Solid Energy based failed strategy on non-existent analysis, papers show

The ambitious growth strategy that has imperilled Solid Energy was developed on a far more optimistic outlook for oil and coal prices than its industry peers, but it had no analysis to back those views, Treasury papers released today under the Official Information Act show.

The plans, which included converting low grade Southland coal to fertiliser and diesel, first appeared seven years ago, but it took another five for the Treasury to discover the company had nothing to back the bullish view on oil and coal prices required to justify the expansion.

The papers show it was not until November 2011 that merchant bank UBS complained it had been “unable obtain evidence of internal or external documentation, analysis or review appropriate to support Solid Energy management and board views on commodity price paths” while assessing the company for partial privatisation.

This was “concerning”, given the importance of such analysis for Solid Energy’s “strategy, operations and generation of shareholder value.”

Between 2005 and 2011, Solid Energy had used the earnings from its traditional, but high cost coal mining business to plough $165 million into the lignite plans and other plans, none of which ever made money and some of which never got off the drawing board.

As late as March last year – three months before announcing a $40 million loss and $151.9 million in write-downs for year to June 30 – Solid Energy continued to argue its case was “unique” and that it “almost certainly does not fit comfortably within the proposed” partial privatisation policy.

The focus on partial sale had produced “narrow” advice that “may not be in the best interest of the business nor its shareholders,” Solid argued.

The coal miner was withdrawn from the list for possible part-sale after announcing losses, and further deterioration in its commercial performance saw Solid Energy seek the support of its bankers and its government owner as it breached banking covenants in February.

A rescue package is still being stitched together, with Ministers hinting the company may have no future.

The papers show a trail of concern since the middle of last decade in advice to the then Labour-led government about an unauthorised land buying spree in Southland in 2005 and 2006.

That was when the company’s visionary chief executive Don Elder began snapping farmland and mineral rights for bio-fuels project involving low-grade lignite coal, which would have required other investors to build plant worth perhaps $6 billion.

In a December 2006 report to Ministers,

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the then Crown Company Monitoring and Advisory Unit, now part of the Treasury, noted that “no mention was made of the intention to purchase the minerals and land.”

“While the purchase of land is low risk and the development of the option may be reasonable, the mineral right purchase is higher risk and the lack of material consultation is unacceptable,” said the report of outlays worth $137 million at the time.

Meanwhile, Treasury analysts identified in reports through the late 2000’s and into 2011 that Solid Energy’s non-traditional plans relied on high and rising coal prices to fund its capital development and pay dividends, and a view of coal prices at odds with industry forecasts.

By 2011, the company was borrowing to pay dividends so it could use operating cashflow to keep developing various projects, of which the lignite plans were the largest, most speculative, and least environmentally acceptable. However, historically high coking coal prices on world markets masked the problem until a slowdown in China caused a global price collaps early last year.

Yet as long ago as the December 2006 report, officials had flagged concerns about Solid Energy’s departure from established strategy.

“Coal prices are particularly crucial to Solid Energy because its mines are small, and its cost of mining high, in comparison to the market setting Australian mines,” CCMAU said.

In the same report, officials said: “The very high development cost makes the probability of successful execution of this project low, and therefore the probability of write-downs for the non-land component of the project significant.”


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