|
Mr Drury
introduced the item and outlined the history of the process to date, advising
that Deloitte has been asked to review material changes to the business case
since 2014 and they had been provided with the updated financial model and
all other information required. Mr Drury then introduced Mr Alan Dent and Mr David
Morgan.
Mr Dent noted
that, as some negotiations are ongoing, there is some information still
commercially confidential which will not be discussed today. Mr Dent further
explained that the purpose of today’s presentation is to provide
Council with an update on Deloitte’s review work and preliminary
answers to critical questions while also providing an opportunity for
Councillors to raise further issues of concern they would like addressed in
the final report.
In response to
queries about the information available, Mr Dent and Mrs Lambert reiterated
that the presentation today is ‘stage 1’ of the two stage process
of receiving the Deloitte Peer Review – and the opportunity for
councillors to raise possible additional issues they would like to have
addressed in the final report. Stage 2 will occur on 15 June, with
councillors having received Deloitte’s final report with the agenda
papers for the meeting in line with statutory timeframes (on 9 June).
The scope of
the Deloitte work (as agreed by Council resolution on 16 December 2015) includes
review of the latest financial model and base case financial projections in
order to understand the calculation and allocation of financial
returns by investor; to identify key assumptions; to confirm the water up-take
‘breakeven’ point; and undertake sensitivity analysis. Deloitte
has also carried out analysis of the RWSS model and HBRC’s proposed
purchase of an additional 4 M m3 of water (currently
being consulted on), HBRIC’s 6% return assumption; and validated key
assumptions in regards to the construction contract, investor and financing
terms and the basis for the water uptake assumptions.
In updating the peer review, Deloitte primarily undertook enquiry
and analysis in-line with the Scope of work agreed-upon and has neither
repeated nor re-litigated matters covered in the previous review except to
the extent that they were specifically asked to do so. Deloitte:
·
Looked at key inputs and assumptions, investor terms sheets,
the D&C contract and the financial and other key documents to identify
key issues / risks / areas of concern to the Project, the HBRC and other
investors and other answer key questions; and
·
Examined returns under the Base Case and the sensitivities of
these under a range of alternative scenarios, some of which are more
plausible than others.
An overview of the Key Assumptions was provided, in particular
noting material changes including:
·
Increased dam and distribution costs due to
additional 2 years inflation and adverse foreign exchange rate movements,
plus irrigation footprint expansion from 23,000 ha to 28,000 ha and
higher specification distribution system (higher pressure) and additional
pumping; increased development costs due to delay in Financial Close; removal
of the hydro generation station (retain option to retrofit); and the
introduction of debt (similar to Scenario B in 2014 business case) adding
interest during construction upfront for the sole purpose of funding the
secondary distribution network.
·
Operations and maintenance (O&M) costs have been prepared
by HBRIC’s technical advisor and are more thorough and detailed than
preliminary costings provided in 2014. Key changes to O&M costs include
the substantial increase in energy costs due to the removal of hydro
generation; increased costs due to a higher number of pumps in the secondary
distribution network; and increased mitigation / consenting (estimated only
in 2014) costs. Timing issue with hydro generation not financially viable at
this time, however infrastructure will be built so that future generation is
an option.
·
Mr Newman explained that the aggregated Scheme
area is now 90,000 ha, containing 42,000 ha irrigable land and the secondary
network enabling delivery lays across 28,000 ha.
·
Mr Newman explained that the Scheme (via a
subsidiary of HBRIC Ltd) will employ and contract staff to carry out the
environmental management and compliance work, and these costs are built into
the Scheme operational budgets.
·
Uptake assumptions have been updated, with take
or pay contracts to reach 105.6 M m3 (100% uptake) in
2031, Spot water sales ramp-up to 8.5 M m3 in 2031
(average year) – reaches 9.0 M m3 (circa 8% total
sales) in 2031 and thereafter flat. If spot sales are higher than forecast
HBRIC will benefit by receiving its uptake-linked share of distributions, and
even after environmental and flushing flows have been considered, on average
there should be sufficient headroom for spot sales, with more than 115 M m3
water available. Final report will identify the proportion of spot
sales, how those ramp up over time, the contribution they make to cashflows
and how the returns from those cashflows get allocated.
·
The Call Option was explained, whereby a person pays a
substantial fee based on the amount of water they expect to purchase (one
example $500k) in order to have a ‘right’ to enter into a
contract on the same terms as a FWUA within a specific period of time. Mr
Dent, in response to a query, confirmed that a ‘call option’ is a
sensible financial instrument to use to achieve water uptake, priced to
ensure that the parties have material skin in the game and are making a
prudent decision with the intent to exercise that right.
·
There was a query about ‘related parties’ purchase
of Call Options, however it was unclear as to where the concern lies or how
Deloitte might address the associated ‘risk’
·
In April 2016, the Project’s water uptake condition
precedent was satisfied with contract sales exceeding 40Mm3 (42.8Mm3).
The uptake CP was set in 2014 (under the proposed structure and parameters at
the time) so investors neither had to fund operating losses nor the repayment
of other investors. At the 2014 CP level, the Project was also cash flow
positive, rather than just breaking even. The breakeven uptake under the
current model/structure is not directly comparable to the 2014 uptake CP as
the structure has changed significantly (e.g. bank debt on day 1).
The meeting adjourned at 12.30pm and
reconvened at 1.00pm
Further discussions traversed:
·
Deloitte reiterated that at the current contracted level (42.8 M m3
contracted) HBRIC’s financial advisers have demonstrated that the
Project is able to fund opex, bank debt servicing and repay bank debt with no further water user agreements entered into, no farmer notes
issued and no spot revenue.
·
The definition of ‘break even’
Deloitte uses is the point at which the company can meet obligations with no
further investment, however it does not include provision of returns to investor
parties
·
financial returns to all equity investors have
to be paid out of positive cashflows in accordance with the Terms of their
investment contract
·
The updated Foundation Water User Agreement
and water price, including discounts and when those would apply
·
Key changes to the financing structure since 2014 include a
change in potential investors, including the addition of an Institutional
Investor that has risk exposures (excluding demand risk); the addition of
bank debt from financial close; and HBRIC’s equity being drawn down
first (with its development costs to-date capitalised), followed by CIIL Sub
Debt, bank debt and finally Institutional equity.
·
Mr Dent explained that under the base case, over the 70 year
life of the project HBRIC is repaid in full and earns a positive return on
capital (equity IRR exceeds required rate of return of 6%); the Institutional
Investor is repaid in full and earns a positive return on capital; the Farmer
Note is repaid in full and earns a positive return on capital; Bank debt is
repaid in-full and earns base lending rate plus a margin; and CIIL Sub Debt
is repaid in full. Deloitte arrived at this conclusion after calculating all
the figures – and confirming the underlying assumptions are reasonable.
· Evidence examined to support the assumptions included the irrigation
scheme’s unique characteristics (size, existing irrigation, land-use
etc.); the HBRIC, CIIL and the Institutional investor are undertaking due
diligence on uptake risk’ substantial work done by HBRIC to validate the
uptake assumptions including constructing a bottom-up water demand model
based upon a database of farmers within the catchment area, re-running the
MacFarlane farm financial feasibility work and commissioning a separate piece
of work about on-farm financial feasibility; and undertaking analysis of
approximately 20 differing farms for soil types, climatic risk, farming
systems to assess optimal volumes of water / application rates per hectare.
· Water
users signing contracts have ‘hedged’ what they have contracted
with the intention of signing up for more water once they have ‘bedded
in’ their initial uptake; and the ‘security of supply’
element of the decision to sign a water user agreement.
·
Sensitivity analysis and testing the
assumptions with the Castalia model and HBRIC carrying out further testing
using the Monte Carlo model, and other investors carrying out analysis in
their own due diligence processes
·
Mr Dent confirmed that sensitivities were run to illustrate the
impact on the equity IRR of individually changing key assumptions under three
uptake scenarios. In each scenario there is no need for additional equity to
cover opex or bank debt servicing as the level of contracted water is already
in excess of the breakeven amounts.
·
Inflation rate impacts on both sides of the
equation, i.e. water price increases and so do interest rates.
·
It was suggested that the only further debt
HBRIC may need to incur would arise in the circumstance where HBRC required
payment of the 6% rate of return.
·
It was confirmed that councillors expect the
final Deloitte report to cover all of the scheme’s obligations and how
those have been met or addressed, and to highlight any residual uncertainty
Deloitte may have.
|
