Agenda of Extraordinary Regional Council Meeting

HAWKE’S BAY REGIONAL COUNCIL

Friday 08 July 2016

Subject: HBRIC Ltd Report on Ruataniwha Water Storage Scheme Conditions Precedent and Pre-conditions

Reason for Report

1. The role of the Hawke’s Bay Regional Council as the initiator of the feasibility work on water storage options for the Tukituki catchment ultimately led to a delegation of responsibility for preparing a business case for the Ruataniwha Water Storage Scheme (RWSS) to HBRIC Ltd. Council itself retained responsibility for the plan change for the catchment (Plan Change 6).

2. The Hawke’s Bay Regional Investment Company Ltd (HBRIC Ltd) has now reported back on the work which it was tasked to carry out and has made a suite of recommendations to Council. Their report is appended as Attachment 1.

3. The Report from HBRIC Ltd outlines the process undertaken by HBRIC Ltd., presents the relevant decisions that have been made by HBRC to date, makes recommendations to HBRC on the RWSS investment and describes the process that will occur should HBRC agree to the recommendations in this agenda paper.

Strategic Context

4. The Tukituki Catchment Proposal, which includes both Plan Change 6 and the RWSS, represents an integrated water management strategy, integrating both regulation and infrastructure, not promoting one or the other.

5. It may be useful to restate briefly the background for the water storage project:

5.1. HBRC committed to improving the water quality of the Tukituki River following public concern expressed about the river’s quality, especially in the lower reaches.

5.2. Among a range of tools to do this was an increase in the minimum flows of the Tukituki and Waipawa Rivers.

5.3. As a regulatory measure it is relatively straightforward to implement a plan change to increase minimum flows; however the HBRC recognised that the Resource Management Act requires that in promoting sustainable management Councils must manage the use, development, and protection of natural and physical resources in a way, or at a rate, which enables people and communities to provide for their social, economic, and cultural well-being and for their health and safety.

5.4. In considering this requirement HBRC recognised the potential effects on the economic and social wellbeing of the catchment and wider region through lower water security potentially leading to a downturn in economic output.

5.5. HBRC therefore made a conscious decision to act in a non-regulatory way, in addition to its regulatory plan change, and to assist with options for maintaining or even increasing the security of supply for water for irrigation in the Tukituki catchment.

5.6. Several years investigations to a range of multiple sites for small-scale water storage and medium scale water storage eventually was revised to a larger-scale water storage project on the Makaroro River site, for a range of reasons that have been canvassed previously.

5.7. HBRC has taken an innovative approach to its resource management responsibilities in response to the need to balance the needs of the environment and the needs of people. HBRC creates and maintains regional scale infrastructure to make the region more resilient when there is too much water. It is now considering whether or not to invest in regional scale infrastructure to make the region more resilient when there is too little water.

5.8. HBRC’s objectives for this investment are to:

5.8.1. Help achieve its strategic development objectives for the Hawke’s Bay Region as a whole through establishing and managing a key infrastructure resource to improve agricultural production and productivity while enhancing environmental management of the Tukituki catchment;

5.8.2. Encourage and enable increased private sector investment in the Region’s export oriented agricultural sector;

5.8.3. Generate economic, social and cultural benefits in the region;

5.8.4. Help improve management and control of environmental risks over the long term, especially those relating to water quantity and water quality;

5.8.5. Generate satisfactory tax paid returns to HBRC from the financial performance of the invested assets;

5.8.6. Quantify and manage particular investment risks.

Investment Decision

6. Council’s decision on 25 June 2014 was:

That Council:

8. Resolves to invest up to $80 million in RWSS subject to Council being satisfied with:

8.1. its own legal advice on the RWSS documents and all related legal matters;

8.2. a further review of the final RWSS business case as at the new Financial Close and Council being satisfied with its advice and the steps taken (if any) by HBRIC Ltd to resolve key issues of concern (if any) then identified in the course of Deloitte’s review;

8.3. advice from HBRIC Ltd that all Conditions Precedent to Financial Close of the investment by all investing parties in the Ruataniwha Water Storage Scheme Limited Partnership (RWLP) have been either satisfied or waived by agreement of the parties. These Conditions Precedent are:

8.3.1. The EPA granting satisfactory resource consent conditions for RWSS infrastructure and operations, which in turn are recommended as being workable by all investors;

8.3.2. Agreements to purchase a minimum of 40 million cubic metres of water per annum (Water User Agreements) and that the RWLP has committed to supply a minimum of 40 million cubic metres;

8.3.3. Securing the funding required to build and operate the RWSS infrastructure; and,

8.3.4. Obtaining a bankable construction contract which adequately addresses construction risk allocation through a fixed-time, fixed-cost arrangement.

8.4. a Certificate issued by HBRIC Ltd’s legal advisers:

8.4.1. summarising the terms of all executed Water User Agreements;

8.4.2. identifying the water user parties who executed the Agreements; and,

8.4.3. explaining the enforceability or otherwise of the Agreements.

8.5. HBRIC Ltd increasing its annual distributions to HBRC to provide a 6% return to HBRC on the funds HBRIC Ltd draws down from HBRC from time to time to invest in the RWSS, up to a maximum investment of $80 million.

9. Requires HBRIC Ltd to keep the Council informed on progress toward meeting the conditions stipulated in Recommendation 8.3 over the period to the new Financial Close.

Conclusions

7. HBRC’s decision in June 2014 to invest in the RWSS (subject to conditions precedent and pre-conditions) sent a strong signal to the Hawkes Bay community that HBRC would use its balance sheet, as well as its regulatory role, to drive economic growth in the region while ensuring that the environment – land and water – is sustainably managed.

8. Such an approach has tended to polarise views on this project, and to harden views that would suggest that both objectives – environmental protection and economic development – cannot co-exist.

9. The RWSS is a rare opportunity to drive economic growth within the Hawke’s Bay region. From an HBRC investment perspective it has the potential to drive financial benefits both through a return off the project itself and through higher profitability for Napier Port.

10. At the same time the availability of EPA Board of Inquiry consents for RWSS show the RWSS can be implemented within explicit environmental parameters accompanied by ongoing monitoring requirements.

11. Negotiations between the investment parties will continue to occur up until financial close. Should any material adverse changes occur between HBRC’s Councillors’ final review of conditions precedent and preconditions today and that time HBRIC Ltd will notify HBRC of such changes as they may impact upon Condition Precedent 8.3.3. (securing the funding required to build and operate the RWSS infrastructure). In any event the investors and financiers will provide final written confirmation, no later than two working days prior to Financial Close, of the provision of funding that is required to build and operate the RWSS infrastructure.

12. HBRIC Ltd has completed its brief from HBRC in respect of the development of the business case for the RWSS and importantly has concluded that:

“Investment in the RWSS, on the terms agreed with counter-parties, continues to be an appropriate investment for HBRIC Ltd and is consistent with HBRIC Ltd’s Statement of Intent.”

13. HBRIC Ltd will be in attendance at the meeting to make a presentation on their report.

Decision Making Process

14. The recommendations in this paper cover a proposal to invest up to $80 million in the Ruataniwha Water Storage Scheme following public consultation undertaken under the Special Consultative Procedure provisions of the Local Government Act 2002.

Recommendations

1. Council agrees that the Conditions Precedent required by parts 8.3.1 and 8.3.4 of its 25 June 2014 resolution regarding investing in the RWSS have been satisfied.

2. Council agrees that the Condition Precedent set in 8.3.3 of Council’s minutes of 25 June 2014 will be confirmed to Council management as being satisfied no later than two working days prior to Financial Close, by Investors and financiers providing final written confirmation of the funding that is required to build and operate the RWSS infrastructure.

3. Council agrees that the Pre-conditions required by parts 8.1, 8.4, 8.5 and 9 of its 25 June 2014 resolution regarding investing in the RWSS have been satisfied.

4. Council agrees that Pre-condition 8.2 and Condition Precedent 8.3.2 will be considered at the meeting on 8 July 2016 and if agreed will mean that all Conditions Precedent and Pre-conditions, other than 8.3.3 have been satisfied, subject to no further material adverse changes.

5. Council notes that, subject to investors and financiers each receiving final approvals from investment Committee, Shareholders or Credit Committee, as appropriate; and subject to HBRC being advised of any material adverse changes prior to Financial Close:

5.1. HBRIC Ltd will proceed to Financial Close with counterparties in July/August 2016, with the timing of financial draw-downs from Council to HBRIC Ltd (and all other investor and financier draw-downs) being subject to a Condition Subsequent/Precedent of either

5.1.1. obtaining full and unfettered access to the land being proposed for exchange between Department of Conservation and the RWLP, or

5.1.2. any Council funds drawn down being adequately protected by financial arrangements and/or legal agreements approved by Council.

6. That Council authorises HBRC management to prepare and execute written agreements with HBRIC Ltd for funds amounting to $80 million less the to-be-finalised sum (approximately $18 million) for capitalised development expenses incurred by HBRIC Ltd before Financial Close:

6.1. to be drawn down from Council funds in accordance with the timing and satisfaction of the Condition Subsequent/Precedent, and with the drawdown schedule agreed with counterparties at Financial Close, and

6.2. for a combination of debt and subscription for new equity in HBRIC Ltd with the proportions to be agreed between HBRIC Ltd and Council management, reflecting advice from PWC on achieving both an appropriate capital structure for HBRIC Ltd and an optimal balance of operating and capital cashflows to Council from the expected returns on Council’s investment, via HBRIC Ltd, in the RWSS.

7. That Council acknowledges the work undertaken by the Board and staff of HBRIC Ltd on the RWSS project and expresses its gratitude for their collective efforts.

Liz Lambert

Chief Executive

Attachment/s

HBRIC Ltd Report on RWSS Conditions Precedent and Preconditions

HAWKE’S BAY REGIONAL COUNCIL

Friday 08 July 2016

Subject: Deloitte Peer Review of the Final Ruataniwha Water Storage Scheme Business Case

Reason for Report

1. 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.

2. Precondition 8.2 of the 25 June 2014 HBRC decision is as follows:

8. Resolves to invest up to $80million in RWSS subject to:

8.1 ………….

8.2 Deloitte undertaking a further review of the final RWSS business case as at the new Financial Close and Council being satisfied with its advice and the steps taken (if any) by HBRIC Ltd to resolve key issues of concern (if any) then identified in the course of Deloitte’s review;

8.3 …………...

8.4 ……………

8.5 ……………

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. Out of commercial sensitivity and commercial necessity much of the detailed information provided by Deloitte in its review of the final business case has had to be covered in a public–excluded session on at this meeting. However it is appropriate HBRC deliberations on this matter are held in open session.

May 2014

5. For the peer review of the Business Case Deloitte was tasked, in particular, with assessing:

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

5.2. 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

5.3. 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

5.4. How investment returns could vary under different scenarios

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

6. 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:

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

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

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

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

7. 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:

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

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

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

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

8. The key risk to the project as identified by Deloitte in 2014 is how long the project takes to get to full uptake of water. This is important for two reasons:

8.1. 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)

8.2. 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.

9. 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.

10. Attachment 1 to this paper (the May 2014 Deloitte Business Case Review report) has previously been received by Council but is included in this agenda for completeness.

11. Deloitte noted that the three major moving parts of the proposal, namely the construction contract, the required level of initial contracted water and the capital structure, had yet to be finalised. They also stated that is it not unusual for projects of this nature to have a degree of uncertainty right up to the point of financial close.

May 2016

12. Following receipt of the business case review Council chose to retain the services of Deloitte to undertake a final assessment of the proposal should there be any material change between the base case and the situation at financial close.

13. Deloitte’s final assessment is now presented in this agenda item. This is an addendum to the 2014 Final Business Case and contains an assessments of any changes in investor terms, the final contracted capital construction cost, and any change to the demand curve resulting from the BoI final decision.

14. This report has been prepared in accordance with the scope for this work as approved by Council on 16 December 2015, being to:

14.1. Review latest version of the financial model and base case financial projections to:

14.1.1. understand calculation and allocation of financial returns by investor category

14.1.2. identify key assumptions

14.1.3. confirm water take-up breakeven point

14.1.4. undertake sensitivity analysis to demonstrate the impact of cash flows and investor returns of different water take-up assumptions beyond base case

14.2. Validation of key assumptions:

14.2.1. trace capital assumptions to latest version of the D&C contract

14.2.2. trace investor assumptions to investor term sheets and ownership model/investment structure

14.2.3. trace senior debt finance (if any) assumptions to bank term sheets

14.2.4. test basis for water uptake assumptions

15. At Council’s meeting on 25 May 2016 Deloitte presented their preliminary findings on the updated business case to Council. Material changes to the 2014 business case were described and assessed.

16. 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.

17. Deloitte have concluded in their May 2016 presentation that under the base case scenario, over the 70 year life of the project:

17.1. HBRIC is repaid in full and earns a positive return on capital (equity IRR exceeds required rate of return of 6%);

17.2. the Institutional Investor is repaid in full and earns a positive return on capital;

17.3. the Farmer Note is repaid in full and earns a positive return on capital;

17.4. Bank debt is repaid in full and earns base lending rate plus a margin; and

17.5. CIIL Sub Debt is repaid in full.

18. Deloitte arrived at this conclusion after calculating all the figures – and confirming the underlying assumptions are reasonable.

July 2016

19. Deloitte has now completed an update of the peer review focusing on the key areas that underpin the assessment, being:

19.1. Financial case

19.2. Capital structure

19.3. Investor returns

19.4. Breakeven analysis

19.5. Water uptake

19.6. Sensitivity analysis

19.7. Risk analysis.

20. The presentation from Deloitte will cover areas that are not commercially sensitive nor subject to negotiations.

21. A final written report from Deloitte will be publicly available subsequent to this meeting.

Decision Making Process

22. The recommendations in this paper cover a proposal to invest up to $80 million in the Ruataniwha Water Storage Scheme following public consultation undertaken under the Special Consultative Procedure provisions of the Local Government Act 2002.

Recommendations

That Council:

1. Receives and notes the Deloitte Ruataniwha Water Storage Scheme Peer Review presentation.

2. Confirms that it is satisfied with advice received from Deloitte and the steps taken (if any) by HBRIC Ltd to resolve key issues of concern (if any) then identified in the course of Deloitte’s review.

Paul Drury

Group Manager
Corporate Services

Liz Lambert

Chief Executive

Attachment/s

Deloitte RWSS Business Case Peer Review Report, May 2014

Deloitte RWSS Business Case Peer Review Report, May 2014

Attachment 1

HAWKE’S BAY REGIONAL COUNCIL

Friday 08 July 2016

SUBJECT: Confirmation of Public Excluded Minutes of the Regional Council meeting held on 29 June 2016

That the Council excludes the public from this section of the meeting being Confirmation of Public Excluded Minutes Agenda Item 7 with the general subject of the item to be considered while the public is excluded; the reasons for passing the resolution and the specific grounds under Section 48 (1) of the Local Government Official Information and Meetings Act 1987 for the passing of this resolution being:

GENERAL SUBJECT OF THE ITEM TO BE CONSIDERED

REASON FOR PASSING THIS RESOLUTION

GROUNDS UNDER SECTION 48(1) FOR THE PASSING OF THE RESOLUTION

Confirmation of Public Excluded Meeting held on 15 June 2016

7(2)(a) That the public conduct of this agenda item would be likely to result in the disclosure of information where the withholding of the information is necessary to protect the privacy of natural persons

The Council is specified, in the First Schedule to this Act, as a body to which the Act applies.

RWSS Concession Deed and Project Agreement

7(2)(b)(ii) That the public conduct of this agenda item would be likely to result in the disclosure of information where the withholding of that information is necessary to protect information which otherwise would be likely unreasonably to prejudice the commercial position of the person who supplied or who is the subject of the information

7(2)(i) That the public conduct of this agenda item would be likely to result in the disclosure of information where the withholding of the information is necessary to enable the local authority holding the information to carry out, without prejudice or disadvantage, negotiations (including commercial and industrial negotiations)

The Council is specified, in the First Schedule to this Act, as a body to which the Act applies.

Leeanne Hooper

Governance & Corporate Administration Manager

Liz Lambert

Chief Executive