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Contact: Chairman’s Speech – 2005 Agm


Contact: Chairman’s Speech – 2005 Agm

It is a great pleasure to be addressing my first Annual General Meeting, and an even greater pleasure as Chairman to be reporting to Shareholders the excellent result achieved by Contact Energy in the year to September 2004.

Before reporting these results in more detail I’d like to cast everyone’s minds back to last year’s AGM in Dunedin.

Phil Pryke, our Chairman at that time, outlined the challenges that Contact would face in the coming year. Two key challenges were:

the impending change of majority shareholder, following Edison Mission Energy’s announcement that it wished to sell its international assets, and

the need to progress key strategic issues, particularly the identification of commercially viable opportunities to secure investment in new generation capacity, based on new fuel sources in the post-Maui gas era.

In relation to the first challenge, I want to acknowledge Phil Pryke and Steve Barrett’s leadership. A change in majority shareholder can be distracting to management and a risk to a Company’s performance at the best of times.

Phil and Steve were able to ensure your Company remained focused on delivering sound operational performance, excellent financial results and important progress on key strategic issues.
We thank them for their efforts and leadership throughout this period of change.


Financial Performance

As you are aware Contact reported a tax paid profit for the financial year of $144 million, a 22 per cent increase over the prior year. Earnings per share were almost 25 cents (24.98 cents), also up 22 per cent over the prior year, whilst dividends for the year of 25 cents (fully imputed) were up 9%. Across the year borrowings decreased slightly, leaving net debt at year end of $1.035 billion and gearing at a conservative 26 per cent after also accounting for the $550 million revaluation of the Company’s assets as at 30th September 2004.

However, our credit rating remains at BBB, a level lower than the board regards as appropriate for the longer term. This issue will require careful consideration as we look to an increasing level of expenditure commitments in the years ahead.

With that context, let me also say that the board has no current intention for a capital return to shareholders.

Your Company is in a sound financial position. Contact’s solid performance is recognised by the market in the 20 per cent increase in the Company’s share price over the twelve months to September 30, 2004.

The company is now well-placed to pursue investment opportunities as they arise. This is particularly important at a time when New Zealand is facing substantial challenges in meeting its fuel and generation needs over the next decade.

Together with the strong financial performance, Contact has made significant progress over the last 18 months in addressing the key strategic issues facing the New Zealand energy sector. Key achievements have been:

renewal of resource consents for our Clutha River hydro assets and, just after the end of the financial year under review, for the Wairakei geothermal power station.

Both consents are still subject to appeal processes, but we are confident that workable frameworks will emerge.
commitment of approximately $1 billion to capital investment and to new gas contracts. These contracts relate to the Pohokura gasfield and settlement of our entitlements to remaining Maui gas, leaving us certain about our capacity to run our modern thermal plant until the end of the decade.
Encouragement of an increasing level of upstream gas exploration in New Zealand

Progressing a viable LNG option as a backstop should domestic gas resources be insufficient to meet demand
Fostering public discussion and understanding of future energy options through the Positive Energy campaign.

Board and Governance Issues

As shareholders are aware, in the course of the year, Edison Mission Energy was successful in selling its majority interest in Contact Energy – the successful acquirer of this interest being Origin Energy.

Following this transaction, and for a number of other reasons arising in the normal course of business, a number of significant changes have been made to the Board, senior management, governance processes and the Company’s constitution.

The Contact board has been reduced from eight to six members, who collectively represent an excellent mix of upstream, generation and retail experience in Australia and New Zealand, and an appropriate balance between new perspectives and continuity of contribution.

I also want to acknowledge the EME-affiliated directors whose efforts over the five years until September last year contributed so much to Contact’s strength today: in particular, the contribution of Bob Edgell and Ray Vickers from EME, who served on the Contact board over the past five years.

We also greatly appreciate the contribution of Dr Patrick Strange, who stepped down as an independent Director at the end of September.

I am delighted that the company has retained the skills and counsel of Phil Pryke, who chaired Contact from its creation in 1996 until last September, and continues as deputy chairman.

With the sale of EME’s international business, Steve Barrett decided to end his more than 30 year association with EME and become a Contact employee as Chief Executive Officer of Contact Energy. He has been instrumental in the quality of the transition achieved over the last few months.

Steve is an outstanding chief executive, respected and trusted by staff and industry peers alike. We will be sorry to lose his services when he returns to the United States to be closer to family later this year.

The ownership change has also necessitated a change in balance date for Contact. We will be reporting for a nine month financial year to June 30 this year, and meeting again with shareholders in October, in Auckland. Consistent with the change in ownership we have also changed our auditors to KPMG who also audit Origin Energy. We also thank our retiring auditors Ernst and Young for their efforts and contribution during their term as auditor.

We have also enhanced some of our governance processes during the year by introducing a regular review of Board performance and a review of individual directors’ performance, conducted prior to their renomination.

And finally, as you know, we are taking this opportunity to standardise and modernise Contact’s Constitution, in line with new Listing Rules requirements. We will discuss these changes in detail, later in the meeting.

Looking Ahead

Looking ahead, a robust economy continues to drive growth in electricity demand higher than the historical average. At the same time, the fuels that New Zealand has typically used are either becoming scarce, as in the case of natural gas, or more difficult to access on a large scale, such as hydro.

The progress that the industry has made over the last year has been positive. There has been a wave of new investment announcements, of which Contact is a part, proof that the industry will respond to market signals by demonstrating through investment that new, albeit higher cost sources of energy are commercially viable.

However, this continues to be a time of great challenge and opportunity for investors in the New Zealand energy sector… not a time for complacency. The next three to five years should see a steady intensification of the major new capital commitments already occurring, provided the Government holds firm and does not move away from market based policies that encourage investment.

Contact has the opportunity to be a major contributor to the approximately $6 billion in new investment that is estimated to be required to achieve ongoing security of supply over the next 10 years.

In the near term, we are looking at new investments to upgrade and expand existing plant across the portfolio, that will add upwards of 100MW to total generating capacity.

Steve Barrett will cover these plans in greater detail in his presentation.

In addition to our direct investment, we also made useful progress towards securing and identifying thermal fuels options beyond 2010 so that we can not only continue to run existing gas-fired plant, but also move to begin construction of a new 350MW-plus gas-fired station at one of our consented Otahuhu-C or Taranaki sites before the end of the decade. The Otahuhu plant option in particular sits in a critical location for access to the fast growing Auckland market.

The Future for Thermal Fuels

While new investment in renewable generation has been gathering steam, there remains a serious challenge for New Zealand to achieve reliable, competitive energy supplies in the longer term.

In our opinion, major new hydro schemes are costly and will inevitably attract spirited local opposition, while the public appetite for large-scale windfarms and their contribution to security of supply has barely been tested as yet.

There is wide agreement in industry and government that gas-fired generation – already providing around one quarter of all New Zealand’s electricity needs - will remain a key part of the electricity generation system.

Development in the natural gas market over the last year has been particularly important for Contact. The new Pohokura and Kupe fields have been committed to market, stimulated by contracting activity from major gas users such as Genesis Energy and ourselves.

This has also allowed Genesis to begin building the next modern, gas-fired power station – E3P – at Huntly - this is an important step towards meeting new electricity demand between now and 2010.

By signing these contracts, Contact has clearly demonstrated that it is a buyer on terms that reflect post-Maui prices, sending a powerful signal to other potential suppliers to accelerate exploration and commercial production of new gas resources.

But the new fields of Pohokura and Kupe will not be sufficient by themselves to replace the Maui field and to power existing thermal plant, let alone allow for investment in new gas-fired plant to meet electricity demand growth.

We know that New Zealand is considered highly prospective for natural gas and somewhat under-explored, compared to many other territories. It is quite clear not only that there has been substantial under-investment in oil and gas exploration, but also that this under-investment continues.

We welcome the shift in policy focus towards improving the investment conditions for explorers and to accelerating the provision of information and opportunities to bid for new licences. It is now up to explorers and producers to respond to the changed prices and Government policy and lift their level of exploration in New Zealand.

As the largest single gas user in the New Zealand economy, it would be unwise for Contact to rely solely on a gas contracting strategy with current upstream participants to deliver the required fuel security in a timely manner.

That is why Contact has ventured for the first time into examining upstream gas options, taking an offshore Taranaki exploration licence and teaming up with Genesis Energy to explore the alternative option to import Liquefied Natural Gas. Contact will also consider direct investment in gas production should this be necessary to secure its future.

LNG backstop

Our strong preference is for further domestic natural gas resources to be found in a timely way and developed so that Contact and other major gas users have access to competitively priced gas at sufficient volumes to meet the strong growth in demand created by a robust New Zealand economy.

It is, however, important that we continue to develop the alternative option of importing LNG if insufficient gas is found.

The challenge for Contact – and other major gas users – will be in timing the major investment decisions that will flow either from local gas discoveries or from the importation of LNG.


Pricing

As you will be aware, electricity and gas prices have been rising as New Zealand moves to a situation of tighter supply, both in terms of generation capacity and fuel availability.

We anticipate some further rises – although they are unlikely to be as significant as they have been in recent years. However, we are exploring investment options to address the shortfall in the balance between supply and demand and to stabilise prices, as, undoubtedly, are other industry participants.

Unfortunately, however, these new supply options – whether they be wind, hydro, geothermal, gas or coal, will be more expensive than generation based on the Maui gas field and ‘old hydro’ that have so successfully underpinned low electricity and gas prices for the last 15 years.

Nonetheless, New Zealand’s electricity prices will continue to be relatively low by developed world standards.

This new, higher cost environment is also one of the reasons that we are seeing an upsurge in interest for energy efficient products and services from our customers.

Our Healthy Homes initiative, launched last night at Parliament House, represents an important commitment by Contact to help our customers and to make the best and most productive use of the energy they consume.

This programme will particularly be targeting New Zealand’s very high rates of respiratory illness and asthma by promoting warm, dry, pollutant-free home environments.

We look forward to making a positive contribution to the health and wellbeing of New Zealanders through this initiative, in partnership with the Asthma and Respiratory Foundation and world-leading researchers from the University of Otago’s Wellington School of Medicine.

Regulatory Environment

It is particularly important to note that the recent investments I have been describing are occurring without substantial government intervention. Investors are responding to market signals reflecting the tighter supply/demand balance and the decline of the low-cost Maui field.

As I have observed, this change in market fundamentals is being reflected in tariffs to consumers, and we are investing in new energy production to stabilise prices at levels that reflect New Zealand’s changing energy landscape.

With the recent investment commitments made by the industry, the Electricity Commission is expressing confidence about supply security through the next two to three winters, and in the way that the electricity market is planning to bring new capacity on stream.

Whilst we understand that increases in energy prices are not, when considered in isolation, welcomed by the community, we also know that the one thing New Zealanders agree they most want from this industry is secure and reliable energy supplies.

The political temptation to intervene in price setting should therefore be resisted as it could undermine the goal of security of supply. The challenge for policy-makers will be to ensure that their focus remains on areas where they can facilitate new investment such as consenting processes, access to resources, transmission infrastructure, appropriate fiscal regimes for exploration and development and general economic conditions such as growth, inflation and interest rates.

The e3p guarantee – still not properly explained and subject to far less disclosure than a public company would be required to make – is an example of an unnecessary action that could discourage future investment.

The reality of the energy sector is that it deals in very costly, very long-life assets. Investors don’t make decisions to proceed with expensive, long-life plant lightly, nor do their financiers, in an environment where returns may be at risk from unpredictable changes in government policy.

It is increasingly common, and appropriate, today for companies to talk about meeting their corporate social responsibility, and to measure that in a variety of ways that include environmental, social and workplace practices.

All of those are important elements of corporate behaviour and are the focus of substantial resource for both your Board and the management of Contact Energy.

However, our greatest social responsibilities remain what they have always been. Firstly, to play our part in providing New Zealand with the secure energy supplies that it needs in order to prosper – socially and economically.

And secondly, to create wealth for our shareholders. In the process of doing so, we directly employ more than 700 New Zealanders, generate around 30 per cent of the country’s electricity, pay taxes to the Government, and provide electricity and gas to more around half a million homes and businesses.

And if that’s not creating Positive Energy, I don’t know what is.

Outlook

In concluding I would observe that Contact, like all participants in the energy industry in New Zealand, faces continued challenges to ensure sufficient investment occurs to maintain secure, reliable and competitive energy supplies for New Zealand, together with appropriate returns for shareholders.

I can confirm that our first quarter results, which we have announced, today are ahead of the same quarter last year, but our expectations for the full year remain on track. Steve will elaborate on these results in a moment.

Since listing in May 1999, Contact has sought to distribute approximately 80% of net surplus as dividend, subject to meeting the solvency test, and considering the future capital expenditure plans and expected performance of the company. Contact has been able to balance these considerations and achieve progressive dividend growth of around 10% pa to date. As shareholders know, this year’s dividend represents a payout ratio of nearly 100%.

Your Board will be giving careful consideration to our future capital expenditure requirements together with the impact of increased gas costs in a post-Maui era and the maintenance of debt levels to support or enhance the current credit rating. We will continue to balance the desire for increased dividends with our plans for future investment and the sustainability of profits in the years ahead.

For example, to put this in context, the investments that Steve will be outlining in his presentation, together with the potential construction of Otahuhu-C and its associated gas contracts could give rise to potential expenditure commitments in excess of $1 billion.

As stated earlier, the change in the Company’s balance date from a September to a June financial year will necessitate a change in the timing of dividend payments from the customary May and December dates. The Board will shortly consider new dividend payment date options bearing in mind also the aim to maintain fully imputed dividends. We willannounce the revised payment dates once the full ramifications of the changed balance date and net cash generation and tax payment profile are fully determined.

In this context I should also draw shareholders’ attention to the new Note 29 in the Annual Report (p70) discussing the impact of the change from NZ-GAAP to the new NZ International Accounting Standards.

There will be consequent changes in both the level of profits, their volatility and in the new balance sheet. Contact expects to adopt the new accounting standards with effect from the reporting period beginning after 1 July 2005. Your Board commits to shareholders we shall endeavour to ensure you are all fully informed about the comparative impacts on Contact Energy.

Finally, I would like to thank my colleagues on the Board, particularly the independent Directors, for their efforts in a demanding year. We also thank Steve Barrett and the management team for ensuring another year of strong performance by Contact Energy.

Thank you.


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