this for Scheme viability – must necessarily be regarded as indicative only.

We note that if bank debt is incorporated into the initial capital structure, it is likely to be on the basis of relatively low gearing. Again, this is a function of the expectation that there will still be a substantial shortfall in take-up in the early years of operation of the RWSS. For other similar projects where a substantial proportion of uptake is contracted from the outset senior debt has typically made up a very substantial portion of the initial capital structure. While this is a limitation of the RWSS initially as the Scheme trends toward full uptake then the ability to access and service a significant quantity of senior debt will improve.

We understand from discussions with BNZ Advisory that the possibility of introducing some senior debt into the opening capital structure is being considered and that terms for senior debt are in the process of being negotiated.

The combination of public and private capital in the proposed capital structure creates additional complexity. It is essential therefore that all investors understand how their returns adjust under different scenarios. At our request BNZ Advisory has undertaken extensive sensitivity analysis to demonstrate and explain how the returns to HBRIC and other investors vary as key assumptions underpinning the financial projections are varied.

Conclusion

As noted above the capital structure for the RWSS has yet to be finalised. The make-up of this capital structure is as important as the quantum of capital raised. In particular:

· The aspirations of the different investor categories need to be compatible;

· The terms under which investors are prepared to commit their capital need to be acceptable to HBRIC and the other investors;

· A substantial portion of capital needs to be provided on non-commercial terms through the initial period.

In this respect the terms and quantum of the CIIL investment are critical. Not only is it proposed that this capital be priced on below commercial terms the proposed redemption profile is linked to water uptake. This aspect of the CIIL investment provides significant protection to HBRIC through the initial period and is critical to the viability of the Scheme.

In addition to providing capital, investors in projects of this nature can typically bring other positive attributes including technical knowhow and governance skills. In this regard it is disappointing that Trustpower has decided to withdraw from the Scheme. We understand that Trustpower had played a valuable role through the procurement process and in validating the financial analysis of the RWSS undertaken by BNZ advisory. The technical skills that Trustpower might have been expected to contribute through the balance of the construction phase in particular, will now need to be replaced by professional advisors unless an investor with similar attributes to Trustpower can be identified.

The analysis undertaken below demonstrates that the financial case for the RWSS investment is finely balanced. Therefore, any material change to the current capital structure or related terms could impact on the risk of HBRIC’s investment.

Peer Review of the Ruataniwha Water Storage Scheme Business Case

Attachment 1

Operating Cash Flows: Key Assumptions

The following is a summary of the key operating revenue and cost assumptions for the RWSS as set out in the Appendix to the Business Case to Council: Financial Case dated 3 April 2014.

Revenue

Contracted water distribution revenues

Contracted water revenue comprises the majority of the Scheme revenue (approximately $26 million at full uptake in 2014 dollars), with the following assumptions built into forecasts:

‘Full Uptake’ has been defined as 104 M m³.

· The financial model assumes contracted revenue caps out at 97.5% of full uptake (104 M m³) for conservatism reasons providing a small additional buffer. We have not tested the impact of increasing this level to 100%;

· The uptake curve used in the base case financial model has been provided by Castalia Strategic Advisors and assumes full uptake by 2028, as discussed further below a range of uptake profiles have been tested.

Additional ‘Spot’ Water Revenues

The financial model assumes water users will purchase a small level of additional water both during the uptake period, and thereafter (with either sales to additional or existing users on a variable basis).

Spot revenue is assumed at less than 9% of contracted water revenues (approximately $2.3 million (in 2014 dollars) at full uptake), increasing proportionately with uptake.

The current consensus from the project team is that spot revenues are expected to generally be higher than the underlying water price, in which case the additional volume implied by the spot revenue assumptions is lower than 9%. We have not verified this other than to note that it would be counterproductive to offer a price of less than the contracted price so on par is a reasonable basis. In an average year there is approximately 55M m³ of surplus water above environmental flow and contracted requirements (and more prior to full uptake).

The following figure sets out the Base Case water volumes. Volumes for 2018 are a part irrigation year of only 6 months. Ground water consent holders are assumed to be 3.9M m³ and in 2023/24 are shown as part of the contracted water (excluding early birds) volumes.

Figure 12: Base Case Water Volumes (Million m³)

Water Pricing

Water distribution price of 26c/m³ (in 2014 dollars) which as discussed is comprised of:

· Base 23c/m³ (in 2014 dollars) take or pay portion (regardless of the schemes supply / ability to supply due to dry year). The draft water user contract assumes that there is no liability to the Scheme for failure to deliver water;

· A 3c/m³ variable charge designed to cover variable pumping costs. As this revenue portion is variable it will fluctuate on an annual basis depending on the level of irrigation demand.

The Model assumes a flat 26c/m³ price (2014 dollars) with no volume variation because it is expected if the water volume is lower than contracted take-or-pay volume in any year (due to either low inflows or low irrigation demand (assumed to be during a wet year), then the percentage of the 3c/m³ variable charge which is not received can be replaced by either additional generation revenues (because this is likely to coincide with a wet year) or offset by a reduction in variable operating costs, e.g. pumping costs etc. (in setting the 3c charge we understand that analysis by the technical team indicated that variable charges are at least 3c and therefore any reduction in revenue received should be 100% offset by the cost saving in not supplying water.

As discussed it is assumed that a “Foundation Water User” discount of 6c/m³ (2014 dollars) is applied for the first 4 years of operation for users who commit prior to financial close. As there is a condition precedent for 40M m³ the Base Case Model assumes this level:

· A reduced price of 10c/m³ (2014 dollars) for deep ground water users for the first 5 years;

· Inflation of 2.0% (in line with all other inflation assumptions) – the underlying price inflation mechanism in the water contract is CPI;

· Revenues received monthly (as per proposed billing, as described in the water contract).

Water Price Affordability

In assessing the affordability of the scheme to farmers a number of considerations have been made. As part of the MacFarlane analysis the range of water prices were assumed with the 2012 report using a 20c m³ assumption (but non-pressurised). The updated Castalia demand forecasts assume a 25c m³ price and most importantly the EOI process used a price range of 22c to 25c m³. In addition to these project specific reference points it is worth noting the comparability to other schemes as these are ultimately the litmus test for an affordability band.

Irrigation New Zealand (“INZ”) has compared standardised costs for the delivery of water to the farm gate for 20 irrigation schemes throughout the country, primarily in Canterbury. The analysis includes adjusting for differences in share costs, fixed costs, variable costs, delivery pressure, any on-farm storage requirements, and reliability. As the Business Case notes there are two key differences between the RWSS and existing Irrigation schemes make comparisons of the RWSS with the INZ report difficult. The first is the capital structure and the second is volumetric charging for water.

The capital structure of existing irrigation schemes have a bias towards a co-operative type structure, this generally involves the investment of capital which does not provide a cash return but is rather used to provide the lowest possible water price. The RWSS is focussed on providing an arm’s length water price and does not require investment by Farmers as a condition for water delivery.

The nature of many of the schemes considered by INZ is such that they are not really comparable to RWSS given the historical nature of the investments. The Business Case selects several schemes for specific comparison to the RWSS after discussions with INZ. These schemes are seen as being comparable to the RWSS based on a combination of both age (built within the last 15 years) and the quality of the infrastructure (i.e. they are not due for significant upgrade). The schemes are:

· Opuha Water Ltd – Kakahu

· Opuha Water Ltd – Sutherland

· Opuha Water Ltd – Totara Valley

· Barrhill Chertsey Irrigation Ltd

· North Otago Irrigation Company

The following figure sets out a comparison of the schemes on a hectare and volumetric basis:

Figure 13: Comparison of INZ Selected Schemes to RWSS

Water distribution costs range from $1,045/ha/year to $1,348/ha/year, with the RWSS in the bottom half of the group on this metric; and on a cubic metre range from $0.21m³ to $0.28m³ with the RWSS also in the bottom half of this group. We note there are a number of simplifying assumptions as part of the analysis and as such while these are useful as a means of assessing the reasonableness of the pricing proposed by the RWSS the key proof of the affordability of the scheme will be in the level of take-up both in the period up to and following financial close.

Electricity Revenues

We understand that Tonkin and Taylor has predicted that the power station will produce an average of 26,000 MWh or a capacity factor of 46%. Of this, half (13,000 MWh) is assumed to be sold to generate revenue with the balance (13,000 MWh) used to offset the RWSS’ own power requirements for pumping. In addition to the 13,000 MWh there is an additional amount of 4,800 MWh which is assumed to be purchased separately. This amount corresponds to the predicted power that is needed to operate pumps as the power produced is unlikely to be able to meet 100% of power requirements due to timing differences between RWSS production and RWSS power demand. These won’t correspond at all times. This cost is assumed as an operating cost and discussed in the section following.

It is assumed that as the dam will primarily be used to meet irrigation demand, rather than optimising for power prices that the power station will not achieve the same level of profitability as a power station which was built solely for electricity generation revenues. As a result the Model includes:

· A peaking factor^{^[10]} of 91% reflecting the fact that the dam will primarily be used for irrigation and accordingly may receive sub-average power prices due to sub-optimal intra-day and intra-year generation timing (from a power price perspective); and

· A discount factor of $12.5/MWh based on assumed power purchase agreement with fixed price and variable volume terms.

As discussed above it is assumed the Scheme will receive ACoT revenues totalling $340,000. While we consider there is a certain level of risk around this revenue source we consider this to be a reasonable assumption.

The following chart shows the electricity prices assumed in the Model. The Australian Securities Exchange (“ASX”) operates a New Zealand Electricity Futures market for base load quarterly contracts with a node in the North and South Islands (being Otahuhu and Benmore respectively). The prices are publically available and we understand these prices are the basis for the forecasts in the Model. The prices are based on those observed on 20 February 2012. The pricing for 2017 of $93.7 has been used as the long run forecast. We have compared the pricing to current pricing and note that current prices are between 15% and 20% lower. Since 2012 there have been a number of downward pressures on forward views of the forecast for electricity prices in NZ the most material being uncertainty regarding Rio Tinto, concern regarding the proposed Labour/Greens single buyer market and excess capacity and soft demand forecasts.

With regard to the longer run forecasts the Model assumes that $93.7 MWh (2014 dollars) is the long price. This price falls within the range of our own views which fall in the range of $80 MWh to $95 MWh. We note that there is a wide range of plausible price outcomes but a reasonable consensus of the views would see lower pricing for longer (out as far as 2018) before increasing towards the long run marginal cost which sits anywhere in the range of $80 MWh to $110 MWh.

Figure 14: Electricity Price Path

Operating Cost Assumptions

The maintenance and operations contract for the Scheme has not yet been tendered. It has been determined by the D&C evaluation committee that the risk and uncertainty premium that would be applied to such a contract would be unnecessarily high. This is driven by two key factors, firstly there is at least a 3 year period between financial close and the start of the operating period and that the final Scheme design for the secondary distribution network is unknown. It has been determined that the risk of not contracting is acceptable given the very high operating margin providing significant headroom.

Despite there being no firm contracted position for the operating costs, the costs can be estimated to a reasonable degree of accuracy and are not a material driver of financial performance. It is difficult for us to benchmark the costs other than to comment on the process that has been used to estimate them. We understand that Trustpower in its former capacity as a potential investor and member of the Investor Representative Committee provided the initial estimates of operating costs for the first three items in Table 13 below. These costs have then been reviewed by SMEC and are considered reasonable over the Concession Period.

The Centralines charges relate to the upgrade of the transmission and lines network. While it would be possible to include a portion of these costs in the construction costs it is generally assumed that electricity distribution companies have one of the lowest costs of capital and instead it is assumed the cost will be recovered through the Scheme paying an ongoing operating charge to Centralines.

We understand that the mitigation costs comprise mitigation, offsets and environmental costs which were estimated by the consenting team and included as part of the package during the Board of Inquiry process. We have not tested these in detail as we understand the cost is fixed and it will be to the discretion of HBRIC and RWSS if additional is to be spent. Mitigation costs vary across time starting off with larger investments of $965,000 in year 1, $725,000 years 2 and 3, $473,000 year 4 to 10 and then $147,000 thereafter. We note the financial model assumes a decrease at year 30 to $96,500.

In the financial case provided to us it was noted that in discussions with Trustpower when it was a potential equity investor indicated on balance the costs to be appropriate, it had noted that the SPV costs were light but that other cost items compensated.

A subsequent review by SMEC broadly aligns to this view but in addition SMEC has noted that maintenance cost assumptions are most likely high for the first 25 years as these costs are more likely to be deferred into an overhaul type event after about 25 years.

From discussions with BNZ Advisory we understand that no allowance for capital expenditure has been included in the financial projections. Any requirement for expenditure to maintain the operating capacity of the Scheme’s assets is considered to have been built into the operating budget.

We note that total operations and maintenance costs comprise around 40% of operational expenses and are close to 1% of the overall capital expenditure. We have tested a sensitivity to a 25% increase in all operating costs. Given the relative fixed/known nature of the Centralines costs and mitigation costs (which comprise close to 45% of costs) this would provide nearly 50% buffer for all other costs. Under this scenario the investor IRR decrease around 50 – 75 basis points and at no point does the cumulative cash flow to HBRIC turn negative for the period to full uptake.

Table 13: RWSS Operational Expenses

Asset life and depreciation

We understand that the current view is that the dams economic/planned life should be in excess of 100 years. The dam and remaining components of the Scheme are depreciated over a range of various terms which results in a depreciation charge of $14.4 million in FY19 which decreases on a diminishing value basis to around $8.1 million in FY28 (full uptake). The following table sets out the depreciation rates used for the various construction components.

Table 14: Depreciation Rates for Construction Components

We note that in line with the observations from SMEC it is possible that annual maintenance costs may be lower for a period and then comprise a larger capital refurbishment. The result would be that taxable income would be higher for a period and that the costs would be of a capital nature and therefore the tax benefit would be realised over time through the depreciation charge as opposed to an operating cost deduction.

Tax losses

As HBRIC’s investment is expected to be treated from a tax perspective as an interest in a partnership, HBRIC will be allocated its proportionate share of the partnership’s income and expenditure, which will be passed through under the limited partnership structure. It is anticipated that the partnership will be in a tax loss position until approximately 2023 (including for the construction period), before turning into a taxpaying position. To the extent that losses arise, these losses can be set off against the taxable profits of other entities in the HBRIC group assuming 66% or greater common ownership.

We understand that HBRIC has received tax advice from PricewaterhouseCoopers (“PWC”) which sets out their view on how the tax losses/income should be distributed. During the construction period assessable income/losses is assumed to be passed to HBRIC in line with its contributed capital. During the operational phase assessable income/losses are assume to be passed in line with cash distributions. The result of this is that HBRIC receives a timing benefit during the early stages of construction given it contributes capital first and in operations the institutional investors and Farmer note receive a timing benefit up until the conversion date given the nature of their respective fixed interest instruments.

Senior Debt

As discussed, it has not yet been determined whether there will be bank debt within the initial capital structure. If there is debt at financial close the current view is that it is not likely to be more than $50 million.

During the operating period bank debt will likely be drawn down progressively as uptake increases. The base case includes assumptions in this regards, based on a structure that demonstrates covenant compliance on a historical and forecast basis, and repayment prior to the end of the resource consent period with a 1-2 year tail before the end of each consent period. We note that there are a number of bank covenants which are used to size the debt including debt service and interest service cover ratios.

We have not yet sighted a draft term sheet indicating the availability of debt on the terms modelled but note that BNZ Advisory has been in dialogue with commercial lenders regarding the Scheme in particular around ensuring the project documentation and construction contract are sufficient to cover the needs of the lenders.

Base Case financials under the two capital scenarios

Overview of Projected Operating Revenues and Costs

The following section sets out a review of the operating cash flows from the Scheme and assesses HBRIC’s returns under various sensitivities and scenarios. In undertaking our analysis we have been focused on:

· Whether the HBRC can have comfort that its exposure to calls on capital can be limited to its current funding envelope of up to $80 million;

· The circumstances under which HBRC may be required to contribute additional capital and where possible the quantity of those potential calls and the risks that such calls could eventuate;

· The extent to which HBRC can have comfort that the projected returns on its investment have been accurately calculated and are based on reasonable assumptions; and

· How investment returns could vary under different scenarios.

The preceding section has already outlined the assumptions which have been used to generate the projected returns so this section is primarily focused on addressing points 1, 2 and 4.

Summary of business model

The proposition is to invest approximately $276 million to construct, over a 3 year period, a dam which will provide access to 104 M m³ per annum of water to be used for irrigation with 95% reliability. The water will be sold under contract on a take or pay basis for $0.26 m³ generating approximately $27 million revenue (2014 dollars). In addition a 6.5 MW hydro station will generate electricity, half of which will be used for the Schemes pumping requirements and half sold for revenue. The Scheme has a steady state operating cost of approximately $6 million which will generate operating profit in a steady state of approximately $25 million in 2014 dollars. The following table shows a breakdown of theoretical operating profit at full uptake and several other key milestone dates. The table illustrates the very high operating profit margin at over 80% once full uptake is achieved.

Table 15: Operating Profit (Base Case)

One of the Conditions Precedents to financial close is to sign up take or pay Water User Agreements representing 40M m³ of annual water use. Breakeven analysis demonstrates that, from an operating cash flow perspective, the Condition Precedent uptake volume is more than sufficient to ensure positive operating profits from the commencement of operations, with sufficient buffer for further adverse impacts (for example, lower than expected spot water sales or higher than expected operating costs).

BNZ Advisory as part of the financial case has undertaken further scenario analysis based on the inclusion of 15% bank debt gearing (interest only) which results in circa $35 million debt at financial close and a further $10 million capitalised interest and fees by the end of construction. Under this scenario bank debt interest in year 1 would be around $3.4 million which would leave circa $1.9 million headroom and therefore not require a capital call for senior debt servicing. The head room in that year would almost be sufficient for payment of the farmer note coupon (circa $2 million) however would not cover any further servicing for CIIL or the institutional fixed interest portion.

The following charts summarise the projected operating revenues and profits under the Base Case and some of the key assumptions underpinning these for the first 25 years of the forecast period.

Projected revenues and operating profits under the Base Case are summarised in the following chart. Under this scenario, operating revenues increase proportionately with projected water demand, which is discussed in more detail below. The Scheme’s main source of revenue is water sold under the take-or-pay Water Use Agreements for $0.26 per m³. However, spot water sales and generation revenue also contribute between 10% and 15% of the operating revenue, even once the demand has begun to stabilise at its long-run level.

The main drivers of the losses in the early stages of the Scheme are the large depreciation charges and the relatively large financing costs incurred on the bank debt (if any) and the CIIL interest portion. In fact it is not until the financial year ended 31 March 2024 that the Scheme first makes its first operating profit ($2.4 million) when water demand is approximately 72%. The main operating expenses relate to maintenance and Centralines charges. While depreciation has an impact on operating profit before tax, the Scheme is forecast to earn positive cash flows immediately.

Figure 15: Projected Revenue and Operating Profit

Cash Cascade

The following section discusses how cash flows from operations are distributed under the proposed capital structure. It is important to note that the current capital structure remains in a state of flux and as a result the final negotiated outcome may differ to that described below. Despite this there are a number of key features between the proposed structures which are the same:

· Senior debt interest and principal has first ranking priority and is paid ahead of all other distributions. Failure to do so is likely to result in a breach of banking covenants and would require immediate remedy by the ordinary shareholders or face default;

· Before the conversion date, the 5% fixed interest portion on the Farmer Note is currently assumed to rank ahead of CIIL;

· The CIIL sub-debt assumes a small cash interest cost to meet CIIL’s operating costs, with the balance likely to be capitalised ;

· Importantly the phased CIIL repayments will likely need either bank debt, contributed capital, or both. It will be for a General Partner decision at that time whether this is met by retained earnings, a capital call amongst all investors, a capital call amongst investors of a certain class, bank debt, or a mixture thereof. Scenario modelling demonstrates that the full amount could be available from bank debt whilst still staying within reasonable gearing levels;

· Before the conversion date institutional investors will receive a proportion of their return from a fixed investor feet payment. It is expected this investor fee will be paid however it will have the ability to capitalise without triggering any default or capital call;

· Prior to conversion all remaining cash flows are distributed between HBRIC and the institutional investors;

· After conversion the Farmer Note (Tuki Tuki Investments), HBRIC and institutional investors will receive distributions on a pro-rata basis after servicing interest and principal payments on bank debt.

HBRIC Distributions and Investment Return

HBRIC as an equity investor receives its return from the Scheme based on a proportion of equity distributions.

The calculation of HBRIC’s return on its investment is comprised of three key cash flows:

1. Distributions

HBRIC receives a proportion of free cash flow after payment of all required distributions which rank prior (other than cash which the RWSS GP may elect to retain). In the period up to the conversion date (pre-trigger), assumed to be June 2028, distributions are made on a fixed percentage. After the conversion date they are based on the pro-rata proportion of investment.

Should the negotiated position starts to move materially away from the shareholding percentages and terms currently assumed then the sensitivity and scenario analysis undertaken below should be redone so as to ensure that HBRIC is not providing any additional protection for the other investors in downside scenarios.

2. Tax losses

HBRIC has received tax advice from PWC which sets out their view on how the tax losses/income should be distributed. During the construction period assessable income/losses is assumed to be passed to HBRIC in line with its contributed capital. During the operational phase assessable income/losses are assume to be passed in line with cash distributions.

3. Capital contribution toward repayments of CIIL

The Base Case model assumes that 25% of CIIL repayments are met from ordinary shareholders (being HBRIC and institutional investors) which is simply assuming funds are paid out and then recycled back to repay CIIL. In effect the same outcome could be achieved by setting retained earnings at a level such that it covered the CIIL repayments and distribute the remaining proportion.

We note under a range of unfavourable sensitivities that these payments will continue to be required to CIIL. While the Model shows the payments coming from the respective parties (which results in negative cash flows to HBRIC), in practice it will be for the Scheme to determine at the time whether it wants to manage CIIL repayments via retained earnings, bank debt or capital calls. If it is the latter HBRIC could chose not to participate and instead have its shareholding diluted.

Investment Returns

The following section sets out the calculation of HBRIC’s investment returns. We understand that HBRIC’s investment has been structured such that it will earn lower project returns during the uptake period, compared with institutional investors, to reflect the material positive externalities including economic and environmental benefits to the Hawkes Bay region. Once full uptake is achieved HBRIC’s returns will revert to a commercial arrangement and earn project returns on a basis consistent with all other investors and targeting approximately 10% return which is HBRIC and BNZ Advisory’s target for a commercial brownfield^{^[11]} infrastructure investment.

The IRR, or internal rate of return is not a coupon rate. In its simplest form the IRR is the discount rate which makes the net present value of a series of cash flows equal to zero. The IRR calculation can generate the same return for a series of small regular cash flows or a single large bullet return at the end of the analysis period.

It is therefore important to note that these investment returns are over the life of the respective analysis period and comprise a series of cash inflows and outflows which are not uniform.

The calculation for pre and post measurement date includes a calculation of the inferred market value of HBRIC’s shareholding at the conversion date. This is calculated by discounting the cash flows post measurement date at a discount rate of 10%. This rate is set as the discount rate from the perspective of an incoming brownfield infrastructure investors based on benchmarking BNZ Advisory has undertaken. Given the uncertainty in estimating market discount rates approximately 15 years into the future we would expect the rate to fall within a range of 8% to 12%, so a mid-point of close to 10% seems reasonable. We do note that the pre-measurement date IRR will be sensitive to assumptions regarding the discount rate used to calculate the market value, although this has no impact on cash that would be received by HBRIC (unless it elected to sell at a point when the market was unfavourable). A higher discount rate assumption would result in a lower return being calculated with the opposite effect for a lower discount rate assumption.

The post measurement date return of 10% is the same target under all capital structure scenarios. The post measurement date return assumes that an investor would need to pay the market value of HBRIC’s investment in order to receive the benefit of the future cash flows.

The following three charts set out the cash flows used to establish the returns. We note the large distribution in 2050 is the result of the re-gearing of the Scheme following the start of the second consent period.

We note the repayment and subsequent investment in 2016 and 2017 of circa $8m relates to an assumption within the financial model which provides a repayment to HBRIC following the 3^rd tranche of the farmer note which is required to be drawn down again the following quarter. In practice the required drawdowns for HBRIC in the quarters following would be reduced rather than a repayment. The impact on the investment returns are immaterial (i.e.1bps).

Figure 16: HBRIC Cash Flow - Whole Concession

Figure 17: HBRIC Cash Flow - Pre Trigger Date

Figure 18: HBRIC Cash Flow - Post Trigger Date

Risks and Mitigants

HBRIC and BNZ Advisory have provided us with a comprehensive list of the risks faced by the Scheme and we requested a series of scenarios and sensitivity analysis which sets out the impact on investor returns (in IRR terms) to HBRIC’s return. In addition consideration has been given to scenarios which may result in additional capital calls for HBRIC.

In broad terms however the risks are allocated as follows:

· Design and construction risks are borne by the D&C contractor. These include cost over runs and timing delays (where there is no scope change initiated by the Scheme); The financial impact to investors is largely expected to be covered by liquidated damages (“LDs”) however we note that there will be a cap on the LDs level, as is standard construction contract practice.

· Demand and uptake risk is borne by HBRIC and the portion of Institutional Investor returns other than the investor fee firstly. CIIL provides a timing buffer through the proposed repayment mechanism which depresses the repayment while uptake remains low thereby making a higher proportion of cash flows available to HBRIC and institutional investors than would otherwise be the case. If uptake was very slow then it would also be likely to impact institutional investors investor fee and then part of CIIL interest would likely capitalise.

· Operating costs and performance is largely met by all parties in the post trigger date period, however in the ramp up period HBRIC is bearing a larger proportion of the risk given the majority of its return ranks behind other cash distributions including the institutional investor fee payment.

· Regulatory risk is borne by all investors equally, assuming that the trigger date is reached prior to the end of the first consent period.

Scenarios/Sensitivity Analysis

The following section sets out an overview of the scenarios and sensitivities which BNZ Advisory has run as part of the financial case.

Demand Scenarios

HBRIC and BNZ Advisory have undertaken sensitivity analysis in relation to demand ramp up:

· Under the “Moderate High Case” (see Figure 22), which assumes full uptake is reached 2 years earlier, under the capital structure scenarios run, HBRIC’s project IRR increased moderately: by approximately 20 basis points;

· Under the “Extreme Low Case” (see below), which assumes full uptake is not reached until 2040, HBRIC’s project IRR reduces by less than 1% under the capital structure assumptions;

In addition to the upside and downside demand scenarios provided to us we have added a further scenario which provides a very aggressive downside which assumes that demand never reaches full uptake and caps out at 75%. This scenario has been provided in response to questions from HBRC and in our view given the long run value of water is unlikely to transpire. Under this case, HBRIC’s project IRR fell by approximately 150 basis points, although HBRIC would recover its capital after 29 years and earn a positive return over the life of the Concession Period.

Figure 19: Projected Demand Uptake

Sensitivity Analysis

The table opposite highlights the impact of a number of key sensitivities on HBRIC’s investment returns under the current base case. Appendix 6 has further detail and commentary on each sensitivity. At a high level we note there is significantly more sensitivity for the returns to the trigger date (14 years) as opposed to over the full concession period (70 years). This is primarily because the returns to trigger date are comprised of generally low cash returns and are largely the result of several one off events such as the gearing up of the Scheme in 2018 and release cash from reserve accounts.

Table 16: Investment Returns

We note that for all scenarios the behaviour of returns for investors depends materially on the agreed repayment profile and backstop date with CIIL and the Farmer Notes. For the purposes of the analysis presented for the extreme downside where demand never exceeds 75% of capacity BNZ Advisory has assumed the Farmer Note converts in 2040 (the same as the full uptake under downside case) regardless of uptake never getting to 100%. Under this same scenario HBRIC’s initial investment is recovered after 29 years.

In addition to the scenarios above we asked BNZ Advisory to consider a scenario which had 100% uptake at day 1 of operations. Under this scenario a reasonable commercial capital structure is considered to be:

· 75% bank debt gearing via project finance (with this higher level of gearing able to be obtained on the back of pre-contracted full uptake); and

· The balance funded by institutional investors solely (that is, no public funding).

This scenario results in institutional investor IRR which would be in a reasonable range for institutional investors investing in an infrastructure project with no uptake risk. This demonstrates that public sector participants are effectively being required to cover for the uptake gap in an otherwise commercial project.

Regulatory Risk

Resource Consent with acceptable terms is a Condition Precedent to financial close as a result for the first consent period it is not a risk which should impact investors. Assuming the Condition Precedent is met, the Scheme will have residual resource consent risk in the renewal of the resource consent at the end of the first 35 year consent period. BNZ Advisory believe that, based on past experience of renewals of similar resource consents, that the risk of non-renewal is very remote. They consider the more likely risk being the possibility of additional or more onerous consent conditions applicable for the second half of the Concession Period. This aligns to our experience where we observe for a number of the electricity generation assets in New Zealand consent renewals are usually renewed but generally with higher environmental standards and significantly higher compliance monitoring levels.

While the Scheme has a reasonably small contribution (in the context of operating cash flows) to mitigation measures, the measures align to the proposals made to the Board of Inquiry. In assessing ways to mitigate re-consenting risk BNZ Advisory have increased the operational expenditure on mitigation costs The following graph demonstrates the post-tax cash distribution impact on HBRIC Ltd of increasing the resource consent mitigation costs from $96,500 per annum over the long term to $1,500,000 per annum from year 35 (plus inflation). On the Base Case scenario with capital structure A the movement in HBRIC’s post tax IRR over the 70 year concession is a negative movement of around 10 basis points.

Equity raising for the retirement of CIIL

CIIL repayments will likely be phased and aligned with uptake. However the RWSS GP will need to determine whether it meets this cash requirement from retained earnings, bank debt, or as part of its capital structure scenario modelling, BNZ Advisory has tested the impact of CIIL’s repayment, and the concept of there being further rights issues to assist in meeting CIIL repayments. For example, a number of scenarios have been run whereby one quarter of CIIL repayments are met by investor rights issues, with HBRIC and Institutional Investors electing to subscribe for half (i.e. 12.5%) (We note however that there is no contractual obligation to commit more capital). The repayment is assumed to be incremental and in line with uptake and for HBRIC it is never more than approximately $2.5 million per annum. We note that the 25% contribution is a modelling assumption only and not a contractual obligation. It will be for the Scheme to determine at the time whether it wants to manage CIIL subordinated debt repayments via retained earnings, bank debt, or capital calls.

The following graph prepared by BNZ Advisory summarises cumulative net distributions (excluding the original contribution) for HBRIC Ltd for the first 20 year period assuming the following scenarios:

1. As per Base Case financial model (capital structure A): HBRIC and Institutional Investors each contribute 12.5%;

2. CIIL repayments met from retained earnings and existing bank debt (no equity calls, and bank debt assumptions as per Base Case);

3. CIIL repayments met from retained earnings and an increase in bank debt gearing assumptions, no equity calls;

4. No bank debt drawn during the operating period at all, and no capital calls capital calls to meet CIIL repayments increased to 20% each for HBRIC Ltd and Institutional Investors to enable CIIL repayments without excessive retention of earnings;

5. Scenario 4 above, assuming the downside uptake scenario; and

6. Scenario 3 above (no equity calls, bank debt increased), assuming extreme downside uptake.

The scenarios and analysis demonstrate the following:

· Even if rights issues equal to 12.5% of CIIL repayments for HBRIC are decided upon by the Scheme; under Base Case assumptions, these capital calls will not exceed cumulative distributions received to that point.

· From a cash flow perspective, no equity calls are required under Base Case uptake and bank debt assumptions.

· Under Base Case assumptions, an increase in bank debt - in our view this is unlikely until full uptake is reached - in lieu of no further rights issues would result in favourable IRR and cash flow returns for Institutional Investors and HBRIC.

· If strictly no bank debt is available during the operating period, approximately 40% of CIIL repayments may need to be met from rights issues (or by retained earnings). Under this scenario, if HBRIC subscribes for half of this rights issue, its net cumulative exposure could increase to approximately $12 million at its peak (before subsequently reducing). Alternatively, HBRIC could elect not to participate in the rights issues and be diluted.

· Under an extreme downside uptake scenario, again with no bank debt, the results for HBRIC (from a net cash investment perspective) are slightly less severe due to the deferral of CIIL repayments under a downside scenario.

· Even under an extreme downside uptake scenario, if approximately 60% gearing was available to the Scheme (which we note as unlikely); no capital calls are actually required from a cash flow perspective.

Figure 20: Cumulative Post Tax Distributions to HBRIC

Discussion

The financial analysis prepared by BNZ Advisory produces financial projections that reflect the interplay between assumptions as to the initial capital cost of the scheme, earnings and cash flows from operations and the assumed capital structure.

The analysis set out above is focussed on demonstrating how assumptions made in relation to these factors come together to produce a base case set of earnings and investment returns and how these vary under an alternative capital structure and as key assumptions are changed.

Conclusion

The base case financial projections show HBRIC achieving a sub commercial internal rate of return (“IRR”) on its investment up to the point of full uptake which the Base Case assumes is June 2028 (the “Trigger Date”) with an IRR of approximately 10% beyond that point. We are satisfied that the IRRs have been correctly calculated but note that a number of factors influence these calculations and in particular assumptions as to:

· Uptake

· The quantum and timing of the introduction of debt

· Interest rate assumptions

· The assessed value of HBRIC’s investment at full uptake

· Refinancing

At full uptake the RWSS will generate sufficient operating cash flows to provide market returns to all capital providers. Further, at this point a range of options will be available to HBRIC as to how it structures its investment. In particular infrastructure assets such as the RWSS once fully committed are typically capable of supporting a significant amount of bank debt thereby creating the opportunity to return capital to the original investors. The Base Case assumes a refinancing event on the second year of operations which releases funds available to distribute. Following this there is a gradual gearing up of the Scheme to a relatively lowly geared level relative to the market value of the Scheme.

9. Other Benefits

Introduction

As discussed previously the RWSS as currently proposed cannot be justified as an investment by HBRIC on purely commercial terms. A significant motivation for the RWSS is the environmental and wider economic benefits anticipated from the Scheme. These considerations have been extensively canvassed in other reports and were subject to scrutiny through the BOI process. It is not the purpose of our review to undertake further investigation into these matters. However, for completeness we summarise below the key additional benefits anticipated from the RWSS and which are critical to the HBRC’s consideration of the investment proposal. Fundamentally HBRC is being asked to accept a less than commercial rate of return on its investment in order to achieve these wider benefits.

Environmental Benefits

The HBRIC prepared business case for the RWSS summarises the role that the RWSS is intended to play in improving the integrated management of the Tukituki catchment. The business case notes that the current environmental issues associated with the Tukituki Catchment occur during the summer months when river flows are lowest. Generally there is a nutrient imbalance in the system with excessive phosphorus generating slime and algae growth. In addition, current water allocation exceeds Regional Plan limits contributing to frequent very low flows during summer. This, combined with the braided nature of the river bed, leads to the warming of river water, accelerating slime and algae growth.

The water stored by the RWSS and designated for environmental purposes will enable minimum flows to be increased through the summer months. These increased flows combined with the setting of appropriate nutrient levels will improve environmental and cultural outcomes. The Tukituki Plan Change 6 (a land and water management plan) was developed to achieve these benefits, and has been subject to a decision through the BOI process.

In the absence of the RWSS improvement in flows would require water user allocation limits would need to be adjusted resulting in existing irrigators having significantly reduced security of supply, with resulting economic impact. Furthermore, given water allocation and quality issues, there is little or no prospect of substantial additional irrigation development in the Tukituki Catchment through groundwater abstraction or surface water takes.

Working in tandem with Plan Change 6, RWSS is expected to allow the HBRC to improve water quality and minimum flows, while off-setting the economic impacts of Plan Change 6.

The Butcher Report

In addition to the environmental benefits anticipated from the RWSS the Scheme is also expected to unlock the significant agriculture potential of the Tukituki Catchment through providing high reliability water for irrigation, allowing further economic development. This is considered to be particularly important for the future of the Hawke’s Bay economy where the temperate climate and high sunshine hours offer a key competitive advantage for the Region through primary production and processing of food for export. While the Region contributes 3.4% of national gross domestic product (“GDP”), primary production and processing is more than double this at over 7%. Additionally, RWSS will, to the extent of its area of influence, assist in buffering the regional economy from the predicted impacts of climate change, with forecasts suggesting a drying trend with more droughts.

Butcher was engaged by HBRIC to undertake an assessment of the RWSS as well as a Cost Benefit Analysis (“CBA”) from a commercial perspective. In undertaking this analysis Butcher referenced the report entitled Ruataniwha Water Storage Scheme: Project Description, Tonkin & Taylor (May 2013) and the work undertaken by Macfarlane previously referred to in this report.

Butcher breaks its analysis of regional economic impacts into two categories being the one-off construction impacts associated with the construction of the physical infrastructure of the RWSS and the on-going impacts arising from increased farm production.

The one off construction impacts estimated by Butcher are summarised in the table opposite (one-off effects spread over 12 years):

Table 17: One Off Construction Impacts Estimated by Butcher

Output

($m)

Jobs

(job-years)

Value Added

($m)

Household Income

($m)

Direct impacts

690

N/A

Total impacts

1,200

4,700

410

270

The on-going impacts arising from increased farm production estimated by Butcher are summarised in the table below:

Table 18: On-going Impacts From Increased Farm Production Estimated by Butcher

	Output ($m per annum)	Jobs (FTEs)	Value Added ($m per annum)	Household Income ($m per annum)
Farming and farm support	325	1,310	135	59
Processing and processing support (high uncertainty)	380	1,210	120	67
Potential total impacts per year (rounded)	705	2,520	255	126
Potential NPV of impacts 8% over 35 years 5% over 70 years	2,500 4,900	19,000 37,000	1,850 3,700	970 1,900

We note that the on-going impacts are broken into a further two categories being farming and farm support and processing and processing support. Both categories are dependent on assumptions made as to land use change which have been sourced from Macfarlane. Given the draft determination of the BOI it is likely that some of the land use assumptions made by Macfarlane may need to be revisited. This in turn may require the Butcher analysis to similarly be updated.

We also note that Butcher considers the process and processing support benefits to be “highly uncertain”. This does not mean that such benefits are unlikely but rather that predicting the form and quantum of such benefits is more challenging than is the case for farm and farm support benefits. We also note that while the farm and farm support benefits are spread relatively evenly between pastoral and arable farming, orchards and vineyards and farm support the processing and processing support benefits are heavily weighted towards vegetables and wine.

Since issuing its report Butcher has revisited their calculations and has revised downward their estimate of the one-off construction benefits to $330 million and their estimate of ongoing benefits to $3,300 million. They have also revised their estimate of jobs created under the ongoing benefits analysis from 2,500 FTEs to 32,500 job years.

Nimmo-Bell & Company Limited (“Nimmo-Bell”) was engaged by HBRIC to review the original and updated Butcher report. This evaluation specifically assessed the report’s methodology and findings on:

· Cost-benefit analysis for Scheme investors and farmers;

· Economic impact assessment nationally, regionally and sub-regionally/local authority district level; and

· While Nimmo-Bell note some differences between their analysis and that of Butcher they note that “overall, it is considered that these differences are not of such a magnitude as to negate the overall conclusion of Butcher that the RWSS will have a very positive net economic impact for the Hawkes Bay economy.”

Impact on Existing Irrigators

HBRIC commissioned two reports on the implications of minimum flow proposals contained in Tukituki Plan Change 6 in the event that the RWSS did not proceed. Harris Consulting prepared a report “Tukituki River catchment: Economic Impact of Minimum Flow Proposals on Existing Irrigators (February 2013) and Horticulture NZ prepared a report “Economic Impact of Proposed Minimum Flows on Horticulture Irrigators on the Tukituki river (March 2013).

Under the HBRC’ s proposed regime, minimum flow levels would be higher than their present levels at Red Bridge and Taipairu Road on the Tukituki River and at State Highway 2 on the Waipawa River.

The proposed minimum flow levels are likely to increase the frequency, severity and duration of restrictions on water use. Currently, if restrictions come into force, they can be extreme and often occur at key points in the production cycle, impacting both the quantity and quality of the resulting output.

Based on the Harris Consulting and Horticulture NZ analysis HBRIC have estimated the RWSS’s ability to reduce the negative economic impacts of Plan Change 6 associated with the increased minimum flow requirement to have a NPV of between $16 million to $41 million.

Discussion

The environmental and wider economic benefits from the RWSS are the reasons why HBRC is prepared to accept a less than commercial return on its investment in the Scheme. These benefits have been subject to extensive scrutiny and analysis by independent advisors. The projected benefits were also scrutinised through the BOI process.

The projection of economic benefits from major infrastructure projects can never be an exact science. They necessarily require assumptions to be made in relation to factors many years into the future the majority of which are beyond the control of the HBRC. Actual outcomes will vary from those currently assumed and may be either more or less favourable.

Fundamentally expected benefits are underpinned by the assumption that primary sector will remain a major part of the Hawkes Bay economy over the long term and that the performance of this sector will be such that viability is maintained. This is likely to require continued productivity improvements and the maintenance of commodity prices in real terms at a minimum.

Conclusion

The importance of the environmental and economic benefits in the context of the RWSS business case has necessitated extensive analysis of both. However, no amount of analysis can eliminate the risk associated with the prediction of economic benefits far into the future.

Based on the information available today the economic benefits from the RWSS would appear to be very considerable. Ultimately realisation of these benefits will depend on the continued strong performance of the New Zealand primary sector which in turn will depend on the ability to continue to achieve productivity improvements and to maintain a good level of commodity prices.

HAWKES BAY REGIONAL COUNCIL

PROPOSED RUATANIWHA WATER STORAGE SCHEME

BUSINESS CASE PEER REVIEW

TERMS OF REFERENCE

INTRODUCTION

The Hawke’s Bay Regional Council is considering investing up to $80million, (through its wholly owned subsidiary Hawke’s Bay Regional Investment Company Limited (HBRIC)), to acquire a substantial but minority shareholding in a company to be formed to implement the Ruataniwha Plains Water Storage Scheme (RWSS). The new company will build and own a reservoir and dam in the Tukituki Catchment in Central Hawke’s Bay to be used to collect and store water and distribute it from the reservoir to farmers and other stakeholders on the Ruataniwha Plains on commercial terms.

HBRIC has completed its own evaluation of this investment, recommending it to the Council and asking the Council to fund up to the $80million required.

The size and nature of the proposed investment is likely to have a substantial impact on the structure and performance of the Council’s investment portfolio and potentially on its operating surplus over a considerable period. On the other hand the scheme is expected to help economic development of the region and add to its regional GDP over time.

As part of its ongoing public engagement the Council has committed to a Special Public Consultative Process (SPCP) the adoption of a Statement of Proposal to underpin this. The Council has therefore decided to conduct its own review of the strategic, financial and economic elements of the proposed investment and their likely impacts on its broader economic development, financial performance and environmental protection responsibilities, as well as its risks to its ratepayers and other stakeholders.

As part of this process, the Council requires an independent Peer review of the business case for the investment developed by HBRIC. This document contains the Terms of Reference for the required Peer Review.

BACKGROUND

The new company will be responsible for designing, constructing and operating a dam and reservoir and distribution system to collect and store water from the Tukituki Catchment in Central Hawke’s Bay and supply it to farmers and other customers and stakeholders on the Ruataniwha Plains. It will charge users for its services and is intended to become commercially viable and generate financial returns to its investors over time.

Design and construction of the infrastructure, development of the business case for investment in the scheme and establishing funding for it is the responsibility of and is managed by HBRIC. Council and HBRIC are jointly seeking the appropriate consents required to enable the scheme to be implemented.

HBRIC has already secured investor interest, and both Ngai Tahu Holdings and Trustpower Limited have joined with HBRIC to form an investor group in which all three parties are contributing funds towards the costs of design and consenting processes.

In addition, Crown Irrigation Investments Limited (CIIL), a state owned enterprise, has formally notified its interest in investing in the scheme and is working with HBRIC and the investor group to progress its interest to a final decision whether to invest. Indicatively CIIL could invest up to $80million.

The proposed investment has been presented in LTP2012-2022 and publicly consulted on in 2012 and included in the Council’s Annual Plans for 2013/2013 and 2013/2014. However the Council has committed to undertaking a SPCP on the proposed investment once its terms have been finalised and all conditions satisfied. This is expected take place following the completion of the Council’s evaluation, (including this Peer Review of the Business Case), of HBRIC’s final proposal.

The Council assumes HBRIC will have resolved all design and construction matters and the EPA Board of Inquiry consent process will resolve the major environmental and social and cultural matters. In its decision-making role the Council will therefore only be called upon to consider strategic, financial and economic issues and any legislative requirements in making its decision about investment in the RWSS.

TERMS OF REFERENCE - KEY ISSUES

The key issues for the Council in evaluating HBRIC’s business case are:

· Financial feasibility – is the Council’s investment supported by a sound business case? What are the strengths and weaknesses of the business case?

· Returns on investment – what financial returns can the Council expect from its investment and over what time period are these expected to occur?

· Business Risks – what risks does the company face and how will these be managed or mitigated?

These issues are expected to be addressed by the independent peer reviewer by reviewing the business case projections, their underlying assumptions and its assessment of impacts of changes in a range of market, management and financial variables, including:

· Market demand, including projected farmer take up and on farm profitability;

· Pricing of services and sensitivity of revenue to price changes;

· Financial projections including revenues, margins, expenses, operating position and free cash flow;

· Financial position/balance sheet of the new company including the financing plan, debt/equity structure and conditions (if any) required by shareholders that will/may affect profitability and application of free cash flows;

· Risk identification, evaluation, management and mitigation both in respect of the initial capital investment and ongoing operations;

· Returns to shareholders;

· Planned application of free cash flows; and,

· Management model.

TERMS OF REFERENCE – DETAILED ISSUES TO BE CONSIDERED

The Peer Review should be in the nature of an “audit” of the HBRIC prepared business case, but should include assessment of the critical business case factors, including all assumptions underlying it, and key elements such as the market for water storage and distribution services, projected demand by farmers and others, the resources required to establish and operate the business and the company’s projected operating and financial performance and financial position over time. This will include review of the impacts and sensitivities (if any) of assumptions and information available about:

Market Demand - Farmer/Irrigators

· Projected farmer demand/take-up;

· Projected on-farm investment, future farm production, farmer profitability and their ability to pay water distribution charges;

· Projected demand from other users and for other services (e.g. for supply of hydro power); and,

· Terms of sale of water storage and distribution services to farmers (for 35 years or lesser periods).

Operating model

· Operating structure for delivering services to be sold;

· Operating and marketing plans underlying the business case; and,

· Risk management plans for managing conditions imposed on the business by regulators (consents), shareholders, bankers and others.

Management Model

· Proposed management structure; and,

· Proposed use of external advisors/consultants.

Governance Model

· Size of Board;

· Board membership; and,

· Chairperson.

Financial projections

· All revenues, whether from distribution service charges or other sources, and operating expenditures, including discussion of major issues of insurance, repairs & maintenance and environmental controls;

· Gross margins and gross profit and their sensitivity to service price changes;

· Operating surplus;

· Cost of funds;

· EBIT & EBITDA;

· Depreciation and amortisation;

· Income tax position;

· Net profit after tax;

· Capital expenditure; and,

· Free cash flow.

Funding model

· How the invested funds are to be used;

· Funding Structure (equity & debt components);

· Provision of working capital requirements for ongoing operations;

· Funding compensation for acquisition of existing consent holders right to their consents (if any);

· Sensitivity of funding model to varying cash flows as a result of changes in farmer uptake and water distribution price improving over time;

· Long term capital management plans; and,

· Provision (if any) for contingencies, especially during the construction stage.

Investment Returns

· Sustainability of returns over the long term; and,

· Projected distributions of net profits and proposed dividend policy.

Ownership Model

· What implications there may be for the operation of the business from the structure of the shareholding partnership in the new company – who the partners are (CIIL, Ngai Tahu Holdings, Trustpower, other private investors), what their class of investment and respective rights to dividends (e.g. ordinary shareholders or preference shareholders), fees, dividends and other payments are and what the relationships will be (such as shareholder agreement on pre-emptive acquisition rights, and board membership)?

· What effect (if any) will arise from pre-emptive acquisition rights in the new company planned for customers and other stakeholders?

· Relative returns to shareholders and rationale/justification for any differences as between shareholders.

· Impact of shareholder’s planned exit requirements/strategies.

Business Case Risks

Including risk identification and evaluation, mitigation plans, and management and control plans arising from:

· market demand and famer uptake;

· project completion;

· business operation;

· variations in farmers ability to pay water distribution prices over time;

· regional environmental issues, especially from possible adverse effects on the Ruataniwha Plains;

· funding & financial structures, costs and obligations;

· uncompleted contracts or agreements, including farmer’s contractual obligations to make payments over the 35 years of water distribution contracts; and,

· external environment (economy, legislative etc).

Non-business financial issues

· Significance of recreational functions (if any) from using the reservoir; and

· Costs to be incurred by the new company (if any) for establishing and maintaining recreational facilities and access to them.

Peer Review Findings & Recommendations

· Overall summary of business case Peer Review findings on the proposed investment in the new company in financial, economic and operational terms compared with investment in alternatives.

· Recommendations (if any) of steps Council could/should take to meet concerns raised from the findings of the Peer Review.

DELIVERABLES

A comprehensive report of the scope, work and findings of the Peer Review together with any recommendations for Council action as a result of the findings is required.

If necessary, the Peer Reviewer may be called on to make a presentation of its findings and discuss them with Council.

DUE DATE

Assuming HBRIC’s final proposal is received by the Council in February 2014, the peer review of the business case should be completed and a draft report delivered to the Council no later than 3-4 weeks after receipt of a full business case.

Background material and a briefing will be provided to the Peer Reviewer in early February 2014 so that the Peer Reviewer will be as well informed as possible and can move to full review of the business case immediately upon its receipt from HBRIC.

23 December 2013

Hawke’s Bay Regional Council – Peer Review of Business Case: Terms of Reference

HAWKE’S BAY REGIONAL COUNCIL

Wednesday 28 May 2014

SUBJECT: Register of Members' Interests

Reason for Report

1. Following are the Interests registered by each elected representative and the Chief Executive of the Hawke’s Bay Regional Council. This ‘Register’ (confirmed as correct 30 April 2014) is presented as a means for Councillors and the Chief Executive to advise Council of any changes to their interests, and to ensure that the Council record is current at all times.

Councillor Richard Barker	Property Ownership in Hawke’s Bay
	409 Burnett Street, Hastings
	409A Burnett Street, Hastings
	18 Thorn Place, Onekawa
	Shareholding/Partnerships/Trusts or Trading Interests
	Barker Family Trust
	Directorships or Trusteeships
	Barker Family Trust
	Other Interests
	None declared
	Directorships or Businesses of partners/spouses
	None declared
Councillor Peter Beaven	Property Ownership in Hawke’s Bay
	35A McHardy Street, Havelock North
	Shareholding/Partnerships/Trusts or Trading Interests
	None declared
	Directorships or Trusteeships
	Lagoon Family Trust
	Prevar Ltd
	Pipfruit NZ
	100% Pure NZ Ltd
	Other Interests
	None declared
	Directorships or Businesses of partners/spouses
	None declared
Councillor Thomas Belford	Property Ownership in Hawke’s Bay
	40 Raratu Road, RD 14, Havelock North
	Shareholding/Partnerships/Trusts or Trading Interests
	Belford Partnership – interest 50%
	BayBuzz Ltd – interest 100%
	Directorships or Trusteeships
	None declared
	Other Interests
	None declared
	Directorships or Businesses of partners/spouses
	None declared

Councillor Alan Dick	Property Ownership in Hawke’s Bay
	3 Newbury Place, Taradale, Napier
	227 Taradale Road, Greenmeadows, Napier
	Shareholding/Partnerships/Trusts or Trading Interests
	Aliz Investments Ltd (not trading)
	Directorships or Trusteeships
	Aliz Investments Ltd (not trading)
	Napier Academy Trust Inc (Trustee)
	ME/CFS Support HB (Committee member and Treasurer)
	Other Interests
	Gisborne Rail Establishment Group (Interim Chairman)
	Directorships or Businesses of partners/spouses
	Elizabeth Dick, Director of Aliz Investments Ltd and employed as part-time co-ordinator for ME/CFS Support HB, also part-time field officer (Napier) for the Stroke Foundation
Councillor Rex Graham	Property Ownership in Hawke’s Bay
	Eastella, 232 St Georges Road, Hastings
	Shareholding/Partnerships/Trusts or Trading Interests
	Graham Greene Ltd
	RGA Holdings Ltd
	Fresh New Zealand Ltd
	NZ Fruit Tree Company Ltd
	Zeesweet Ltd
	John Morton Ltd
	Shennong Variety Management Ltd
	Graham Family Trust
	Eastella Trust
	Directorships or Trusteeships
	Gladeye Ltd (Chairman)
	Te Aranga Ltd (Director
	Te Aranga-O-Heretaunga Marae Charitable Trust (Trustee)
	HB Regional Sports Park Trust (Trustee)
	Te Matau a Mau Voyaging Trust (Trustee)
	U-Turn Charitable Trust (Chairman)
	Other Interests
	None declared
	Directorships or Businesses of partners/spouses
	None declared
Councillor Deborah Hewitt	Property Ownership in Hawke’s Bay
	227 Porangahau Road, Waipukurau
	238 Pourerere Beach Road, Aramoana
	Shareholding/Partnerships/Trusts or Trading Interests
	None declared
	Directorships or Trusteeships
	Hewitt Agribusiness Ltd
	Hewitt Livestock Ltd
	Hewitt Family Trust
	Other Interests
	None declared
	Directorships or Businesses of partners/spouses
	None declared

Councillor David Pipe		Property Ownership in Hawke’s Bay
		25 Vigor Brown Street, Napier
		Shareholding/Partnerships/Trusts or Trading Interests
		Napier Community House Trust – Chair (Charitable Trust)
		Directorships or Trusteeships
		Hawke’s Bay Tourism
		Other Interests
		None declared
		Directorships or Businesses of partners/spouses
		None declared
Councillor Christine Scott		Property Ownership in Hawke’s Bay
		43 Napier Terrace, Napier
		Shareholding/Partnerships/Trusts or Trading Interests
		RM & CH Family Trust
		Directorships or Trusteeships
		ACW Ltd
		WASSTB
		Other Interests
		None declared
		Directorships or Businesses of partners/spouses
		None declared
Chairman Fenton Wilson		Property Ownership in Hawke’s Bay
		141 Maromauku Road, Wairoa
		80 Maromauku Road, Wairoa
		Shareholding/Partnerships/Trusts or Trading Interests
		Oruru Land Company Ltd (5%>)
		Directorships or Trusteeships
		Wairoa Community Development Trust
		St Vedas Trust/AH Gordon Trust/Gary Wilson Family Trust
		Other Interests
		Smedley Advisory
		Directorships or Businesses of partners/spouses
		None declared
Elizabeth Lambert (CE)	Property Ownership in Hawke’s Bay
	1 Eton Street, Taradale, Napier
	34A Kensington Drive, Napier
	Shareholding/Partnerships/Trusts or Trading Interests
	None declared
	Directorships or Trusteeships
	HB Local Authority Shared Services Ltd (Director)
	Other Interests
	None declared
	Directorships or Businesses of partners/spouses
	None declared

Decision Making Process

2. Council is required to make a decision in accordance with Part 6 Sub-Part 1, of the Local Government Act 2002 (the Act). Staff have assessed the requirements contained within this section of the Act in relation to this item and have concluded that, as this report is for information only and no decision is to be made, the decision making provisions of the Local Government Act 2002 do not apply.

Recommendations

That Council confirms the Interest Register is correct as at 28 May 2014.

That Council records the following changes to the Interests Register as:

Liz Lambert

Chief Executive

Attachment/s

There are no attachments for this report.

HB Tourism Quarter 3 2013-14 Report

Attachment 1

Hawke’s Bay Tourism Ltd – Quarter 3, 2014

Prepared by Annie Dundas, GM Hawke’s Bay Tourism

Overall

Hawke’s Bay Tourism Limited was officially formed in July 2011 and began a three year strategy for implementing visitor growth to the region supported by a three-year funding commitment from the Hawke’s Bay Regional Council as well as privately pledged funds and membership fees. A set of KPI’s were developed and Hawke’s Bay Tourism has completed all KPI’s to date.

This report will focus on the January – March 2014 period.

1. Visitor Statistics

In an effort to take a broader industry view of what is happening within Hawke’s Bay we will use the following measures to record visitor arrivals and economic impact.

· Regional Tourism Estimates – reflecting visitor spend (Please see appendix with graph). The RTEs provide regional stakeholders with absolute dollar estimates of tourism expenditure at a detailed regional level (i.e. by regional council, territorial authority, visitors’ country of origin and industry). Dollars spent is measured by dollars spent in accommodation, food and beverage services, retail sales, retail sales fuel, other tourism products and other passenger transport.

· International Visitor Survey – international visitor arrivals

· Commercial Accommodation Monitor – hotels, motels, holiday parks and backpackers

· Private Household Monitor – a measure of friends and family staying in Hawke’s Bay

Overall, Hawke’s Bay has seen a gradual increase in both domestic and international visitors staying in the region. This quarter saw good initial growth but this has slowed in March due to Easter and the school holidays falling in April (Easter fell in March in 2013). Spend figures show international visitors spent $85m in the region year end March 2013 and domestic visitors spent $372m over the same period. (Source Regional Tourism Estimates) – MBIE – see Appendix for breakdown of spend.

Arrival results for Hawke’s Bay year end March 2014 combining Commercial Accommodation and Private Household guest nights show a positive result with an estimated 129,200 extra guest nights year on year spent in Hawke’s Bay. Commercial nights rose 0.8% year end March and private stays are up 4.6% year on year.

Hawke’s Bay Tourism, 19 Waghorne Street, Ahuriri, Napier. PO Box 12009, Ahuriri, Napier 4144, New Zealand

WEB: www.hawkesbaynz.com TWITTER: www.twitter.com/visitorHB

FACEBOOK: www.facebook.com/hawkesbaynz

Commercial Accommodation and Private Household Monitor - Hawke's Bay

Commercial Accommodation Monitor Hawke’s Bay

Commercial Accommodation Monitor (CAM) year end March 2014 shows Hawke’s Bay guest nights up 0.8%% compared to the same period year end March 2013.The month of March saw a decline overall which directly relates to Easter falling in April in 2014.

Private Household Monitor

The Private Household Monitor estimated 58,770 visitors to the Hawke's Bay Region stayed 22,100 nights in private accommodation during March 2014. This was an increase of 1,021 guest nights on the previous March. Visitors stayed 3.8 nights. Note this excludes those who stayed in holiday homes and baches, but includes children aged 15 or under. The major reasons for visiting Hawke's Bay were visiting friends and family (74.4% of total nights stayed), and general holiday or leisure (6.6%) of total nights stayed.

International visitor arrivals into New Zealand also felt the brunt of Easter with a negative arrival result overall of -6.3%. Australian arrivals were down 13.4% and the UK was down 19.4%. USA growth continued with arrivals +9.5% and China was up 11.9% for the month. Year end March 2014 international arrivals were +5.4% or the 12 month period.

International Visitors to NZ	March 2014		Year end March 2014
Total	253,561	-6.3%	2,752,257	+5.4%
Australia	99,520	-13.4%	1,221,152	+4.3%
China	23,200	+11.9%	239,712	+14%
USA	26,528	+9.5%	207,664	+10.4%
UK	18,720	-19.4%	191,872	+1.3%
Commercial Accommodation	March 2014		Year end March 2014
Hawke’s Bay
Total visitors	45,460		440,793
Total guest nights	101,830	-9.7%%	943,297	+0.8%
International guest nights	31,745	-13.8%	238,227	-3.1%%
Domestic guest nights	70,085	-7.8%	705,070	+2.2%
Average length of stay	2.24	Up from 2.22	2.14	Down from 2.15
Overall occupancy rate	40.9%	Down from 42.1%	32.9%	Up from 31.3%
Occupancy excl Holiday Parks	57.9%		45.5%
Hotels	14,694	-27%	147,384	+4.0%
Motels	55,630	+2.5%	497,137	+5.1%
Backpackers	15,235	+8.8%	114,611	-4.0%
Holiday Parks	16,272	-33.2%	184,166	-8.8%
Napier guest nights	52,721	-25.7%	527,177	+0.1%
Hastings guest nights	41,038	-10.5%	343,337	-0.7%
Wairoa and Central Hawke’s Bay	8,071	+7.2%	72,783	+3.7%
Other Regions Total Guest Nights
Coromandel	78,230	-10.4%	729035	0%
Bay of Plenty	95,031	-13.4%	1,069,526	+7%
Rotorua	160,761	-7.5%	1,792,225	+3%
Taupo	86,102	-17.7%	954,518	0%
Gisborne	30,954	-6.6%	326,153	+4%
Wellington	228,814	-2.2%	2,390,143	+2%
Nelson	134,236	-0.7%	1,224429	+2%
Wanaka	59,707	-8.1%	627,158	-7%
Queenstown	268,443	+5.2%	2,837,398	+9%
Private Household Monitor	March 2014		March 2014
Total Visitors	58,770	+15%	672,631	+8.4%
Total Visitor nights	222,100	+0.5%	2,762,022	+4.6%

Key Performance Indicators for Hawke’s Bay Tourism

The organisation has been working towards the goals and objectives set out in the Strategic Plan signed off by HBRC in May 2011.

In the third quarter of the 2013 2014 financial year the following KPI’s have been met;

1. Hawke’s Bay Tourism - the Regional Tourism Organisation is well established and has almost completed three years of operation.

2. Brand – The “Hawke’s Bay” brand continues to be widely used and is well established and used consistently in all marketing activity. Many Hawke’s Bay entities such as Business Hawke’s Bay, Food Hawke’s Bay, Central Hawke’s Bay, Havelock North Business Association, and Education Hawke’s Bay have adopted the brand for their own representation. Regional collateral also carries this brand which covers the Hawke’s Bay Visitor Guide, The Art Guide, The Food Trail Map, The Hawke’s Bay Trails Map, The Wine Trail Map and the Hawke’s Bay Summer Guide. In addition Hawke’s Bay Tourism has created and owns the F.A.W.C! brand as well as The Big Easy brand.

3. Consumer Marketing -

· Advertising - “Get me to Hawke’s Bay”

“The Get me to Hawke’s Bay” is the tagline used in all campaign activity.

Campaign activity has run through the third quarter online. The focus of activity through this period has been to target families (up until the end of January) and boomers for late summer and autumn travel. Hawke’s Bay Tourism has utilised the video assets created in conjunction with Napier Tourism Services and Hastings District Council and pushed them via targeted online channels. Channels used include Youtube and Facebook and websites such as stuff.co.nz and nzherald.co.nz.

Advertising to promote the Big Easy focused on using a new Big Easy video clip posted via Facebook. One paid for post generated over 34,500 views.

· Search engine marketing also continues.

· Public relations

Hawke’s Bay Tourism has hosted the following media in region between Jan-March:

· Times Life India

· Taste Magazine

· Jetstar Inflight Magazine

· Jose Cuancas VIP USA

· Wine NZ Magazine

· Escape Travel Supplement, Australia (Hawke’s Bay Trails cycling specific story) News Limited syndication

· Golf Magazine, Australia - 35 000 readers monthly

· Golf Travel, China readers 400 000

· Golf traveller, China

· Motorcylist Magazine, USA 206 000 readers, 500 000 unique users per month

· Motorhome Magazine, USA 350 000 readers

· San Fran Chronicle USA 400 000 readers

· Niijiro Jean TV, Japan (Art Deco W/e) 8 million viewers per episode

· Asian Food Channel NEW

· Arthub, Australia (Art Deco Weekend)

· Livelounge, Australia(Art Deco Weekend)

· Baccarat, Indonesia (Art Deco Weekend) 50 000 readers

· MSN Canada (Art Deco Weekend) 9.6 million unique users per month

· Ensemble Vacations, Canada 120 000 readers

· Financial Times UK 236 000 readers

· Marie Claire Travel, UK 230 000 readers

Media Results from Jan –March include:

· India Times http://articles.economictimes.indiatimes.com/2014-02-09/news/47149191_1_bike-tour-wineries-vineyards

· ArtHub http://www.artshub.com.au/news-article/festival/news-article/news/festivals/art-deco-comes-to-life-198254

· http://www.artshub.com.au/news-article/news-article/feature/design/art-deco-capital-embraces-tragic-gift-198245

· http://www.artshub.com.au/news-article/festival/news-article/feature/festivals/eight-reasons-new-zealand-is-now-a-cultural-destination-198279

Digital Strategy

www.hawkesbaynz.com is performing well with unique visitation up 16%. Over 20,000 people visit the site each month. In addition Hawke’s Bay Tourism also owns www.fawc.co.nz and www.thebigeasy.co.nz . Both of these sites are generating strong traffic. The region’s official facebook page has 27,000 followers.

www.hawkesbaynz.com	Year end March 2013	Year end March 2014	+/-
Visits to site	218,859	247,095	+12.90%
Unique Users	156,046	181,368	+16.22%

Research

A monthly one-page tourism monitor has been established and is distributed to stakeholders and industry each month.

4. Trade Marketing

Trade Shows

· Explore Central North Island Expo – Hawke’s Bay Tourism coordinated the Hawke’s Bay branded area where 11 Hawke’s Bay operators attended the show in Auckland to showcase their businesses to over 150 travel sellers specializing in free and independent travel for international visitors.

· Convene Tradeshow – Hawke’s Bay Tourism coordinated the Hawke’s Bay branded area where 8 Hawke’s Bay operators attended this show in Auckland which focuses on corporate and conference business.

Trade Familiarisations

· 8 American based travel agents attended Art Deco Weekend in order to experience the event to then package and sell in the USA to potential travelers. This activity was part of HBT’s commitment to the Major Event Funding received by the Art Deco Trust.

· 8 North American agents from travel seller Goway visited Hawke’s Bay on a two day famil program. Goway is the largest wholesaler in North America.

Product Workshops

· Hawke’s Bay Tourism attended the Tourism New Zealand UK/European Workshop in London, representing the Pacific Coast Highway. Sixty-six appointments were had with buyers from the UK and Europe. Explore Central North Island (three touring routes – Thermal Explorer Highway, Pacific Coast Highway and the Volcanic Loop) is made up of eight central North Island regions. Each contributes an annual marketing fee to be represented at Tourism New Zealand run events in our key visitor markets.

Trade Collateral

· Hawke’s Bay Luxury brochure has been developed and sent to key luxury travel sellers

· A Chinese language Hawke’s Bay tool kit has been developed for the China market

Conference Activity

Key business won in this quarter -

· Bus and Coach Conference – Oct 2015 – 300 pax – venue pending due to Hawke’s Bay Opera House closure

· Harcourt’s Real Estate – the executive board and 100 top sellers - 2014

· Air NZ Wine Awards – confirmed Pettigrew Arena, November 2014

5. Events

Regional Events Strategy

· A renewed focus to the events strategy has been undertaken due to the priority given to events by both Napier City Council and Hastings District Council having employed key event staff. Hawke’s Bay Tourism is coordinating the regions effort with close collaboration with both Councils and Sport Hawke’s Bay. The key objective is to increase visitor nights in the region, particularly in the off-season.

Event Activity

· Art Deco Weekend was held over 20-23 February 2014 and it attracted crowds of 35,000 - 40,000.There were 200+ events held (mixture of free and ticketed events) with approximately 70% of tickets available sold. There were increased international visitors to Hawke’s Bay, + 39.5% on the previous year’s attendance. HBT played a large part in supporting this event with a substantial media and travel agent programme running alongside the event.

· Cricket World Cup 2015 – Hawke’s Bay Tourism will lead the Community Engagement Group – made up of Councils, Cricket Associations and promotions groups. HBT has sent a plan to Cricket New Zealand for consideration which will be worked on with all Councils. We hope to include an Art Deco cricket game at the Clifton County Cricket Club.

Events being worked on by HBT

· The Big Easy at Easter and the ‘Not so Easy”, April 18/19, 2014 in conjunction with Napier City Council, Hastings District Council, Hawke’s Bay Regional Council and Sport Hawke’s Bay.

· Four Weekends of Winter F.A.W.C! June 6-29

· The All Black vs. Argentina Test September 6, 2014

Hawke’s Bay Tourism – Financial Statement

Hawke’s Bay Tourism Ltd is tracking favourably to the end of the third quarter in 2014. The variance reflects greater campaign and event management spend in Q3 which we had planned for in Q4.

External/Other Revenue includes F.A.W.C! (Summer and Winter) ticket sales. This is collected by Hawke’s Bay Tourism and then passed on to event managers. This also includes income from The Big Easy which goes towards the running of the event.

Membership changes have resulted in 214 financial members joining the organization, the total membership is approximately 800.

Appendix

Spend data: Regional Tourism Estimates Year end March 2013

Sum of Spend ($m) by origin
Product	Accommodation	Food and beverage serving services	Other passenger transport	Other tourism products	Retail sales - fuel and other automotive	Retail sales - other	Grand Total
Domestic	38	43	34	156	90	123	483
Auckland	9	8	6	7	11	15	57
Bay of Plenty	3	2	1	39	5	6	57
Canterbury	2	3	2	2	3	6	17
Gisborne	1	1	2	2	4	4	15
Hawke's Bay	2	9	12	11	31	46	111
Manawatu-Wanganui	4	4	2	17	9	12	48
Marlborough	0	0	1	0	0	1	2
Nelson	0	0	0	0	0	0	1
Northland	0	0	0	4	1	1	7
Otago	1	1	1	1	1	1	5
Southland	0	0	0	0	0	1	2
Taranaki	1	1	0	6	1	4	13
Tasman	0	0	0	0	0	0	2
Waikato	3	4	2	58	7	8	83
Wellington	10	8	5	9	15	18	64
West Coast	0	0	0	0	0	0	0
International	15	27	9	5	7	22	85
Australia	6	11	4	2	3	9	36
Japan	1	1	0	0	0	1	3
Germany	1	1	0	0	1	1	3
Canada	1	1	0	0	0	1	3
Rest of Asia	1	2	0	0	0	2	5
Rest of Americas	0	0	0	0	0	0	1
Rest of Europe	2	3	1	0	1	2	8
Rest of Oceania	0	0	0	0	0	1	2
Africa and Middle East	0	1	0	0	0	1	3
United Kingdom	2	5	2	1	1	3	14
China, People's Republic of	0	0	0	0	0	0	1
Korea, Republic of	0	0	0	0	0	0	0
United States of America	1	2	1	0	0	1	6
Grand Total	53	70	42	161	97	145	568

HAWKE’S BAY REGIONAL COUNCIL

Wednesday 28 May 2014

SUBJECT: Monthly Work Plan Looking Forward Through May 2014

Reason for Report

1. The table below is provided for Councillors’ information, to provide them with an indication of issues and activities coming up over the next month in each area of Council.

Group	Area of Activity	Activity Status Update
Asset Management & Biosecurity	Land Management Engineering Upper Makara Scheme Open Spaces	- Papanui catchment pilot implementation for Plan Change 6 being progressed. 1 further steering group meeting planned prior to 30 June. - Hill eountry erosion programme of in Wairoa district and initial work in Tukituki catchment commenced. Regional hill country programme for next 4 years being developed in collaboration with Ministry of Primary Industries (MPI) as potential funding application. - Further discussions to be held with MPI regarding potential collaboration on Maori agribusiness development. - Huatokitoki research outcome field day to be held on 26 June. - Asset Management Plans for each of the Flood Control and Drainage Schemes administered by HBRC will be progressed during the month. Plans will need to be adopted by Council late in 2014. - A 30 year infrastructure strategy is also required by the Local Government Act 2002 Amendment Bill. A programme for the development of this strategy will be developed. - Construction work to repair the Makara No 1 Dam will be completed. - The development of individual management plans for Pekapeka, Tutira and Pakowhai Regional Parks initiated with objective of completing to draft stage for consultation by 30 June 2014.
Asset Management & Biosecurity	Forestry Coastal Biosecurity	- A review of Council’s forestry portfolio is being undertaken and will be reported back to Council later in 2014. - A review of the Tangoio Soil Conservation Reserve Management Plan has been commenced. The review process will include consultation with a number of stakeholders. Once the consultation process has been completed it will be brought to Council for consideration and adoption. - Harvesting of Stands 2.01 and 2.02 in the Reserve underway. Harvesting is expected to take until May 2014. - Proposal for development of a strategy for coast between Clifton and Tangoio approved by HBRC. Liaison with HDC, NCC and iwi continuing to enable establishment of a governance group. - Cost benefit analysis for individual pest species under the plan and preparation of broad plan review framework underway. - Cape to City trial underway. - Transfer of 16,000ha of land from TBfree programme to HBRC possum control area programme to be achieved by 30 June. Preparations for the transfer of a further 80,000ha in the 2014/15 year being considered.
Corporate Services		- Draft Annual Plan: – 103 submissions received. – Staff responses to submissions under development, for distribution to Council with Hearing Agenda on or before 28 May. – Submissions hearings scheduled for 4 & 5 June 2014. - Adoption of the final Annual Plan for 2014/15 at the 25 June 2014 Council meeting. - Amended proposal to be received from HBRIC Ltd re funding the shortfall and/or amended drawdown schedule to keep Council’s contributions to RWSS cost neutral.
External Relations/ CE’s office	Communications CE’s Office	- National Horticultural Field Day Hawke’s Bay Showgrounds – HBRC principal partner with A&P Society – Thursday 5th June 2014. - Coordination of responses to submissions on Draft Annual Plan and on HBRC Statement of Proposal for Potential Investment in the Ruataniwha Water Storage Scheme
Resource Management	Client Services	- Science charging, data verification for year end billing.
Resource Management	Compliance	- The global consent trial with Twyford Irrigators will be evaluated with a view to forming a template for future consents of the same type. - A draft compliance strategic plan has been completed and in conjunction with recommendations for continued compliance service will be presented to the Executive and Council. - A request will be made to reconsider the cost recovery regime and requirement to align with the current and projected work stream and mix.
Resource Management continued	Science	- Science investigations for the Greater Heretaunga and Ahuriri management zone continue - Sediment modelling continues in the Tukituki, and riparian mapping continues in the TANK area. - Technical Advisory Group formed for the proposed development of a coupled/linked surface-groundwater model has met and decided on the initial approach. Initial groundwater model design continues. - Conduct of fieldwork associated with Greater Heretaunga and Ahuriri management zone plan change continues – surface water quality, estuarine water quality and spring-fed streams. - The Hydrometric Network continues to be under internal review. The review includes the potential addition of any NIWA sites and the resulting resourcing required to operate and to archive the data according to relevant performance standards. A paper is to be provided to Council on this in the near future. - Workstreams associated with the Mohaka Plan Change implementation continue. Hawke’s Bay is working with Environment Bay of Plenty and GNS on a collaborative investigation of catchment boundaries and groundwater. - Workstreams associated with the Tukituki Plan Change implementation continue, with emphasis on phosphorus mobilisation. - Routine monthly SoE surface water and groundwater monitoring programmes continue. - Regional SoE reporting is being developed. - First draft of “Mohaka River catchment characterisation report” being edited. - The first draft of the Mohaka River SoE report will be reviewed and edited. - Assessing additional investigations for Taharua/Mohaka and requirements for groundwater flow model. - Collating available data for Lake Poukawa. Assessing additional investigations for modelling requirements. - The planning and execution of the TANK programme of work continues. - The draft process for publishing reports to HBRC website will continue to be developed with assistance from Corporate
Resource Management	Consents	- Ongoing consent processing - Havelock North Fruit Co. application to take groundwater has been limited notified. A tentative hearing date is proposed for late May. Hearing panel to be appointed. - NCC application for coastal protection structure at Whakarire on hold but likely to proceed to a hearing. - Poukawa group of consents on hold while monitoring is identified and a Catchment Management Strategy is considered which may avoid the need for hearing.
Strategic Development	Resource Management Planning	- Negotiations with appellants and associated parties continuing on Change 5 following 2 Environment Court mediation sessions. Most parties willing to participate in 3^rd mediation session yet to be scheduled by Environment Court. - Board of Inquiry’s draft decision issued 15 April. Ministers have granted a further extension so BOI’s final decision now to be issued by 28 June 2014. Work continuing on Implementation Plan. - TANK Group reviewing terms of reference and meeting schedule/work programme for Phases 2 and 3 of their tasks leading to preparation of a plan change. Next TANK Group meeting scheduled for 22 or 29 July. - Taharua/Mohaka stakeholder discussions continuing in parallel to science investigations. Includes hui with iwi representatives. - Further submission lodged in relation the proposed Hastings District Plan. Initial discussions with other submitters occurring prior to hearings commencing mid-late 2014 on Hastings District Plan and Plan Change 10 to Napier District Plan. - Further revision of first draft of HB Biodiversity Strategy by the Core Working Group following feedback from external Steering Group at 10 April meeting. Steering Group to meet in July to review second draft version of Strategy.
Strategic Development	Transport	- Preparation of the Regional Land Transport Plan and Regional Public Transport Plan has commenced, as required by the Land Transport Management Act 2003. The Regional Land Transport Plan is the region’s bid to central government for all transport funding (for roading, public transport, walking and cycling, road safety etc) for 2015-21. The Regional Public Transport Plan sets out how public transport services will be provided in the region for 2015-18. Preparation of this plan will commence with a review of the existing bus service. - Initial results from the New Zealand Transport Agency’s review of funding assistance rates have been announced and councils in the region are evaluating the effects on their transport budgets from 2015 onwards. - The Ministry of Transport has advised that consultation on the Draft Government Policy Statement for Land Transport has been delayed until early June.
Civil Defence & Emergency Management	HB CDEM Group - Draft Group Plan	- Submissions heard on 11 April by Joint Committee Meeting; the outcome of that meeting being some minor changes to the draft plan which was sent to the Minister of Civil Defence for her comments. These are expected back before the end of May.

Decision Making Process

2. Council is required to make a decision in accordance with Part 6 Sub-Part 1, of the Local Government Act 2002 (the Act). Staff have assessed the requirements contained within this section of the Act in relation to this item and have concluded that as this report is for information only and no decision is required in terms of the Local Government Act’s provisions, the decision making procedures set out in the Act do not apply.

Recommendation

1. That Council receives the Monthly Work Plan Looking Forward Through June 2014 report.

Mike Adye

Group Manager

Asset Management

Helen Codlin

Group Manager

Strategic Development

Paul Drury

Group Manager

Corporate Services

Ian Macdonald

Group Manager/Controller Hawke's Bay Civil Defence Emergency Management

Iain Maxwell

Group Manager

Resource Management

Liz Lambert

Chief Executive

Attachment/s

There are no attachments for this report.

[1] Noting that there is likely to be some residual minority ownership for some specific community based investors.

[2] The 2012 BNZ financial feasibility report stated the RWSS was viable under a 35 year concession however we understand that the current proposal for 70 years (two 35 year resource consents) is preferred as it gives a greater flexibility to deal with uptake risk, in particular offering a buffer period to provide for a sufficient period of operations at full uptake for investors to generate a return of and on their investment, even under slower uptake scenarios.

[3] Current irrigation in the catchment area is 6.000ha.

[4] We understand there will be a small level of flexibility in the contract regarding the layout but the primary distribution is unlikely to be changed. For the secondary distribution there may be small changes such as to pipe diameter for specific sections but ultimately a decision will need to be made very early in the construction stage regarding the layout so it can be locked down.

[5] The original MacFarlane analysis had assumed that the water pressure at the farm offtake would only be 10 m head and therefore require additional on farm pumping to achieve sufficient pressure (35m head) to run centre pivots. The pressurising of the Scheme was a change which arose during the construction tendering process when it became apparent that it was more cost effective and attractive from an uptake hurdle perspective (i.e. limiting capital expenditure on farm) to have centralised pressurisation as opposed to it being required on farm.

[6] We understand there will be a small level of flexibility in the contract regarding the layout but the primary distribution is unlikely to be changed. For the secondary distribution there may be small changes such as to pipe diameter for specific sections but ultimately a decision will need to be made very early in the construction stage regarding the layout so it can be locked down.

[7] Appendix 5 sets out the price assumptions used for the key products arising from the key farming types.

[8] The Opuha scheme has contracted Trustpower to operate the scheme and as a result they have been able to optimise ACoT revenues.

[9] The CIIL contribution to RWSS will be a debt instrument with a favourable interest rate. The actual quantum will be flexed according to the final capital structure and forecast water uptake.

[10] Generation weighted average price / time weighted average price or GWAP/TWAP.

[11] For the purposes of this assumption, a brownfield investment is one for which the majority of the construction risks have been removed and the project is in its operational phase.

Request Status	Date Received	Requested By	Request Summary	Group Manager Responsible for Response
Active	19/05/2014	Ian McIntosh	? within your "delegated authority" in making a submission to the EPA Board of Inquiry on their Interim decision. Answers to the following questions under the Official Information Act: 1. Did you believe you were acting under your "delegated authority" as 'Acting Chief Executive' when you submitted the 7th May material to the EPA? 2. Did the Regional Council vote at any time on whether such a submission should be made and, if so, when?	Liz Lambert
Active	20/05/2014	Rick Barker	1. A copy of the submission HBRC made in response to the interim decision of the Board of Inquiry re Plan Change 6. 2. Why was the HBRC's submission not forwarded to Councillors as a matter of course. 3. A description and the timing sequence for the planning that was considered by the leadership team for the consultation process as a lead up the expected necessity for making submissions to the BoI in response to its interim decision. 4. Outline of the process of consultation actually undertaken for the development and conclusion of HBRC response. 5. List of the people, other than HBRC staff who provided input, comments or advice on the development of HBRC's response - including Regional Councillors, the Board of HBRIC, staff seconded to HBRIC, iwi and their reps, local government, non governmental organisations, commercial entities and individuals. 6. Description of the process of engagement with Councillors in the development of the response by HBRC to the interim decision and how you arrived at the view that this was both adequate and appropriate.	Liz Lambert
Active	7/05/2014	A Better Hawke's Bay	HBRC financial info, being: 1. current level of external borrowings 2. current level of internal borrowings 3. proportion of rates revenue charged to service debt for of last 5 rating years and 4. relative $ amounts 5. interest rate used to calculate debt servicing content of rates charged 6. actual interest rate paid on external borrowings for each year 7. total amount of interest paid on external borrowings for each of last 5 years 8. projected level of borrowings from each external & internal source for next 5 years	Paul Drury

Product	Price
Milk solids	$6.50/kg
Weaner bull	$3.90/kg
Manufacturing beef	$4.25/kg
Store bull beef	$1.90/kg
Store lamb	$2.70/kg
Lamb	$6.00/kg
Wool	$4.00/kg
Feed wheat	$470/t
Feed barley	$440/t
Italian ryegrass seed	$1,700/t
Maize grain	$450/t
Vining peas	$400/t
Squash	$700/t
Russet potatoes	$220/t
Baby beans	$430/t
Grapes	$1,744/t
Apples	$26/ctn

Item	$	%
Dam, Generation & Distribution	$243.0 million	87.9%
Development costs, land, ancillary roads and surveying	$21.8 million	7.9%
Construction Period Operating Costs	$11.7 million	4.2%
Total Capital Cost	$276.5 million	100.0%

1	HBRC Investment Policy - Section 7.1
2	HBRC Financial Assets Maturity Profile and Allocation by Institution at 31 March 2014

1	HB Tourism Quarter 3 2013-14 Report
2	HB Tourism 2013-14 Financials to 31 March 2014