Additional Work on Solid Energy New Zealand Limited

1 Introduction

In December 2013, the Auditor-General decided to carry out additional work on aspects of Solid Energy New Zealand Limited’s (Solid Energy) governance and management, so that comments could be provided on some specific issues to the Commerce Committee for the company’s financial review in early 2014.

The additional work involved:

  • a review of board minutes and papers between 1 July 2008 and 30 June 2013, and other relevant documentation;
  • consideration of reviews and other information released by the Treasury on its website; and
  • interviews with Solid Energy’s former Chairman (Mr John Palmer) and its former Chief Executive (Dr Don Elder), as well as the deputy Chairwoman of the Board (Ms Pip Dunphy) and the Interim Chief Executive (Mr Garry Diack). We also spoke with representatives from the Treasury.

We selected two projects for review and considered some particular questions, as follows:

  • The Board’s decision to invest significant capital in the Stockton Mine – the coal handling and processing plant was estimated to cost $128 million, and funding the plant significantly contributed to the company’s debt levels.
  • For one non-coal investment, the consideration that the Board and management gave (through reviews and monitoring processes) to the risks associated with the investment. The non-coal investment we looked at was the Taupo wood pellet plant.
  • Management and the Board’s rationale for adopting a higher “price path” for coal prices than others in the industry, and their consideration of risks associated with the higher coal price path.
  • The appropriateness of management and the Board’s response to a drop in coal prices.
  • Whether there are any lessons that can be learned by Solid Energy and other public entities.

Our consideration was limited to the above questions. We did not cover:

  • the company’s spending and whether it was extravagant. The change in the management and the Board of Solid Energy has resulted in significant cost control measures. Given Solid Energy’s focus on cost containment, we decided not to look at past expenditure by the company.
  • the Treasury’s monitoring and oversight of Solid Energy – this work was completed by Deloitte. Neither did we look at Ministerial oversight.
  • all development projects undertaken by Solid Energy. We selected two projects to consider, to gain an understanding of the company’s decision-making and project management.

2 Background: Evolution of the business strategy

Before 2010: Mining coal and diversifying into “new energy” and renewable energy

For the period of our review, Solid Energy’s core business was the mining of coking coal for the international steel industry from the West Coast region, and thermal coal from the Waikato region. Solid Energy’s main mines are at Stockton and Spring Creek on the South Island’s West Coast and at Rotowaro and Huntly East in the Waikato region.

Given that most of Solid Energy’s coal resources were either deep thermal/semi-soft coal or shallow, low-value lignite, the Board considered and agreed to a long-term strategy of projects to maximise and realise the company’s coal resources. This strategy involved two streams of development: “new energy” and renewable energy. The new energy projects all related to the company’s core coal resources and comprised:

  • Lignite conversion projects. These projects were located in the Eastern Southland region and included:
    • the prototype production of low-moisture, high-energy lignite briquettes for heating and industrial use;
    • conversion of lignite into urea for use as fertiliser; and
    • conversion of lignite to transport fuels (diesel and aviation), reducing New Zealand’s reliance on crude oil products. This was considered a possible long-term development option. No capital was spent by Solid Energy in this area.
  • Coal seam gas – harvesting methane from deep, hard-to-mine coal fields. These projects were focused on coal reserves in the Waikato and Taranaki regions.
  • Underground coal gasification – the gasification of coal deep underground, producing synthetic gas that can be used as a fuel for electricity generation or to make synthetic fuels or fertilisers. The project was focused on a pilot plant in Huntly.

The renewable energy projects involved different resources and comprised:

  • Wood pellet fuel through Solid Energy Renewable Fuels Limited (trading as “Natures Flame”), a manufacturer and marketer of wood pellets. Natures Flame had production facilities in Rotorua, Rolleston, and Taupo.
  • Switch Energy Solutions, a company that sold a range of pellet heating appliances, boilers, and solar hot water equipment.
  • Biodiesel, producing diesel fuel from used vegetable oil and canola pressed into oil, primarily through Biodiesel New Zealand Limited, which operated a plant in Christchurch.

Solid Energy’s overall vision was to “develop natural resources to capture maximum wealth for New Zealand in a socially acceptable and environmentally sustainable manner”.1 The range of new energy and renewable energy projects shows that Solid Energy was looking to expand from being a coal producer to a diversified resources enterprise involved in a wide range of energy projects.

A media release in 2007 from Solid Energy’s then Chief Executive, Dr Don Elder, outlined the rationale for the diversification strategy. It said that:

… we identified some time ago that we wanted to build a diversified portfolio of energy businesses alongside our existing coal mining operations. This strategy, and our increasing presence in the bioenergy sector, support national objectives to increase energy security and affordability in future through utilisation of diverse indigenous energy resources while also increasing renewable energy and reducing energy-related emissions.2

The traditional coal-mining business and diversification were the company’s business strategy until 2012.

2010: Exploring the possibility of managing more of New Zealand’s natural resources

Early in 2010, management presented a proposal to the Board to transform itself into a national resources company. The concept of a national resources company included:

  • Solid Energy’s existing business of coal mining
  • Solid Energy’s business activities based on the company’s existing resource access, specifically this included the new and renewable energy projects listed above. These projects differed in their state of development
  • New capability, including conventional oil and gas exploration and production, other minerals, and iron.

The proposal would require Solid Energy to be provided with preferential resource rights to maximise the value of New Zealand’s mineral resources.

The Board of Solid Energy decided to put the proposal and business plan to its shareholding Ministers in mid-2010 to seek their opinion. The cover letter to the Ministers noted that the proposal was “audacious”. We were told that the Board discussion, in respect of the submission to the shareholders, had considered that the proposal was high risk in both policy and economics. However, the Board believed that the best way to obtain the shareholders’ response and their appetite for Solid Energy to pursue such a strategy was to formally ask.

Officials from the Treasury, the Ministry of Economic Development, and the Department of the Prime Minister and Cabinet considered the proposal and provided advice in a joint report to Ministers before a meeting between the Ministers and Solid Energy on 10 May 2010. The joint report recommended that the Ministers indicate, in principle, support for the projects currently in Solid Energy’s business plan (that is, coal mining and the existing diversification projects).

The Treasury completed further analysis and produced a report in August 2010. In that report, it was clear that Treasury officials did not support the development of a single national resources company. The Treasury considered that Solid Energy should focus on areas where the Treasury considered the company had specific capability and resources – specifically, coal, lignite, and non-conventional gases. In the Treasury’s view, Solid Energy had adopted aggressive future oil prices and Ministers would need to accept those forecasts if they accepted the company’s business strategy for a national resources company.

In September 2010, the then Minister of State Owned Enterprises, Hon Simon Power, wrote to the Chairman, noting that Ministers were encouraged by the vision of Solid Energy in developing the national resource company proposal. However, at that stage, shareholding Ministers did not support the development of a single national resource company. They were supportive of Solid Energy developing its current natural resources, which included its lignite and unconventional gas projects.

The Board accepted the shareholders’ decision and continued to pursue its original strategy, including its diversification into new energy and renewable energy projects using the company’s existing natural resources. This was consistent with the communication from the shareholders. At no point was the national resources company proposal incorporated into any agreed statement of corporate intent.

During our interviews, we asked about the key challenges of implementing the company’s strategy. We heard that there were challenges in recruiting and up-skilling staff in the new energy and renewable energy areas of the business. The company also faced challenges in retaining mining staff, due to competition with mines in Australia.

2011: Preparation for the mixed ownership model process results in questions about the business strategy

In the second half of 2011, and in preparation for the Government’s mixed ownership model process, the Treasury commissioned UBS to carry out a scoping study of Solid Energy. Scoping studies were completed for all companies that were selected for participation in the mixed ownership model process. Solid Energy also completed its own scoping study.

UBS’s scoping study and recommendations did not support Solid Energy’s business strategy. In a Treasury report, it was noted that the scoping study concludes that Solid Energy:

requires a focus on the core coal mining business with:

  • downsizing of the New Development activities particularly around the large scale projects associated with the Southland lignite resources (coal-to-fertilizer (CTF) and coal-to-liquids (CTL) for liquid fuels)
  • sale of the renewable businesses (biodiesel and wood pellets)
  • increased expenditure on drilling to prove up the level of coal reserves to meet equity market requirements, and
  • repayment of Solid Energy’s debt at time of listing to meet the debt free norm for listed coal companies.3

As previously noted, the coal-to-liquids initiative was considered a long-term development option and had not been advanced by Solid Energy.

Solid Energy’s management considered the UBS study and contrasted it to its own scoping study. Management’s initial views were summarised in a paper to the Board in October 2011. The paper to the Board noted the differences between the two studies. One of the key differences was the two studies’ descriptions of “value”. It noted that the “Solid Energy scoping study seeks to give the Board a perspective of an IPO consistent with its existing strategy.” The same Board paper notes that “UBS make several recommendations …. the fundamentals of Solid Energy’s current strategy are questioned for the purposes of an IPO”.4 The Board invited representatives from UBS and the Treasury to discuss the UBS scoping study on the same date that it met to consider management’s paper.

In response to the UBS report, management’s initial views, and after hearing from the Treasury and UBS, the Board made a number of requests in its October 2011 meeting. The Board recommendations included that management:

  • formally respond to the Treasury on the key elements of the report;
  • bring a proposal on renewables to the next Board meeting; and
  • generally rationalise and refocus new developments.5

The minutes document that the Board agreed with most of UBS’s recommendations. The Board adopted the 11 milestones in the UBS report for participation in the mixed ownership model process. Management were asked to prepare a paper on what needed to be done to achieve the above aims of the Board.

During the next six months, Board papers and minutes reflect much consideration of the UBS scoping study and the differences from Solid Energy’s business strategy. The 11 milestones were reported against. At the same time, coal prices were continuing to drop – there had been a decline in international hard coking coal prices since the beginning of 2011. Solid Energy also stopped investing in new capital projects. There was no change to the diversification strategy.

2012: Sharp decline in coal prices leads to a new business strategy

In July 2012, there was a significant and sudden drop in international coal prices. Solid Energy’s management and Board put in place some immediate measures, over and above those actions already being undertaken (as noted later in this report) to adjust to the market conditions, such as:

  • ceasing planned capital investment to upgrade the ventilation at Huntly East Mine and work with a reduced mining team;
  • suspending operations at Spring Creek Mine while Solid Energy completed a review of its future viability;
  • selling or closing its biodiesel business;
  • increased restructuring and downsizing of Christchurch office staff across all areas; and
  • disestablishing the Christchurch-based resource development group, who had been responsible for long-term resource assessment and medium-term mine planning. The group consisted of approximately 70 staff.

There was also a significant change in the Board and a number of changes to management personnel. The Chairman of the Board informed the Minister in early May 2012 of his decision to resign and he left in August 2012. The strategy being pursued by the company halted.

During the last year and a half, the substantially new Board has created a new strategy for Solid Energy. In the 2012/13 annual report, the Interim Chief Executive notes that “Solid Energy is a vastly different company than it was a year ago” – the business has been refocused on coal exploration, mining, and marketing in response to a significant market downturn.6


Our work has confirmed that Solid Energy had a clear business strategy across the period of our review, which was focused on the core coal business and the diversification into “new energy” and renewable energy. The discussion about the possibility of pursuing a grander vision in 2010 did not proceed very far, as agreed by the Board, Ministers, and officials.

A business strategy is never static. It requires constant monitoring and management to ensure that it remains appropriate and that risk is properly managed. In this case, management of the strategy involved regular consideration of:

  • the coal price forecasts, which provided the heart of the financial projections for the company’s revenue;
  • planned capital investment and the level of borrowing required to support it; and
  • the identification and management of risks to individual projects and the strategy as a whole.

It is now well known that, in 2012, the international coal price dropped, suddenly and significantly, when Solid Energy had taken on a lot of debt to support its investment programme. Therefore, we looked at:

  • how the company was managing investment decisions for two projects - a project relating to the core coal business (Stockton) and a renewable resources project (the Taupo wood pellet plant);
  • the company’s approach to forecasting the coal price, its reasons for assuming a higher price path than others in the industry, and its consideration of risk; and
  • the company’s response to the drop in coal prices.

3 How Solid Energy managed investment decisions and projects

Investment in the Stockton coal handling and processing plant

We reviewed the Board’s decision to invest $128 million in the coal handling and processing plant (CHPP) at Stockton Mine. We wanted to know whether the Board had enough information to authorise the expenditure, whether the Board understood the risks associated with the project, and whether the Board appropriately monitored the project.

Broadly, the CHPP screens and washes coal that Solid Energy has extracted but which is not yet suitable for sale. Screening and washing effectively filters waste to maximise the market potential of the coal.

In December 2008, the Board authorised the construction of the CHPP at Stockton Mine. We reviewed the relevant Board papers and concluded that management provided good information to the Board to allow the Board to make a fully informed decision.

Before approving the investment in the CHPP, Solid Energy had carried out a pre-feasibility study (at a cost of $2.09 million) and a feasibility study (at a cost of $5.33 million). Both studies were reported to the Board. Also, Solid Energy obtained independent external reviews of its CHPP design and cost estimates, equipment installation rates, and contractor charge-out rates. These reviews were made available to the Board at its December 2008 meeting.

Board papers appropriately considered the risks associated with the project and included execution, resource, construction, market, and technology risks. These were individually identified in the December 2008 Board paper and also identified in a project risk register attached to the Board papers.

At each Board meeting, management provided a report on how the CHPP project was progressing. Each report discussed any issues or “red flags” associated with the project, how management was responding to risks, progress against schedules, and financial costs. Relevant photographs were also attached to the report.

Finally, Solid Energy carried out a post-investment review of the CHPP project that looked at the overall cost of the project and actual performance compared with that expected in the business case. The review concluded that the final cost of the project ($123.6 million) was below that budgeted ($128 million), the actual commissioning date (April 2010) was before the planned commissioning date (July 2010), cash flows from the project had significantly exceeded business case forecasts, and that the “payback” for the project was achieved in 15 months rather than the anticipated 28 months.

We were told that, without the CHPP, Solid Energy would have struggled to continue to operate successfully in the depressed coal market.


The $123.6 million CHPP was the largest component of capital investment in Stockton Mine during the period 2008 to 2010. In our view, the Board was provided with the necessary information from management to appropriately consider, approve, and monitor the CHPP project, including its risks. The Board understood and managed those risks. Every document we read and each person we spoke with believed that the investment in the CHPP was a sensible business decision.

Investment in the Taupo wood pellet plant

Solid Energy entered the wood pellet business in 2003 through its Natures Flame brand. In early 2008, the Board approved the building of a Taupo wood pellet plant.

We reviewed the Board’s decision-making for the Taupo wood pellet plant because the investment was outside Solid Energy’s core coal-mining business and involved significant capital expenditure.

The Board first considered management’s proposal for this investment in November 20077. At that time, the Board considered that management had not provided enough information for the Board to approve such a significant investment. The Board asked management for more information for its December meeting, including:

  • a more extensive paper including detailed financial statements, cash flow, and profitability figures with sensitivity analysis;
  • a comparison of the project’s value with the long-term plan;
  • the risk of competition; and
  • a risk review.

We understand that the Board did not receive information about a financial operating model for the wood pellet plant or a funding model, setting out the potential effect on Solid Energy’s existing business.

The Board received further information from management during the December 2007 Board meeting, including risks associated with the project and mitigation strategies. Notably, there was no mention of the risk associated with developing a new product for sale into new overseas markets.

The Board also received a report prepared by Mr John Swann, the Executive Director of the Wood Pellet Association of Canada. The review confirmed the feasibility of the project. Again, the Board minutes reflect that the Board questioned management about certain aspects of the proposal, including pricing assumptions and payback periods, and requested further financial information and the potential cash flow implications of the proposal. However, the Board noted its approval in principle of the project. Three Board members were delegated authority to consider the further information and then approve the proposal.

That subcommittee of three Board members met on 31 January 2008. Again, Board minutes show that the subcommittee questioned management about several matters, including sales price assumptions, distribution costs, the drivers of gross margin, working capital assumptions, links to international markets, and the effect of the Emissions Trading Scheme on revenue assumptions and project feasibility. The subcommittee approved $24.6 million to build the first stage of the plant (with a production capacity of up to 60,000 tonnes each year) and approved in principle the expansion of the plant to 150,000 tonnes each year. At its meeting on 18 December 2008, the Board approved increased capital expenditure of $9.3 million for the project, bringing the capital cost to $33.9 million. The cost increases resulted from scope changes, cost increases, omissions, and incorporating some design changes.

In our view, the Board and the subcommittee asked appropriate questions of management about the proposal. There is evidence for this view in the minutes of three separate Board or subcommittee meetings.

Once it had approved the project, the Board received monthly project status reports on the project. The reports covered how the project was progressing against schedule and budget, risk and issues arising, key achievements and activities, and activities planned for the next period.

The plant was opened in March 2010.

Solid Energy carried out a post-investment review of their project, which showed that the project significantly underachieved. In particular:

  • Solid Energy underestimated the complexity of the construction project and the project management resource required to complete it. This resulted in an increased capital cost (see above) and subsequent outsourcing of the project’s management.
  • Sales volumes were lower than expected, especially in target markets (such as Asia). In part, this may have been due to Solid Energy’s over optimistic view of the marketing challenges facing them when entering and developing new markets.
  • Prices received from the sale of wood pellets were lower than forecast and the total and variable costs of production of the wood pellets were higher than forecast.
  • The originally planned capacity of 60,000 tonnes each year was not met. The plant, as commissioned, was completed to a constrained initial capacity (30,000 tonnes of production each year) in order to manage the project within budget and match market demand.
  • As a result of the above factors, gross margins from the plant were significantly negative, and were forecast to continue to be negative in the short term.

We understood that the objective of this investment was to create shareholder value through:

  • building capability and capacity in the biomass energy sector;
  • building sales in the emerging domestic wood pellet market;
  • building a presence in the emerging Asian market and, later, in the existing European market; and
  • securing “first mover” advantage over the required biomass feedstock.

Solid Energy concluded that:

A learning from this project has been that the business would have benefited from a more thorough understanding of the complexities and risks of developing new or emerging markets with relatively new products. Management and directors have discussed the benefit of carrying the learnings forward to future projects and that these should be included in Solid Energy’s future strategic planning sessions.

Those we interviewed noted that, with hindsight, more risk analysis should have been done on the pellet price and market. Also, better financial analysis would have been prudent, specifically to consider the operational costs, including materials to run the pellet plant.

Solid Energy had considered the drivers for investing in renewable energy, specifically carbon price. But its risk assessment about these drivers changing should have been better. The drivers for investing in renewable energy changed in the New Zealand and in the international markets. For example, the Japanese government pushed its mandate about renewable energy back three years because of the global financial crisis. This had a significant effect on sales volumes.


The Board spent a considerable amount of time challenging management about the investment in the Taupo wood pellet plant and there is clear evidence of a high level of scrutiny over the project. However, management underestimated the complexity of the project and the skills required for it, which led to cost increases. Also, Solid Energy did not carry out enough risk analysis about the product’s target markets in New Zealand and internationally. Nor did it sufficiently consider the ongoing operational costs, including materials.

The plant’s capacity was also significantly less than originally planned. Solid Energy followed a reasonable decision-making process to consider the investment in the pellet plant but missed key risks. New business ventures can be costly and risky, and they will not always succeed. The Taupo wood pellet plant is such an example.

Our comments on how these investment decisions and projects were managed

In these two instances, management provided the Board with the necessary information to allow the Board to appropriately consider and approve projects. In addition, if the Board considered it required further information to allow it to make an investment decision, it requested that information from management. The Board’s consideration of the Taupo wood pellet plant provides a good example of the Board requiring more information from management before it was prepared to proceed with the plant. The Board was also willing to challenge management about its proposals.

Management also provided the Board with relevant information to allow the Board to appropriately monitor projects. The information was provided in specific monthly reports and specific management briefings.

Although management provided risk assessments to the Board in these two situations, in the case of the Taupo wood pellet plant the assessment did not recognise some key risks. For example, Solid Energy did not fully understand the complexities and risks associated with developing new or emerging markets with relatively new products. Solid Energy’s forecasts were too optimistic and did not adequately consider a down-side scenario.

4 Solid Energy’s coal price assumptions

Solid Energy’s earnings are largely determined by the price it receives for its commodities – primarily coal.

The chart below sets out the hard-coking coal prices for the period we considered.

Hard-coking coal prices.

The chart shows that there is a lot of volatility in coal prices. The chart shows that:

  • Coal prices were at a peak in 20088, with a significant drop in prices late in the 2008 year.
  • From March 2010 to the beginning of 2011, coking coal prices climbed to reach about US$370 per tonne (in January 2011).
  • From the start of 2011 to March 2012, prices declined. The prices oscillated in September 2011 to late 2011 before declining below US$300 per tonne.
  • From March 2012 to June 2012, prices were reasonably stable at around US$200-US$220 per tonne.
  • From the start of July 2012, prices started to fall significantly, to a low of US$140 per tonne in September 2012 (down from US$225 in June 2012 and a high of US$350 in January 2011).

Solid Energy’s price path

Solid Energy’s short-term price projections are based on direct market information, including supply and demand and feedback from customers. At the time, Solid Energy’s long-term forecasts closely considered oil prices, which directly or indirectly influence the outlook for coal, natural gas, urea, wood pellets, and biodiesel.

We have set out below both the brokers’ consensus price paths and Solid Energy’s price path for semi-soft coking coal and hard coking coal for the 2012 to 2017 financial years. In most instances, Solid Energy’s base forecast was higher than the brokers’ consensus.9

Solid Energy’s forecast “real” semi-soft coal prices versus consensus by brokers (US$/tonne)

Financial year 2012 2013 2014 2015 2016 2017
Broker consensus 191 161 142 128 113 113
Solid Energy Base Case 188 181 194 208 219 230
Solid Energy High Case 236 214 233 251 264 277
Solid Energy Low Case 142 135 135 122 128 135

Solid Energy’s forecast “real” hard-coking coal prices versus consensus by brokers (US$/tonne)

Financial year 2012 2013 2014 2015 2016 2017
Broker consensus 260 225 196 172 158 158
Solid Energy Base Case 250 241 258 277 292 307
Solid Energy High Case 315 285 311 335 352 369
Solid Energy Low Case 189 180 180 162 171 180
Actual 224 135        

The chart below sets out Solid Energy’s 2011 future price path for hard-coking coal compared to the market consensus forecasts.10

Hard-coking coal forecasts

Hard-coking coal forecasts.

In the short term, from 2012 to 2015, the consensus price forecast was within Solid Energy’s price scenarios. Over the long term, Solid Energy had a higher view of oil and coal prices in all three of its price scenarios than the consensus view.

We understand that Solid Energy justified its higher price path compared to the consensus path because Solid Energy:

  • considered that it had a better track record than analysts in predicting future price paths. Solid Energy’s understanding of the fundamentals of global coal and related markets, and its application to its business, had been conservatively accurate in the previous decade;
  • considered that analyst valuations (and capital markets) do not express concern when companies outperform analyst projections, but are rarely happy with analysts when companies underperform relative to forecasts. Accordingly, analysts have an incentive to make conservative project and price forecasts; and
  • believe that few resource companies, at least in the coal sector, rely on market analyst forecasts to make their internal investment decisions.

A comparison of actual coal prices with market analysts’ forecasts and Solid Energy’s price projections shows that from 2008 to 2011:

  • analyst forecasts were generally lower than Solid Energy’s forecasts; and
  • Solid Energy’s forecasts were nearer the actual price ranges.

We reviewed Solid Energy’s Board papers and minutes to see the information that management had provided to the Board about commodity prices and trends and the Board’s consideration of that information. In our view, management provided the Board with:

  • relevant information about price paths that formed the basis of budgets, business plans, and investment decisions;
  • information comparing Solid Energy’s price paths with the consensus price paths; and
  • updates and general information on prices in the Chief Operating Officer and Chief Executive Officer’s reports to the Board. For example, in the first half of 2012, the decreasing coal prices were a recurring topic in Board reports. The reports show that management were monitoring coal prices and considering the implications of the decrease.

We did not see evidence in the minutes that the Board:

  • asked management about its methodology for determining the price path;
  • asked management about why its price path varied from the consensus price path; or
  • asked for a peer review, or external assurance, that management’s price path was reasonable.

Minutes serve as a record of major decisions and are not a full transcript of a meeting. Therefore, we asked about these matters during our interviews. We were told that the Board actively considered and debated the price of coal and the price path adopted during Board meetings. The company had a high-base forecast and a low-base forecast for coal prices. During our interviews, we heard that these forecasts were talked about frequently. The discussion focused on the range and what Solid Energy thought was realistic.

The Treasury told us that it was their view that Solid Energy’s price path was bullish and aggressive. This was a key consideration by the Treasury in reporting to Ministers on Solid Energy’s national resources strategy in 2010. In the Treasury’s reporting, it noted that using the Ministry of Economic Development’s projections would lead to quite different views about risk/return on the projects being proposed by Solid Energy. The timing of this advice was during a period when coal prices were increasing and before the coal price rose to about US$350 per tonne in January 2011.

The Treasury was not the only entity using more conservative projections than Solid Energy. The Treasury commissioned both Macquarie Equities Research and Forsyth Barr to carry out independent valuations of Solid Energy for the purpose of the Treasury’s benchmarking of commercial valuations prepared by Solid Energy. The Macquarie Equities Research valuation was completed in November 2010 and the Forsyth Barr valuation was completed in November 2011. Both used more conservative price paths than Solid Energy had been using to value Solid Energy (for the purpose of determining its commercial valuation, as disclosed in its statement of corporate intent).

Solid Energy acknowledged that its operations and strategy would have to be reconsidered if its forecast price path was not achieved. In one of Solid Energy’s Board papers, which considered the UBS analyst’s view of future coal prices, it was noted that … “clearly if there were persuasive arguments to support the UBS price path Solid Energy would have cause to fundamentally review its current strategy and operations”.

Solid Energy’s risk assessment did not consider the possibility of the extent of price drop that occurred in July 2012. The significant drop in coal prices was not anticipated by Solid Energy or the analyst or business community. The views on coal prices held by Solid Energy, the Treasury, and others all differed. Of course, there is judgement involved in any forecasting, but the price paths of coal and long-term coal prices are particularly volatile.


Risk management requires a Board and management to consider a range of possible scenarios. Solid Energy considered a number of price path scenarios, including a high, base and low-case forecast. We were told that the range of Solid Energy’s price path was regularly debated and acted upon by the Board and management.

However, Solid Energy’s low-case forecast did not anticipate the worst-case scenario, being the significant drop in coal prices that occurred in July 2012. In our view, it is prudent for entities operating in such a volatile market to also consider the worst case scenario, even if it is unlikely. If the impact would be significant it is wise to have given some thought to contingency plans.

Capital expenditure and debt levels

We considered Solid Energy’s capital expenditure and debt levels during the period we reviewed to gain an understanding of Solid Energy’s investment activities and how the company’s price path may have influenced its decisions to invest in new capital.

The table below shows Solid Energy’s capital expenditure11

Year ended June 2009
June 2010
June 2011
June 2012
June 2013
Stockton 50.112 114.513 42.414 41.4 11 259.4
Spring Creek - - - 42.7 15.4 58.115
Huntly East 13.3 18.0 14.4 25.0 10.2 80.9
Rotowaro 0.8 2.4 -0.1 0.6 0.2 3.9
New Vale 2.4 0.8 2.3 3.2 0.2 8.9
Other coal 4.8 6.6 13.2 18.4 7.9 50.9
TOTAL COAL 71.4 142.3 72.2 131.3 44.9 462.1
TOTAL RENEWABLES 30.716 15.2 3.7 1.9 0.3 51.8
UCG 0.4 2.0 11.5 9.5 - 23.4
CSG - 3.8 6.8 - - 10.6
Lignite Gasification - 1.8 5.8 1.2 0.1 8.9
Briquetting - - 5.1 21.3 2.4 28.8
TOTAL NEW ENERGY 0.4 7.6 29.2 32.0 2.6 71.8
Property – Southland 1.9 0.3 2.0 0.1 3.2 7.5
Property – Other 1.8 0.3 4.4 0.3 - 6.8
Corporate 3.3 6.3 6.9 4.4 0.5 21.4
TOTAL CORPORATE 7.0 6.9 13.3 4.8 3.7 35.7
TOTAL CAPITAL EXPENDITURE 109.5 172.0 118.4 170.0 51.5 621.4

The table shows that the company’s largest capital expenditure was in 2009/10, over half of this being on the CHPP at Stockton Mine, closely followed by capital expenditure in the 2011/12 year. We were told that most of the spending in 2011/12 was to complete existing capital investment projects. Most of the spending was incurred in the first six months of the financial year. There was a significant drop in capital expenditure in 2012/13. This timing is consistent with the drop in coal prices.

Solid Energy invested significantly in its new energy and renewable energy projects ($123.6 million over five years) and most of its capital investment was in its core mining activities ($462 million over the five years). This included the significant investment in the CHPP (a major component of the capital investment in Stockton Mine).

The following table sets out some relevant balance sheet information for 2006 to 2013.17

Year ended June 2006
June 2007
June 2008
June 2009
June 2010
June 2011
June 2012
June 2013
Debt 65 29 46 75 225 236 313 399
Equity 234 342 368 434 443 519 423 92
Gearing 21.6% 7.9% 11.2% 14.7% 33.7% 31.3% 42.5%  
Dividends 20 - - 60 54 20 3018 -

he table shows the increased level of borrowing, which funded much of Solid Energy’s capital investment. It gave the company little room to deal with declining revenue when the coal price declined significantly. The high debt and gearing starts in 2010. Debt was used to fund the capital expenditure on the CHPP at Stockton Mine, which was a big component of the increase.

During our interviews, we were told that a big influence on Solid Energy’s debt in 2011/12 and 2012/13 was Spring Creek Mine. Until February 2012, Spring Creek Mine’s assets were held by Spring Creek Mining Company Limited, owned 51% by Solid Energy and 49% by Cargill International SA (Cargill).

Throughout our review of Board papers, we noted a number of references to poor performance at Spring Creek Mine. For example, a report went to the March 2009 Board meeting outlining the performance of the mine and its effect, both from the shareholders’ perspective and from a banking perspective. The report noted that there had been:

  • high development costs;
  • delayed extraction of coal; and
  • less extraction than planned in some panels.

Furthermore, the Board queried health and safety risks at the mine.

For the year ended 30 June 2011, Spring Creek Mining Company was reliant on support from shareholders to operate as a going concern. Cargill sought to withdraw from the partnership, and a decision was made for Solid Energy to purchase Cargill’s share of the business.

We did not review the Board’s decision-making process to buy out Cargill’s share of the business in this additional work. We note that this may be an area that the Committee might wish to explore with the company if it wants to understand more about this project.

After Solid Energy bought out Cargill, it immediately considered options for partial divestment. We were also told that Solid Energy was proposing to put Spring Creek Mine into “care and maintenance” (that is, rather than production) in early 2012. In August 2012, Solid Energy, in its quarterly report to the shareholders, reported that poor development rates continued, there were ongoing Department of Labour interventions with safety incidents, and partner discussions had stalled due to the difficult market environment. In September 2012, the Treasury commissioned a mining expert to report on the future operation of Spring Creek Mine. The review found that that the mine had been deployed in the most appropriate method of mining. However, it was recommended that, if the mine could not be expeditiously returned to a cash positive status, then it should be placed in care and maintenance. The decision to put Spring Creek Mine into care and maintenance was made in October 2012. 

The decision in October 2012 was a significant time after Solid Energy had first considered the need to put the mine in care and maintenance. During this time, the mine was operating at a loss and was having a detrimental financial effect on the business. We have not quantified that financial effect.


The Board and management actively and regularly considered the price path. However, some critical decisions (both operational and capital) made by management and the Board meant that the company was more highly geared when coal prices dropped significantly in July 2012. There was also a delay in decision-making around the future operation of Spring Creek Mine and the continued operation of the mine had a detrimental effect on Solid Energy’s debt levels.

The investment decisions made by the Board and management, and the delay in decision-making in respect of Spring Creek Mine, resulted in a company that was not resilient to the substantial and sharp drop in international coal prices.

5 Response to the drop in coal prices

A lot of attention has been given to the sharp drop in international coal prices that occurred in July/August 2012. However, as noted earlier, the price of coal had been declining from the start of 2011 to March 2012.

January 2011 to June 2012

Solid Energy was aware of and monitoring the drop in coal prices. In February 2012 Solid Energy was flagging that market downturn in coal prices was occurring. In the 2010/11 financial review of Solid Energy, held in April 2012, the Chairman explained that the international demand for hard-coking coal had decreased, putting coal prices under increasing pressure. Solid Energy expected further weakening of international coal prices and that it would lead to a drop in export revenue of around $200 million. However, Solid Energy was confident in the long-term demand for coal.

In our interviews, we were told that Solid Energy was actively responding to the drop in coal prices. Early in 2012, the company made a decision to cease new capital expenditure. At the March 2012 Board meeting, possible options for further cost reductions and potential divestments were discussed. A company restructure took place, which resulted in some staff losing their jobs. As noted above, there was also discussion about placing Spring Creek Mine in care and maintenance at this time. 

July 2012 to 30 June 2013

Solid Energy has said that the reason for its financial distress was the unprecedented and unexpected decline in coal prices in 2012. For example, Mr Don Elder, speaking at Solid Energy’s 2011/12 financial review said that:

In the second half of 2012, last year, the coal industry around the world received a stunning blow from an unprecedented collapse in international coal prices. Coking coal prices, our primary export, fell very fast, far, far below the range anyone was forecasting anywhere in the world. Unlike the previous two downturns in 1999 and 2008, this time the Australian and New Zealand dollar stayed very high. Our export prices in New Zealand dollars dropped back to 2004 levels. It may not sound that significant, but we were now mining coal in 2012 that was at least three times deeper than the coal we had available to mine in 2004. What that means in mining terms is that the cost of mining three times deeper is likely to be six or nine times higher, and, in fact, the achievements we’ve made on productivity meant the cost was only four times higher. But the price was still back at 2004 levels and our mining was three times deeper and four times more costly. Even Stockton mine was cash-negative during the low part of the price period in 2012. So for us, like almost every other coal company in Australia, this was the perfect storm. The global industry, which had been very strong, fell from strong to struggling in the space of less than 3 months.19

Analysis of coal prices supports Solid Energy’s view that the fall in coal prices was the primary reason for its financial distress. Other evidence confirms that Solid Energy was significantly and adversely affected by the sharp decline in coal prices. For example, Deloitte state that:

It appears that the ultimate failure of Solid Energy was primarily due to a steep and sustained fall in coal prices in mid to late 2012 that neither the company nor the analyst community had foreseen.20

The pricing issues that Solid Energy faced were international. According to research by UBS, in the 12 months to August 2012, an index of Australian listed coal companies was down 42% (in Australian dollars), relative to a 10% drop in the ASX 200 index. Since January 2011, an index of United States coal companies was down 68%, with some companies within the index down 80-90%. In comparison, the S&P 500 index was up 0.5% during the same period.21

Finally, while coal prices were falling in 2012, the New Zealand dollar was strengthening against the United States dollar. This made Solid Energy’s financial position worse.

The effect on Solid Energy’s revenue from the declining coal price and, to a lesser extent, the strengthening New Zealand dollar, has been significant. Solid Energy estimated that its revenue was forecast to fall from NZ$978 million in 2011/12 to NZ$645 million in 2012/13, a drop of NZ$333 million (or 34%) on smaller coal volumes.22

As a result and as explained earlier, Solid Energy has had to fundamentally change its strategy.


The Board and management continued to adapt the business and their strategy to address the decrease in coal prices from the beginning of 2011. They also adjusted forecast assumptions and activity as a result of their deliberations.

Solid Energy’s actions were not transparent to all parties, including the Treasury.

6 Findings

In the two projects we considered, we found that Solid Energy had good processes in place to ensure that the basic disciplines of planning, reporting, and project monitoring were in place. However, when considering Solid Energy’s risk management for the Taupo wood pellet plant, we did not see enough consideration of the worst-case scenario in respect of the product’s target market.

Solid Energy should have thought more about the risks of the plant. In undertaking the post-investment review and through our interviews, we heard that, with the benefit of hindsight, a more robust risk assessment would have been beneficial and was a key lesson for the Board and management for the future.

We also found that Solid Energy did not consider the worst-case scenario in respect of coal prices. Solid Energy did actively consider a range of coal price scenarios and debated these. The Board and management also reacted to changes in the coal price. We saw evidence of this through cost-reduction initiatives and discussion on asset divestments. But the significant drop in coal prices in July 2012 was never anticipated, so Solid Energy was not alone.

The investment decisions made by the Board and management and the continued operation of Spring Creek Mine meant that Solid Energy was not in a financial position to react to the sharp and large drop in coal prices.

The investment undertaken by Solid Energy was consistent with its business strategy. However we found that the company’s investments and reasons for these were not always transparent to all parties, such as the Treasury.

7 Lessons that can be learned by Solid Energy and other public entities

Clear communication is important between shareholders, the Board and management

Mining coal in New Zealand is technically difficult and the coal price is volatile. This increases the risks for the business. These risks need to be managed by clear communication, strong management, and good governance.

We found insufficient clear communication between Solid Energy and its shareholders. Good communication is essential for the Board and shareholding Ministers to make good decisions and for monitoring agents to provide support for that decision-making.

There was a lot of discussion between the Treasury and Solid Energy about the future price of coal rather than a discussion about how Solid Energy would manage the risks of a change in the path of coal prices. There was not enough effective communication.

The Solid Energy proposal to expand and grow the business into a national natural resources company typifies the communication problems. The Board believed that the proposal was “audacious” and put it to the shareholders for initial review. Officials did not support this proposal, but the lack of support was not clearly communicated to the company by the shareholders. Instead, communications were interpreted by Solid Energy as indicating that there was no support “at that time”, rather than as a message to abandon the idea. Differences in views need to be made clear and discussed early.

Good risk management requires a sceptical mindset

We found that Solid Energy did not give sufficient attention to possible downside risk in its planning and forecasting. Nor did it think about a worst-case scenario and develop a contingency plan for dealing with the unlikely. We encourage entities to keep an eye on risks of all kinds.

Solid Energy appeared to take an optimistic view of the market for pellets produced from the Taupo wood pellet plant. The company also had a more optimistic view of future coal prices than others in the industry.

Organisations face all sorts of risks. The governing body has to maintain an overview of those risks and have systems or advice streams in place to assure itself that those risks are being appropriately managed.

The Board and management need to include relevant industry experience

In our view, the Board was receiving adequate information and asking the right questions.

From 2008 to 2012, there was only one Board member and one member of senior management with mining experience. Having a senior management team and Board with industry-appropriate skills provides relevant and additional expertise and contributes to the effectiveness of the management and governance of an organisation. A Board needs to have the right experience and a broad range of skills.

In our view, a company involved in coal mining should have some Board members with commodity experience. This helps them to ask the right questions and helps to provide independent thought about the operational risks of the entity.

The same principle applies to management. We believe that there should also be a level of relevant experience of the business in management.

Project scoping and management need to be clear and thorough

Projects need to be scoped well, and the key assumptions for completing the project need to be clearly considered. This includes consideration of not only the construction phase of the project, but also the future operations of the project. In our view, there was not enough ongoing consideration of the key assumptions about the Taupo wood pellet plant. Solid Energy did not adequately consider the risk of a change in national or international policy. Changes to policy affected the demand for the plant’s products and resulted in a project that was not successful. We accept that this lesson is learned with the benefit of hindsight.

It is right to invest in core assets

Solid Energy recognised a need to invest in, and maximise the life and productivity of, its core coal assets. It planned and executed construction of the CHPP well. In doing so, it maximised the ability of Stockton Mine to continue to produce coal in challenging circumstances.

This capital investment has helped Solid Energy to remain in operation in difficult trading conditions. In the current low price environment it is more economic to leave what is now expensive and deep hard coking coal in the ground. The CHPP allows previous waste stockpile coal to be washed and meet contracted hard coking coal obligations and maintain reserves. Without the CHPP Solid Energy would not be able to respond to this low pricing environment as it has.

1: Solid Energy Strategic Plan overview, and Solid Energy’s Business plan 2012-2014, page 2.

2: Solid Energy New Zealand Limited media release, 9 May 2007.

3: T2011/2373: Solid Energy New Zealand Limited Scoping Study Report, page 2.

4: Agenda Item 10; Mixed Ownership Model: Scoping Studies, Solid Energy Board Meeting, 18 October 2011.

5: Minutes of the Solid Energy New Zealand Limited meeting of the Directors on 18 October 2011.

6: Solid Energy New Zealand Limited, Annual Report 2013, page 3.

7: We note that this was outside of the timeframe of our review, but we considered information from November 2007 for this project in order to provide a complete picture of the Taupo wood pellet plant investment.

8: From February 2008 coal prices climbed from around US$200 per tonne, peaking in June 2008 to around US$400 per tonne.

9: Solid Energy: Extension of mixed ownership model scoping study, page 126 and Solid Energy New Zealand Limited.

10: Solid Energy: Extension of mixed ownership model scoping study, page 30.

11: Information provided by Solid Energy New Zealand Limited.

12: Includes $28.5 million relating to the CHPP (there were also low levels of capital expenditure on the CHPP in earlier years).

13: Includes $87.6 million relating to the CHPP.

14: Includes $11.7 million relating to the CHPP.

15: In addition, Solid Energy contributed $56.2 million of capital expenditure to Spring Creek Mining Company over the five years under review.

16: Comprises a significant level of capital expenditure for the Taupo wood pellet plant.

17: Deloitte (19 April 2013), The Treasury: Review of Monitoring of Solid Energy Limited, page 12. The information for the June 2013 year has been extracted from Solid Energy’s 2012/13 annual report.

18: The $30 million dividend paid in 2011/12 was the final dividend made in respect of the 2010/11 financial year and was paid in September 2011.

19: 2011/12 Financial Review of Solid Energy Limited, Appendix C, page 48.

20: Deloitte (19 April 2013), The Treasury – Review of Monitoring of Solid Energy Limited, page 44.

21: Treasury Report Aide Memoire, 14 August  2012, page 1.

22: Solid Energy Limited’s opening comments to Commerce Committee, financial review of Solid Energy Limited, 7 March 2013.