• J niti?o o S o
Manx Electricity. Authority
Review on behalf of the Isle of Man Government into the recent affairs of the Manx Electricity Authority and "subsidiary" companies Manx Electricity Authority PKF
Contents
Page
Introduction 1
Executive summary 6
3 Historical trading performance 16
Historical assets and liabilities 34
Historical cash flow generation 60
4 Accounting policies 69
Previous forecasting history 71
Projected trading and cash flows 75
Review of contractual relationships 93
10 Financial reporting environment and liaison with auditors ..115
11 . Review of Board minutes and delegation of responsibility..126
12 Review of bank tendering process 135
13 Review of legal opinions 142
14 Skyward 145
1 July 2005 Contents .
Manx Electricity Authority • PKF
Appendices 1 Scope of PKF engagement letter dated January 2005 2 Board response to PKF questions 3 Letter from the MEA to Barclays dated 26 February 2004 4 MEA business plan for the five years to 2005 5 , - Cains letter dated 9 July 2003 6 PAIN Elizabeth Appleby OC's notes
1 July 2005 v Contents Manx Electricity Authority PKF
Introduction
1.1 • In:accordance with our engagement letter dated January 2005 addressed to the isle of Man Government we have carried out a review of the recent the affairs of the Manx Electricity Authority ("the MEA" or "the Authority") and companies which are wholly owned by the MEA, which we refer 1 to as subsidiaries'.
1.2 ' Our report is solely limited to the matters set out in the scope of our engagement letter, which is • attached at appendix 1.
•
On 23 May 2005 PKF transferred its business to a new limited liability partnership, PKF (UK) LLP. This report.is therefOre •a report prepared and issued by PKF (UK) LLP.
1 July 2005 • Introduction
Manx Electricity Authority 13Kr
1.3 In preparing our report we have held discussions with and/or received information from the . following:
Role MEA and subsidiaries
• The non executive Board of the MEA John McCallion Chairman Terry Mackay Deputy chairman Trevor Ferrer Member Dr John Taylor Member Charles Fargher Member Ashton Lewis Chief executive Mike Proffitt Former chief executive Clive Wilcox Director of corporate services Ross Stephens Commercial manager Paul Dewar Head of internal audit • Clodagh Maher Financial accountant Jim Crombie, John Beckett and Bill Cochran Generation and project directors respectively Paul Tudge Commercial manager Richard Bujko and Paul Barnett Energy director and risk analyst respectively Dr Jennie Relief Commercial manager — Skyward project KPMG Audit LLC Mike Gardner Audit partner to the MEA Michael Fayle z partner to the MEA Raymond Gawne Audit manager Banking relationships Andrew Baxendale Corporate manager Royal Bank of Scotland/Isle of Man Bank David Boulter Area manager HSBC Jonathan Pine, Les Coates, Keith Reay and Phil Barclays Private Clients International O'Shea Government Colin Kniveton Financial controller to the Treasury Clive McGreal Chief internal auditor to the Treasury Chris Corlett Chief executive Department of Trade and Industry John Corlett, QC Attorney General to the Government David Morter Director of Infrastructure Development Mary Williams Chief secretary Alan Bell Treasury minister 7 Mark Shimmin Chief financial officer Richard Corkill Former Chief minister John Cashen Former Chief financial officer Fred Kissack Former Chief secretary
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Manx Electricity Authority PKF
Role Ken Bawden Former Chief executive Department of Trade and Industry • We asked a number of specific questions of the Board and their written answers are reproduced in full in appendix 2. We do not comment on this response and note that it includes certain opinions and statements that are not shared by the Treasury or the DTI
1.4 t This report is based on discussions with and the information supplied by the above. Our review n'as not constituted an audit in accordance with Auditing Standards of either the financial or non- financial• information presented to us and will not necessarily have disclosed all matters of • significance. • 1.5 Drafts of this report has been reviewed by the MEA and draft extracts have been reviewed by • those parties specifically referred to in this report and their comments have been incorporated where appropriate. This has been carried out solely to ensure the factual accuracy of the report.
1 .6 Where we have reviewed the financial projections of the MEA we do not express an opinion as to whether future cash flows will correspond to those projected. We would emphasise that whilst we include Certain comments on assumptions underlying the projections, the accuracy of the -; projections. and the assumptions remain the responsibility of the Board and officers of the MEA 1 • who alone are able to judge their reasonableness.
• .1.7 This report has been prepared for the sole use of the Chief Minister and/or Council of Ministers of . .the -Isle of Man Government and may not be disclosed to any other person without our prior written consent. No other person receiving this report should act in reliance upon its contents (which may be unsuitable for any purpose other than that for which it was prepared). Any person who, notwithstanding the foregoing, elects to place reliance upon this report does so at their own risk and PKF assumes no duty of care or other responsibility towards them.
Background
,1 .8 The following text has been provided to us in writing on behalf of the Board of .MEA and sets out I the" Board's view. of the context for the need for additional electrical power supply on/to the Isle of • Man:
"The current Board was appointed in January 1997 at the request of the Department of Trade 0 . Industry and .charged with addressing their concerns about the adequacy of strategic planning for future supplies of electricity. It can be seen from the Mertz & McLellan report into the Scottish Power Bid iri 1991 that MEA were forecasting load growth of 1 to 1.5 Megawatts per year. In 1991 the system load was 56 Megawatts and the forecast was that by 2014 the load would be 82 Megawatts. In fact we [the Isle of Man] reached that load of 82 Megawatts by 2002 which is some twelve years ahead of the original forecast.
2 For legal reasons we ha.ie blanked out part of the Board's response to question 19.
1 July 2005 Introduction 3 Manx Electricity Authority PKF
This radical change was brought about by the economic strategy adopted by the Government. The success of which has achieved a huge improvement in the economic wellbeing of the Island. The outcome of this as far as IvIEA was concerned has been a dramatic increase in power demand ' that required a commensurate response from the Board to ensure this increase in prosperity was not jeopardised by an inability to provide supplies of electricity.
Each member of the new Board was appointed because of their proven commercial experience and strengths within industry. The new Board very quickly picked up the issues that were of concern, the most serious being the lack of generation capacity to meet the rapidly increasing commercial and industrial demand - on a number of occasions we were perilously close to a lights out situation. Other areas of concern were the lack of an internal audit department and poor corporate governance in addition to no management succession planning, which is fundamental to any business. All these issues have been successfully addressed.
The simple solution with regards to capacity would have been to put two AC subsea electricity cables to the UK — this was strongly opposed by Government on the grounds that they were adamant we [the Isle of Man/MEA] retained generating capacity and remained independent of outside control. A second option was to build a new, green-field site power station because the then current Pulrose Power Station had some serious environmental issues for the surrounding population. Unfortunately, we know that to obtain planning permission for the new green field site facility could have taken many years (e.g. New Prison — 10 years, Incinerator — 20 years) which was out of the question. It was therefore decided to build a new facility on the existing site with the deblared • policy of making it both environmentally acceptable and a state of the art facility, complementing the neighbouring National Sports Centre, and at the same time linking into the existing MEA high voltage circuit and the subsea cable link into the National Grid to provide a safe and secure supply of electricity to the Island. At this stage Mike Pro if'i tt, an existing Board Member, was appointed Acting Chief Executive and agreed to oversee the project management because of previous project management expertise. To do this the Board felt he should resign his Board position and. consequently be answerable to the Board for all Executive rationale.
The Board sought a Commitment from Mr Proffitt to successfully implement the laid down 5 year plan. it was at this stage that we were approached by Government to study the feasibility of bringing Natural Gas to the Island which was previously an aborted project of Government. 3
On Mr Proffitt's appointment he developed a very close working relationship with both the Department of Trade and Industry and the then Chief Executive of the Treasury (Mr Cashen) for 3 years and they jointly with Clive Wilcox, Director of MEA Corporate Services negotiated the Bond with the clear understanding that at some future date it would be tapped for additional funds.
3 The DTI do not agree with the Board's comments on the feasibility study. The DTI state that this was a joint project between the DTI and MEA whereby a number of possible options were investigated, presented to Tynwald after which a budget was voted to the DTI to fully investigate the SIPS II option. Shortly after this • the project was handed over .for the MEA to complete as it was by now an integral part of the Pulrose power station project.
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During the course of the ongoing development the Board have seized the commercial opportunities which became available to the MEA in both securing a continuity of supply and at the same time broadening the revenue opportunities which is in keeping with many utility companies within the UK and Europe. 4 "
1.9 We note that the above statement "with the clear understanding that at some future date it would
be tapped for additional funds" is not consistent with the statement made on the floor of Tynwald , by Mr Gorki!! on 11 July 2001, when the £185 million treasury bond issue was approved by Tynwald, as follows:
"The MEA believes that subject to electricity demand not massively outstripping its projections, the. borrowing of the planned £185 million will provide secure and long-term finance sufficient that the MEA will be able to fund any Nture capital projects without further government or external borrowings."
1.10 -, Mr Corkin 'went on to state that the cost of the MEA's infrastructural work which related to the borrowing authority of £185 million were indicative costs. We understand that at this stage the
. project had not been specified in detail.
1.11_- Mr John Cashen has confirmed to us in writing that:
"At the time that the bond. issue was put in place there was no indication from the MEA that the proceeds of £185M would be insufficient to meet the Board's agreed capital programme... The cost of the agreed capital programme was £185M. The bond was for about 34 years; who could determine in 2001. what other capital expenditure would be required over the next 34 years? _ However it was certainly not envisaged that there would be significant additional capital • •• expenditure required by 2004."
1;12 t. me Corkill has stated to us in writing that:
"I can confirm that it was definitely my opinion at the time of the initial 185 million pounds [sic] bbnd, that this was the total planned spend 'required for the proposed capital infrastrUcture• program [sic]... I wish to make it clear that I was never advised by anyone that costs would exceed [E] 185 million."
4 Neither Treasury or the DTI share this view and consider that the DTI played the primary role in securing --the Island's future supply of electricity rather than the MEA.
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2 Executive summary
2.1 We were instructed in January 2005 to carry out a review of the MEA by the Isle of Man Government. The scope of this review was determined by Treasury and approved by Tynwald. The scope was to cover the following key headings in relation to•the.MEA: ( <,
historical cash floW generation;
• historical assets and liabilities;
• historical trading performance;
• financial prospects;
• contractual/cOMmercial matters;
• various other matters.
2.2 The period covered by the historical review was the three years and nine months ended 31 • December 2004 being the period which coincides with the construction and commissioning of the new Pulrose emitter station.
Background
2.3 Due to substantial economic growth the on-Island demand for electricity had been projected to increase rapidly. In 1991 the system load was 56 Megawatts whilst the forecast at that time was that by 2014 the load would increase to 82 Megawatts. In fact the load of 82 Megawatts was reached by 2002.
2.4 It became evident that there was a need for a strategy to meet this demand and following the decision by Government to maintain on-Island generating capacity, it was agreed that the most desirous solution was to build a new power station at the existing Pulrose site. In order to ensure' • flexibility of fuel supply it was agreed that the new power station should be capable of running on both oil and gas.
2.5 A key part of this strategy was the objective to bring clean gas supply to the Island. This required a tap into the existing and/or planned Scotland to Ireland undersea gas pipelines.
2.6 The funding to finance the above capital programme was approved by Tynwald in July 2001 via the issue of a E185 million Treasury bond.
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. • The above capital programme has been substantially completed so that the Isle of Man now has a - modern and highly specified dual energy supply power station together-with the ability, under a • longterm contract, to bring gas onto the Island to supply both the power station and via Manx Gas,
- the domestic and industrial gas requirements of the Island.
2.8 In addition, via the interconnector cable, the Island has access to a fibre optic cable capable of providing a high speed telecoms link with the UK.
2.9.4 We summarise below the key issues arising from our review. This summary should be read in the context of, and in conjunction with, both the scope of our review and the detail of this report.
Historical cash flow,. trading and net assets fi
2.10' After re-stating the accounts to comply with UK GAAP 5 and adding back the exceptional performance bond receipt 6 the MEA has made cumulative losses over the three years and nine months ended 31 December 2004 of £27.9 million. This figure is not final as the adjustments in . 'respect of the restatement of interest charges and the treatment of payments to BGE in relation to `the SIPS. 11 gas spur pipeline capacity costs are still being discussed by. the MEA with its auditors, KPMG.
' 2.11 Over the same period the MEA has incurred a net cash outflow after interest but before Capital expenditure and borrowings of £10.0 million. Over this period the MEA has spent £273.1 .million on capital expenditure (including the purchase of the 50% of MCC formerly owned by National Grid 'Company-and subsequent refinancing of MCC's debt).
2.12 At 31 December 2004 the MEA had net assets of £48.3 million, primarily made up of fixed assets . of £349.5 million less external' borrowings of .£304.1 million.
Capital expenditure .. • . 2.13. - The MEA was lent the proceeds of the £185 million Isle of Man Government bond issue. This was - • primarily to be used to fund the construction of the new gas fuelled Pulrose power station and associated infrastructure works and the acquisition of the NGC stake in and refinancing of the existing external debt of MCC. An analysis of the indicative capital cost programme submitted to . Treasury and subsequently presented to Tynwald by the Chief Minister to approve the bond issue is set out at.paragraph 2.1,7 below.
5 The• MEA's statutory accounts, which have been prepared in accordance with the Audit Act 1983, have not however complied with UK GAAP in relation to the capitalisation of interest charges arising on the loan of £185 million."
6 The MEA received an exceptional payment in the financial year ended 31 March 2004 of £10.2 million from J.P Morgan in relation to the collapse of Enron ("the performance bond receipt"). This has been treated as a revenue receipt in the M EA's draft 2004 accounts.
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2.14 An- outline analysis of MEA's actual capital expenditure, excluding capitalised interest, over the period is as follows:
£000 Power station related costs 138,866 Cross island gas pipeline 23,519 Pressure reduction system 19,176 BGE capital payments 11,100 Acquisition of 50% of MCC (including refinancing of debt) 54,597 Other capex generation and pipeline related capex 7,669
254,927' On going network capex 15,589 Other capex 2,542
Total capex (excluding capitalised interest) 273,058
2.15 The above compares to a total of £183.5 million included on capital returns to Treasury over the same period, a difference of £89.6 million of which the principal differenCes are:
• AcquiSition of 50% shareholding in MCC and debt refinancing not included on the returns to Treasury - £54.6 million;
• Amounts capitalised in PGT after the relevant return to the Treasury had been submitted and not subsequently corrected on the quarterly capital returns - £36.0 million.
2.16 The analysis of capital expenditure supplied to Treasury via the quarterly returns was insufficient to allow a reconciliation of the information contained in the returns to the indicative capital cost programme submitted to Treasury without additional information. We are not aware that the Treasury attempted such a reconciliation or requested the further information required. We are informed by Treasury that such a reconciliation would not be attempted as a matter of course as, in the absence of a request for further funding, Treasury would conclude that the total costs on the quarterly returns did not exceed the indicative capital cost programme. In addition, a proportion of the 2002 expenditure would have been incurred prior to the drawdown of the loan from the Government .and therefore should not be matched against the indicated use of the £185 million.
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Manx Electricity Authority PKI
2.17 The Board of the MEA received regular updates of the estimated capital cost of the power station project and associated infrastructure via monthly Board packs. A comparison of the original „ . indicative costs supplied to Treasury/Tynwald with the revised total forecast expenditure on these .capital projects at various points is as follows: • Tynwald Total forecast capital expenditure Jul 2001 Apr 2002 Mar 2003 Mar 2004 Jan 2005 ,.. £m £m £m Lin £m CAPITAL SCHEMES: Pulrose Power Station .► A EPC Contract, Pulrose site and system network and commissioning costs 80.0 84.4 101.3 . 128.9 129.0 . MEA Works re Pulrose Power Station • 11.9 11.0 10.9 10.8 'Gas pipeline to Isle of Man Development fees 4.0 4.4 4.4 4. Pressure reduction station Construction and related costs 2.8 9.2 14.5 . 15.1 Cross-island gas pipeline 20.0.. 17.5 23.9 23.5 23.5 Pulrose Diesel Station Workshop redevelopment - 3.3 3.2 2.8 2.8
100.0 119.9 152.6 185.0 185.6
4 INTERCONNECTOR CABLE: 'Acquisition of NGC share of * 18.0 18.0 18.0 18.0 ,MCC Repayment of loans - 31.0 31.0 36.0 • 36.0
50.0 49.0 49.0 54.0 54.0 OTHER: . Wind farms 10.0 10.0 10.0 10.0 10.0 Transmission strengthening 25.0 16.4 16.4 16.4 :16.4 7 Treasury debt repayment • 2.0 2.0 2.0 2.0 Bond issue costs .- 2.0 2.0 2.0 , 2.0 A
35.0 30.4 30.4 30.4 30.4' ri 185.0 199.3 232.0 269.4 270.0
. . • The total cost of £50 million was not analysed further in the proposal to Tynwald The above analysis excludes capital expenditure not associated with the Capital Project'
2.18 We refer to the above programme of works as the "Capital Project" in the rest of this report.
2.19 Of the above, the £10 million allocated to wind farms has not yet been spent.
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2.20 We understand from the Beard that the indicative cost figures submitted at the time of the bond issue did not represent a budget and that it was always expected that additional funds would be. required and . that these would be supplied via a further "tapping 'of the bond". The Board also believes that. Government ministers/officials similarly anticipated further 'bond tapping. We have not seen documentary evidence to support this nor have those Treasury or Government officials contacted by us acknowledged this to be the case.
2.21 • The Board considers that, via the quarterly capital returns to Treasury and the MEA's annual • reports, capital expenditure was being properly reported to the Treasury. It does not consider that it was necessary to have further informed Treasury of the increase in the capital costs of the above projects compared to the figure of £185 million submitted to Treasury. Treasury's view of this is as set out at paragraph 2.16 above, namely that, in the absence of any indication from the MEA that costs were significantly greater than originally anticipated it would not have carried out detailed analysis of the figures provided to them.
2.22 The 2002 annual report (being the first year in which the MEA spent significant amounts in relation to the-Capital Project) discloses capital expenditure in that year of £93.3 million (note 6). The 2003 annual report discloses further capital expenditure of £98.2 million (note 6) with capital commitments of £34.9 million. Taken together these indicate total actual and committed capital expenditure of £226.4 million. Treasury note that the 2003 accounts were provided to them in February 2004, i.e. after the first Barclays loan had been drawn down and the month in which the second loan was approved.
2.23 In his Chairman's Statement to the 2003 annual report, Mr McCallion states in relation to the power station project that we have delivered this project on time and on budget."The Board have confirmed that this statement related solely to the direct cost of the EPC contract.
External borrowings
2.24 At 31 December 2004 the MEA consolidated net debt was as follows:
£000
Due to Isle of Man Government 185,000 . • Due to Barclays 110,000
295,000
2.25 In addition to the above, accrued interest charges at 31 December 2004 totalled £8.9 million.
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2.26 The amount due to Barclays has been borrowed by MCC. Of the total Barclays debt drawn down at 31 December 2004, a total of £104 million had been paid into the MEA's bank account with the balance being either retained by MCC or paid to PGT. The Board have stated that these transfers to the MEA relate to purchases of fixed assets from MEA. The current draft of the 31 March 2004 accounts has been drawn up to reflect this although we have not had sight of this draft. • 2.27 • KPMG's preliminary view of this proposed treatment is that it is not supported by • • contemporaneouS documentary evidence. KPMG have requested confirmation from the Board of the MEA of the proposed treatment and further documentary evidence to support it. As at 24 June . 2005; the latest practicable date prior to issuance of this report, they had not received such confirmation or evidence. •!' 2.28 It is possible that the final treatment of these transfers will be significant in determining the nature of these transactions under the Electricity Act 1996.
• 229 The £110 million Barclays debt at 31 December 2004 is made up of two facilities being:
A £70 million facility agreed in July 2003;
A £50 million facility agreed in March 2004.
2.30 • At 31 DeCember 2004 £10 million of the £50 million facility had not been utilised. We understand that the MEA has subsequently sought Treasury consent to draw this down.
• :I-2.31 • The £70 million facility is due for repayment in September 2008 and the £50 million, earlier, in September 2005.
2.32 •' The provision of the first £70 million facility was the subject of a tendering process on the part of the MEA.' We have reviewed the papers provided to us by the MEA related to the tendering for the t. •
provision of debt and also held discussions with representatives ' of the banks that . were ' • approached, being Isle of Man Bank, HSBC and Barclays Private Clients. We consider that the tendering process, in relation to which the cost of the debt was the over-riding factor, was • independent and, based on the documents we have seen and discussions we have held, there is ,no indication that the former Chief Executive's position on the Board of Barclays influenced the choide of Barclays as debt provider. The Board of the MEA has confirmed this to be the case.
• 2.33 -In relation to the first facility, Barclays offered the MEA a reduced borrowing rate if the debt was guaranteed by the Isle of Man Government. This would have reduced' the borrowing costs on the £70 million facility by some £600,000 over the term of the loan. The Board has stated that it did not pursue this option on the basis that the Barclays loan was considered to be interim finance , • which would be repaid out of further bond proceeds and to seek a Government guarantee would have led to delays in the ability of the MEA to fund the Capital Project. At the time that the first Barclays loan was taken the MEA estimates the cost of a delay in the Capital Project at £50,000, per day. We have not reviewed the basis of this estimate.
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2.34 • The second facility was not the subject of a tendering process on the basis that the previous process had taken place less than 12 months earlier.
2.35 Both facilities were provided to MCC with the MEA acting as guarantor.
2.36 As part of the approval process for both loans, Barclays obtained legal opinions from Gains Advocates on the legality of the loans and also the provision of the guarantee by the MEA. These • opinions were addressed and solely provided to Barclays. The Gains opinion letters are complex in their structure but conclude that there is no restriction on the ability of MCC to borrow either .
under its articles or under the Isle of Man Companies Acts and that, provided that the facilities, are used for purposes that are within the MEA's power, the provision of a guarantee by the MEA is_ within its power. We understand that this advice was subsequently confirmed after the event, by the Attorney General in written advice .(of which we have not been provided a copy) to Treasury, dated 15th November 2004.
2.37 The Board did not obtain its own legal opinion in relation to the legality of the borrowings but relied on the Gains opinion. The Board had earlier obtained a legal note from Ms Elizabeth Appleby QC on the different subject of PGT taking over the Enron Power Station contract and MEA potentially - providing guarantees to contractors. Our understanding of her note is that Ms Appleby expressed doubt as to the ability of a subsidiary of MEA to do more than the MEA itself can do and also that - there was doubt over the ability of MEA under the Electricity Act 1996 to provide guarantees to • third parties.
f 2.38 The Board's view of these possibly conflicting opinions is that the Gains opinion takes precedence on the basis that it expressly considered the issue of borrowing by the MCC and was prepared under Manx law. (the Appleby note was under English law). This is a matter of law and therefore not one upon which we are qualified to opine. KPMG have written .to the MEA setting out their view,- based on QC advice, that there is a case for the Barclays loans and related guarantees by the MEA being "contrary to law". The Board of the MEA refute this. We 'understand that this matter is ongoing and has not yet been resolved.
2.39 The Board has stated that it considered that they had adequately informed Treaiury of the Barclays loans on the basis that the 2002 and 2003 annual accounts showed borrowings in excess of £185 million (2002: £218.5 million.gross but £86.1 million net'; 2003: £217.0 million gross and £193.3 million net) and that the Treasury should have been aware from the quarterly returns that the MEA had incurred costs in excess of the £185 million borrowings.
2.40 In addition, the Board haS stated that based on the cumulative fixed asset additions from 1 April 2001 to 31 March 2003 of £191.5 million plus capital commitments of £34.9 million as disclOsed in the March 2003 statutory accounts, Treasury should have been aware that the cost of the Capital Project was going to be in excess of £185 million. Treasury's view of this is set out at paragraph 2.16 and 2.21 above. . f.
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- • . 2.41 . » In relation to the second facility, Barclays asked the MEA for confirmation that it had the ability to A • ensure that the Government would arrange lake out" finance within the 18 month period of the • new lOan. MEA provided a letter to Barclays on this subject and a copy of thig letter is attached as . appendix 3 to this report. The letter was approved by the Board as a whole as part of the formal, loan approval process. We understand that neither the content nor the substance of this letter was discussed with the Government or Treasury by the MEA or Barclays.
• -2.42 Prior to the Barclays facilities, the previous material borrowing by either the MEA or its subsidiaries was in relation to the MCC HSBC facility used to fund the construction of the interconnector cable.
2.43 So far as we are aware no Treasury consent was sought prior to MCC taking out this borrowing
-.although ,the MEA requested and received consent for the borrowing it took out to fund its investment in MCC:
Projected trading and cash flows
2.44- The MEA has prepared financial forecasts for the period through to 31 March 2011. These "indicate a further funding requirement, after the drawing down of the remaining £10 million on the .Barclays•facility but before any repayment of the existing facilities, of £49 million. The MEA is not projected to generate positive cash flows after interest but before repayment of debt until the year - ending 31 March 2011.
.2.45 We understand that new projections have subsequently been prepared that show a worse financial
4 . position. We have not had sight of these.
o";; r " " 2.46 The projections are based on a number of key assumptions as set out in the detail of our • report. We consider that.there are number of risks in relation to the assumptkins on which the projections are based, notably the growth in annual demand of 4% (albeit that the assumption is Consistent with 15 year average increase in demand of 4.3% and is lower than the five year 'average of 5.3%) and fuel costs and prices (which have fluctuated significantly in recent years but in a general upwards direction). In addition to the risks we have identified there are likely to be further inherent uncertainties (both positive and negative) which are outside the control of the MEA. . , '‘f . 4 2.47 - Consequently we consider that the projected additional peak borrowing requirement of £49 millicin dcies not necessarily represent a "worst case" scenario and, without any increases in tariffs over and above those projected, could be exceeded.
'Review of contractual relationships • A ' 2.48 The payments due to BGE in relation to the SIPS I / SIPS II and Isle of Man spur pipelines are material financial commitments. These represent a combination of capital recovery for 'the construction of the SIPS pipelines and the spur (which were funded by BGE) and operating/maintenance charges.
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2.49 These agreements run until September 2023 and commit the MEA to annual expenditure, based •on current levels, of . some £6.4 million. This is projected to increase substantially if the amount of gas imported through the pipeline increases. Under the agreements with BGE if there is a material change of 'circumstances or status in the MEA that causes reasonable doubt as to the security, .credit or ability of the MEA to perform its obligations under the agreements, the MEA has 'a contractual obligation provide to BGE a letter of credit equal to the net present value of the outstanding future capital cost payment due to BGE.
4 . • • 2.50 • The details of the MEA's contractual relationship with BGE has been removed from this report on the grounds of commercial confidentiality.
2.51 The MEA entered into a memorandum of understanding ("MOU") with Manx Gas for the supply of
natural gas via the BGE gas pipeline. We understand that the period of the MOU ended in March . !.! 2005. Calculations by the MEA show that under the terms of the agreement the MEA has been subsidising Manx Gas in respect of recovering the capital cost associated with the SIPS I / SIPS II • and Isle of Man spur pipeline.
Skyward
2.52 Skyward refers to the project for the commercialisation of the fibre optic cable laid with the interconnector cable to England for telecoms related activities. In 2000 the telecoms capacity of the cable was leased to the DTI under a 30 year lease at an annual rental of £375,000.
2.53 In early 2003 the DT1 indicated that it wished to end the payments to the MEA under the lease. As part of this process the then Chief Executive of the MEA sent a letter titled "Memorandum of Understanding" to Mr K Bawden in his capacity as Chief Executive of the DTI.
2.54 The Memorandum of Understanding stated that "For consideration to be agreed upon MCC will take ownership of all the tenant improvement fixtures and fittings, etc. at Ridgeway Street and all intellectual property concerning the fibre' optic cables and any business plans arising from this, developed by the DTI (or Manx Optical Agency),"
A total of £1'.7 been spent- by_ the . MEA on the Sk7iniard- project via MCC. budget, approximating to'this amount was . approved by the Board of MCC. The Treasur y has t. Government re uested-details - -eTafriciunt - spent bu this WasTiot-provided:This7iSlnot a:view '
2.56 The DTI attended regular liaison meetings with the MEA. We have reviewed the notes of these meetings from February 2003. From these it is evident that the DTI were informed that the MEA was investigating carrying out telecoms related activities. The notes of the meetings do not refer to the level or detailed analysis of actual expenditure incurred. We understand that-the-MEA did not_inform_the - DTI of -the_level_of actual expenditure and in the, opinion_of both the. Board-and "DTI " •
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2.57 The !DTI has been asked by the . , r Council of Ministers to review and report on the MEA's telecommunications business case and is in the process of assessing how best to pursue the Commercial application of the Skyward project.
Overall
2,58 We understand that recently the Board of the MEA has resigned.
• 2.59 As referred to above there are material matters outstanding between the MEA and the auditors, • particularly regarding the treatment of the payments from MCC to the MEA.
4 .2.60 Subject to the resolutibn of the above, we have found no evidence to suggest that either the Government departments involved or the MEA have acted other than as they each saw fit under their perceived remits. verthelessAitrisapparent.that those perceivedfremits,laken,in aggregate
ere insufficient, allowing_a veryrisu_ antial brk–d(Tnlirilin'communication between-the- E r nd 141i4canrana " IiiWtvernmentila84.resTli t- of which Government a • - iciently cognisant of develop menti at th-e V
As a matter of urgency the MEA requires substantial additional funding over and above that currently in place to fund it through to when it delivers positive cash flows from its operations. To obtain this will require the MEA and the Isle of Man Government to act together in ensuring that the best terms to the benefit of the people of the Isle of Man and the MEA.
2.62 . In our view the structures are already in place to allow better communication and cooperation 'between the Government and the MEA.
• . —
•
1 July 2005 Executive summary 15 -'7,17‘1111777
Manx Electricity Authority PKF
3 Historical trading performance
3.1 We set out below an analysis of MEA's consolidated historical trading results for the three years ended 31 March 2004, as extracted from the audited accounts for the two years ended March 2003, the draft accounts for the year to 31 March 2004 and the nine months ended 31 December 2004, as extracted from the management accounts:
Nine • months ended .31 Year ended 31 March December 2002 2003 2004 2004 £000 £000 £000 £000 As originally reported Turnover 32,458 32,662 34,921 27,381 Receipt of performance bond 10,200 Operating costs (28,576) (32,767) (38,063) (34,074)
Surplus/(Deficit) on ordinary activities 3,882 (105) 7,058 (6,693) Net interest receivable/(payable) 2,751 1,839 (2,944) (11,892)
Surplus/(Deficit) for the year transferred to 6,633 1,734 4,114 (18,585) Asset Replacement Reserve
As restated Impact of restatement for UK GAAP treatment (6,063) (5,137) (1,379) of bond interest Adjustment to BGE capacity costs for new (999) accounting treatment
570 (3,403) 2,735 (17,586)
3.2 The table shows the effect of the restatement for bond interest and issue expenses that were originally capitalised, together with an adjustment to the accounting for the BGE capacity costs. The above restatements have not yet been eudited by KPMG. The accounting treatment of the BGE lease will make no difference to the MEA's cash position as it does not pay tax.
3.3 Payments to BGE in the year to 31 March 2004 of £6.6 million have been capitalised within fixed assets. The total payments made to BGE in the nine months to 31 December 2004 are £5.3 million, of which £3.5 million have been capita:Used within fixed assets and the balance charged to the profit and loss account. The accounting 'treatment of these is being considered by the MEA and •KPMG.
1 July 2005 Historical trading performance 16 4
Manx Electricity Authority PKF
,• 3.4. .The results for the year ended 31 March 2004 include other income of £10,200,000 relating to the "one-off" receipt of the Nepcb Europe Limited ("Nepco") performance related bond from J.P • Morgan relating to the collapse of Enron. The Authority has informed us that; 'as PGT took over the contract within a matter of weeks, there was no material delay or financial loss associated with the collapse of Nepco. As such, the bond receipt was a "Windfall" profit and was taken to the profit r. and loss account in the year rather than be deducted from fixed asset costs. However in order to ...preent normalised trading performance, this receipt should be excluded as exceptional, Which would show a deficit for the year of £6 million.
, •
•.r- 3.5 The results-show that, both before and after interes , the MEA's profitability has declined substantially Clue to sharply rising costs with limited increases in revenues. The relatively flat • revenues are a result of tariffs not changing over the 3 years to 31 March 2004. The MEA have — informed us that the Electricity Acts require the MEA to develop. and maintain an efficient and economical supply of electricity. As a result the MEA have been under pressure to keep electricity prices to a minimum during the period under review.
3.6 The loss for the nine months ended .31 December 2004 ncludes nine months of depreciation on the Capital Prdject assets of 0.5 million and interest charged to the profit and loss account on the bond and Barclays loans . of £11.9 million. In 'previous accounting periods .interest had been capitalised on borrowings and no depreciation had been charged as the CCGT power station was not fully commissioned until 1 April 2004.
3.7 • ,. There has .been substantial growth in operating costs each year due to the increased overheads • • associated with running the. Capital Project and the costs of operating and maintaining this new plant.
July 2005 Historical trading performance 17
, Manx Electricity Authority PO"
Turnover
3.8 Turnover is further analysed below:
Nine months ended 31 Year ended 31 March December 2002 2003 2004 2004 £000 £000 000 £000
Sales of electricity 27,362 27,693 28,237 22,161 Retail and other income 5,096 4,969 4,973 3,671 Receipt of performance bond 10,200 Gas supply 1,711 1,549
32,458 32,662 45,121 27,381
Sales of electricity
3.9 Sales of electricity is further analysed below:
Nine months . ended 31 Year ended 31 March December 2002 2003 2004 2004 I £000 £000 £000 £000
Domestic 11,479 12,177 11,775 10,090 Non- Domestic 7,929 6,252 6,461 5,269 Demand 4,435 7,134 7,711 6,019 Public lighting 350 110 272 257 Exports of electricity 1,434 264 239 526 Rebated Standing charges. 1,735 1,756 1,779
27,362 27,693 28,237 22,161
Units sold (MWh) 344,722 363,812 371,199 266,695 Price per unit (pence per kWh Sold) 7.93 7.61 7.61 8.31
1 July 2005. Historical trading performance 18
4
Manx Electricity Authority PKr
3.10 Overall turnover from electricity increased by 1.21% from 2002 to 2003 and by 1.96% from 2003 to 2004. During the same time the Mega Watt Hours (MWh) units distributed increased by 5.5% and 2.0% respectively. The growth in turnover does not match the equivalent growth in units despite constant tariffs over the same period because of the change in tariff mix over the period.
Domestic
3.11 Domestic electricity is the main source of income for the Authority, representing approximately 42% of all electricity income in the year to 31 March 2004. Whilst the actual income received from . • domestic increased in the year to 31 March 2003 by 6.08% and then reduced in 2004 by 3.3%, the number of units in MWh over the same period increased by 2.6% and 1.2% respectively.
-'3.12 4 We understand that the fall in domestic income in 2004 can be explained by the efforts of the MEA . to move customers on to the correct tariff. Although the tariff for domestic and non domestic cost • the same, a different VAT rate applies, so the MEA1 have moved more small businesses to non domestic tariff.
Tariffs
3.13. The tariff did not change during the period from 1 April 2001 to 31 March 2004. Previous changes to the 'tariff were a reduction in the unit charge from 8.06 pence to 7.25 pence on 1 April 2001 and a reduction in the Fuel Cost Adjustment (F.GA) from 0.8 pence per unit to 0.4 pence per unit in Jarivary 2001.
3.14 • The tariff has since increased in August 2004 by.16.8°/o and in December 2004 by a further 20.7%.
Rebated standing charges
3.15 , Rebated standing charges represent the standing charge element of domestic electricity . • • • .amounting to £42 per year per-customer. The amount received in respect of standing charges in . the period to 31 December 2004 is included within domestic as it is not split out from the management accounts until the year end.
• 3.16 - . In previous years the standing charge has been thel subject of a rebate as the MEA has used funding from the Government to pay the standing charge on behalf of the consumer, however the funding expired at the end of March 2004. Consuml ers have therefore paid the £42 standing charge for the first time in a number of years from 1 April 2004, in addition to the increases in tariff.
3.17 Treasury has stated that it was originally anticipated that when the Government funding was exhausted, the standing charge would be withdrawn.
I ; 1 July 2005 Historical trading performance 19
Manx Electricity Authority 4 PO"
Non-dometic
• . • 3.18 Non-domestic income represents electricity income from small business users. The tariffs are the same as domestic users except that a higher daily standing charge is levied. The reasons for the fall in income from non-domestic sources in the year to 31 March 2003 is that more business users have been encouraged to switch to demand tariffs as the Authority tries to match consumers with the tariff that suits their need best. As a result of this non-domestic income fell by 21.1% in 2003.
Demand
3.19 Demand is a tariff that is designed to suit the biggest users of electricity. Under this tariff the users are billed based on their maximum demand to encourage them to use electricity at non peak times to enable the Authority to smooth out times of peak demand. The electricity charge is based.on a • lower unit cost, a monthly standing charge and a monthly demand charge based on the maximum • demand.
3.20 Income from demand has grown under the period under review due to the Authority encouraging users to switch to demand tariffs.
3.21 The biggest users can be • split into three main groups; namely government' departments,. manufacturing and supermarkets. There are approximately 25 customers who take more than one • million units.
Public lighting
3.22 , Public lighting income represents monies billed to local authorities for street lighting which is based on charges per street per year.
3.23 The level of income, from public lighting has fluctuated during the period under review from £350,000 in 2002 to £110,000 in 2003. We understand that this was an accounting error with an over accrual of income being taken in the yea!) to 31 March 2002 which reversed in the year to 31 March 2003. The level of income achieved in 2004 is a more accurate level of ongoing income. A small level of growth is expected in public lighting with better lighting being added to streets through improvements to the network and with the addition of new houses.
1 July 2005 Historical trading performance 20
Manx Electricity Authority PKF
Exports of electricity
124 The MEA's income from energy exports is presently derived both from exporting electricity to the UK via the Manx interconnector and from capacity-related sales associated with Triad Benefits and Standing Reserve contracts. Triads are regulated • by the National Grid and are the three half hours of highest loads in a season. There are exit capacity charges for electricity suppliers and large directly connected consumers such as Network Rail to off-take electricity from the transmission system during Triads. The MEA have informed us that they would face onerous exit capacity charges if they imported on the interconnector during these periods but by exporting they reduce exit charges for a third party supplier in.the !same zonal region. We understand that the MEA., has contracted with National Power to secure 90% of the benefit afforded to the latter's customers in the North West from the MEA exporting into the same region. It is this credit payment to the MEA which is known as a Triad Benefit.
3.25 The MEA has informed us that they have developed a sophisticated IT system to predict when loads are likely to peak to ensure that the MEA is supplying as much power as possible to the . National Grid at these times. The MEA considers that with the additional capacity though the CCGT and .diesel generators, it is well placed to export during these times and so gain Triad Benefits. The MEA has provided data to demonstrate that in 2004/05 a cost saving of £620,000 was achieved and it is expected that this will increase, to over £1,000,000 in 2005/06. We have not verified either of these amounts.
3.26 Substantial income is also derived by the MEA from Standing Reserve contracts with NGT via an agent, Gas de France. These contracts have been in place since 2003/04 and annual revenues have increased substantially — 2004/05 gross revenues are expected to be in the order of £756,000 and new contracts negotiated for 2005/06 are forecast to deliver more than £1 million. In I simple terms, NGT pay the MEA an 'insurance' prem ium which ensures that a fixed quantity of diesel generation is always available for them to call on within 20 minutes. NGT utilise this facility, together with numerous other demand management customers and generators, to balance I generation output and customer demand on a half-h ourly basis to maintain system security and quality of electricity supplies in England and Wales. Apart from the insurance premium known as an Availability Fee, MEA is also paid a Utilisation Fee for the operating costs of running the diesel plant when called on by NGT. In 2004/05, the MEA expects the Availability Fee to total £435,000 and the Utilisation Fee approximately £221,000. The Standing Reserve contracts are a very lucrative source of revenues with a profit margin of the order of 80%. The MEA have provided us with copy Standing Reserve contracts. These contracts do not quantify the Availability Fee or the I Utilisation Fee derived from Standing Reserve arrange ments.
3.27 The 'Authority can also 'float' the cable and sell to third parties the electricity the Island would normally draw down the cable.
3.28 The substantial income of £1.4 million received in the year ended 31 March 2002 were front ended contractual payments received from Enron for electricity capacity. These income receipts were of a one-off nature.
1 July 2005 Historical trading performance 21
4
Manx Electricity Authority PKF
3.29 The growth in income to 31 December 2004 +s as a result of having the two gas turbines available with the diesel engines to export electricity. Export incomes are also derived from exporting the output from either the diesel plant or the combined cycle gas turbines to the England & Wales . market during periods when the external market price is well aboVe the strike price for MEA's gas oil or gas derived generation portfolio. The MEA estimates that for 2004/05 both contracted and 'spilled' export revenues will be approximate y £340,000 with an estimated profit margin of 42%. The MEA considers that both export revenues and profit margins would have been significantly higher had the combined cycle gas turbine (CCGT) been more available during export 'windows' but unplanned technical issues resulted in reduced output froin the CCGT. The MEA has informed' us that the majority of the difficulties for the CCGT plant are expected to be eliminated in readiness for 2005/06 and consequently the MEA fOrecast export revenues to be significantly higher I particularly given the tight generation capacity margins prevailing in England & Wales for the next financial year.
Retail and Other Income
• 3.30 'Retail turnover and other income is further analysed below:
Nine months ended 31 Year ended 31 March December 2002 2003 2004 2004 £000 £000 £000 £000
• - Retail 3,412 3,386 3,700 2,713 Fibre optic cable rental on operating lease to 394 347 101 the DTI 182 171 197 214 Public lighting revenue _ Property rental 59 165 200. - 100 Service alterations 585 449 311 259 Deterred customer contributions 240 265 265 • 209 Profit on sale of fixed assets 128 51 Other 96 135 199 176.
5,096 4,969 4.973 3,671
3.31 Retail and other income consists mainly of retail turnover from the MEA showrooms. Retail income increased by 9% in the year to 31 MarLh 2004 after remaining stable in 2003. The growth in turnover is attributable to the increase in products stocked, in particular in the home entertainment range.
3.32 The fibre optic rental income relates to the lease between the MEA and the DTI for annual incomes of approximately £370,000. The DTI have stopped paying the lease although the lease is still in place.
Historical trading performance -22 Manx Electricity Authority PKF
Gas supply
3.33 Gas supply turnover is further analysed below: •4.
Nine months ended 31 Year ended 31 March December 2002 2003 2004 2004 £000 f000 £000 £000
Sale of gas .. • 1,254 1,389 Share of operating costs 256 95 Transportation charge 201 65
1,711 1,549
1
3.3,4 The AUthority has only been able to supply gas 61lowing the completion of the. spur and cross- island pipeline and the Pressure Reduction Station at Glen Mooar. All sales are made to Manx Gas.
3.35 The Authority sells to Manx. Gas at cost but separately recovers a share of operating costs from Manx Gas at 4.5 pence per therm. However, the energy trading team estimate thatsMEA fces operating costs of 22 pence per therm on a fully absorbed cost basis frOm BGE. •
r.
,.1
.r
•
1 July 2005 Historical trading performance 23
Manx Electricity Authority PKF
Gross profit and margin
Electricity
3.36 The turnover from electricity and costs of generating electricity and importing electricity during the period under review are set out below:
Nine months ended 31 Year ended 31 March December 2002 2003 2004 2004 £000 £000 £000 £000 Sales of electricity 27,362 27,693 28,237. 22,161
Direct costs of electricity supply
Generation 7,841 12,607 12,459 7,788
Importation of electricity 5,424 5,284 6,252 5,186
13,265 17,891 18,711 12,974
Gross margin 14,097 9,802 9,526 9,187
Gross margin percentage 51.5% 35.4% 33.7% 41.4%
3.37 The table shows that the gross margin has deteriorated over the period under review from 51.5% l to 33.7% in the year to 31 March 2004. Th e fall in margin is due to the increases in imported electricity prices and the cost of diesel and gas during this period. The MEA has not increased the I tariff during the three years from 1 April 2001 t o 31 March 2004, despite rising generation costs.
3.38 The margin for the period to 31 December 2004 shows an improvement due to the price increases referred to above. This figure is expected to reduce in the three months to 31 March 2005 as the winter months haVe higher fuel costs without any corresponding increase in electricity prices.
1 July 2005 Historical trading performance 24 fr` Manx Electricity Authority PKF
.Retail
• 3.39 Retail cost of sales and gross margin are analysed further as follows: •
Nine months ended . 14 31 r. Year ended 31 March December 2002 2003 2004 2004 £000 £000 £000 £000 Retail sales 3,412 3,386 3,700 2,713
Cost of sales, salaries and related costs, 3,175 3,233 2,629 administrative expenses 3,522
Gross margin 237 153 178 84
Gross margin percentage 6.9% 4.5% . 4.8% 3.0%
3.40-• As can be seen . from the above analysis the Retail division operates on very small margins. The • , . margin to 3i December 2004 is . considerably less than previous periods. The MEA has informed
us that. , there has been a debate over whether these showrooms should be privatised, but currently • the Government is unwilling to do this.
.1 July 2005. Historical trading performance 25 Manx Electricity Authoritt
Operating costs
3.41 Operating costs are analysed below: •
Nine ; months ended 31: Year ended 31 March December. 2002 2003 2004 '2004 £000 £000 £000 £000 Electricity supply
Generation 7,841 12,607 12,459 7,788
Importation of electricity 5,424 5,284 6,252 5,186 Distribution network services 3,747 • 4,425 5,857 6,252 Administration and general expenses 4,283 3,182 2,834 3,405
21,295 . 25,498 27,402 22,631
• Depreciation 4,106 4,036 5,629 7,535
25,401 29,534 33,031 30,166
. Gas supply ; Purchase of gas 1,254 1,119 b. Share of operating costs 256 160 w
1,510 1,279
4 .
Retail Cost of sales, salaries and related Costs, 3,175 3,233 2,629 administrative expense's 3,522
Total operating costs • 28,576 32,767 38,063 34,074
1 July 2005 Historical trading performance 26"
4 Manx Electricity Authority PKF
3.42 Electricity supply operating costs are further analysed as follows:
Nine months ended 31 Year ended 31 March December 2002 2003 2009 2004 £000 F000 £000 £000 Electricity supply
Importation of electricity 5,424 5,284 6,252 5,186
Fuel costs 3,078 5;941 1,661 970
Gas purchases 3,288 2,646
8,502 11,225 11,201 8,802
Direct staff costs 6,837 8,320 11,026 7,767 Staff Costs transferred to capital (1,313) (2,700) (963)
Net staff costs 6,837 7,007 8,326 6,804
indirect staff costs 615 882 918 619
Repairs and maintenance 2,565 3,458 3,544 2,485
EstablishMent costs 2,460 2,398 2,688 1,782
Administration costs 283 308 ., . 431 152
Fleet costs ' 33 190 233 . 191
Finance costs 30 61 -
BGE operating costs , 274
BGE capacity costs 1,522
12,793 14,273 16,201 13,829
Depreciation 4,106 4,036 5,629 7,535
25,401 29,534 33,031 30,166
4
1 July 2005 Historical trading performance 27 •
Manx Electricity Authority PKF
3.43 The above analysis shows that the direct costs of generating electricity, that is fuel and gas purchases and the importation of electricity, increased by £2,723,000 from 2002 to 2003, an increase of 32%. On a per unit basis the direct costs of generating electricity went up by 25.1%, largely due to the increase in market prices. These direct costs stabilised in the year to 31 March 2004 at €11.2 million.
3.44 The year to 31 March 2004 was the first year of operation of the gas spur which enabled the MEA to bring natural gas to the Island. Gas purchases connected with running commissioning trials of the CCGT amounted to some £3,288,000. This also includes purchases of gas to sell onto Manx Gas.
3.45 During the year to 31 March 2003 nearly all expenses increased from the level seen in 2002. Expenses continued to rise in the year to 31 March 2004 and have continued to rise in the period to 31 December 2004.
3.46 The rise in expenses is because of the capital projects that were being undertaken during these periods, and due to the increased number of staff taken on by the MEA during this time. Once the new power station had been built the MEA also had to hire experienced staff to operate the power station, a number of these positions were at senior level which required high salaries.
3.47 In addition a number of external sub contractors were engaged during the first year of operation to operate the power station the costs of which have been capitalised separately. The staff costs transferred to capital consists of the costs of the capital projects team at the MEA and other staff costs attributable to the restructuring undertaken.
3.48 We understand that as completion targets were met on the capital projects, bonuses of approximately £400,000 were approved to be paid to staff. The MEA has confirmed that these bonuses cover the three years of the capital projects but are entirely included in staff costs to 31 December 2004.
3.49 Indirect staff costs consist of training, health and safety costs, travel and subsistence, health insurance and director's fees.
3.50 Repairs and maintenance expenditure has increased considerably during the period under review due to - maintenance of .the new assets and backlog maintenance being carried out on the older assets including substations. Expenditure is expected to increase further with the operation of the gas turbines as the parts required are more expensive due to level of precision engineering required.. Also we understand that major refurbishment of the diesel engines is necessary following the recent period of extensive use whilst the gas power station has been built,
3.51 BGE capacity and operating cost represent the payments for the construction and operation of the • gas pipeline to the Island. Prior to the commissioning of the power station in May 2004 these costs' had been capitalised within fixed assets.
1 July 2005 Historical trading performance 28 • _Manx Electricity Authority PKr
. 3.52' Establishment costs include the insurance premiums which have increased as a result of the capital projects and which are currently around 21 million per annum. 'Also included under this cost heading are computer costs, rates, wayleaves (the number of one-off payments made for wayleaves increased over the period as the pipeline was built, these items will not recur and were priced at the standard UK agreed rate for equivalent bodies and as agreed by UK National -. Farmers Union and the Country Land and Business association), telephone and postage. .
:3.53 . Fleet costs represent the costs of running and maintaining the Authority's fleet of vehicles.
1 July 2005, Historical trading performance 29
Manx Electricity Authority PKF
Interest payable and receivable
3.54 An analysis of interest payable and receivable is shown below:
Nine months ended 31 Year ended 31 March December 2002 2003 2004 2004 £000 £000 £000 ,£000
Interest receivable from bank and other 3,911 2,722 -152 deposits 152
Interest payable Borrowings from loM government (45) (8,164)
Lease finance (308) (209) (109) (52) Bank overdraft and loans (211) (564) (2,954) (3,812) Relieved loM government interest (596) (110) (33) (16)
(1,160) (883) (3,096) (12,044)
Net interest (payable)/receivable 2,751 1,839 (2,944) (11,892)
3.55 The accounting treatment for bond interest did not comply with UK GAAP in the years ended 31 March 2002, 2003, 2004 although it was in accordance with the Isle of Man Audit Act 1983. Interest on the 10M Government bond has been capitalised regardless of what the proceeds have been used for whilst interest receivable on the bond proceeds has been taken as income in the profit and loss account. AS noted at paragraph 4.8 below this was raised by KPMG. The 2003- 2004 session of the Standing Committee on Expenditure and Public Accounts reported that the Treasury were satisfied that th*e method of accounting was fully compliant with the Audit Act 1983. In 2004 the Chief Minister directed that the accounts be re-stated to UK GAAP and the MEA have acted in accordance with this direction. The restatement makes no material difference to the cash position of the MEA as it does not pay tax and the restatement only affects non cash charges to the Profit and Loss account.
3.56 The interest payable for the period ended 31 December 2004 includes the interest charge on the loM government bond and the Barclays loans. A full annual interest charge on the bond and Barclays loans is expected to be Z17.5 million.
3.57 - Interest received has fallen from the level seen in 2002 due to the bank deposits from the bond receipts being used to fund capital expenditure.
1 July 2005 Historical trading performance 30 •
Manx Electricity Authority PKF',
Adjusted earnings
.3.58 We consider the following items to be exceptional/non-recurring:
. ∎ . Receipt •of performance bond - £10.2 million;
• Enron electricity sales - £1.4 million
• Capitalised Skyward expenditure - E1.7 million
3.59 Currently the Skyward costs, totalling £1.7 million in the period from mid 2003 to 31 December 2004 have been capitalised in fixed assets.
• 4.
; • .11/6 i nta inab le earnings
3.60 The above items should be considered befor=e making adjustments to the reported results to reflect a maintainable level of earnings as follows:
Nine months ended 31 Year ended 31 March December 2002 2003 2004 2004 £000 £000 £000 £000
Surplus/(deficit) for the year transferred to 6,633 1,734 4,114 (18,585) Asset Replacement Reserve . Deduct , . One-off performance related bond proceeds (10,200) . resulting from failure of CCGT station contractors
Adjustment to interest payable based on UK (6,063) (5,137) (1,379) GAAP treatment , • v . Adjustment for accounting treatment of - 999 finance costs of BGE pipeline Depreciation (4,482)
Adjusted Surplus/(deficit) 570 (3,403) (11,947) (17,586)
3.61 The adjustments to interest payable based on UK GAAP treatment have been prepared by Clive Wilcox as prior year adjustments in the March 2004 statutory accounts. The above adjustments . represent the release of interest so the only the net interest payable is capitalised in the period. These adjustments are being reviewed by KPMG.
1 July 2005 Historical trading performance 31 F .
Manx Electricity Authority PKr
3.62 The one off performance related bond has been deducted from the surplus for the year in 2004 to arrive at maintainable earnings.
3.63 An adjustment has also been made to the results for the year ended 31 March 2004 to reflect a year's depreciation charge on the power station assets of £4.4 million as has been included in the projections. The new assets were not depreciated in the accounts to 31 March 2004 as the plant had not been commissioned until April 2004.
3.64 The adjustment for accounting treatment of finance costs of BGE pipeline relates to the reversal of
the spur capex.that had previously been expensed in the profit and loss account following the. . decision by the MEA to treat the BGE payments as a finance lease. The charge left in the profit 7 • • •• and loss account for the nine months . to 31 December 2004 of £523,000 approximates to the depreciation charge for the period. As noted in paragraph 4.89, a detailed review of the .. accounting treatment of the BGE lease commitments is being carried out by the MEA and KPMG.
Trading between,group companies
3.65 The MEA leases the interconnector electricity cable between the UK and the isle of Man from its wholly owned subsidiary MCC. The lease term is for thirty years from 30 October 2000.
3.66 • The annual rental income recorded in the accounts of MCC is as follows:
Nine months ended 31 Year ended 31 March December 2002 2003 2004 2004 £000 f000 £000 £000
Rental income 1,168 3,674 5,703 n/a
1 July 2005 . Historical trading performance 32
Manx Electricity Authority PKF
3.67 The MEA also has traded with PGT during the period under review. The annual turnover recorded in the accounts of PGT consists entirely of sales to MEA in respect of the power station project and are as follows:
Nine months ended Period from incorporation Year ended 31 to 31 March 31 March December 2003 2004 2004 £000 £000 £000
Turnover ' 82,565 39,944 4,705
3.68 None of the Skyward companies have traded and all the Skyward committee expenditure has been made by MCC.. Details of the Skyward expenditure are given in section 14 ("Skyward").
Hedging orforward contracts
3.69 The MEA adopts a partial hedge for its forward purchases of electricity and gas during the winter months when energy prices are most volatile. The risk management strategy adopted by the MEA benefits from forward purchases of gas oil for diesel generation to act as a cap on the upside .movement • in gas costs. In addition the combination of surplus generation plant and the high availability (and two way capacity) of the Manx Interconnector enables the MEA to maximise exports profits to offset higher import costs. During the summer months when prices are more stable a higher proportion of gas and electricity is purchased on the forward market. In 2004/05 and for the next financial year, the Triad Benefit has been sold a year ahead. The MEA considers that by just hedging around 25% of its winter purchases, it is estimated that it has saved over £1.5 million on their import costs due to the unseasonably mild winter temperatures resulting in outturn electricity and gas prices being substantially below forecast wholesale forward prices. We have not independently confirmed the above savings. The MEA have informed us that their trading team constantly monitors its monthly purchase costs against recognised power and gas indices such as those produced by Heren and invariably beats them. The MEA also informed us that despite substantial increases in oil and gas prices in the global marketplace of the order of 20+%, MEA's annual purchase costs for 2004/05 are expected to have increased by less than 10% when discounting the export related revenues from Triad benefits, Standing Reserve and contracted physical exports. We have not independently confirmed the above savings. It is Treasury's view that the expected-financial benefits have not materialised.
3.70 • The MEA does not engage in speculative trading but there are occasions when unplanned outages • of CCGT require spot sales of gas volumes which may have been purchased on a month ahead t basis. Electricity trades centre around contracted exports which are transacted normally on a day ahead and within day basis.
1 July 2005 Historical trading performance 33 Manx Electricity Authority PKr
4 Historical assets and liabilities
4.1 We set out below the consolidated balance sheets of the Authority as at 31 March 2002 and 2003 as extracted frOm the audited accounts, at 31 March 2004 as extracted from the draft accounts and as at 31 December 2004, as extracted from the management accounts:
At 31 At 31 March December 2002 2003 2004 2004 £000 £000 £000 £000 Fixed assets Tangible assets 168,989 263,178 323,493 345,667 Deferred expenditure 8,853 18,796 2.8,740 3,840
177,842 281,974 352,233 349,507 Current assets Stocks • 2,716 2,951 3,225 4,925 Debtors 6,307 6,227 7,032 4,809 Cash at bank and in hand 132,442 23,798 7,910 7,486
141,465 32,976 18,167 17,220 Creditors: amounts falling due within one year Loans and overdraftS (1,242) (1,342) (532) Creditors (18,883) (15,360) (12,506) (14,256)
(20,125) (16,702) (13,038) (14,256) Net current assets 121,340 16,274 5,129 2,964
Total assets less current liabilities 299,182 298,248 357,362 352,471 • ., Creditors: amounts falling due after more (226,491) (223,823) (278,823) (304,100) than one year ,
Net assets 72,691 74,425 78,539 48,371
Represented by: Reserves: General 12,000 12,000 12,000 12,000
Asset Replacement • 60,691 . 62,425 66,539 36,371
72,691 74,425 78,539 48,371
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••4.2 The balance sheets as at 31 March 2002 and 2003 are as signed off by the auditors, KPMG, - accepted by Treasury and laid before Tynwald. They comply with the Isle of Man Audit Act 1983 but do not include any adjustments to bring the treatment of interest payable into line with UK .:.GAAP. The balance sheet as at 31 March 2004 is extracted from the draft accounts as originally stated and is subject to change.
. 4.3 Included within creditors due after one year in the balance sheet to 31 December 2004 is a loan of £50 million which is repayable in September 2005.
4.4 As noted in section 3 ("Historical trading performance"), the accounting treatment of the BGE lease , costs is still being considered by the Authority and KPMG.
Tangible fixed assets
4.5 • . The net book value of each class of tangible fixed asset at each date under review is as follows:
At 31 At 31 March December 2002 2003 2004 2004 £000 £000 £000 £000
Generation plant 116,966 208,515 218,768 231,725 Pipeline systems 46,837 52,994 Distribution systems • 36,800 39,607 42,205 45,059 Freehold land & buildings 14,548 14,123 13,676 13,322 Vehicles & equipment 675 933 942 910 Telecom 1,0651 1,657
168,989 263,178 323,493 345,667
Depreciation policy
•* 4.6 'Details of the depreciation policy are set out in section 6 ("Accounting policies").
„Capitalisation policy
4.7 ' All expenditures associated with capital projects are capitalised by the MEA. These costs included staff costs of employees working on the project, all travel_ and subsistence, all legal and professional fees.
• • 1 July 2005 Historical assets and liabilities • k 35 Manx Electricity Authority ' 01(f"
4.8 Up to 31 March 2004 the audited accounts capitalised all interest payable on the bond and the bond issue expenses as well as the interest on the Barclays loans, which totalled £28.7 million to 31 March 2004. This treatment was in accordance with the Isle of Man Audit Act 1983, but does not comply with UK GAAP. This was raised by KPMG. The 2003-2004 session of the Standing Committee on Expenditure and Public Accounts reported that the Treasury were satisfied that the method of accounting was. fully compliant with the Audit Act 1983. In 2004 the Chief Minister directed that the accounts be re-stated to UK GAAP and the MEA have acted in accordance with this direction. The restatement makes no material difference to the cash position of the MEA as it does not pay tax and the restatement only affects non cash charges to the profit and loss account and net assets. The revised accounts to 31 March 2004 have been prepared on the basis that only interest specific to the Capital Projects has been capitalised. A prior year adjustment of £12.5 million has been included in the revised accounts.
1 July 2005 Historical assets and liabilities 36 Manx Electricity Authority PIT;
Reconciliation of fixed asset additions to Treasury returns
4.9 • The additions to fixed assets from the statutory accounts and summary of Treasury returns made during the periods under review are set out as follows:
At 31 Total At 31 March December additions 2002 2003 2004 • 2004 £000 £000 £000 £000 £000 4 Additions per Statutory accounts Generation plant 89,494 60,772 46,785 3,357 200,408 Pipeline systems 32,881 13,956 7,682 54,519 Distribution systems . 3,630 4,084 3,973 3,902 15,589 Freehold land & buildings 33 13 - 46 Vehicles & equipment 155 455 152 77 839 Telecom-Skyward - 1,065 592 1,657 Interest capitalised 14,097 14,097
93,279 98,225 65,944 29,707 287,155
Additions per treasury returns
PGT - Power Station 33,953 39,929 4,470 78,352 Gas Pipeline 21,544 12,725 3,176 37,445 Bard Gais Eireann Charges 6,593 4,564 11,157 ^ Network Services 5,025 3,845 4,049 3,916 16,835 •. Generation/phase 5 32,000 2,243 832 171 35,246 Vehicles & EqUipment 150 436 112 76 774 Other 875 8 2,169 619 3,671
38,050 62,029 66,409 16,992 , 183,480'
Difference 55,229 36,196 (465) 12,715 103,675
Analysis of differences Acquisition of MCC 54,597 54,597 PGT invoices capitalised in MEA after Treasury reports 36,000 36,000 were submitted PGT stock transfers (1,322) (1,322)
• -
1 July 2005 Historical assets and liabilities 37 Manx Electricity Authority PKF
At 31 Total At 31 March December additions • 2002 2003 2004 2004 £000 £000 £000 £000 £000 BGE costs capitalised 998 998 BGE transfer to profit and loss account for operating (673) (673) costs BGE timing differences - (382) (382) Interest capitaliSed - 14,097 14,097
Unanalysed difference 632 196 (465) (3) 360
55,229 36,196 (465) 12,715 103,675
4.10. We note that an element of the capital expenditure during the year ended 31 March 2002 was incurred prior to Treasury bond issue approval in July 2001 and subsequent drawdown in August 2001. This element should not be matched against the amount of £185 million received from the bond issue and lent on to the MEA. •
4.11 £54,597,000 of assets are included in the additions to generation plant during the year ended 31 March 2002 as a resultof the acquisition of the remaining 50% share of MCC for £18 million. This was not included in the returns made to the Treasury detailing capital expenditure.
4.12 These assets, which mainly consist of the sub-sea interconnector cable, had been purchased and commissioned during the previous 3.years when MCC was a joint venture between the MEA and
the National Grid. During this time MC_ C's assets had been reported in the footnotes to the Annual accounts. Now with the MEA taking a 100% share of the company the accounting treatment of these assets changed from the equity method to the consolidated method. This resulted in £54.6 million of MCC assets and £30.4 milliortof MCC debt now being • reported in the Balance sheet while previously MCC had been accounted for in the footnotes to the MEA's accounts.
4.13 • The MEA considers that the Treasury returns were not an appropriate means to report these historical figures and consider that the Treasury, the DTI and Tynwald were fully aware of the purchase of 50% of MCC for £18 million as the issue had been discussed with them in advance. The purchase of MCC was included in the statutory accounts explaining the amount paid for the • 50% share and the value of both the assets added to the balance sheet and the debt.
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. 4.14 The difference of £36 million in 2003 relating to PGT invoices occurred because the capital expenditure had been undertaken by PGT and not the MEA. The value of work done in PGT at 31 March 2003 of £36 million had not been invoiced to MEA at 31 March 2003 and was later capitalised during the time the financial accounts were being finalised. We understand that the MEA did not adjust the Treasury returns for this as they have stated that any adjustments that occur in either the 1st, 2nd or 3rd quarters are added into the next quarter's Treasury return while adjustments that occur in the 4th quarter are added into the statutory accounts. Consequently the MEA considers that the 4th quarter PGT invoices adding £36 million in assets were satisfactorily reported through the statutory accounts, even though they were not reported in the Treasury' returns.
4.15 The Treasury's opinion on the above is set out at paragraph 2.16 above.
4.16 The PGT stock transfers relate to spare parts and equipment that had been included on the Treasury returns as capital expenditure but have subsequently been treated as stock by MEA.
4.17 The BGE costs capitalised relate to BGE costs which were originally charged to the profit and loss account before the new accounting treatment was implemented.
4.18 The BGE transfer to profit and loss account for operating costs relates to the amounts paid to BGE for'the spur pipeline that were treated as revenue payments as opposed to capital because the amount related to the costs of operating the pipeline. The timing differences occur as the accruals made for management accounts are offset against actual payments.
4.19 As well as capex associated with the CCGT power station and associated infrastructure the Treasury returns . also include on-going capital spend such as Network Services transmission strengthening costs, totalling £16.8 million and Vehicles and Equipment, totalling £0.75 million. Of the total expenditure of £16.8 million on transmission strengthening_ during the period under review, £16.4 million (relating to the period from July 2001, when the Treasury bond issue was approved by Tynwald, to date) has been treated by us as if it related 'to the Capital Project (paragraph 9.12 below), This is because funds raised to upgrade the Isle of Man transmission system from 33kV to 132kV (which the MEA studies have deemed unnecessary) were instead used to strengthen the existing transmission system. The costs of this strengthening are reported as on-going capital expenditure on the Treasury returns.
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4.20 The MEA has stated that the power station involved some works that could be classified as ongoing but which were rolled up into the project and that on-going works were altered to take into account the new power station. Ongoing works that were rolled up into the project include:
• Change of fuel for diesel generators from heavy oil to light oil;.
• Refurbishment of fuel oil bulk storage tanks;
• Addition of fire protection for fuel oil bulk storage tanks;
• Replacement of diesel generator silencers;
• Removal of diesel generator day tanks from roof of building;
• Refurbishment/replacement of diesel generator water cooling system;
ReplaCement/improyernent of diesel generator contaminated water drains and oil water separation;
• Higher fault level capability of 33kV switchgear at Middle River;
• Improvements to the 11 kV switchgear;
• Increased transformer capacity;
• Construction of a new Central Control room to manage Pulrose and Peel generators together with Lord Street control of the cable import/export of VARs;
• Improved workshop and storage facilities at Pulrose;
• Improved security measures (CCTV/Access control).
4.21 Interest of £12.3 million has been treated as capital expenditure in the draft accounts to 31 December 2004 as a result of a change in the accounting policies. Consequently this was not included on the Treasury returns as capital expenditure. Treasury has stated that it was not aware that capitalised interest was not included on the returns.
1 July 2005 Historical assets and liabilities 40 Manx Electricity Authority PKr
Analysis of flied additions
.Generation plant and pipeline systems
- 4.22 . Further analysis of fixed asset additions over the three years and nine months ended 31 December 2004 for the generation plant and pipeline systems, that is excluding 'normal' fixed asset spend, are given below:
£000 Pulrose power station CCGT scheme 89,948 Pulrose site and system network 32,167 Operational commissioning costs 3,776 MEA expenditures 10,185 D Statiorfworkshop 2,790
-Total CCGT project 138,866
, Cross Island gas pipeline scheme 23,519 LS. Pressure reduction station 19,176
Total pipeline and PRS 42,695
MCC assets purchased prior to buyout of outstanding 50% share 54,597 BGE capital payments for spur pipeline• 11,106 Other generation plant 4,831 Additional capital expenditure on electrical inter-connector cable 2,838
254,927
•
4.23 A review of the expenditures incurred shows that most of the costs under "Pulrose site and system • , network", "operational commissioning costs", the "D station workshop" and the ''MEA expenditures" were in relation to the same sub-contractors used to build the power station. In addition it is unlikely that these expenditures would have been incurred if the power.station project or a similar project to secure a similar capacity for the Island was not being undertaken.
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Pulrose power station CCGT scheme
4.24 This relates to the design, build, and installation of the Pulrose power station.
• 4.25 The main contractors used for this work and the "Pulrose site and system network" together with their cost are listed below:
Contractor Description £000
PB Power CCGT Construction management services 7,054 NEL Power Limited Design, procurement, technical support 12,823 .GE Energy (Norway) Gas Turbines 11,294 Auldyn Construction Limited Civil work 11,880 Westbury Tubular Structures Limited Structural Steelwork 8,233 Man Turbomaschinen AG GHH • Steam Turbine/generator system BORSIG 3,255 Bronswerk Heat Transfer BV Air cooled heat exchangers 3,484 Innovative Steam Technologies (a Once Through Steam Generator (OTSG) division of Aecon Holdings Limited) • 3,071 Charles Henshaw & Sons Limited Glazing 1,900
62,994 Other 59,121
122,115
4.26 Further information on the contractors for the CCGT power station is given in section 9 ("Review of contractual relationships'').
Pulrose site and system network
4.27_ This relates to expenditure necessary to fit the new power station into the existing network, and all the variations and work done outside the scope of the EPC contract. A large amount of this expenditure was foreseen but could not be quantified by the MEA until after the power station had been designed. .
•
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Operational commissioning costs * • • 4.28 • The operational commissioning costs relate to the costs of contractors engaged by the MEA to commission the power-station.
OStation workshop
4.29 These expenditures relate to construction of a new heavy duty workshop for diesel engine repairs; a new Central Control Room for the operation of Pulrose and Peel power stations, the inter- connector cable, the hydro-electric power units, the gas pipeline and the EfW plant output; new offices and over-cladding of the Pulrose D Station building to fit in with the architecture of the new
•Power station and National e. Sports Centre." The main expenditure related to Auldyn Construction for the civil and building works associated with the D Station works at an approximate cost of £2 million. £50,000 was paid to the architectural firm Savage and Chadwick for the design and -contract management.
Including.the work documented in paragraph 4.29 an analysis of the expenditures on the 0 Station .Workshop are given in the table below:
£000 Civil and building works associated with D station workshop, Control room, Offices and 2,350 recladding. Contaminated land removal — Excavate oil- contaminated soil, placing in impervious bags 200 and transport to Snugborough Design team — design and structural design for D station 240
. : 2,790
These expenditures related to laying the cross island pipeline from the PRS to Pulrose.. The 'majority of the spend related to the construction by three local civil engineering firms, (ROW , :Construction (£1.5m), Carey and Sons, Stephen Christian and Sons) and the design • and - • • . management of the project by PB Power (£6.6m). Morrison Utilities (£2.2m) were also used for the mechanical contract to weld the pipeline and to direct the local civil firms who were unused to • , laying major pipelines.
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Pressure reduction station
4.32 This related to the design and construction of the PRS at Glen Mooar. It was initially anticipated that the PRS would be constructed and owned by BGE with .BGE recovering their costs via an annual rental charge. .Included in this is a development fee paid to BGE in accordance with the pipeline connection agreement totalling £4.4 million. The balance of the spend can be split between design, £2.3 million, and construction of the PRS, £12.5 million.
ri 4.33 Treasury informs us that it was not made aware of the change in arrangements for the funding of the PRS.
4.34 The MEA has informed us that extra costs were incurred by the Health and Safety Executive _ overturning an accepted industry standard inspection procedure. As a result a large section of 4: pipe in the PRS• had to be exhumed for retesting; no faults were found. This change in testing methodology resulted in delays in testing the PRS and caused costs of approximately £500,000. f
4.35 The design was done by Sofregaz at the insistence of BGE.
4.36 Morrison Utility Setvices were responsible of the civil works and installing and commissioning the station at Glen Mooar. The spend with Morrison was approximately £5.7 million. The remaining £4.4 million was spent on various construction contractors, with £2 million of costs from PB Power relating to project management.
x
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MEA expenditures
4.37 These relate to spending on PB Power under the original owners engineer contract of £1.9 million, the capitalised MEA staff costs £1.1 million, feasibility studies and various civil engineering work including demolition, decontaminated land removal, re routing the diesel exhausts and refurbishing the control rooms: •
4.38 An analysis of the MEA expenditur'es are given in the table below:
£000 PB Power owners engineer services Preparation of technical specifications and tender documents, design audit, review of quality assurance, supervision of construction activities, prepare per tender health and 1,900 safety plan.
Enabling works 1,500 MEA staff, travel and subsistence costs capitalised 1,300 GaS feaSibility study 800 Designers and MEA costs associated with the studies for the East coast scheme Demolition of A B and C station at Pulrose 800 Building design/planning application by external consultants 800 Diesel exhaust re-routing costs 700 Contaminated land removal - Collection of Oil contaminated land from Snugborough and transport to facility in Germany 700 for treatment Land and workshop rental • 650 — Rental of land for Materials storage at Middle River industrial estate, rental of site offices Legal and administrative costs including insurance 250 Control room refurbishment and instrumentation — Design, build and installation of new 340 control room at D station. Other 445
10,185
• MCC assets purchased prior to buyout of outstanding 50% share
• 4.39: . This relates to the acquisition of the remaining 50% share in MCC Limited, from the National Grid. At the date of acquisition MEA valued the assets of MCC at £54.6 million: MCC also had a loan • from HSBC of £30.4 million and an intercompany balance with the MEA of £5 million. The assets of MCC consist mainly of the inter connector cable built between the Isle of Man and the UK between 1998 when MCC was first formed and 1 April 2001 when the MEA bought out National Grid's 50% share for £18 million.
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tTn • Manx Electricity Authority "=., PKr •
BGE capital payments for spur pipeline
-- 4 4.40 - These payments relate to commitments to BGE for capacity through their pipelines. The accounting treatment for this is still being considered by the MEA and KPMG. We understand that KPMG are of the view that the lease between BGE and MEA is a finance lease. Under this treatment the net present value of the total payments would be included within fixed asset additions and as a finance lease creditor.
Other generation plant
4.41 These expenditures relate to capital spend on other generation plant.
Additional capital expenditure on electrical inter-connector cable
4.42 These expenditures relate to the capital spending by MCC after it became a wholly owned MEA subsidiary. They include spending .on the interconnector cable and the capitalisation of. finance costs.
Distribution systems
4.43 Expenditure on the distribution systems relates to improvements and additions to the network through capital projects. Capital expenditure in this nature is usually in the region of £4-5 million per annum.
••
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Telecom
4.44' Telecom additions relate to the expenditure on Skyward. Further details are given in section 14 . , (76kyward").
Investments
4.45 We set out below details of the investments held in subsidiary companies by MEA, which are all eliminated on consolidation of the gioup accounts:
A131 At 31 March December Y. 4 2002 2003 2004 2004 £000 £000 £000 £000
Manx Cable Company 22,606 22,606 22,606 22,606 PGT 2 2 2
22,606 22,608 22,608 22,608
-s 4.46 The MEA held a 50% share in MCC since the company was incorporated in the Isle of Man as a joint venture with National Grid Company (Isle of Man) Limited on 6 May 1998. The principal activity of MCC was to construct and lease an electricity cable link between the United Kingdom and the Isle of Man.
4.47' The £22.6 million investment was made up of the initial 50% subscription of £4.5 million ordinary B 'shares at nominal value, and £18.106 million consideration paid for the remaining 50% shareholding of which £16 million was paid in April 2001 and the balance of £2 million paid in September 2002 when the cable was fully commissioned.
4.48 No goodwill was recognised on the acquisition of the remaining 50% shares as the fixed assets were revalued to a fair value equal to the surplus of the consideration over the net assets of MCC.
4., 4.49 The investment in POT represents 100% of the issued share capital. PGT was incorporated in the Isle of Man on 10 December 2001, with its principal activity being to construct the Pulrose Combined Cycle Gas Turbine generating station for the MEA.
4.50 . PGT was set up after Enron collapsed, resulting in Nepco reneging on its contract with the MEA. We understand that without prompt action the entire project and secure energy supplies to the Island would have been under threat. The MEA were able to set up PGT and novate all the Nepco . ' ■ contracts to PGT without significant delay enabling the project to continue.
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Deferred expenditure
4.51 Deferred expenditure represents costs associated with the bond issue which were treated as • deferred assets and are being written off in equal amounts from 1 April 2004 until the bond matures in 2034. • Of the total expenses incurred at 31 March 2004, interest amounts to • £26,516,146 and bond issue expenses amount to £2,224,000.
4.52 'The deferred expenditure has been adjusted in the accounts to•31 December 2004, with a prior. •tc. year adjustment of £12,582,000 to reflect the element of interest capitalised that was not specific to the capital projects.
4.53 An amount of £12,.318,000 has been capitalised in respect of the interest specific to the capital • ' projects and this has been transferred to fixed assets.
Stock
4.54 Stock is analysed as follows:
At 31 . N At 31 March December 2002 2003 2004 2004 £000 £000 £000 £000
Raw materials and consumables 2,329 2,688 2,641 4,087 Goods for resale 387 263 584 838
2,716 2,951 3,225 4,925
. . 4.55 Raw materials and consumables consist of electricity generation stock and other generation stock. The increase in the level of stock held at 31 December 2004 is because of the additional parts held for the new gas turbines at Pulrose.
4.56 Goods for resale consist of the white goods sold at the MEA showrooms. We understand that the increase in the level of goods for resale is because of the new contract for the distribution of Sony products.
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Debtors
1. Debtors are analysed below:
At 31 At 31 March December F. 2002 2003 2004 • 2004 £000 £000 £000 £000 Trade debtors: :. Electricity billed 1,324 837 1,544 151 Provision for unbilled electricity 2,927 2,990 3,352 3;727 Credit sales 345 199 629 Hire purchase instalments not yet due 342 235 58 VAT 967 962 779 150 Staff loans 80 65 46 35 Provision for bad debts (11) - - Prepayments and accrued income 333 939 , 624 746
6,307 6,227 7,032 4,809
4.58 Trade debtors have increased over the period under review as would be expected from the growth in turnover. At each month end the provision for unbilled electricity is calculated based on the .estimated number 'of units used . in the year to date less the amount invoiced in the year to date and the debtor brought forward.
.4.58 Credit sales represent work done by network services which would typically include new housing . schemes, new supply, and service alterations. Debtors at 31 December 2004 are comparatively low because the amount of credit sales has not been split out from debtors. In addition the debtors balance at 31 December 2004 has not been grossed up by credit balances which are transferred to creditors in the preparation of statutory accounts.
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4.60 Prepayments and accrued income is further analysed below: . 11
At 31 At 31 March December 2002 2003 2004 , 2004 • , . „. £000 £000 £000 . , £000
Prepayments 37 443 165 266 Other debtors 404 333 306 MCC prepayment 296 - 10 Key/token control • 92 126 ... 16,4
333 939 624 746
4.61 Keyitoken control debtors relate to amounts owed from non AEA retail outlets for key and token payments. Cash at bank and in hind
•At 31 At 31 March December 2002 2003 • 2004 2004 £000 £000 £000' £000 MEA 113,955 15,771 7,686 7,301 MCC Limited 2,067 (1,142} 27 111 PGT Limited 16,420 9,169 197 74
132,442 23,798 7,910 7,486
4.62 High initial cash balances arose following the bond issue. Cash has declined over the period as the Authority has spent money on capital projects and funded operations.
• • 1 July 2005 Historical assets and liabilities 50 Manx Electricity Authority PKr
Creditors: amounts` falling due within one year Loans and overdrafts
4.63 The balance relates to a finance lease balance with the Isle of Man Bank and is analysed as; - . • • '." -follows:
• , *1'1-
At 31' At 31 March• December 2002 2003 2004 2004 £000 £000 £000• £000 ArpoLints falling due after one year: At 1 April 4,582 3,116 1,874 Less: repayments during the year (1,466) (1,242) , (1,342)
3,116 1,874 532 Less airiounts falling due within one year (1,242) (1,342) (532)
1,874 532
it 4:64 *The finance leases related to the diesel engines at Peel and Pulrose. We understand that, e>cluding- the gas pipeline the treatment of which is under consideration, there are no other assets held under finance lease. •
, Creditors
4.65 .Short term creditors are analysed below:
7-• At 31 At 31 March December 2002 2003 2004 • 2004 £000 £000 £000 £000
• .Trade creditors 7,561 3,394 648 A, 183. • 1 . Other.creditors 8,632 8,571 10,708 11,750
'Accruals 938 1,649 • :1,150 • 2,323. 1. Provision for rebate 1,752 1,746
18,883 15,360 12,506 14,256
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• 4.66 The level of trade creditors has fallen at 31 March 2004 and 31 December 2004 due to the capital project spend reducing.
4.67 Further analysis of other creditors is given below:
At 31 At 31 March December 2002 2003 2004 2004 £000 £000 £000 £000
Bond interest accrual 6,629 6,629 6,632 6,629 Barclays loan interest 2,000 607 2,317 Gas purchase - 1,247 2,090 Credit balances on the debtors control 806 1,511 . account Oil stock creditor i - 808 279 419 Other 3 328 432 295
8,632 8,571 10,708 11,750 •
4.68 . The bond interest is payable annually in arrears in August.
4.69 The gas purchase creditor relates to BGE.
4.70 Further analysis of accruals is given below:
At 31 At 31 March December 2002 2003 2004 2004 £000 £000 £000 £000
N power creditor 389 547 304 1,252 MCC accruals for Bispham shore.station 252 252 252 r Bonus accrual 200 250 Other 349 600 594 819.
938 1,649 1,150 2,323
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4.71 = The N power creditor at 31 December 2004 relates to electricity imports and is high due to two months of accruals being included and due to the higher monthly usage associated with November and December (when compared to March).
4.72 "Other accruals" includes a significant payment to a supplier now in administration; it is unlikely this creditor will be paid.
4.73 - The MCC accruals for Bispham shore station represent the accrual for rates and other costs for • the station which have not been requested of MCC to date.
Creditors: amounts falling due after more than one year
4.74 Long term creditors'are analysed as follows:
At 31 At 31 March December 2002 2003 2004 2004 f000 £000 £000 £000
Loan payable- due after one year -Barclays - _ 85,000 110,000 Loan Payable — HSBC • 30,398 30,179 Deferred income 7,579 8,112 8,823 9,100
..- Provision for rebate 1,640
:S• Amount due to loM Government 185,000 185,000 185,000 185,000 Finance Debt 1,874 532
z • 226,491 223,823 278,823 304,100
Loan payable
.4.75 . MCC has drawn .down £110 million of the Barclays loans facility totalling £1 20 million. We
1- understand that MCCintends to draw down the remaining £10 million at the end of March 2005. s • The loan amounts were received by MCC and were transferred thereafter to MEA bank accouhts. The MEA has explained that these transfers comprise consideration for assets-held by the MEA as • _ part of the requirement for there to be clear separation between the different businesses the MEA r. :undertakes: electricity generation, gas supply etc under the Gas and Electricity Act 2003. The 'DTI comments that in its view the Act only provides for separation to prevent cross-subsidisation of one • s. function by another.
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4.76 KPMG's preliminary view of this proposed treatment is that it is not supported by contemporaneous documentary evidence. KPMG have requested confirmation from the Board of the MEA of the proposed treatment and further documentary evidence to support it„ As yet they ," have not received such confirmation or evidence.
4.77 The first facility of £70 million is due for repayment on 8 July 2008, and the. second facility of £50 million is due for repayment on 25 September 2005.
4.78 During the year ended 31 March 2004 the HSBC loan to MCC of £30 million was repaid from the . funds received under the Barclays facilities.
4.79 Further comment on the loans is given in section 12 ("Review of bank tendering process").
Deferred income
x 4,80 Deferred income is as follows:
At 31 At 31 March December 2002 2003 2004 . 2004 £000 £000 £000 £000
Customers' contributions at 1 April 6,802 7,579 8,112 8,823 Recdived in the year 1,016 798 996 485 Released to profit and loss account in the (239) (265) (285) (208) year
7,579 8,112 • 8,823 9,100
4.81 Customer contributions are released to the profit and loss account over the same period as the assets are depreciated which is a period of 40 years. The balance of deferred income has increased as the Authority,receives more contributions from customers than are released to the - profit and loss account.
Provision for rebate
4.82 The provision for rebate relates to a standing charge of £42 per customer that was being paid on . behalf of consumers by the Isle of Man Government. This is discussed further in section 5..
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Amount due to loM Government
4:83 The amount due to the Government represents amounts due to the Isle of Man Treasury on back to back terms with the bond issue made by the Treasury. The bond was issued at a rate of 5.375% per annum and has a maturity date of 14 August 2034.
.'ginance debt
4.84 The finance debt balance is analysed in paragraph 4.63 above.
BGE Capacity payments
4.85 The balance sheets at 31 December 2004 and 31 March 2004 do not include any provision for - liability in respect of BGE capacity costs because it had been treated as an operating lease. However the accounting treatment is under consideration by the auditors.
4.86 . There are two separate leases under which the MEA are contracted to pay BGE until 30 September 2023. Under the `MEA Capacity Agreement' the MEA pay BGE for the apportionment
••-of capital costs of the main SIPS II pipeline and also pay the operation and maintenance charge. • -;.Under the second agreement, Aniended and restated Isle of Man Pipeline Connection Agreement', the MEA pay BGE for the capacity charge and operation and maintenance charge for the spur pipeline.
• • 4.87 •• • The table below sets out the estimated total payments under both leases:
Main Spur Total Pipeline Pipeline £000 £000 £000 total amounts payable from 1 January 2005 to 30 September 2023 Capacity charge 90,000 95,000 • ' 185,000' Operating and maintenance costs 5,000 18,000 • 23,000
95,000 113,000 208,000
• The figures stated take into account monthly cost increases in line with United Kingdom RPI
4.88 - Both the capacity charge and operating and maintenance costs are variable depending on the total • • ,pipeline usage and the MEA's share of the total usage. These costs have a capped upper limit of 15% of .the total maintenance costs on the pipeline.
tS.
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Manx Electricity Authdrity
4 4.89 A detailed review of the accounting treatment of the BGE lease commitments is being carried out by the MEA and KPMG. We have been informed by KPMG that their current thinking is that' the correct accounting treatment for: the ;BGE leases would be to treat them as a finance lease. 'We, understand that the accounting treatment of the BGE• lease will make no material difference to the MEA's cash position as it does not pay tax.
4.90 If the spur pipeline costs were to be accounted for as a finance lease the estimated capital cost of £95 million would be included in fixed assets with the corresponding liability recognised on the balance sheet.. •
4.91 If the MEA capacity and operating and maintenance agreements for the main pipeline were to be accounted at operating leases then the operating lease commitments.would be disclosed in the notes to the financial statements in accordance with UK GAAP .and charged to the profit and loss . account as incurred. -
Reserves
4_92 Reserves are as follows:
At 31 At 31 March December 2002 2003 2004 2004 . £000 '£000 £000 £000
Asset replacement reserve Balance brought forward at 1 April • .. 54,508 60,691 62,425 66,539 Transfer from profit and loss account in the 6,633 1,734 . 4,114 (17,586) year ' . . Prior year adjustment - - (12,582)
Balance carried forward at 31 March 60,691 62,425 66,539 36,371
General reserve At 1 April and 31 March 12,000 12,000 12,000 12,000
4:93 We understand that there are no restrictions on the use of the reserves or level of reserves that '- need to be retained other than the Electricity Act 1996 which requires at section 3(1) that:
"The Authority shall perform its functions so as to secure that its revenue is not less than sufficient to meet charges properly chargeable to revenue account, taking one year with another, and • to enable the Authority to make such allocations to reserves as it considers adequate or as the - Treasury may dire& under subsection (2)(b)." • •
1 July 2005 Historical assets and liabilities .56 Manx Electricity Authority . PO"
.4.94 • .1. The Treasury's view is that by forecasting losses as set out in section 8 ("Projected trading and cash flows"), the MEA is in breach of this section of the Electricity Act.
. .The prior year adjustment represents the correction of the accounting treatment of the - interest - payable on the bond and loan which had been previously capitalised.
, icPensions
) 4.96 The Government operates a pension scheme on behalf of the MEA, whereby the MEA contributes 7% and the employee'6% of his or her pensionable pay.
4.97 We understand that this is a defined contribution pension scheme and that no liabilities exist that are not included on the balance sheet.
•
,-•
', , 1 July 2005 Historical assets and liabilities 57 Manx Electricity Authority PKF
Inter-company balances and subsidiary debt
4.98 We set out below a summary of the net assets, outstanding debt and inter-company balances of each of the Authority, MCC and PGT as at 31 March 2003, 31 March 2004 and 31 December 2004:
At 31 March At 31 December 2003 ' 2004 2004 £000 £000 £000 Authority Net assets 72,225 76,059 47,162 Third party loans/overdrafts (186;874) (185,532),. . (185,000) Amounts due from PGT 4,290 Amounts due from MCC 3,661 Amounts due to PGT (13,318) Amounts due to MCC (12,363) (50,029) .
MCC Net assets 10,975 11,617 10,650 Third party loans/overdrafts (31,597) (85,000) (110,000)
Amounts due from POT 39,305 29,475 • Amounts due from Authority 12,363 50,029 Amounts due to Authority (3,661)*
POT Net assets 2 Third party loans/overdrafts Amounts due from Authority 13,318 Amounts due to MCC (39,305) (29,475) Amounts due to Authority (4,290)
Note -The intercompany balances do not take account of the subsequent restatement of assets with a value of £50.2 million between MEA and MCC in the accounts for the year ended 31 March 2004. T3,490,000 included in trade creditors in error
4.99 The MEA has prepared revised draft accounts for the year to 31 March 2004 which adjust the intercompany balances between MCC and MEA to reflect the acquisition by MCC of certain fixed assets from the MEA to which the transfers to the MEA relate. The above table reflects the balances presented before this adjustment and reflects actual cash movements.
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4.100 KPMG's provisional view, in their role as auditors to the MEA, based on the documentation they have seen is that the..Proposed treatment is not supported by contemporaneous documentation supporting this as being the original intention of either entity. We understand that they have requested that the MEA confirm whether they wish to pursue this proposed treatment and, if so, provide further documentary evidence to support it. As yet, KPMG have not yet received such . confirmation or documentation. .
4.101 We have verified the receipt of payments made to the Authority and PGT from MCC to the bank - statements of all the companies. £50 million was paid on 16 July 2003, with £48.64 Million being paid from MCC to MEA Barclays bank account and £1.36 million being paid into PGT bank account. Of the remaining £60 million payments made to the end of October 2004, £55.3 million was paid to MEA and £4.6 million was paid to PGT.
4.102 The intercompany balance has reduced to £50 million from a total payment of £103 million • • ' because of repayments of HSBC debt of £32.3 million (including interest), repayments to MCC of £5.2 million, recharges of the interconnector rent of £8.2 million, Barclays loan interest payable of - £5.2 million, and other inter company transactions of £2.1 million.
'Third party loans/overdrafts
4.103 The loan/overdraft balance is analysed as follows:
At 31 March At 31 December 2003 2004 2004 £000 £000 £000 Authority Amount due to IOM government 185,000 185,000 185,000 Isle of Man Bank finance debt 1,874 532
186,874 185,532 185,000
MCC Bank loans 30,179 85,000 110,000 Overdraft 1,418
Third party loans/overdrafts 31,597 85,000 110,000
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jlf Manx Electricity Authority 14;f: ' 4.• ,..PKF
•
Historical cash flow generation ,
Summary of cashflow statements • •. 5.1 The MEA does not prepare individual entity cash flows as cash management is a centralised • ..•, function within the business. We set out below the consolidated cash flow statement of the Authority for the periods ended 31 March 2002 and 31- March • 2003 as extracted from the consolidated audited accounts, for the year ended 31 March 2004, as extracted from the .. ,, consolidated draft accounts and for the nine months to 31 December 2004 as prepared by PKF based on the management accounts: "V•
' •;
. '
• July 2005 Historical cash flow generaticin .4 Maiix Electricity Authority PKF
Nine months ended Year ended Year ended Year ended 31 March 31 March 31 Maich Decenther .„ 2002 2003. 2004 2004
£000 £000 £000 . '.£000 . Net cash inflow from operating activities 8,810 (1,762) *8,436 3,906
Returns on investments and servicing of finance • . .. : Interest received 3,911 2,722 152 152' Interest paid (564) • (10,716) (12,996) . .(13,823) • . ' Net cash flow from returns on investments 3,347 (7,994) (12,844) (13,671) and servicing of finance .__ -Cashflow from operating activities after 12,157 _ (9,756) (4,408) . (9;765) interest paid
Capital expenditure Purchase of subsidiary . (16,106) , ,. Payments to acquire tangible fixed assets (38,682) (98,225) (65,944) , (15,612) '. Cash acquired on purchase of subsidiary 430 Deferred income• received - customers' 1,016 • 798 996 485 contributions
(53,342) (97,427) (64,948) (15,127)
4-.•■ Cashflow before financing (41,185) (107,183) (69,356) (24,892)
• Financing (Repayment)/borrowing of HSBC loan (5,000) (219) Repayment of loan (1,986) (30,179) New loan finance arranged 185,000 - 85,000 .25;000 Costs of financing (2,224) Repayment of lease finance (1,466) (1,242) (1,342) .. - (532) ..
174,324 (1,461) 53,479 - , 24,468 -
Increase/(decrease) in cash in the period 133,139 (108,644) (15,888) (424)
Opening net debt (12,265) (86,702) (193,225) (262,622)
Closing net debt (86,702) (193,225) (262,622) (287,514)
.* Includes performance bond receipts treated as a 'windfall" profit of £10.2m. Excluding this the Authority had a cash outflow from operations of £1.7m
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• Overview
5.2 After taking account interest, the 'MEA group has been cash negative, before capital expenditure • . - . and financing, since the financial . year ending .31 March 2003. The year to 31 March 2003 produced a negative cashflow of £9.8 million, the year to 31 March 2004 a negative cashflow of £4.4 million (including a performance bond receipt of £10.2 million - £14.6 million before the bond proceeds), and the nine months to 31 December 2004 a negative cashflow of £9.8 million.
5.3 The net cash flows before financirig• show that each year the MEA group had the following cash • outflows:
• Year. to 31 March 2002 - £41.2 million;
• Year to 31 March 2003 -£107.2 million; •
. - • Year to 31 March 2004.- £69.4• million;
• Nine months to 31 December 2004 - £24.9 million.
5:4 The above reflects the high capital.spend in the period under review. The total cash out flows over this period before financing amounting to £234.7 million.
f!
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Comparison of cash flows against profits
5.5 We set out below a reconciliation of operating profit to cashflow from operating activities:
, Nine '. months . ended Year ended Year ended Year ended 31' 31 March 31 March 31 March December. 2002 2003 2004 2004 £000 . £000 £000 £000 Operating surplus/(deficit) 3,882 (105) 7,058 . 7,5( 5, 69 345) Depreciation,charges ' 4,107 4,036 5,629 i, - . Deferred income release (239) (265) (285) t (208)
Working capital movements Decrease/(increase)•in stock 497 • (235) (274) ._ (1,700) Decrease/(increase) in debtors (381) 80 (805) . 2;223 , 1,750 (Decrease)lincrease in creditors 2,931 (3,532) (2,854) . —
Mcivement in provision for rebate (1,391) (1,640)
Relieved loM Government interest (596) (110) (33) ;
Net cash inflow/(outflow) from operating activities 8,810 (1,762) 8,436 3,4906
Depreciation y . 5.6 The depreciation charge in the nine months to 31 December 2004 has increased due to the new generating plant and pipeline systems being depreciated for the first time.
Deferred income release
5.7 ''The movement in the fable above relates to the amortisation of the customer contributions in respect of fixed assets. • The actual customer contributions towards capital expenditure are. • recognised in the • cashfloW statement in the year in which they are received, Linder. capital expenditure in the cashflow, but they are released to the profit and loss account over 40 years. •t
4.
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Working capital movements
Stock
5.8 There have been significant increases in the level of stock held particularly. in the period to 31' December 2004 as parts stock have been purchased for the new CCGT power station:
Debtors
5.9 There is a large decrease in debtors to 31 December 2004 due to a number of debtors and
creditors not being grossed up in the management accounts as they would be in statutory account , format. Historically movements in debtors have not been significant.
Creditors
5.10 The large decrease in creditors in the years to 31 March 2003 and 2004 areas a result of trade creditors declining over the period due to Capital Projects creditors balances reducing as the work. neared completion. The increase in creditors to 31 December 2004 is due to two months of electricity import creditors being included in the creditor balance and the cut off in December being' at a time of higher usage in the winter months, causing both gas and electricity creditors to be higher than at 31 March.
Movement in proVision for rebate
T. 5.11 We understand from Treasury that the Government took responsibility for payments relating the borrowings thereby enabling the MEA to set up and internal fund to cover. the cost of the standing charge to consumers. In the Treasury's view it was anticipated that the standing charge would be, withdrawn when the funding expired (although it is acknowledged that this was not documented). Following this the Treasury's view is that it was agreed that the Standing charge would remain for a further six months before being withdrawn. It is now anticipated by the MEA that the standing charge will remain. (see further paragraph 3.16 above). We understand from Treasury that this was not agreed with them in advance.
5.12 The adjustment to the cashflow was necessary to show that this income was not" received in cash during the period. However the standing charge is now being paid for by the consumers so there will be no adjustment necessary to the cashflow from operating activities in future periods. -`
Returns on investments and servicing of finance
5.13 The interest payable on the bond and on the Barclays loan were capitalised in the years ended 31 March 2002, 2003 and 2004. The above reflect the actual amounts paid each year.
5.14 The level of interest received has reduced from the level seen in 2002 as the cash balances of the • bond receipt have reduced through capital spend on the projects. •
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Capital expenditure
Purchase of subsidiary
5.15 This relates to the paymerits to acquire the remaining 50% share in MCC for £16m. A further £2 million of deferred consideration payable to National Grid was paid in September 2002 and we assume is included within payments to acquire tangible fixed assets. This payment of £2 million was a retention sum payable by MEA to MCC when certain defects were completed by the original MCC contractor Pirelli. If the work had not been completed this payment would have been withheld to cover the cost of MEA undertaking the work.
Payments to acquire tangible fixed assets
5.16 We set out below an analysis of capital expenditure by company from the individual company statutory accounts and management accounts to 31 December 2004:
At 31 At 31 March December 2002 2003 2004 2004 £000 £000 £000 000 MEA 63,730 72,278 36,858 12,807 Less: PGT Limited invoices to MEA (36,000) (50,000) (11,000) (335) Add: PGT actual expenditure 9,190 73,373 40,180 4,471 . MCC Limited 1,896 2,439 *1,305 26 Unanalysed timing difference between (134) 135 1,399 (1,357) cashflow statement and statutory account additions
Capital expenditure per cashflow 38,682 98,225 65,944 15,612
*The additions by MCC are based on the original financial statements and do not include the subsequent restatement of assets with a value of £50.2 million between MEA and MCC in the accounts for the year ended 31 March 2004.
5.17 The cashflow statements show payments to acquire tangible fixed assets of £218 million during the period from 1 April 2001 to 31 December 2004. The total spend on the Pulrose Power Station and system network through PGT Limited at 31 December 2004 was £127 million, with £97 million having being invoiced to MEA, and the balance of £30 million being work in progress to be invoiced to the MEA. The analysis of additions is set out in section 4 ("Historical assets and liabilities"). The main other items of additional expenditure include the PRS and the acquisition of MCC.
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Comparison of capital receipts and payments with quarterly returns provided to the treasury
5.18 An analysis of capital spend in the period under review and comparison of capital payments with quarterly returns provided to the Treasury has been carried out in section_4 ("Historical assets and • liabilities").
Authorisation procedures
5.19 Authorisation procedures are discussed in section 10 ("Financial reporting environment and liaison with auditors").
5.20 There have been no significant asset disposals in the period.
Identification of cash flows used to finance discretionary activities
5,21 The only discretionary activities identified relate to the Skyward Committee. The cash flows used to finance the Skyward expenditure is discussed in section 14 ("Skyward").
Financing
5.22 The main cash inflows have come from the loans taken out by the MEA group which are shown in more detail in the table in paragraph 5.24, below.
5.23 The total cash inflow from loans amounted to £295 million in the period under review. £185 million was raised thrbugh the Government bond issue and £110 million has been drawn down on the Barclays loans facilities entered into by MCC which total £120 million.
1 July 2005 Historical cash flow generation. 6 6
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Third party loans/borrowings
5.24 We set out below an analysis of the movement in third party loans borrowings by entity over the period:
At 31 At 31 March December 2002 2003 2004 2004 £000 £000 £000 £000 Third party loans/ borrowings MEA 185,000 MCC Limited *30,398 85,000 25,000
215,398 85,000 25,000
Repayment of third party loans borrowing MEA (6,986) • MCC Limited (219) (30,179)
(6,986) (219) (30,179)
*The third party loans of MCC were included in the consolidated balance sheet and consolidated cashflow statement of the MEA for the first time in the year ended 31 March 2002 following the purchase of the remaining equity in MCC by the MEA. The loans were actually taken out in 1999 and had been reported in the notes to the financial statements prior to 2002.
5.25 The Authority repaid the loM Bank debt of £2.0 million and the HSBC £5 million loan during 2002. The HSBC loan of £30 million was repaid by MCC in the year to 31 March 2004. The remainder of the funds were used to make transfers to the Authority (£103.9 million) and to PGT (£6
5.26 The MEA have stated that the transfers to MEA by MCC comprise payments for assets purchased . by MCC from MEA in order to separate out the different business assets as required in the Gas and Electricity Act of 2003. This is first documented in Board minutes in 2005, i.e. after the 31 March 2004 year end.
5.27 The Treasury does not agree with the MEA's views in respect of the transfers and considers that they represent loans from MCC to the MEA.
5.28 KPMG's preliminary view of this proposed treatment is that it is not supported by contemporaneous documentary evidence. KPMG have requested confirmation from the Board of the MEA of the proposed treatment and further documentary evidence to support it. As yet they have not received such confirmation or evidence. It is possible that the final treatment of these transfers will be significant in determining the nature of these transactions under the Electricity Act 1996.
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5.29 The original draft March 2004 accounts did not reflect this treatment but, we understand, have since been re-drafted.
5.30 We are not aware as to whether the MEA have a register of which assets are owned by MCC.
Repayment of lease finance
• 5.31 The Authority has also paid off all lease financing in the period, (totalling £45 million).
Costs of financing
5.32 The costs of financing cash flows in 2002 relate to the costs incurred in issuing the bonds and represents a 'One-off' cashflow.
Current adherence to banking and statutory covenants
5.33 There are no banking covenants or statutory covenants either with Barclays or on the Isle of Man • treasury bond.
1 July 2005 Historical cash flow generation 68 •Manx Electricity Authority PKF
Accounting policies
6.1 We have reviewed MEA's accounting policies as set out in the draft accounts to 31 March 2004 and comment where appropriate below:
Tangible fixed assets
6.2 Extracted from the draft MEA accounts for the year ended 31 March 2004:
6.3 Depreciation is not provided on freehold land. On other assets it is provided on cost in equal annual instalments over the estimated useful lives of the assets. Depreciation is first charged in the year following that in which the expenditure was incurred or, in respect of generation plant, the year of commissioning.
6.4 . The rates of depreciation are as follows:
Years Buildings 40
Generation plant
Diesel stations 20 Hydro-electric station 30 1 Oil storage 25 Distribution Systems 40 Vehicles and equipment
Meters 10 or 20 (according to meter type) Vehicles and other 5 Pipeline systems 60 CCGT Plant 40
6.5 • In respect of the' as pipeline, power station and associated infrastructure, including the PRS, no depreciation was charged in the year to 31 March 2004 on the grounds that the power station was not fully commissioned until April 2004. We understand KPMG have accepted this treatment.
. 1 July 2005 Accounting policies 69 :0
4 Manx Electricity Authority PKF
Deferred Expenditure
• 6.6 Extracted from the draft MEA accounts for the year ended 31 March 2004: I, t ,
6.7 The MEA has borrowed £185 million from the Isle of Man Government as the financial 'solution - within the overall re-structuring strategy. Interest is being deferred until the re-structuring is complete and will be amortised over the remaining life of the loan.
6.8 The MEA accounts have always been prepared in accordance with the Isle of Man Audit Act 1983. Until the MEA started borrowing money in its own right there was no fundamental difference between accounts that complied with the Audit Act and thoSe prepared under UK GAAP. Although the 2001-2002 and 2002-2003 accounts conform to the Audit Act 1983, they do not conform to UK GAAP as all bond interest payable prior to commissioning in April 2004 has been capitalized whilst interest receivable has been taken to the profit and loss account.
6.9 KPMG changed their audit opinion on the accounts for the years ended 31 March 2002 and 2003 from the previous "true and fair" opinion to an opinion that the accounts had been "properly prepared in accordance with the Accounts and Audit Regulations 1984, made under the Audit Act •' 1983". Both the 2002 and 2003 accounts were accepted by Treasury and approved by Tynwald.
6.10 The treatment of interest was investigated by the Standing Committee on Expenditure and Public . Accounts who reported that the Treasury were satisfied that the method of accounting was fully compliant with the Audit Act. In 2004 the Chief Minister directed that the accounts be re-stated to UK GAAP and the MEA has acted in accordance with this direction. The restatement makes no material difference to the cash position of the MEA as it does not pay tax and the restatement only affects non cash charges.to the profit and loss account. •
BGE capacity charges
6.11 • The MEA are in the process of finalising the way it accounts for the payments to BGE for capacity charges on the spur pipeline. The current accounting treatment has been to capitalise the payments and to depreciate the capitalised amount over 60 years.
6.12 We understand that KPMG have reviewed the lease for the spur pipeline and recommend that it' should be accounted for as a finance lease, with the grossed up amounts being treated as fixed assets and a lease creditor.
1 July 2005 Accounting policies' '70 Manx Electricity Authority PKF
7 Previous forecasting history
7.1,,E We set out below the consolidated actual and budgeted results for the Authority for the year ended 31 March 2004 and the nine months ended 31 December 2004, both periods being.extracted from the management accounts:
Actual Budget Variance Variance £000 f000 £000 Year ended 31 March 2004 Turnover: Energy (incl interest) 28,512 33,351 (4,839) (14.5) Other income including receipt of 11,766 12,642 (876) (6.9) performance bond Retail 3,697 3,537 160 4.5
.
43,975 49,530 (5,555) (11.2) Operating Energy (incl interest) (36,747) (32,871) (3,876) (11.8) costs: Retail (3,522) (3,457) (65) (1.9)
(40,269) (36,328) (3,941) (10.8) Net profit: Energy 3,531 13,122 (9,591) . (73: 1) Retail 175 80 95 118.8
(Deficit)/surplus after interest 3,706 13,202 9,496 •(71.9) 6
6
Nine months ended 31 December 2004 Turnover: Energy (incl interest) 23,701 26,478 (2,777) - (10:5) Retail 2,713 2,943 (230) (7.8)
26,414 29,421 (3,007) (10.2) Operating Energy (incl interest) (42,350) (39,884) (2,466)' (6.2) costs: Retail (2,649) (2,835) 186 6.6
(44,999) (42,719) (2,280) > (5.3) ' Net profit: Energy . (18,649) (13,406) (5,243) • (39.1) Retail 64 108 (44) (40.7)
(Deficit)/surplus after interest (18,585) (13,298) (5,287) (39_8)
- i July-2005 Previous forecasting history 71, t
Manx Electricity Authority POCF
7.2 The actual results for the year ended 31 March 2004 are as per the AuthOrity's management accounts for the purposes of comparability with the budgeted results: The =surplus per the management accounts is some £408,000 lower than the surplus per the draft •statutory financial statements. This is not considered material for the purposes of reviewing the Authority's previoUs, forecasting history. .
7.3 The MEA consider that the two periods reviewed above are not representative as they involve the commissioning and initial runs of the CCGT power station and other assets.
- Variances to 31 March 2004
7.4 There was an adverse variance of £5,555,000 on turnover. The principle reasons highlighted in ; the monthly Board papers were energy sales variances of £2,276,000 caused by a price variance of £570,000 and a volume variance of £1,706,000. The average unit selling price was 7.54 pence
against a plan of 7.69 pence. Actual volumes were below plan by 22,174,000 KWH which was a . negative variance of 5.6%. The original plan forecasted a growth of 10% compared to actual growth in number . of units achieved of only 2.03%. The 10% growth forecast had overestimated the demand in network planning, as new business customers had been expected to come to the Island which would contribute up to 5% of the Island demand. The main reason for the variance in price was that forecast increase in tariffs did not take place until August 2004.
7.5 The other principle variance came from a shortfall in export sales of £2,557,000. This shortfall was • due to a reduction in the overall spark spread during the year. However during the summer . months, when the spark spread is at its maximum due to low gas prices, demolition works scheduled on the old chimney flue stack prevented the use of one gas turbine. This curtailed export opportunities throughout the summer months. The MEA's energy traders expect that with increasing demand in the UK and minimum new generation being built, future spark spreads will increase. Moreover increased carbon trading associated. with the introdUction of the UK and European Emissions Trading Scheme from January 2005 has already started to widen spark spreads.
7.6 The energy operating cost variance of £3,876,000 principally consisted of a staffing cost variance. • of £1,893,000 and an establishment cost variance of £981,000. Staffing costs Were higher than' ••:•. budget due to the additional staff needed to be taken on to work the gas turbine p-ower station and the bonuses paid to the staff and directors following the completion of the projects. The main. variance on establishMent costs was the additional insurance premiums as a'result of the new t . generation plant and infraStructure that has been built.
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Variances to 31 December 2004 7.7 In the nine months to 31 . December 2004 there was an adverse turnover variance of £2,777,000. The variance principally consisted of adverse energy sales with an Island domestic variance of £1,931,000 and export profit variance of £948,000. As before the reasons for these variances were that the plan included growth assumptions of 10% and a strong view on prices whereby gas prices were forecast to reduce when in fact they increased. This resulted in budgeted export profits not being met. In addition, there was not full availability on the gas turbines as they were both intermittently unavailable during the period to 31 December 2004. There were also technical' problems during the commissioning of the steam turbine which have now been rectified. This resulted in efficiencies not being gained from recycling the heat given off from the gas turbines.
7.8 The high market price for gas and the availability problems with the turbines led.to an electricity import cost variance of £3,695,000 and a fuel cost variance of £625,000 due to the supply of electricity from the interconnector and diesel generators being much higher than planned. However these were partially offset by lower gas costs of £1,079,000 and favourable other expenditure costs variances of £826,000.
Bases of preparation of the projections
7.9 The projections for the year ended 31 March 2005 have been based on nine months actual figures to 31 December 2004 and a reforecast of the budget for the three months to 31 March 2005. The ti reforecast figures are based on current rates of output and current levels of cost, which have been annualised for the reforecast figures.
7.10 The projections have been prepared on behalf of the MEA by Clive Wilcox, with assistance from the energy trading department for the assumptions on fuel costs. The energy trading department calculate the fuel requirements for the year and use forward prices to model the cost of generating the electricity output needed to meet the growth in Island demand. The assumption are p'repared on the basis that electricity will be imported through the cable interconnector at night and that the gas turbines will used to generate electricity during the day. •
7.11 The projections for the year ended 31 March 2006 and beyond are prepared based on the following assumptions:
• RPI each year of 3%;
• Annual units growth of 4%;
• Tariff increases of RPI plus 5% applied in August each year;
• • Forward fuel prices as at 9 February 2005 for years to 2008/2009 and RPI plus 5% thereafter;
• Fixed rate borrowing at appropriate rates with variable borrowing at 6%;
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• Other costs increase at RPI.
7.12 The cashflow projections are prepared on the same basis as the profit and loss account projections with no adjustment for working capital.
Compliance of the projections with UK GAAP
7.13 The projections are compliant with UK GAAP, revised to clarifying the treatment of the BGE lease costs, as the projections are based on the revised 2004 accounting policies of the Authority. The adjustments needed in order to comply with UK GAAP in 2004 have been included in the 'Authority's latest 2004 draft accounts and include prior year adjustments to reflect the agreed treatment of bond interest and issue costs. The changes in accounting policies have no impact on the cash position of the MEA.
1 July 2005 Previous forecasting history, 74 Manx Electricity Authority PKF
Projected trading and cash flows
Projected trading
8.1 We set out below the projected trading results for the period ending 31 March 2006, as extracted • from the Authority's budgets, together with historical results for the year ended 31 March 2004 and the nine months ended 31 December 2004:
Nine months Three months Year ended Year ended ended ending Year ended 31 31 March December 31 March 31 March 31 March 2004 2004 2005 2005 2006 Actual Actual Projected Forecast Projected £000 £000 £000 £000 £000
Turnover: Energy 29,732 23,549 11,021 34,570 • 47,072 Retail 3,697 2,713 903 3,616 4,000 Other income 10,200
43,629 26,262 11,924 38,186 51,072 Operating Energy (33,049) (30,306) (12,458) (42,764) (48,907) costs: Retail -(3,522) (2,649) (882) (3,531) (3,681) Interest
(36,571) (32,955) (13,340) (46,295). (52,588) Net profit/(loss) Energy (3,317) (6,757) (1,437) (8,194) (1,835) Retail 175 64 21 85 319 Other income 10,200
(Deficit)/surplus before interest 7,058 (6,693) (1,416) (8,109) (1,616) Net interest payable/(receivable) (2,944)• (11,892) (4,266) (16,158) (17,488)
(Deficit)/surplus after interest 4,114 (18,585) (5,682) (24,267) (19,004)
'Before any adjustment for capitalisation of interest
8.2 The forecast energy turnover to 31 March 2005 represents a 16% increase over 2004 with a . further 36% increase in 2006. Both these increases are a result of higher prices and to a lesser
. extent projected growth in demand.
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8.3 Energy operating costs are forecast to be 29% higher in the year to 31 March 2005 from the level seen in 2004 with the main increases being energy costs, staff costs, depreciatiOn and BGE costs., Operating costs are forecast to grow by 14% for the year to 31 March 2006, 4
8.4 Overall the growth in turnover in the year to 31 March 2006 reduces the forecast deficit to £19 million compared to a forecast deficit of £24 million in the year to 31 March 2005.''
Energy turnover
8.5 Actual and projected turnover for the period under review is set out below:
Nine months Three months Year ended Year ended ended ending Year ended 31 31 March December 31 March 31 March 31 March 2004 2004 2005 2005 2006 Actual Actual Projected Forecast Projected £000 £000 £000 £000 £000
Energy sales— Island Domestic 27,998 21,635 10,238 31,873 43,682 Export profits . 239 526 220 746 1,826. Gas sales 283 430 245 675 914 Other income 1,212 958 318 1,276 650
29,732 23,549 11,021 34,570 47,072
Units sold (MWh) 371,199 277,117 105,308 382,425 402,000 Average Price per unit over the year (pence per kWh Sold) • 7.61 7.81 9.72 8.33 10.86
8.6 There are two main assumptions behind the growth in energy turnover. An assumption of an increase in the tariff of 8% from August 2005, based on a 5% increase and an API adjustment of 3%, and an assumption that the units sold will increase by 5.1% per annum represents an unadjusted increase in turnover on a nominal basis of 12.3%,
8.7 The MEA has informed us that it has attempted to ensure that the cost of electricity generally decreases in real terms over the long term. The chart below, prepared by the MEA, shows the inflation linked price of a unit of Electricity (including the Fuel Cost Adjustment) between 1990 and 2010 assuming the price changes projected in this report occur. it can be seen from the data provided that even with these price rises the real price of electricity in 2010 will be approximately 90% of its 1990 value. We have not confirmed the accuracy of the chart.
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• Inflation Linked Price of Bectricity 1990-2010: 1990 = 100% - 120% . .100% .. -.....7'" , ----'------ ..---- .. 60%
40%
20% .
0% • .... , .
Actual Future Inflation 3% – — – Future Inflation 5%
Tariff 8.8 The actual price per unit at 1 January 2004 is 10.29 pence which is an increase of 35% from the price charged throughout 2003/04. The tariff has been increased twice since 31 March 2004. There was an increase in the fuel . cost adjustment (FCA) of 0.9 pence from 0.4 pence to 1.3 pence, together with a 5% increase on all tariffs in August 2004. This was followed by an increase of 1.4 pence in the FCA in DeCember 2004, taking the FCA to 2.7 pence. The actual unit price at 31 March 2006 is forecast to be 11.11 pence based on the increase of 8% in August 2005.
8.9 • The projected price increase is weighted to reflect the higher usage during the winter months.
r • Units sold
8.10 Units sold are projected to increase by 5.1% from the year ended 31 March 2004. The table below • - summarises the history of growth in units sold up to 31 March 2004:
Growth in units sold to 31 March 2004 % Annual Growth 15 year average 4.3% 10 year average 4.42% •,.. 1 5 year average 5.29%
" 8.11. . The highest annual growth in units sold achieved over the last 20 years was 9.5% in the year to 31 March 2001, and the lowest annual growth was 1.0% in the year to 31 March 1995.
8.12 Based on historical data the MEA considers that the supply of electricity is reasonably price inelistic on the Isle of Man due to the majority of the customers being financial services organisations and domestic users. There are a number of manufacturing customers which are more sensitive to price increases but management does not consider that the changes in tariff will materially affect the demand.
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8.13 Whilst the assumption that growth in units of 4% seems to be reasonable over, the longer term, actual growth in demand can vary significantly from year to year with growth • in the year to 31 March 2004 of 2.0% and in 9 months to 31 December 2004 of 3.9% so there are sensitivities to this assumption that may materially affect the projections.
Export profits
8.14 Export profits for the year ending 31 March 2006 are forecast.to increase by £1,080,000 from the reforecast level -set to be achieved in the year to 31 March 2005.
8.15 The MEA has entered into larger standing reserve contracts in the next year in order to boost profits from exporting energy. The forecast for the year to 31 March 2006 is based on receipts of £1 million under standing reserve contracts.
8.16 The forecast also includes an increase in income from Triads to a total of £480,000.
8.17 Based on a strategic analysis of the export market the MEA considers that export of this level could be achieved, but the MEA has no track record in this market. The MEA considers that in the period of operation the MEA's record in delivering standing reserve and triad benefits has been very good and they expect to build on this success as they now consider they have the plant and people in place to deliver. We are unable to comment on this.
Gas Sales
8.18 Income from gas sales is the contribution from Manx Gas for using the Irish Sea pipeline and the spur to the Island. The forecast is based on Manx Gas using 8.7 million therms for the year to 31 March 2006. Manx Gas will pay a 4.5 pence contribution to the capital cost of the pipeline and a 6 pence contribution per therm to the operating and maintenance of the pipeline. This is significantly . lower than the fully absorbed cost to the MEA of transporting the gas. The actual gas sale to Manx Gas is made with no mark up on cost.
Other Income
8.19 Other income represents the contracting income the Authority are forecasting they will receive in the year of £476,000 and rent of £174,000. Other income seems reasonable based on previous results.
Retail turnover
8.20 Retail turnover is projected to grow at 10.6% to 31 March 2006 from the annualised , figures to 31 . March 2005. Annual growth since 31 March 2002 has been -0.8%, 9.2% and -2.2%, so there is no trend of growth to support the projected figures. However the MEA have informed us that they have extended their product range bringing in new prestige product ranges such as Sony and Panasonic.
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8.21 Projected net profit for the retail division is £319,000, which is a 7.98% margin. The average net margin achieved over the previous four trading years is 4.6% which would give a net profit of • £186,000 on projected turnover of £4,000,000.
8.22 The Authority's projections for retail look ambitious but as retail is not material in the context of the overall projections no further review has been done on this area.
Energy operating costs
8.23 Energy operating costs are analysed are as follows:
Nine months Three months Year ended Year . ended ended ending Year ended 31 31 March December 31 March 31 March 31 March 2004 2004 2005 2005 2009. Actual Actual Projected Forecast Projected £000 £000 £000 £000 £000 Energy costs: • Gas 3,288 2,646 3,645 6,291 10,667 Cable 6,252 5,186 • 1,345 6,531 3,892 Fuel 1,661 970 300 1,270 571
11,201 8,802 5,290 14,092 15,129 Direct staffing costs 11,026 8,059 2,686 10,745 13,035 Direct staff costs transfer to capital (2,700) (1,267) (422) (1,689) (469) Indirect staffing costs 918 629 210 839 930 Depreciation 5,609 7,535 2,512 10,047 10,111 Repairs and maintenance 3,569 2,490 830 3,320 4,841 Establishment costs 2,857 1,921 640 2,561 2,715 BGE Capacity costs 1,522 507 2,029 1,000. Other costs 569 615 .205 820 1,615
21,848 21,504 7,168 28,672 33,778
33,049 30,306 12,458 42,764 48,907
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Energy costs
8.24 Energy costs are forecast to increase by 7.4% in the year to 31 March 2006 despite the increase in output only being 4%. We are informed that the price assumptions behind the energy costs are based on forward gas and electricity prices as extracted on 10 February 2005. These forward prices for gas show that the average price of gas in the year to 31 March 2006 will be 34.5 pence per therm compared to an average price per therm of 25.0 pence in the year to 31 March 2005, which represents an.increase of 38%. Forward prices for electricity show a similar trend.
8.25 Projected energy costs equate to a unit production (based on units sold) costs as follows:
Nine months Three months Year ended Year ended ended ending Year ended 31 31 March December 31 March 31 March . 31 March 2004 2004 2005 2005 2006 Actual Actual Projected Forecast Projected
Units sold (MWh) 371,199 277,117 105,308 382,425 402,000 Total energy cost (£000) 11,201 8,802 5,290 14,692 15,129 Average cost per MWh (£) 30.18 31.76 50.23 36.85 37.63
rt
8.26 The total projected fuel cost on a units sold basis is projected to increase by 2.1% in 2005/06 compared to the year ending 31 March 2005. Based on the stated assumption re forward prices the trend' in average fuel 'prices outlined above looks lbw. Based on the stated assumptions regarding energy costs and assuming no efficiencies in generating electricity we estimate that the total energy cost for the year ending 31 March 2006 would be £20.4 million, some £5.3 million higher than the present projected cost of £15.1 million.
8.27 The MEA considers that the relatively small projected increase in costs/unit is due to increased efficiency in the usage of CCGT power station as it moves from "secure" production into "economic" production mode (i.e. from a situation of over production). The MEA has not been able to quantify any theoretical 'cost reductions' or to reconcile between the energy costs under secure and economic mode. We consider this to be a significant area of uncertainty in the projections.
A
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8.28 The projections are prepared on the basis that the gas turbines will be used throughout the day and during periods of peak demand and that electricity wilt be imported through the interconnector during the night. This explains why the energy costs for gas are to increase and the energy costs for electricity and fuel are to fall. The projected cost for fuel looks low considering the profits the Authority expect to make from exporting and standing reserve contracts which will require the diesel engines to be used during peak demand times to give the Authority capacity to export. The majority of the export revenues for 2005/06 will be derived from Standing Reserve availability fees, i.e. close to £1 million will be secured by just making plant available throughout the day, not physically running the plant. Based on its experience, the MEA'expects that actual running of the diesel, plant may amount to approximately 70 hours yet capturing close to £200,000 of utilisation . the peak fees, and that Triads only require diesel plant to be run for approximately 30 hours in winter months to capture fully Triad benefits.
8.29 The Authority has developed and is refining a model that will analyse the projected energy costs based on the efficiency of the turbines and certain assumptions about when the gas turbines will • be used to.generate electricity and when electricity will be imported through the interconnector.
Direct staffing costs
8.30 Direct staffing costs are forecast to be £1,086,000 per month for the year to 31 March 2006 whilst actual staff costs for the 9 months ended 31 December 2004 averaged £895,000 per month, and the three month reforecast to 31 March 2005 are included at the same average.
8.31 As the Capital Project is almost complete the amount of staffing costs transferred to capital have fallen to £469,000 based on the remaining element of the CCGT power station and ori -the ongoing level of capital projects.
Indirect staffing costs
8.32 The projected level of costs appear reasonable based on the level of the year to 31 March 2004.
- Depreciation
8.33 Annual depreciation of £10 million is consistent with the annualised depreciation charge for the nine months to 31 December 2004.
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• 1,11.1 .
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Repairs and ,maintenance
8.34 Repairs and maintenance costs are forecast to increase by £1.5 million in the year to 31 March 2006 due to planned maintenance work on the diesel 'generation .plant_and additional•maintenance costs of the new assets.
Establishment costs
8.35 Establishment costs appear reasonable based on the previous year but allow little room for an increase in the establishment costs from the level seen in the year ended 31 March 2004. The projected level Is based on the current level in the nine months to 31 December 2005 plus 6% increase..
BGE capacity costs
8.36 - In the projections for 2005/2006 BGE costs are split between:
• energy costs of £1 million;
other costs of £1 million. ' 4-
8.37 The energy costs represent an estimate of depreciation and:are a non .cash, item. In addition a further cash payment of £6.2 million is included as a capex/cashflow movement. Thus the total .cash cost is projected to be £7.3 million. The equivalent forecast charge fo'r, 2005 is £7 million. Given the projected increase.in gas usage the projected charge appears low.
8.38 As noted elsewhere the , accounting for these payments are still under review. The accounting treatment of the BGE lease will make no difference to the MEA cashflow.
1 July 2005 Projected trading and cash flows 82 Manx Electricity Authority PKr
Other costs
8.39 Other energy costs are analysed further as follows:
Nine months Three months Year ended Year ended ended ending Year ended 31 31 March December 31 March 31 March 31 March 2004 2004 2005 2005 2006 Actual Actual Projected Forecast Fiojected £000 £000 £000 £000 £000
BGESpur Opex costs 274 91 365 998 Administrative costs • 336 155 _ 52 207 299 Fleet costs 233 186 62 248 318
569 615 205 820 1,615
8.40 The BGE Spur opex costs relate 10 the operation and maintenance charge of the Bord ,Gais Eireann spur pipeline. The costs for operation and indeed the capital element of the ,'payn -ient for the pipeline are determined by the usage of the MEA as a proportion of total usage. • • - 8.41 , The•reason for reduction the in administrative costs in the year to 31 March 2005 is that both, legal 7•and 'professional, and public relations costs reduced in 2004/5. . The increase in the projected . • figure to 31 March 2006 is due to the forecast costs for consultancy on the new energy trading • system. , • 4
" , 4 • .8.42 • Fleet costs represents the costs of running the Authority's fleet of company vehicles •which total approximately 100 in number. The increase from £33,000 in 2003 to £233,000 in 2004 reflects a change in MEA practice from buying to hiring vehicles.
r. 4
1 July 2005 Projected trading and cash flows 83 Manx Electricity Authority PKr.
Retail operating costs
Nine months Three months Year ended Year ended ended • ending Year ended 31 - 31 March December 31 March 3.1 'Ma 31 March
2004 . 2004 2005 2005. 2006 • Actual Actual Projected Forecast • Projected £000 £000 £000 £000 £000
?1/4.
Cost of sales 2,421 1,756 618 2,374 2,491 . Marketing costs 1,101 893 327 1,220 1,190
3,522 2,649 945 3,594 3,681
Finance costs
8.43 The charge for interest in the year to 31 March 2006 is calculated based on £185 million at 5.375%, £70 million Barclays bah at 5.555%, and £50 million Barclays loan at 5.30%. Allowance is therefore made for the additional £10 million borrowing. No specific allowance is made for borrowing above this level although there is a release of £1 million of capitalised interest included in the profit and loss account. No adjustment is made for this in the cathflow. The total interest charge therefore appears sufficient to cover projected borrowings for 2006 although it may not be enough for future years. t •
•
1 July 2005 Projected trading and cash flows 84 6 3
#11 •
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Projected cash flow
• ' 8.44 We set out below the projected cash flows of the Authority for the period ending 31 March 2006:
Nine . months Three months .. ended ended Year ending . Year ended , 31 December . 31 March 31 March 31 March 2004 • 2005, 2005 2006 Actual Projected Forecast . Projected
£000 £000 £000 . £000 1 .. i .. (Deficit)/surplus after interest (18,585) (5,682) (24,267) , : ' (19,004) Add Depreciation 7,535 2,535 10,070 10,111' back: BGE Capacity costs - - - 1,000
• Cash flow from trading activities (incl interest) (11,050) (3,147) (14,197) [. , (7,893) Capital expenditure (16,991) (2,880) (10,871). (5,300)
.BGE capacity costs . - - (6,215)
(28,041) (6,027) . (34,068) . (19,408) . ..- .
• 8.45 The table shows that the Authority is projected to continue to generate significant negative cash ' flows in the year to 31 March 2006. :
Capital expenditure •
8.46 The capital expenditure forecast for the three months to 31 March 2005 of £960,000 per month is based on the full year budget to 31 March 2005.
8.47 The 2005/6 forecast estimates network services at a cost of £450,000 per month with no costs
specifically included for the completion of the power station project. Management , currently estimate this capital expenditure shortfall to be £3.2 million although this may be .offset by the forecast expenditure being higher than the trend.
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Projected month end cash balances
• 8.48 We set out below the projected month end cash balances of the Authority:
Opening Trading Capital i Other Closing . i • balance cash flows expenditure cash flows Balance £000 £000 £000 . £000 £000 January 2005 7,486 (1,066) (960) 5,460 February 5,460 (1,177) (960) 3,323 March 3,323 (904) (960) 10,000 11,459 April 11,459 (546) (960) 9,953 May 9,953 (595) (960) 8,398 June 8,398 (732) (960) 6,706 July 6,706 (673) (960) 5,073 August 5,073 (657) (960) 3,456 September 3,456 (618) (960) 1,878 October 1,878 (736) (960) 182 November 182 (634) (960) (1,412) December (1,412) (456) (960) (2,828).
January 2006 (2,828) .(636) (960) (4,424) February (4,424) (838) (960) (6,222) March (6,222) (772) (955) (7,949)
8.49 The above are shown before any further borrowings (except for the £10 million undrawn on the • existing Barclays facilitieS).
8.50 The above 'projections have been prepared by the Authority on a . straight line. basis. In reality trading cash flows and in particular capital expenditure will not occur on this basis. As can be seen from the above monthly projections there is a funding requirement required for the next financial year.
-8.51 r Die—above does.not .include_anyrepayment.dfthe_Barclays_facilities (£50 million 8.52 . The Authority has no other borrowing facilities, including letters of credit and guarantees, in place. 8.53 The continued solvency of MEA is subject to additional funding being put in place. The Board's view on such funding appears to be covered by the response to question 6 in appendix 2. We are not aware how advanced any discussions are in connection with the suggested sources of funds or the conditionality surrounding such sources. 1 July 2005 Projected trading and cash flows 86 4 Manx Electricity Authority PKF Potential' upsides 8.54 The MEA considers the following to be potential upsides: Skyward Project – The MEA has prepared a business plan projecting worst case revenues of £5 million and expected revenues of £9.7 million in the first five years of the project. The MEA does not currently have the authorisation to pursue this project. An independent review •of the busineSs Plan by. GOS , Consulting (telecommunicati ons —_ ,expresses-Concerns over-its-robustness .(paragraph beige). Export profits – The MEA considers that the UK market shows strong trends to have a positive upside on electricity exports. • Spare capacity in the gas pipeline – The MEA considers that the spare capacity in the gas pipeline can be sold to provide gas to suppliers in Eire. We understand that the MEA has established contracts for the period April to May 2005 which will generate around £18,500 per month. This is not significant in the context of the overall negative cash flows. Recovery of cost on sales to Manx Gas – The MEA considers that it is equitable.for the MEA to increase the charges made to Manx Gas to enable the MEA to recover the cost of importing gas. Nevertheless we understand that there are no negotiations with Manx Gas at the moment to increase charges., Projections for the 6 years ended 31 March 2011 8:55 The projections for the 6 years ended 31 March 2011 together with the cashtlow have been summarised in the table below. As can be seen the Authority is projecting a cumulative negative cash outfloW of £60 million to 31 . March 2010 which results in a negative cash position of £48.5 million, before the year to 31 March 2011 is shown to generate positive cash flows of £317,000. We understand that the Authority has no facilities in place to fund this. 8.56 In addition the sensitivities outlined in paragraph 8.65 below would have a material impact on .this • borrowing requirement. 1 July 2005 Projected trading and cash flows 87 0-• la 0 to r-- N . i■:1 co cn to o .92 2: N CV CJ (1.1 0 41) c co 3' co CO co a. r. Cr) -0 4 "a Cs .4- CV (0 C C:b CD 0 0 0) rn 0 • .... L.0 a *412 oCO LO N-. 'a ca 0.4 c.) 0.4 _.:- C') • C Z cu ,..., .a:- a) --. r- N- c‘i cb ... a co 00 ri a. >0. 11 •C a) '10 co N L40, a) 0.) 4 0 co 2 R R co -a .-•. a CV 03 C CC; NU U.! (.6 „t- CD C') 0) o) Z a) co 06. a) I.. ,~.IT:r N- ca 0.1 )... as a. 01 -0 4 "0 0 ..:0 C 1.) C3 CLI C3 .4" "r1 0 0 CD CV O C-- lo 0¢ cy 0 c,4 U) 0) •••••■ co 0) a Lo N- Q. sn O.- O --- 0 0 a.) co N- 0) (0 co cv N- L O I- c..) a) 4- 0 4,01 in CO (0 U) -ci.. CO N- ; ; 1.. ---- -_, ra CL 'co g) 00 lb 0 N. 0 ti CD 10 1s 0 4" 0 0 o O 07 03 ■ C.1. c es c I 0 Z ---. vt U) O ., C.0 r•-• tc•-) Co -C to TA 0 o co c 1.7 0 0 N. co co im m 0 al 10,4 LC) CO Cn cv a )... CO CV a) 0 so U. Cti C.1 01 d — O LI CI O (.1) CO r-- de L C:3 0 CO CO cv N LI/ c`l !...-1 C-'I ai ci d of (0 a) en -.. cv ,- co ;27 Year income >-. income 0) ..=_ r ..• CA CD t C 7) he her res LI.J CC Ot Ot te in '8 r fte a ts: lus loss) cos urp tA /s fi a) ing t U it) ro 0 ra fic C p e U t De Op Ne a) ( C ca 2 70- ay, Manx Electricity Authority PKF 8.57 The above indicates that a significant restructuring of the MEA's funding is required. Assessment of the principal risk areas in the projections 8.58 In our view the following are the principal areas of vulnerability in the projections: • Growth in output - The demand for electricity may not grow at the forecast level of 4% per annum. Whilst this level of growth is supported in the long term by historical records, the growth may not be achieved in the year to 31 March 2006 which will adversely affect the projections; • Energy costs — The Authority operates a partial hedge against rises in gas, electricity and fuel costs, and is therefore at risk to rising fuel costs. In addition the projected cost of energy appears low given the expected increase in demand, prices and export profits. We consider this to be a significant area of uncertainty in the projections; • Export profits — The Authority may not be able to meet the forecast export profits for the year and the efforts in trying to achieve export profits through standing reserve contracts and TRIADS contracts may in fact increase costs disproportionately to the income available; • Maintenance costs — The level of maintenance costs may not be adequate to meet the requirements of the Authority to maintain all of the new gas assets and the new power station as well as the diesel plant; • Interest and interest rates — Although the bond interest rate is fixed at 5.375%, the Authorities projections are at risk from an increase in the interest rate on the Barclays loans. The projections make allowance for further loans required to fund operating activities from 1 April 2006 by including interest of 6% on the projected cash outflow as well as the previous years interest charge We consider that the allowance made in the projections may not be sufficient compared to the likely actual interest charge over the period of the projeCtions. 8.59 The MEA agrees that growth in output is a serious potential downside but view the projections as based on realistic historical data. 8.60 The MEA agrees that increases in energy costs are also a potential downside but considers that they are compensated by the Fuel Cost Adjustment. The MEA has stated that it is fully aware of the political sensitivity of the price rises but that the costs of world markets cannot be avoided if they rise above those projected. 8.61 We are informed that most of the benefits of the standing reserve contracts and Triad payments do • not come from running plant but rather having the plant available to be run. Hence although the MEA acknowledges export profits do have a fuel cost component it believes these will not be significant against the income available. The MEA regards the figures projected as conservative but accept that they are not based on a worst case scenario. 1 July 2005 Projected trading and cash flows 89 Manx Electricity Authority PKF 8.62 The MEA considers that future spend on repairs and maintenance will depend on the .level of operation of the plant but do not expect to receive as many calls on the standing reserve contract this year and expect to generate Island requirements via the gas turbines rather than the diesel plant. We are informed that the maintenance cost per MWhr for the gas turbines is either £4.35 or £5.50 depending on the running mode (one or two turbines running) which is less than the £7.10 per MWhr for the diesels. 8.63 The MEA views the interest rate of 6% as a conservative figure. It is presumed that the outstanding loans will be rolled into a fixed rate bond and that the interest rate for this bond will be substantially the same as the current bond rate which is below the 6% mark. 8.64 The MEA accepts that a further uncertainty concerns the exchange rate between the pound and the euro. AS payments to BGE are based on the euro there is a potential downside if there are unanticipated currency movements, but these are not thought likely to materially affect the projections. Sensitivity analysis 8.65 We consider the following areas to sensitise the projections: • Sensitivity 1 — to illustrate the impact of a growth in output of only 2% which is a similar levels to that in 2004 rather than the 4% growth assumed in the projections; • Sensitivity 2 — a reduction in forecast export profits to the annualised levels achieved for the nine months ended pi December 2004. Although this sensitivity does not take into account existing signed export contracts, it is included to provide an indication of what could occur; • Sensitivity 3 to illustrate only half the rate of efficiency that the MEA are projecting, as the power station moves from "secure" to "economic" mode based on forward gas prices . increases of 38% on the assumption that energy costs only rise by 50% of the increase in current forward prices compared to prices in 2004/05. 8.66 The effects of these sensitivities on the projected trading results and cash flows are set out below., However, it should be noted that the above three scenarios are independent of each other and have not been aggregated. If all of these scenarios occurred together, the effect on profitability and cashflow would be more significant than as set out below. 8.67 The impact of the sensitivity on cash flows is the same as the impact on profit as the projectioris are prepared without any adjustment to working capital. 1 July 2005 Projected trading and cash flows: "90 ,Nlanx Electricity Authority PKF Sensitivity 1 8.68 4. - The effects of this sensitivity on operating profit and month end cash balances are as follows: Year ending'31 March 2005 2006 £000 £000 Impact of sensitivity on trading results: Sensitised turnover 38,141 50, 232 Sensitised deficit after interest (24,464) (19,844) Base projected deficit after interest (24,267) (19,004) Impact of sensitivity on operating prOfit and cashflow 197 • '7840 .8.69 , This sensitivity has a material impact on the projected deficit for the full year:to• 31 March 2006 of £840,000, which would increase each year of the projections as the base level for output growth : • will be less each year. The cumulative impact on cash is £1 million. _ Sensitivity 2 4 The effects of this sensitivity on operating profit and month end cash are as follows: • Year ending 31 March 2005 2006 £000' £000 • Impact of sensitivity on trading results: Sensitised turnover 38,293 • 49,942 Sensitised deficit after interest (24,312) • (20,134) Base projected deficit after interest (24,267) (19,004) Impact of sensitivity on operating profit and cashflow 45 1,130 8.71 - This sensitivity has a material impact on the projected deficit for the full year to 31 March 2006. ' The cumulative impact on cash requirement is £1.2 million. 1 July 2005 Projected trading and cash flows 91 41' • Manx Electricity Authority - PKI Sensitivity 3 8.72 The effects of this sensitivity on operating profit and month end cash balances are as follows: . Year ending 31 March 2005 2006 £000 4, £000 Impact of sensitivity on trading results: Sensitised energy costs rile r. 17,633 Sensitised deficit after interest n/a (21,508) Base projected deficit after interest n/a (19,004) r Impact of sensitivity on operating profit and cashflow n/a " 2,504 8.73. The sensitivity has not been performed on the forecast period to 31 March 2005.:. 8.74 This sensitivity has a material impact on the projected deficit for the full year to 31 March 2006 of £2.5 million, which could increase in the year and each subsequent year dependent on the w. movement in fuel prices and the efficiency actually achieved. If no efficienCy in the usage of the • CCGT plant was achieved, the impact of the sensitivity on operating profit would increase by a i" further £2.8 million. kr . 1 July 2005 Projected trading and cash flows 92 - Manx Electricity Authority PKF Review of contractual relationships . 9.1 • In the late.1990s the MEA set out its long-term strategy in its business plan for the five years to . • • 2005 (attached at appendix 4). This was provided to Treasury and discussed in the sitting of Tynwald on 11 July 2001. The Minister for the Treasury stated that three fundamental principles • had been adopted by the MEA as follows: • To eliminate dependency on heavy fuel oil, an expensive, environmentally unfriendly and insecure supply; • To reduce the price of electricity to more acceptable levels; • - To prepare the MEA for unprecedented load growth. . 9.2 The Treasury Minister went on to say that the MEA planned to achieve these fundamental objectives by: • Developing a pipeline infrastructure to allow natural gas supply to the Island; Commissioning a combined cycle gas turbine power station to generate electricity at 40% of • . existing costs; • • Developing the infrastructure to trade on the sub-sea electricity interconnector cable; • Reinforcing the Island's distribution network; and • ' Developing a long-term financial solution. 9.3: . The MEA determined in conjunction with Treasury that the best method of financing its long-term plans would be for Treasury to borrow on its behalf £185 million via,a bond issue, obtaining access to cheaper finance than the MEA borrowing in its own right. This sum would be . lent to the MEA on. identical terms. Treasury borrowing requires the authority of Tynwald and this matter was debated and sanctioned in July 2001. The Treasury Minister stated in this debate: • The MEA believes that, subject to electricity demand not massively outstripping its - projections, the borrowing of £185 million will provide secure and long-term finance sufficient that the MEA will be able to fund any future capital projects without further government or external borrowing." • 1 July 2005 Review of contractual relationhips 93 , • Manx Electricity Authority PKF 9.4 The Treasury Minister went on to say: .„4 "There are no further plans to issue any further bonds. Indeed, the Treasury is not likely to agree to further external borrowing in fUture. The annual financing costs associated with the proposed bond will be fully met by the MEA; and I say again that no cost will fall on the taxpayer." 9.5 The Treasury Minister stated in respect of the borrowing authority for £185 million: "Indicative costs of the MEA's infrastrubtural work which make up the £185 million are as follows: the power station £80 million; the gas pipeline infrastructure, £20 million; the cable buy-out and refinancing, £50 million;. wind farm proposals, £10 million; network reinforcement, £25 million, and these are indicative costs." The figures above are summarised in the following table: - fm Power station 80 Gas pipeline infrastructure , 20 Interconnector cable buy-out and refinancing 50 Wind farm proposals 10 Network reinforcement 25 9.6 The above analysis is broadly consistent with that provided to Deloitte & Touche by the MEA. Deloitte & Touche subsequently prepared a report on financing options for the above funding requirement which contained a similar analysis to the above at paragraphs 1.6 and 5.2 of that report. However we note that paragraph 1.6 states that the financing requirement is estimated to be £185 million. The introduction to the Deloitte & Touche report states that it proposes a strategy, based on the MEA's objectives, for raising the necessary debt finance of £150-200 million for the investment programme. This report was submitted to Treasury as part of the papers supporting the £185 million bond issue. 9.7 Mr Corkill has stated to us in writing that: "I can confirm that it was definitely my opinion at the time of the initial 185 million pounds [sic] bond, that this was the total . planned spend required for the proposed capital infrastructure program [sic]... 1 wish to make it clear that I was never advised by anyone that costs would exceed [E] 185 million." 1 July 2005 Review of contractual relationships - 94 Manx Electricity Authority PKF 9.8 The above analysis does not include any capital costs associated with the construction of the BGE gas pipeline to the Isle of Man (paragraph 9.60 below) estimated at approximately £34 million at . . the date the Deloitte & Touche report was prepared. As set out in the various analyses below the MEA has made upfront capital payments of £4.4 million in respect of development .fees with the - . bulk of the cost being paid over a 20 year lease. We are informed that the above figuees. Were prior to detailed design'work being carried out. 9.9 The MEA's actual expenditure on the capital programme against the indicative costs ,of £185 million provided by the Treasury Minister is summarised as follows. All costs are total forecast costs at a particular point in time and have been extracted from the capital expenditureanalysis prepared for the MEA Board: . • 1 • Tynwald Total forecast capital expenditure Jul 2001 Apr 2002 Mar 2003 Mar 2004 Jan 2005 Em Em Em Ern = Em CAPITAL SCHEMES: Pulrose Power Station EPC Contract, Pulrose site and •system network and . 7 commissioning costs • 80.0 84.4 101.3 128.9 129.0 MEA Works re Pulrose Power Station - 11.9 . 11.0 10.9 10.8 Gas pipeline to Isle of Man Development tees - 4.0 4.4 4.4 Pressure reduction station Construction and related costs 2.8 9.2 14.5 15.1 Cross-island gas pipeline 20.0 17.5 23.9 23.5 23.5 Pulrose Diesel Station Workshop redevelopment 3.3 3.2 2.8 2.8 100.0 119.9 152.6 185.0 185.6 INTERCONNECTOR CABLE: Acquisition of NGC share of * 18.0 18.0 18.0 18.0 MCC Repayment of loans 31.0 31.0 36.0 36.0 ' ., • 50.0 49.0 49.0 54.0' • 54.0 OTHER: Wind farms 10.0 10.0 10.0 10.0 .10.0 Transmission strengthening 25.0 16.4 •16.4 16.4 16.4 •-. Treasury debt repayment 2.0 2.0 2.0 .- .2,0 Bond issue costs 2.0 , 2.0 2.0 2.0 • . , 35.0 30.4 30.4 30.4 :30.4 185.0 199.3 232.0 269.4 270.0 * The total cost of £50 million was not analysed further in the proposal to Tynwald 1. July 2005 Review of contractual relationships 95 Manx Electricity Authority PKF 9.10 In preparing this review of the contractual and commercial position of ,,the MEA we have commented on the following capital projects shown in the table above:. •• • Pulrose power station — paragraph 9.14 below (forecast final cost €129 million); • Gas pipeline to the Isle of Man — paragraph 9.60 below. This was constructed by BGE in relation tdwhich the MEA paid upfront capital development fees of £4.4 million. This is leased to the MEA for 20 years at a total cost of £6.8 million for the year ended 30 September 2004; • Pressure reduction station — paragraph 9.65 below (forecast final cost £15 minion); • Cross-island gas pipeline — paragraph 9.80 below (forecast final cost £23.5 million). 9.11 We also comment on the acquisition of the 50% share in MCC held by National Grid to bring the interconnector cable within the full ownership of the MEA•— paragraph 9.94 below (final cost £1 .8 million). 9.12 The remaining areas of capital expenditure in the above table are not dealt with as part of the contractual and commercial review. They are summarised as follows: • MEA works costs associated with • the Pulrose power station. Of the forecast final cost of £10.8 million, 21.9 1 million relates to owner's engineer services provided by PB Power , (paragraph 9.92 below). These costs are discussed at paragraph 4.37 above. • Pulrose Diesel Station redevelopment costs (forecast final cost £2.8 million). These are discussed at paragraph 4.29 above. • Repayment of loans in respect of the interconnector cable (final cost £36 million). The total cost of the cable was £45 million, of which £9 million was financed equally by the MEA and National Grid (paragraph 9.11 above) and the remaining £36 million was debt financed; • Wind farm proposals (forecast cost El 0 million). The indicative cost estimate provided by the Treasury Minister to Tynwald included £10 million to be spent on develoPing wind farms. We are informed by the MEA that it has not yet been able to obtain planning permission and therefore no money has been spent on wind farms to date. The DTI informs us that although . planning permission was turned down for the initial site, an alternative has been identified. This site would have to be investigated further by the MEA, which has not been undertaken to date to the best of the DTI's knowledge; • Transmission strengthening (final cost £16.4 million). Estimated costs for transmission strengthening in the Deioitte & Touche report were £21 million. There is a relatively small difference of £4 million between this and the indicative cost estimate of £25 million provided to Tynwald. 1 July 2005 Review of contractual relationships 96 • Manx Electricity Authority PO' The estimated costs of £21 million in the Deloitte & Touche report primarily related to a proposed upgrade of the Isle of Man transmission system from the existing 33kV to 132kV. We are informed by the MEA that subsequent design and system studies identified that such an upgrade was unnecessary and that there are no current plans to upgrade any part of the transmission system to 132kV. Instead, the 33kV transmission system has been strengthened at Douglas North, Castletown and Baflagawne. Total expenditure on this work was £16.4 million. These costs were not monitored as part of the capital projects figures in the Board Packs as transmission strengthening is regarded as routine capital expenditure for internal reporting purposes. • Treasury debt repayment (final cost £2 million). This relates to the repayment of 25 year Treasury loans which was funded out of the bond proceeds but not included in the proposal to 4 Tynwald; • Bond issue costs (final cost £2 million). The bond issue costs were not included in the proposal to Tynwald. 9.13 The MEA was also relieved of £3 million of Treasury borrowings in order that it could provide a maximum annual rebate of £42 to all domestic and non-domestic customers (paragraph 4.82 . above). The MEA also spent £3 million on the repayment of lease finance and £5 million on the repayment of a loan from HSBC (additional to the loan between HSBC and MCC). Pulrose power station (£129 million) 9.14 Work on the Pulrose combined cycle gas turbine ("CCGT") power station commenced in early 2001. An engineer, procure and construct ("EPC") contract was signed in July 2001 between the MEA and Nepco. Nepco was a subsidiary of Enron Corporation. Nepco had existed for some 50 years in North America and was acquired by Enron to build turnkey power plant. Nepco has built . more than 50 power stations mainly in North and South America. 9.15 Following the demise of Enron in around December 2001, Nepco went into administration and the MEA incorporated PGT to take over responsibility for the construction of the power station. The MEA, PGT and Nepco entered into an agreement whereby PGT acquired the intellectual property rights and interests in sub-contracts held by Nepco. All sub-contracts were novated•to PGT, which settled Nepco's outstanding liabilities. PGT effectively took the place of Nepco. The power station was first operated in November 2003, with official completion and handover in May 2004. . • • 1 July 2005 Review of contractual relationships 97 Manx Electricity Authority PKF Nepco contract 9.16 The original contract between the MEA and Nepco was divided into five sections, with completion scheduled for May 2003. The initial contract price was £79.9 million which is consistent with the figure submitted to Tynwald in respect of the Pulrose power station of £80 million. This amount was guaranteed by Enron and a performance bond of £12 million provided. Nepco designed and constructed power stations using its own design and construction staff. Plant and equipment was purchased by Nepco along with specialist subcontractor skills. We understand that the Nepco contract was deliberately designed to be VAT efficient saving 17.5% on the £79.9 million contract. 9.17 The initial contract price, included sub-contracts for the steam turbine, air-cooled condensers, distributed control system, building glazing and steelworks and once-through steam generators with a total target price of £14.4 million. These were areas that Nepco considered could vary as no firm price had been obtained. The actual cost of these sub-contracted elements was £23.5 million. 9.18 The principal contracts relating to the power station (both novatedto PGT and entered into by PGT in its own' capacity) are considered below. The MEA entered into a contract with . PGT for the power station. PGT contracts • . 9.19 The total cost of the CCGT project was £129 million, including £90 million for the power station itself, £35 million for Pu'rose site and network costs and £4 million for spares and commissioning costs. We have reviewed contracts with a total value of £67.3 million (52%). There are approximately 200 further contracts costing less than £1.9 million making up the remaining £60.3 million. • "' 1 July 2005 Review of contractual relationships 98 Manx Electricity Authority PKF 9.20 - The final CCGT project cost of £129 million is analysed below by principal contractor. In the case of contracts novated from Nepco to PGT, we have also 'included (where available) the initial contract price negotiated by Nepco: Initial Nepco Variations / new Final contract value PGT contract cost Note £m £m £m Gas turbines (GE) 13.0 0.5 13.5 Contract management (NEL Power) n/a 12.8 12.8 - (1) Civil work (Auldyn Construction) 5.7 6.2 11.9 Structural steelwork (Westbury Tubular 5.6 2.6 8.2 Structures) PB Power n/a 7.0 7.0 . Steam turbine system (Man 3.6 1.7 5.3 ' Turbomaschinen) Air cooled heat exchangers (Bronswerk 2.9 0.6 3.5 Heat Transfer) Once Through Steam Generator (Innovative Steam Technologies) 3.1 0.1 3.2 Glazing (Charles Henshaw & Sons) n/a 1.9 1.9 67.3 Other contracts 61.7 (2) 129.0 (1) The initial estimate for the cost of the contract with NEL Power was £9.5 million (2) We do not have an analysis of the total initial Nepco contract value of £80 million between.sub-contract costs and Nepco internal costs Gas Turbines (£13.5 million) 9,21 This contract was a closed consortium agreement, dated 26 September 2001, between Nepco (the Consortium leader) and GE Energy (Norway) ("GE") for the MEA Pulrose Combined Cycle Power Station. It was novated to PGT in January 2002. 9.22 A consortium contract was used for this part of the project as the gas turbines were a key but discrete part of the power station EPC contract. We understand from discussion with Mr John Beckett (Project Director) that it was felt necessary to allocate responsibility for the relevant parts of the EPC contract to a compaily with turbine expertise. It also led to a closer relationship between GE and the MEA (which is expected to be beneficial over the remaining life of the turbines). 9.23 The purpose of the consortium agreement was: • to allocate the parties' respective scopes of work for the purpose of performing the EPC contract; and • to define the rights and obligations of the parties in connection with these purposes. • 1 July 2005 Review of contractual relationships 99 Manx Electricity Authority PKr 9.24 GE's scope was to supply and install two base mounted gas turbine generator sets and accessories. 9.25 The contracted amount was £13 million. This includes the core engine and other, associated plant but excluded site services. Around 26 variation orders were submitted: , with a net value of £532,000, giving a total final contract value of £13.5 million. The variations relate to minor changes to the specification. 9.26 Performance guarantees , and emissions guarantees were given but an,availability guarantee was not. The turbines are designed for a minimum life of 25 years. 9.27 The warranty periods for the gas turbines were extended by 6 months after a negotiation between MEA/PGT and GE. The warranty period ended on 9 August 2004 for one gas turbine and 18 August 2004 for the other. Agreement between MEA, PGT Limited and NEL Power Limited (£12.8 million) 9.28 NEL was the former contract management team of Nepco. Following the collapse of Enron NEL managed the contract on behalf of PGT. 9.29 The agreement was dated 25 January 2002. The scope of.the agreement included the provision of engineering services on site, design services, performance testing, managing the tender process, providing training and operational support to PGT and warranty management services in relation to the CCGT power station. A 9.30 The contract was designed at cost plus. Payment was made at cost for the man-hours worked plus an overhead contribution of £96,880 per month. The profit for the project would only be paid on completion and was variable depending on the date the work was finished. The profit was a maximum of £1.5 million:and on completion was actually £1.3 million. The estimated total value was £9.5 million. 9.31 The total amount actually:paid to NEL was £12.8 million. This was made up of: • Home office project Management £1.3 million; • Home office engineeting £2.3 million; • Field construction Management £1.7 million; • Commissioning £1.3 million; k • Management £1.7 million; • Additional works and costs £2.0 million; 1 July 2005 Review of contractual relationships—. 100 Manx Electricity Authority PKF • NEL power fee and upfront payment £1.2 million; • Profit £1.3 million. 9.32 The total was higher than the estimated amount because the scope and complexity of the work increased and extra members of staff were provided. 9.33 The warranty period expires on 1 May 2006. NEL's liability for negligence will expire on 1 May 2010. Civil work (£11.9 million) 9.34 The scope of the contract was to provide civil works including concrete work, brickwork and masonry units, architectural building finishes, piling, earthworks, foundations, floor slabs and underground services. 9.35 The original contract was signed on 9 November 2001 between Nepco and Auldyn Construction Limited. It was novated in December•2001 to PGT. 9.36, The contracted amount was £5.7 million. Variations, via site instructions, totalled approximately • .£6.2 million, giving a total value of. £11.9 million. The final value was considerably higher than the initial value because at the time of the initial contract there were only conceptual drawings. When the final drawings were produced they involved more work than previously suggested. In addition, the ground conditions were poorer than expected and the scope of work increased. Cost overruns were identified at the final drawing stage and also once ground work commenced. As is standard for construction contracts there was a contractual mechanism in place to adjust the contract price once ground conditions had been fully evaluated. 9.37 The warranty period will expire on 1 May 2006. Structural Steelwork (£8.2 million) • 9.38 The scope of the contract was to supply, fabricate, paint, deliver and erect structural steelwork and aluminium roof cladding to the main building on the power station site, secondary steelwork to the main building and structural steelwork to secondary buildings on an adjacent site. 9.39 The original sub contract was signed on 8 October 2001 between Nepco and Westbury Tubular Structures Limited. In December 2001 the contract was novated to PGT. ' 9.40 The contracted amount was £5.6 million. Variations, via site instruction, totalled approximately £2.6 million giving a total contract value of £8.2 million. The increase in costs arose because the initial price was based on concepthal designs and the final design involved more work that led 10 further costs. 1 July 2005 Review of contractual relationships .101 A • Manx Electricity Authority pkr 9.41 The warranty period will expire on 1 May 2016. i. Steam Turbine/generator system (E5.3 million) 9.42 The scope of the contract was to furnish, design, fabricate, test, paint and . deliver a steam 1 turbine/generator system. 9.43 The original contract was signed on 24 July 2001 between Nepco and Man Turbomaschinen AG GHH BORSIG. It was novated in December 2001 to PGT. 9.44 The contracted amount was £3.4 million for the steam turbine/generator set plus £167,500 for • delivery and extras. Around 30 variation orders were submitted with a net value of £1.7 million, giving a total cost of approximately £5.3 million. The variations relate to changes to the original specification such as a new bypass value for the steam control system and the provisioh of technical field advisors and training instructors. 9.45 The warranty period will expire on 18 September 2005. 9.46 There were terms requiring the seller to pay damages for failure to meet the guaranteed output (22,560 kw) up to a total of.1 5% of the total purchase order value. 9.47 The minimum life of the turbine is to be 25 years. The plant is designed to allow for a possible future increase in gas turbine output of up to . 10%. • Air cooled:heat exchangers (£3.5 million) 9.48 The scope of the contract was to furnish, design, fabricate, test, deliver, install, erect and provide training for two air cooled heat exchanger systems for the Pulrose CCGT power station. These are used to cool the condensed steam after it has passed through the OTSG. (see below). 9.49 The original contract was signed on 22 October 2001 between Nepco and Bronswerk Heat Transfer BV. In December 2001 the contract was novated to PGT. 9.50 The contract price was £2.9 million. Around 12 variation orders were submitted with a net value of £512,000 giving a total value of £3.5 million. The variations relate to minor changes to the original specification such as reducing the height of the coolers and addition of a wind wall. 9.51 The warranty period will expire on 1 November 2005. Once Through Steam generator ("OTSG") (£3.2 million) • 9.52 The scope of the contract was to furnish, design, fabricate, test and deliver two OTSGs complete with all required accessories/ancillaries. The OTSGs use the exhaust gases produced by the gas turbines (that would otherwise be wasted) to produce superheated steam, which is then used to generate further electricity. m, 4 .1 July 2005 Review of contractual relationships 102 Manx Electricity Authority 1310" 9.53 The original contract was signed on 4 August 2001 between Nepco and Innovative Steam Technologies, a division of Aecon Holdings Limited. It was novated in December 2001 to PGT. 9.54. The contracted amount was £3.1 million, including transport of the OTSGs to the Isle of Man. Around 13 variation orders were submitted with a net value of £150,000, giving a total value of £3.2 million. The variations related to minor changes to the original specification such as the 'provision of additional valves and instruments and the provision of welding services. 9.55 The warranty period will expire on 1 November 2005. Glazing (£1.9 million) 9.56 The scope of the contract was to design, manufacture, deliver and install glazing work for the Pulrose CCGT power station. 9.57 The contract was signed on 21 February 2002 between PGT Ltd and Charles Henshaw & Sons Limited. • 9.58 The total value of the contract was £1,868,842. There were minor variations to this, which resulted in a total cost of £1,900,000. 9.59 The warranty period will expire on 1 May 2006. Gas pipeline to the Isle of Man 9.60 Natural gas is supplied to the Isle of Man via gas pipeline. The gas pipeline (known as SIPS II) runs from Moffatt in Scotland to Ballough, County Dublin in Ireland, through Manx territorial waters. There is another gas pipeline running from Moffatt to Ireland alongside SIPS II, known as SIPS I. Both pipelines were constructed by BGE. The MEA have stated that the Island was unable to tap into the existing SIPS I pipeline, at the time that the Government decided to bring natural gas to the island, on safety grounds. The MEA comments that it would have been possible to tap the SIPS I pipeline at the time of its construction had action been taken earlier. The DTI comment that at the time SIPS I was laid there was no requirement for natural gas to be brought to the Island and that to tap into SIPS II was significantly less expensive than .SIPS I. Thus at the time of construction of SIPS II the MEA in conjunction with Government negotiated 'a spur pipeline connecting SIPS II to Glen Mooar in the Isle of Man. BGE operate and maintain both pipelines. 9.61 Documentation shows that from an early stage it was anticipated that the spur pipeline would be constructed and owned by BGE with MEA paying 'rental' relating to transportation costs. 1 July 2005 Review of contractual relationships 103 Manx Electricity Authority 9.62 BGE charges the MEA monthly for the transportation costs associated with .the - SIPS II pipeline, and the Isle of Man spur pipeline (including construction costs). and .also for the operation and maintenance costs of both pipelines. All four elements of the charge were initially set out in the Isle of Man Pipeline Connection Agreement dated February 2002 ,("Pipeline Connection Agreement"). We are informed that this agreement was negotiated by Mike Proffitt acting with authority delegated (for a limited period in 2001) . by the then Minister tor Trade and Industry on behalf of the DTI. The agreement was novated and amended into two agreements in July 2003 being the: • MEA Capacity.Agreement between BGE and the MEA (SIPS II); and • Amended and Restated Agreement in relation to the Isle of Man Pipeline Connection between - BGE (IOM) Limited and the MEA (spur). 9.63 The MEA makes payments to BGE under both of the above agreements. 9.64 THE DETAIL OF THE MEA'S CONTRACTS WITH BGE HAVE BEEN EXCLUDED ON THE GROUNDS OF COMMERCIAL CONFIDENTIALITY. PresSure reduction station (£15.1 million) 9.65 The total cost of construction of the PRS was £12 million. In addition £3.1 million was spent on related costs such as land acquisition, access roads, utilities and design work. We have reviewed contracts with a total value of £7.9 million (52%). Construction work on the PRS began in October 2002 and the PRS was completed in September 2003. 9.66 As the PRS forms part of the SIPS II pipeline system it was anticipated that it would be constructed and owned by BGE with BGE recovering their costs via an annual rental charge. 9.67 During the contract negotiations for the construction of the spur pipeline it was agreed that the PRS would be constructed by the MEA (on behalf of BGE) as BGE were required to follow EU procbrement regulations (requiring that all public works are formally advertised across Europe) and would also be obliged to make a formal planning application. We are informed that BGE estimated that following the procurement regulations would add 6-12 months to the construction programme and that applying for formal planning approval on the Isle of Man may have resulted in a delay in excess of one year. We understand it was recognised that EU Procurement rules did not apply to the MEA and that the MEA had the benefit of a Permitted Development Order ("PDO"). 9.68 The PDO allowed the MEA to construct the spur pipeline and PRS (within certain restrictions). without following the fOrmai planning process which could introduce delays. Since the rights under the PDO did not extend to BGE the MEA, acting on behalf of BGE, undertook the spur pipeline construction works on the Isle of Man (including the PRS). 1 July 2005 Review of contractual relationships 104 Manx Electricity Authority Pkr 9.69 Had the PRS been constructed by BGE then the MEA would have made higher annual payments (albeit with lower upfront •capital payments) for the spur pipeline construction at a rate of return higher than that obtained for the bond or for other borrowing and the 'development fee' paid to BGE would have been higher as it was based on the capital cost of the spur line. 9.70 The PRS is an integral part of the SIPS II system and BGE, as the Operator under the Code, retains full responsibility for the design, construction and operation of the PRS. The Code covers the responsibilities and liabilities of constructing and running a system operating at 2000 PSI." Failure to meet the Code's requirements would mean that the system could not be gassed up. It was therefore expected that the PRS design would be carried out by Sofregaz (the shore station designer for SIPS II) and that the materials procurement and construction would be subject to Soiregaz's approval. 9.71 The initial budget for the PRS was £7 million and this was based on early design estimates by Sofregaz. However this estimate was based on a normal project and did not reflect the following: • the short construction period;. • the increased construction costs for the Isle of Man; • the amount of excavation required (budget based on flat site); • the requirement to maintain the site 'below treetop level'; and ' • the complete design which incorporated extra works necessary to provide domestic supply security. 9.72 The MEA considers that it would not be in its best interests to pursue a negligence claim against BGE to recover an element of the costs of the PRS. The MEA considers that there is no clear proof that BGE have acted negligently in the design of the PRS and have weighed the minimal chance of success against the damage to what it considers to be a key commercial relationship. Civil and mechanical works (£5.6 million) 9.73 The contract for civil and mechanical works was between Morrison Construction Limited and the MEA. The scope covered the civil works (excavation, foundations etc), mechanical works (welding, testing, pipework and instrumentation installation) and electrical works associated with the construction of the PRS as well as assistance with commissioning of the PRS. 1 July 2005 Review of contractual relationships 105 a. Manx Electricity Authority PKF 9.74 - The initial contract price was £1,794,800 but was based on the scope as designed at the time of tender. The total final value was £5,650,000. We are informed that the increase in price was a . result of the following: • increases in scope (the number of pipework design isometrics increased from 75 at tender stage to 205 during construction); • delays during construction (late design, rework following design development, weather); • late design revisions; • • co-ordination problems; • delays in material delivery; • changes of testing methodology; • failure of some materials supplied to perform to specification; and • • additional works carried out at Glen Vine and Pulrose in connection with the domestic supply.. 9,75 We understand that the PRS was 'future-proofed' after the initial tender - by the inclusion of.. additional facilities and structures to allow gas supply to be taken from ' the site to supply Ramsey and Peel at a later date without disturbing the existing supply equipment. 9.76 The defects period expired in September 2004. Distributed COntrol System ("DCS") (£0.3 million) . 9.77 This was a ptirchase order from Foxboro France SA. The scope was for the design, manufacture, delivery, installation and 'commissioning of a DCS for the PRS. The DCS co-ordinates the entire system and the price includes both hardware and software. 9.78 The tender value was £254,859 and final costs were £340,000. The increase was largely due to _ minor changes to the spacification and delays in other parts of the project that impacted on the installation of the DCS. 9.79 The defects liability period expired in September 2004. 1 July 2005 Review of contractual relationships 106 . Manx Electricity Authority Pkr Cross-island gas pipeline (E23.5 million) 9.80 . After the gas passes through the PRS, it is transmitted across a cross-island gas pipeline to Pulrose, at which point it is either used to power the CCGT station or into the island gas supply network for consumer use. 9.81 The total cost of the cross island gas pipeline was £23.5 million. We have reviewed contracts with a total value of £14.6 million (62%) (This includes the PB Power contract of which £6.6 million is attributable to the pipeline). Planning started in early 2001, work on the pipeline started in February 2002 and the completion date was 31 November 2002. Civil works T5.,4 million) 9.82 In order to ensure that the civil works could be completed by island contractors (none of whom were large enough to undertake the entire length of the pipeline), the project was divided into three contracts. The contractors were RGW Limited, Carey and Sons and Stephen Christian and Sons. We understand that the contracts all contain the same conditions and that the time rates are very similar; therefore only the contract between RGW Limited and the MEA has been reviewed. 9.83 The scope of the contracts were to provide civil works associated with the construction the cross- country pipeline, including access ways to the routes from the public highways to the wayleave. The work included topsoil -strip, trenching, pipe stringing, pipe installation, backfill, reinstatement and ancillary works. 9.84 The defects period expired in November 2003. 9.85 Payment was on a rates only basis with full remeasure on completion. The basic rate was £27 per linear metre for a digging a trench suitable for the 10" gas pipeline; £19 per linear metre for a trench which is suitable for installation of the associated equipment and £10 • per .metre for installation of the welded pipes costs. In addition to the basic trench rate contractors were paid for soil strip, reinstatement, distributing pipes and for ancillary work off the strip. No estimate of total cost was provided in the contract, as the position of the pipeline was not known at the time the contracts were drawn up. The actual cost of the three contracts was £5.4 million. 1 July 2005 Review of contractual relationships 107 Manx Electricity Authority PKF Mechanical Welding (22.6 million) •9.86 This contract was between Morrison Construction Limited and the MEA. Its scope covered welding, field joint coating and non-destructive testing for the high pressure gas pipeline from Glen Mooar to Pulrose. 9.87 The tender price was £790,580. The actual amount paid was £2.6 million. The increase arose because the original tender only covered part of the work and was intended as a means of comparing different contractors' rates rather than giving a full scope of work, as this was not known at the time. The tender did not include an estimate of the costs of directional drilling and bends in the pipe or additional management requirements and was based on two teams of workers whereas three were actually used (as there were three civil works contractors). 9.88 The defects period expired in November 2003. PB Power — Owners Engineer and Project Management Services (£17.5 million) 9.89 PB Power Limited ("PB") provided a variety of consultancy services in relation to the power station, the Pressure Reduction Station ("PRS") and the gas pipeline. The original agreement was dated 23 February 2001 and there were five supplemental agreefnenfs, which increased the scope of the work over the course of the projects and includes a call- off 'agreement which allows for extra support in the future should it be required. • 9.90 The MEA considers that PB Power costs as they related to the Owner's Engineer services (£1.9 million) were included in the original indicative cost estimate supplied to Treasury in support of the bond issue. Additional works were caused by the filure of Nepco and so could not have been included in the indicative cost estimate provided to Treasury. In addition the construction management and procurement costs relating to the PRS was not included as they were originally expected to be funded by BGE (subject to the annual charge). 9.91 The scope of the initial agreement was to provide owners engineer services in relation to the power station and EPC project management services in relation to the gas pipeline. As a result of the collapse of Enron, the scope was expanded via supplementary agreements dated 24 September 2001, 25 April 2002 (two agreements were signed on this date), 23 January 2003 and 3 July 2003. The revised scope included construction management services and a design review team for the power station, construction management and advice concerning the intermediate pressure pipeline for the cross island gas pipeline and construction management services for the pressure reduction station. The total tender cost including all the additional services was £16.9 million. 1 July 2005 Review of contractual relationships 108 Manx Electricity Authority PKF 9.92 The total amounts actually paid to PB were £17.5 million analysed as follows: • £7 million in relation to the CCGT power station for construction management services including design review and verification, quality surveillance, site management, technical support on safely, environmental and electrical issues, and construction co-ordination; • £1.9 million in relation to the CCGT power station for owner's engineer services to specify the project, manage the tendering process and the contract award and to oversee the EPC contractor Nepco; • £2 million in relation to the PRS for construction management and procurement services; • £6.6 million in relation to the cross island gas pipeline for construction management services including project management, tendering, design review, supervision, procurement, cost control and environmental and health.and safety review. 9.93 - PB Power's liability for negligence expires on 1 May 2010. Acquisition of National Grid shareholding in MCC 9.94 'MCC was incorporated in May 1998 with an authorised share capital of £2,000 of which £2 was issued. 9.95 In August 1998 the MEA and National Grid (Isle of Man) Limited ("NG (IOM)") entered into a joint venture ("JV") agreement in respect of MCC. MCC was established for the purpose of procuring, constructing and subsequently leasing to the MEA the sub-sea electrical interconnector between the Isle of Man and England. Both the MEA and NGC agreed to subscribe for a further 999 shares of £1 each (divided into 'A' and 'B' shares). All negotiations with sub-contractors engaged by MCC on the interconnector project were to be conducted by the National Grid Company plc ("NG").. 9.96 Both shareholders increased their holdings to £4.5 million. Following completion of the interconnector NG (10M)'s continued involvement in the JV was reviewed and the decision was taken for NG (IOM) to sell its entire shareholding in MCC, terminate the JV and release MCC's financing obligations with HSBC. A DTI liaison meeting (paragraph 14.28 below) on 31 January 2001 notes that: "in the medium term the MEA will seek to own the interconnector outright by buying out National Grid utilising capital borrowings". The DTI note that there were no discussions in relation to the actual cost of acquiring the shareholding of NG (I0M).The actual purchase price was not significantly different to that put • before Tynwald (see paragraph 9.9 above). 1 July 2005 Review of contractual relationships ' 109 Manx Electricity Authority 9.97 The MEA, NG (IOM), NG and MCC entered into a share purchase agreement in December 2001 , whereby NG (IOM) agreed to sell the 4.5 million 'A' shares of £1 each to the MEA for an initial consideration of £16 million, payable on completion. The consideration was a negotiated amount that the MEA consider was lower than the net present value of estimated rental PayMents 'due' to 1. NG (IOM) under the use of interconnector agreement between the MEV and MCC. Further consideration of £2 million was payable when re-burial works were completed and the cable fully commissioned. The additional consideration was paid in September 2002. No contingent • consideration is payable under the agreement. At the same time the parties entered into a deed of termination of the JV agreement. Other significant partnership arrangements and dependencies Incinerator 9.98 There is an agreement iriplace between the MEA and United Waste (Isle of Man) ("UW") for both the supply of electricity to UW and the export of electricity from the UW integrated incinerator (energy from waste) facility. 9.99 The contract was signed on 30 April 2001 and lasts until May 2029. In 2002 UW was acquired by, SITA Waste ("SITA") who have secured the right to operate the plant for the next 30 years. 9.100 The MEA must take all excess electricity generated by the plant. SITA has no obligation to provide any minimum level of capacity or volume to the MEA. 9.101 The tariff for purchases of electricity by the MEA is based on an annually calculated unit charge. The unit charge is the marginal unit cost of the MEA's electricity supplies to the Isle of Man (as per the financial statements): This is calculated as the total annual cost of the energy supplied to the Isle of Man divided by the total number of units used in the Isle of Man. 9.102 SITA is required to pay the MEA a fixed charge of £600 per year plus an export capacity charge of £1.25 for each kVA they supply to the MEA and the standard business tariff for electricity supplied to them. 9.103 For 2004/5 the cost per MWh of electricity purchased from the incinerator is £27 and the total energy purchased from the incinerator from April 2004 to December 2004 was 15,821 MWh giving a value of £427,000. In the same period SITA made payments totalling £274,000 to sthe MEA for standing charges and electricity supplied to them by the MEA. 1 July 2005 Review of contractual relationships > 110 A Manx Electricity Authority w PKr Purchase of electricity from the United Kingdom Use of system 9.104 The MEA and Norweb . plc ("Norweb'") have entered into a use of system agreement dated'26 March 1999. This. agreement governs the MEA's rights of access to the United Kingdom electricity distribution network to the interconnector at Bispham in Blackpool. 9.105 . The agreement specifies that Norweb must maintain their equipment connecting the interconnector to the UK electricity network to enable the distribution system to carry the maximum impart / export 'capacity. The agreement continues in force until terminated' by either party on six months' written notice. 4 9.106 ' For the right to import electricity, the MEA pays: • a standing charge of £175 per month (£2,100 per annum); • availability charges of £0.86 per month per kVA of supply capacity (currently £511,000 per annum on a supply capacity of 49,500 kVA, although this is being renegotiated with effect from 1 April 2005); • - • • reactive power charges of 0.36p per kVArh in excess of the total kWh (we are informed such charges would not be incurred in the normal operation of the interconnector). 4 • 9.10- 7 For the right to export electricity, the MEA pays: • reactive power charges of 0.36p per kVArh in excess of the total kWh (we are informed such . charges would not be incurred in the normal operation of the interconnector). Route to market 9.108 The MEA has entered into a route to market agreement with NPower Limited ("NP'') for the six month period to 3 , 1 March 2005. This agreement governs the import and export of electricity from and to the United Kingdom network. We are informed that it will be renewed for a further six months on the same terms. 9.109 .: The MEA grants to NP the exclusive right to purchase electricity from the interconnector to 31 March 2005. NP agrees to purchase the output, subject to the mutual agreement of forward sales and purchases. NP must also provide information to support charges -made under this agreement to the extent that it is publicly available. '9.110 The MEA must provide within five days of the agreement date a projected operating schedule for the interconnector for each month within the agreement term showing both exports and imports. • r 1' July 2005 • Review of contractual relationships 111 , ; Manx Electricity Authority - i a. i 1. PKF 9.111 . NP must provide a weekly schedule detailing all forward contract positions and .the projected operating schedule for the following week. It must also provide forward wholesale prices on a daily . basis. 9:312 The MEA and NP have the right but not the obligation to enter into forward contracts for the . sale or purchase of electricity. If, in any contracted period, the MEA fails to import or export the contracted amount or imports / exports any amounts of non-contracted electricity it will be liable for the net amount at the system buy or sell price under the Balancing Settlement Code (eifectively the spot price). 9.113 For each forward sale / purchase the MEA is liable for a management fee of £0.10 for each MWh exported / imported. In addition to the management fee the MEA must pay a fixed monthly charge of £5,000 and any supply,charges incurred by NP. Purchase of gas 9.114 The MEA purchases gas from the trading arm of BGE ("BGEET"). The MEA entered into a gas shipping agreement with BGEET from 1 January 2003 to 31 March 2004 whereby BGEET is appointed as agent for the transportation of gas to the offtake point at the PRS. : This agreement was extended from 1 April 2004 to 30 September 2004 and again from 1 October 2004 to 30 September 2005.. There is no right of early termination. 9.115 Under the latest agreement, there is a fixed monthly shipping charge of £3,000 and a monthly. throughput charge of 0.10 pence per therm. The current monthly usage is around 2 million therms,. , resulting in a throughput charge of £2,000 per month. 9.116 We are informed that there is no long-term contract in place for the purchase of gas and that the MEA is free to change supplier. The MEA has chosen not to enter into a long-term agreement to provide for flexibility of supply. At present the energy trading division of the MEA obtains a quote of the relevant forward oi'intra-day rate from BGE Trading and confirms the trade by email. Price , • quoted are checked against data feeds from Reuters. 9.117 The MEA gas traders tend to purchase sufficient gas for the following month's operation in respect of one gas turbine at the Pulrose power station (standard operation). Gas is purchased at spot prices as and when generation choose to operate both turbines simultaneously. Gas is also- purchased on behalf of Manx Gas to sell onto consumers (see further below) in accordance with their instructions. Manx Gas 9.118 The MEA and Manx Gas entered into a memorandum of understanding ("MOU") on 4 August 2003 for the supply of natural gas via the BGE gas pipeline. • 1 July 2005 Review of contractual relationships 112 Manx Electricity Authority PKF 9.119 The MOU states that the MEA and Manx Gas propose to enter into a gas sales agreement ("GSA") whereby MEA sell and Manx Gas purchase gas for distribution in the Douglas / Onchan areas. The MEA and Manx Gas additionally propose to enter into a gas transportation agreement ("GTA") which will set out the rights and obligations of the parties in respect of the transportation of gas sold under the GSA. The terms of the GSA and GTA are to be negotiated based on the MOU, although this is neither exhaustive nor binding. .9.120 The MOU ends on the earlier of six months from signing or the date of execution of the GSA and GTA. Neither the GSA nor the GTA have been signed, although a draft GTA has been produced. We understand that the MOU was extended to March 2005. GSA provisions 9.121 The MEA and Manx Gas will enter into an 'arms-length' GSA which reflects Manx Gas' supply requirements and preferred pricing structure. The terms of the GSA will replicate, on a pass- through basis, the terms of any gas supply agreement entered into by the MEA. The duration of the GSA will be the same as • the Pipeline Connection Agreement (paragraph 9.62 above). Therefore gas is sold at cost under the GSA. GTA provisions 9.122 The GTA will cover the transportation of gas from Moffatt in Scotland to Pulrose (the end point of the cross-island gas pipeline) and is co-terminous with the Pipeline Connection Agreement. The transportation charges will cover a 'capital' element and an operating and maintenance element . This relates to the capital and operating maintenance costs associated with the SIPS I / SIPS Ii pipelines and Isle of Man spur pipeline (paragraph 9.60 above). 9.123 The 'capital' element of the charge is initially 4.5 pence per therm and then increased according to RPI. The draft GTA states that the 'capital' element of the charge will be 4.5 pence per therm for the period 1 April 2004 to 31 March 2005, subsequently adjusted by RPI. The charge of 4.5 pence per therm was based on predicted gas volumes for the Pulrose power station (both island generation and for export) and Manx Gas. By way of comparison, the MEA have performed an illustrative calculation of the current capital cost of the SIPS I / SIPS II pipelines and Spur pipeline on current actual gas volumes, which comes to around 25 pence per therm. .This -is an • approximate calculation and is merely intended to demonstrate that the MEA are at present heavily subsidising Manx Gas in respect of recovering the capital cost of the pipelines. • 1 July 2005 • Review of contractual relationships 113 Manx Electricity Authority PKF - . 9:124 The operating and maintenance element relates to: The Itle of Man share of SIPS I / SIPS II operating and maintenance costs invoiced by BGE; • The operating and maintenance charge relating to the spur pipeline invoiced by BGE (IOM); • Operating and maintenance costs relating to the cross-island gas pipeline; and • Administration overheads relating to the cross-island gas pipeline. 9.125 Manx Gas is to bear the proportion of the total operating and maintenance costs as corresponds to the ratio of Manx Gas annual metered gas volume to the aggregate of annual Manx Gas and MEA gas volumes; where the MEA annual volume is a deemed volume. This is set in advance for the following gas year, based on annual Island demand. 1 July 2005 Review of contractual relationships 114. Manx Electricity Authority PKF 10 Financial reporting environment and liaison with auditors Overview 10.1 The MEA accounting function was until May 2005 headed by Mr Clive Wilcox (Director of Corporate Services) and supported by Ms Clodagh Maher (an Accounts Manager), two purchase ledger clerks, a cashier and one general assistant. Mr Wilcox is a qualified Chartered Accountant and Ms Maher is a qualified Accounting Technician; both worked for the MEA for approximately four years. Both Mr Wilcox and Ms Maher have recently resigned from the MEA. 10.2. Ms Maher is responsible for producing the majority of the accounting information for the Board and for producing the annual financial statements. Management Information .Production of information 10.3 The source of management information for the MEA is the general ledger module within Navision (an integrated accounting package used by the MEA, which covers all areas of the business). 10.4 A number of accounting reconciliations are performed by the accounting function in order to verify the accuracy of information in the general ledger module of Navision, including a weekly bank reconciliation and a monthly reconciliation of stock, debtors and creditors per the general ledger to the Stores module, Sales and Receivables module and the Payables module respectively. 10.5 In order to produce the management information from Navision, Ms Maher exports the account balances in the general ledger (i.e. the trial balance) into an Excel spreadsheet and manipulates it as required to produce the management information reports. Information produced 10.6 The accounting function produces management information each month for the Board and for departmental managers. Information produced for the Board 10.7 The monthly information produced for the Board by the accounting function and included within the Board Packs includes: • Consolidated Balance Sheet showing figures for the current month, prior month and movement in the month; 1 July 2005 Financial reporting environment and liaison with auditors 115 Manx Electricity Authority PKr • Consolidated Profit and Loss account for the year to date, broken down by month..lt includes the budget for both the current month and for the year to date, variance from that 5 budget and last years figures at the equivalent date; ' • Summary Profit and Loss account for current month and the year to date. It is summarised by category: energy supply, energy exports and retail. This has been produced since August • 2004; • Capital expenditure in the year to date broken down by month, the full year capital expenditure budget and % of full year's budget used to date. This has been produced since July 2003; • Accounts commentary which provides further detail' of energy sales, export profits, Manx Gas sales, energy purchases, cable imports, fuel usage and BGE Spur Opex costs. The total amount of spending on the power station and the pipeline and the amount of interest payable on the MCC loans is also stated. 10.8 The above information is prepared within two weeks of the month end. This timetable means that for a number of items, for example depreciation, the figures are an estimate. 10.9 Management accounts are not produced at an entity (i.e. MEA, MCC) level. 10.10 More detailed analyses of the above are prepared at a divisional level, i.e. for Generation, Network . Services, Corporate Servides and Internal Audit divisions. 10.11 In addition, the project team produces a monthly report on the financial position of the large projects. Deloitte & Touche LLP report on Management Accounts 10.12 In August 2004 Deloitte & Touche LLP reviewed the management accounts. They reported on the high level structure and presentation of the financial information included within the monthly Board Packs and in particular the presentation of the Energy Export Profits. However;the report did not highlight any significant weaknesses other than in respect of the absence of cash flow information. Financial Accounting 10.13 The financial statements are prepared by the accounting function in the same way as the management accounts. However, as more time is available, items that are estimated .in the management accounts are updated for actual figures. 1 July 2005 Financial reporting environment and liaison with auditors • 116 Manx Electricity Authority PKF 10.14 We note that in attempting to obtain detailed analyses of financial information at 31 March 2003 and 2004, the reconciliation of the management to the statutory accounts was not readily available. Upon reconciliation the principal differences were the correction of previous estimates in relation to depreciation, stock and export profits. The total adjustment in 2004 in relation to these items.was £889,000. Budgeting Budget setting 10.15 The budget setting process begins in January and is planned to be finalised by the end of March (the financial year end for the MEA). The process works on a 'bottom up' basis with the first draft budget being prepared by the relevant divisional managers. With the exception of staff costs, the key assumptions with regard to the prices of inputs and outputs are set by the divisional managers. In the case of the two largest divisions, Network Services division and Generation division, the starting point for preparing the budget is the long-term technical plan for the division. From this the operations planned for the coming year are determined and budget figures are produced accordingly. The other departments base their budget on the prior year figures, which are updated in line with the plans for the coming year. 10.16 The divisional managers prepare the budget using the categories in the general ledger. The only exception is for staff and establishment costs where the managers provide expected staff numbers and staff grading and the Human Resources department calculate the associated costs. 10.17 Ms Maher co-ordinates the budget process. A reasonableness check is performed on the figures provided by divisional managers and the divisional budgets are then aggregated to produce the draft budget for the MEA. 10.18 The budget is reviewed and challenged by the Director of Corporate Services who has meetings with all relevant managers. It is then reviewed by Mr Charles Fargher (the Board Member with responsibility for finances) and the Chief Executive. When the review process is complete the budget is presented to the Board for approval. 101 9 We note that there is no formal objective setting process prior to determining the budget. Variance Monitoring 410.20 Actual performance against budget is monitored monthly, at a high level by the Board and at a detailed level by the manager with responsibility for the budget. See the Management Information section from paragraph 10.3 above for details of the reports used to monitor budgets and comments thereon. We have not verified whether these reports are used effectively by management. However we note that an Internal Audit was performed on this area in January 2004 and that the key recommendations resulting from this have been implemented by the accounting function. 1 July 2005 Financial reporting environment and liaison with auditors 117. Manx Electricity Authority PKF Internal Audit ("IA") Background 10.21 The MEA IA was set up in the late 1980s by Stan Kewley (a former MEA Chief Executive). Staff • were resourced from various MEA departments to undertake specific internal audit tasks before' Ernst & Young were given a contract to provide internal audit services. However the MEA decided in 1995 to recruit dedicated IA resources. In mid-1997 John Cretney was appointed the MEA's Internal Auditor and in March 1999 Paul Dewar was appointed Head of Internal Audit. 10.22 We note that although the Treasury IA department retains responsibility for the IA of all Government departments and Statutory Boards, including the MEA, there is significant disagreement between the views of the MEA and Treasury in relation to the extent of the interaction between Treasury IA and MEA IA and involvement in internal audit processes and assignments. The MEA states that Treasury IA has never performed any audit assignments within the MEA and that MEA IA has always operated independently of Treasury, whilst Treasury are of the view that that there was initial interaction between Treasury and MEA IA following the appointment of Clive McGreal as the Treasury Chief Internal Auditor in 1999. Treasury states that this interaction related to, inter alia, providing additional resource to MEA IA on capital contract audit and reviewing the planned MEA IA coverage for 2001/02, participating in the tender and procurement process for the Pulrose power station project and a review of the Treasury bond issue in July 2001 (paragraph 9.3 above). 10.23 An Audit Charter sets out the roles and responsibilities of the MEA IA department. It is not clear whether it covers the subsidiary companies. We are told that in practice the IA department:does not cover these companies explicitly although the list of potential audits does include some operational areas associated with transactions and activities of the subsidiary companies. These operational areas are subject to the same selection process as-any other item for inclusion into the audit operating plan. 10.24 The MEA has informed us that formal coverage of the subsidiary companies by MEA IA has been . discussed in recent years with the Chairman of the Audit Committee and the former - Chief Executive. The outcome of these discussions was that, given the subsidiaries are sMall, being controlled by members of the Board with assistance, initially, from the National Grid Company (NGC) and the small volume of transactions the subsidiaries did not warrant a review of the financial processes. 10.25 The MEA IA department has two members of staff in addition to Mr Dewar. One is a qualified .t accounting technician and the other has previous audit experience at the National Audit 'Office and a degree in Public Administration. 1 July 2005 Financial reporting environment and liaison with auditors 118 Manx Electricity Authority PKF IA Planning 10.26 The IA annual operating plan is prepared by Mr Dewar, following discussion with the Chief Executive, MEA divisional managers and the external auditors, KPMG. The starting point for these discussions is the 'audit universe'. This lists all potential areas for audit and rates them according to their financial value, the number of employees, the quality of management, the standard of controls in place, the audit knowledge of the area and the level of concern expressed by divisional directors. A risk number is calculated and based on this the area is categorised as high/medium/low risk. High risk areas are given greater priority but other factors such as the length of time since the last audit are also taken into account. A draft plan is prepared which the Chief Executive reviews and he prioritises the areas to be audited. The MEA Board, on the recommendation of the audit committee, formally approves the plan. 10.27 It is good practice for the audit planning process to be based on a full analysis of the objectives of each area in the audit universe, assessment of the risks faced in achieving those objectives and the likelihood and impact of each risk occurring. We understand that the audit universe dOes not. include activity objective's as these are not available within the sources department, We understand that this is being addressed as part of the current risk management project (paragraph 10.34 below). IA Reporting 10.28 The IA department produces the following reports: • Assignment reports — these look at specific issues/areas as per the annual operating plan. They are copied to the line manager, the external auditors, the Chief Executive and the Chairman of the Audit Committee. Monthly reports to Chief Executive — these are included in the Board information pack. They report on the status of audit assignments completed and in progress during the month and provide a brief summary of the key findings. Quarterly reports to Audit Committee — this includes a summary of the audit work performed in the quarter and the key findings. • Annual report — to the Audit Committee, copied to the external auditors. The report covers the staffing and budget issues, training and development work performed in the year in each division and key findings of the audit as well as performance against the key performance indicators of the IA department. .1 July 2005 Financial reporting environment and liaison with auditors 119 Manx Electricity Authority PKF 10.29 Mr Dewar has three reporting lines: • the Chief Executive of the MEA with whom he meets monthly; • the Chairman of the MEA Audit Committee, with whom regular meetings are held on a formal and informal basis, and; o the Chairman of the MEA with whom a formal meeting is held annually. • 10.30 We understand that Government policy.is for all IA reports to be copied to the Treasury, the Chief Financial Officer and the Public Accounts Committee. We note that there is significant disagreement between the views of the MEA and Treasury over the extent to which the MEA is • required to make its IA reports available to the above named parties and whether it was in fact required to do so. The MEA states that it has never been asked to provide copies of its IA reports ' to the above named parties whereas the Treasury states that this policy has been clearly stated to both Mr Dewar and Mr Proffitt. The MEA acknowledges:that Mr Clive McGreal, in his capacity as ; Treasury Chief Internal Auditor, requested MEA IA reports from Mr Dewar but this request was turned down. 10.31 The implementation of audit findings is monitored by performing a follow up audit six months after the initial review. The quarterly and annual reports also include details of the number of . recommendations which are yet to be fully implemented. We note that the MEA appears to be to implement audit findings and that this has been raised as an area of • concern at • Audit: • Committee meetings. Audit Committee 10.32 The MEA set up its Audit Committee in 2000. The Audit Committee meets at least quarterly and comprises three members of the MEA Board; Mr Terry Mackay, Mr J Charles Fargher, Mr John McCallion. 10.33 The Audit Committee's terms of reference do not cover the period of tenure. We note that two , members have held their positions since April 2000 and one since September 2002. The MEA considers that the members of the Audit Committee remain independent and that the MEA Board members themselves are subject to re-appointment by the Council of Ministers periodically. 1 July 2005 Financial reporting environment and liaison with auditors 120 Manx Electricity Authority PKF Risk Management 10.34 It is generally considered best practice for all organisations to have a fully documented record of the risk affecting the business and the controls in place to manage them (a risk register). The MEA does not currently have a risk register. However, we note that there is a risk management strategy project underway that will be implemented over the next 18 months to two years. If this project is implemented as planned this should bring the MEA into line with current best practice in this area. The MEA considers itself at the forefront of the development of risk management in Government. This view is not shared by Government. We are informed by the DTI that a number of - Government Departments have risk registers and control mechanisms in place. Capital expenditure Background 10.35 MEA capital expenditure consists of a number of large-scale projects and routine capital expenditure (generally less than £250,000 per project). The large-scale projects in recent years include the building of the CCGT power station, the Pressure Reduction Station, the cross-island gaS pipeline and the sub sea inter-connector cable. These are discussed in more detail elsewhere in this report. 10.36 A quarterly report of capital expenditure is provided to Treasury. This includes the total capital expenditure in the quarter in each of the following categories: PGT Power station, gas pipeline, BGE charges, network services, generation, vehicles and equipment and other. It has not included the cost of acquiring MCC (including associated debt) or capitalised interest. Routine capital expenditure 10.37 The Board approves the budgeted level of capital expenditure as part of the annual budgetary process (as described in the Budgeting section from paragraph 10.15 above). 10.38 When individual costs relating to capital expenditure are incurred they are entered into Navision as a purchase order and are subject to the same approval levels as other purchase orders. 10.39 The level of capital expenditure is reported monthly, at high level to the Board and at a detailed level by the divisional managers. The reports used to do this are described in the Management Information section from paragraph 10.3 above. Capital expenditure on large-scale projects 10.40 Large-scale projects are managed by a dedicated team, which has responsibility for all aspects of the project from tendering to implementation to cost control. The procedures may vary slightly from project to project. The procedures described below are based on discussions with the CCGT power station team but we are informed that they also apply to other projects. i July 2005 • Financial reporting environment and liaison with auditors 127 Manx Electricity Authority PKF The budget setting process 10.41 Budgets are prepared by the project team based on the best information..available at the time. , • • • They are updated as further information becomes available. For example, in the initial stages of a large project the exact specifications of the final work are not known but as they become clearer more accurate estimates of costs are included in the budget. The tendering process 10.42 The MEA/PGT invites tenders for all sub-contracted work. The stages involved in the tender process are: • produce the specification for the work to be performed; • agree a shortlist of suitable sub-contractors/suppliers; • prepare the termsand conditions of the contract and the tender documentation to send to, prospective sub-contractors/suppliers; • i‘ • following the return of tenders, carry out a tender review and prepare a report detailing a . recommendation for selection of a specific sub-contractor/supplier; • the recommendation must be approved and the contract signed by the a PGT director/Chief • Executive of the MEA . 10.43 For the CCGT power station external consultants (NEL Power) were used to manage the whole tender process. Contract change control 10.44 if a change is required after a contract has been signed a variation order or a site instruction is issued. In the case of a variation order, the sub-contractor submits a request for the change to the external consultants (NEL Power). NEL Power examines the reasons for the change and the cost . implications and makes a recommendation to PGT for approval/rejection. The Commercial • Manager approves the variation order after consultation with the Project Manager. 10.45 Site instructions are administered by Quantity Surveyors. These are for minor technical changes to the contract and are not required to be authorised by 'PGT at the time of issue. However, the site instructions are monitored: on a monthly basis by PGT and all resulting payments must be • authorised by both PGT and MEA. 1 July 2005 • Financial reporting environment and liaison with auditors 122 Manx Electricity Authority PKF Approval of capital expenditure on large-scale capital projects 10.46 Requests for payment from a sub-contractor are managed by the external consultant. The consultant verifies that the sub-contractor has performed the work and, if so, recommends to the Commercial Manager that a payment be made. 10.47 The Commercial Manager checks contract and when he is satisfied that the payment is valid he • recommends to the MEA that a payment is made. 10.48 The payment request is passed to the MEA accounts department who input it onto Navision. This is treated as a PO and Navision requires an appropriate person to authorise the payment. When the payment is authorised by a member of the MEA staff it will be included in the next payment run. *`- Monitoring capital expenditure on large - scale projects 10.49 The Project team-maintain cost control spreadsheets which show the details of all costs expended to date, committed to and forecast to arise. 10.50 Monthly reports to the Board on the projects were prepared by the Project team. These included the budget, committed costs, costs not yet committed, amount expended to date and costs that are committed but not yet expended. The reports are broken down into the main projects and within these further breakdown into the key areas of expenditure is given. Comments on capital expenditure procedures 10.51 We note that the reported budget figures change over time as more is known about' the work required to complete the project and this means that it is not readily possible from the information supplied as part of the Board Packs to assess how the expected total costs have changed since the project began. 10.52 The monthly reports by the Project Unit give an extract of the total capital expenditure costs. Using the Board Pack information it is not possible to tie these into the costs in the reports by the accounting team. 1 July 2005 Financial reporting environment and liaison with auditors 123 Manx Electricity Authority PKF Liaison with External Auditors 10.53 We have met with the Mr Mike Gardner and Mr Michael Fayle of the external auditors, KPMG. The key issues raised were: Issue Comment Treatment of bond interest on In the 2002 and 2003 accounts the interest was deferred. the £185 million Treasury bond KPMG found that the treatment of this was not contrary to the provisions of the Audit Act 1983 and stated that in their opinion the financial statements have been properly prepared in accordance with the Audit Act 1983, and comply with the requirements of all other enactment's applicable • to the financial statements. However, this treatment did not comply with UK GAAP and in the 2004 the treatment will be changed to comply with it. Treatment of the lease with SG This was treated as an operating lease by the MEA with for the gas pipeline payments being charged to the profit and loss account over the life of the lease. However, KPMG consider that it should be treated as a finance lease and it should therefore appear on the balance sheet. Treatment of Skyward costs In previous sets of accounts the costs of development for the Skyward project have been capitalised. This treatment is now being reconsidered as the MEA does not yet have a license to exploit the research and development undertaken. Treatment of performance bond As a result of the collapse of Nepco a performance bond receipt (E10.2 million) became payable. The proceeds have been included in turnover as it is considered that the collapSe did not lead to a material delay or financial loss. KPMG. agree with the treatment but require the amount to be separately disclosed on the face of the profit and loss account. C-- j a Watie-Od cfajis,lo ar7' KMPG. are ctoiently -seeking:a-legatTopinion -on-thelegality of the BarclYysloan-§-:, Barclays obtained an opinion from Cains solicitors which considers that MCC is within its powers to enter into the loan. It does not comment on any legal conditionality surrounding the use of such funds by way of transfer to the MEA. • July 2005 Financial reporting environment and liaison with auditors 124 Manx Electricity Authority PKF Management letters 10.54 No management letter was prepared in 2000/01 or 2001/02. There was a management letter in 2002/03; the only issue raised related to the treatment of bond interest (see discussion above). The 2003/04 management letter raised the following issues: Recommendation Management response A fixed assets register should be Due to the nature of the MEA's assets (a power introduced and a full verification exercise station and a distribution network) it is not possible undertaken. to analyse and control the separate components at an economic cost. Management consider the current system to give an acceptable level 'of accuracy. Stock levels in the general ledger should The stock levels in the general ledger are be reconciled to the detailed stock listings reconciled to the Inventory module in Navision. It on a regular basis. • is proposed that a working group is established to ensure that stock takes are carried out periodically and any necessary adjustments made to the inventory listings are accounted for in a standard manner. IT issues '' 4 Passwords should expire after 30 days Done The MEA should introduce a business Done for all IT systems continuity plan The introduction of a new fire suppressant Under consideration system in all computer rooms should be considered • An SLA between the MEA and the In progress Government should be prepared July 2005 Financial reporting environment and liaison with auditors 125 • Manx Electricity Authority PO' 11 Review of Board minutes and delegation o responsibility Review of Board minutes MEA Board minutes We have reviewed the. MEA Board minutes from April 2001 to January 2005. In advance of the Board meeting members are provided with a "Board pack". As a matter of course this includes the following documents: • Agenda; • Minutes of previous month's MEA Board meeting; • Chief Executive's report; • Consolidated profit and loss . account, balance sheet and accounts commentary; • High-level historic capital expenditure analysis (April 2003 onwards); • Operational monthly'report; • Detailed forecast and actual capital expenditure reports by project; • Capital investment management report (2001 to 2003). Board packs were not produced for all months. 11.2 Amongst the matters referred to in the Board minutes we note the following: • 29 March 2001 — the Deloitte & Touche report on refinancing options was issued. • 4 July 2001 — the cost of the PRS was expected to be borne by BGE. • 27 September 2001 — purchase of NGC stake in MCC approved. • 30 January 2003 - capital overrun of £1.3 million on steelwork was noted and Skyward Telecoms to be incorporated. • 27 February 2003 — it was noted that the MEA would have negative cash flows for two years but was expected to cash flow positive thereafter. 1 July 2005 Review of Board minutes and delegation of responsibility 126 3 'Manx Electricity Authority PKF • 24 March 2003 — the Skyward "memorandum of understanding" was referred to as having been sent to the DTI. • 29 May 2003 — provision of the bank guarantee to Barclays was approved. • 3 July 2003 — M Proffitt formally declared his interest in Barclays prior to the signature of the loan facility. It was noted that C Wilcox and C Fargher had appraised the loan offers. • 25 , September 2003 — it was noted that the power station had cost £90 million against a budget of £88 million. • 11 December 2003 — the KPMG audit letter was rejected on the grounds that the Board felt that its reference to the treatment of bond interest was inappropriate. It was also noted that following the passage of the Gas & Electricity Act MEA can deal in communications. • 28 January 2004 — it was agreed to accept a £5 million temporary overdraft facility from Barclays. 25 March 2004 — the terms of the £50 million Barclays facility were accepted and the comfort letter provided by MEA to Barclays was approved. • 27 May 2004 — it was noted that the DTI had asked the MEA to produce a business plan for telecoms activities. 8 It was also noted that the £10 million of the bond proceeds allocated to the building of a wind farm had been used for other purposes. ▪ 30 September 2004 — it was agreed that the Board would be provided with a cash flow . statement each month. We are informed that this commenced in May 2005. 24 November 2004 — noted that the Treasury was informed of the extent of MCC's borrowing and provided with a capital expenditure breakdown of £265 million. 11.3 The Board of MEA has confirmed to us in writing that they monitored the full detailed capital cost on a regular basis. MCC Board minutes 11.4 • We have reviewed the MCC Board minutes from April 2001 to date. We note the following: r. • • 2 June 2003 — Skyward committee established. • 4 July 2003 — formal approval of the £70 million Barclays facility. The DTI has stated that it had asked the MEA to produce a business plan since the MEA's initial proposals • in mid 2003. • . 1 July 2005 Review of Board minutes and delegation of responsibility 127 Manx Electricity Authority PKF • 12 August 2003 - noted, that borrowing of £75 million had been undertaken (£70 million facility as above and £5 million overdraft facility) to replace the £35 million facility with HSBC. It was noted that the loan had been taken to fund capital expenditure of which £20 million was to replace-the claim against JP Morgan Chase for recovery of the Nepco performance bond of £12 million (see section 9 - "Review of contractual relationships") if the claim went against MCC. It was also noted that Barclays had offered the most competitive lending rate and that Messrs Fargher and Wilcox were involved directly in the lender decision-making process. The Chief Executive confirmed his conflict of interest as Chairman of Barclays. • 27 February 2004 - Formal approval of the £50 million facility. • 11 February 2005 - It was resolved that MCC would acquire at cost all gas related assets from the MEA. 1PGT Board -minutes 11.5 We have reviewed the PGT' Board minutes from its first meeting on 12 December 2001 to its final meeting on 27 May 2004. We note the following: • 28 January 2002 - The Chief Executive outlined that he had obtained a written legal note from Elizabeth Appleby QC that it was within the MEA's powers to set up PGT as a special . purpose vehicle. Rights and monies could be assigned to POT in accordance with the . Electricity Act 1996 ("EA 1996"). Sub-contractors could not claim that contracts were not binding on the grounds that the incorporation of PGT was ultra vires. !Mr McCallion asked the'Z Chief Executive.to-advise - the- DTI of Ms Appleby's - leg-al-note. We-are infOrmed by the . DTI 1 . - Y t=7" - that it was not in fact advised of Ms Appleby's -note3 rX 11-1 0 41 The Chief Executive also stated that the role of PGT was •identical to that of Nepco, the management of the risk of the power station project. He added that there would be tight corporate governance of PGT to maintain clear independence and demarcation of roles as between the MEA, PB Power and NEL Power. PB Power would have separate duties to PGT for approval and verification of Nepco's plans and to the MEA as owner's engineer. POT would employ some ex-Nepco staff, now trading as NEL Power. The reporting structure. would be unchanged except that PGT took the place of Nepco. • 24 June 2002 - The Chief Executive advised that the programme was secure far delivery on 30 April 2003. • 24 September 2002 - The Chief Executive advised that work was a little behind schedule and that it was planned to address this through PGT's procurement strategy. He added-that completion was on target for 30 April 2003 and was within the project budget: - July 2005 Review of Board minutes and delegation of responsibility. 128 Manx Electricity Authority PKF 19 December 2002 - The Chief Executive advised that commissioning was due to be completed on 30 May 2003 and that commercial trials would follow in June 2003. • 24 March 2003 - The Chief Executive advised that the PIRS was due for completion by the end of April 2003 and gas had been commissioned into Pulrose from 28 March 2003. The first fire of the power station was scheduled for 7 April 2003 and full commercial testing would follow. • 22 September 2003 - It was noted that successful full load tests had been undertaken on both gas turbines. The ChiefExecutive advised that the construction of the power station was almost complete. Expenditure on the power station had now been separated from work on the gas supply for balance sheet purposes. GE deemed the plant to be operational. It was agreed to continue operating PGT to maintain the specific contractual warranties. • 9 December 2003 - It was noted that the power station was now complete and that responsibility would be transferred to the MEA once health and safety criteria had been satisfied. Board delegation of authority MEA delegation of authority policy 11.6 The MEA Audit Committee agreed in July 2000 to establish a formal checklist of matters that required referral to the Board. A paper was presented to the Audit Committee in October 2000 and matter was taken forward by Mike Proffitt and Paul Dewar (Head of Internal Audit). In May 2002 the Board approved a delegation of responsibility framework for the MEA which set out in a structured document the'responsibilities reserved for the Board and the responsibilities delegated to management. It also provides for the nomination of an individual to manage and maintain the framework. The aim was to provide the Board with assurance that business processes and controls were adequate. - 1 July 2005 Review of Board minutes and delegation of responsibility 129 Manx Electricity Authority — PKF 11.7 It was recognised that the Board performs the following functions: • setting the direction of the MEA within overall Government policy; • identifying matters reserved for Government, the Board and those that may be delegated to management; • ensuring financial control and the delivery of planned results; • ensuring standards of corporate governance and personal behaviour in business dealings; and • receiving regular timely information to monitor business activities, management responsibilities and business strategy. 11.8 The Board Delegation of Responsibility Schedule ('Schedule"), attached as part of appendix 2 sets out the specific responsibilities reserved for the Board and those responsibilities delegated to Board Committees, the Chief Executive and to senior management. It is recognised that the Schedule provides guidance and does not cover every possibility and any omissions or requirements for interpretation are to be brought to the attention of the Board. 11.9 The person currently nominated by the Chief Executive to maintain the Schedule is Andrea Shimin (secretary to the Director of Corporate Services). Ms Shimin must: • ensure that the Schedule reflects current organisation structure and management control procedures; • submit the Schedule at least annually to the Board for confirmation that the control environment is adequate; and • issue the Schedule to directors and managers. 11.10 The Schedule was issued by The Chief Executive to directors and Board members in September 2002. We understand that directors were expected to pass down or make the document available to managers. However we are informed by Mr Dewar that it has not been reviewed since its issue in May 2002 and this needs to be addressed. 1 July 2005 Review of Board minutes and delegation of responsibility 130 Manx Electricity Authority Par 11.11 The Schedule details responsibilities in the policy areas of: • Board affairs; • Strategy; • Finance and accounting; • Published statements and other documents; • Audit and internal control; • Personnel; and 4 • Procurement and contracts. Responsibilities in the above policy areas are allocated between Tynwald Court and/or the Council of Ministers, Government Departments (DTI or Treasury as appropriate), the MEA Chairman, the . Board, BOard Committees, the Chief Executive, directors and divisional managers.. The • `responsibility may comprise a decision, consultation, recommendation, origination or notificatioh. 4 Therefore each decision will only be made after the necessary consultations, recommendations and notifications have been undertaken. . 11.13 Points of particular note in the Schedule are as follows: 1%." 4 • Board affairs . • Establishment of Board Committees is a decision of the Board, after consultation with the Chief Executive; and Determination of the terms of reference for Board Committees is a decision of the Board, after consultation with and on recommendation of the Board Committee. . " Taking major decisions on strategy, reorganisation and restructuring is - a decision of • the Board after consultation with and on recommendation of the Chief Executive and directors; , Approval of material activities which have a financial or political impact is a decision of the Treasury, after recommendation by the Board and Chief Executive; and 3. • 1 July 2005 Review of Board minutes and delegation of responsibility 131 3 Manx Electricity Authority PKF ■'; Approval of activities which are outside the principal functions of the MEA is a decision of Tynwald, after consultation with the DTI upon recommendation of the Board in consultation with Chief Executive and directors. This process has been evidenced by Tynwald passing the Gas and Electricity Act 2003. This Act allows the MEA to undertake telecommunications h. activities with the consent of the DTI (see section 14 ("Skyward")). Finance and accounting • Determination of accounting and treasury policies is a decision of the Board, on the recommendation' of the Chief Executive in consultation with the Director of Corporate Services; • Approi/al of the MEA's capital and revenue budgets and business plan is a decision of the Board after recommendation of the Chief Executive and is notified to Treasury annually. There is a timing difference between the MEA's annual budgets which are finalised in March and the Government's annual budgets which are finalised in December; • Approval of capital schemes above £250,000 is a decision of the Board (the building of a generating station requires DTI consent) after recommendation from the Chief Executive; • Approval levels for capital and revenue purchase orders vary according to the amount (see section 10 ("Financial reporting environment and liaison with auditors")); • Approval of banking relationships is a decision of the Board after recommendation of the Chief Executive in consultation with the Director of Corporate Services; and • The approval of borrowing requirements requires Treasury decision (if borrowing from any person other, than Treasury) or Treasury consent (if borrowing from Treasury for over £185 million) on the recommendation of the Board 'and/or Chief Executive. Personnel • Approval of Board members' annual payments and travel allowances is a decision of the Council of. Ministers in consultation with the Treasury; • Approval of Board Committees' chairmen fees is a decision of the Board; • Approval of the Chief Executive's service contract, salary, bonuses and other benefits is a decision of the Remuneration Committee, notified to the Board; and • Approval of directors' service contracts, salary, bonuses and other benefits is a decision of the Chief Executive, notified to the Board and Remuneration Committee. 1 July 2005 Review of Board minutes and delegation of responsibility 132 Manx Electricity Authority PKF Procurement and contracts • . The signing of contracts and agreements over £250,000 •is the decision of- the Board, on the recommendation of the Chief Executive in consultation with the appropriate director. 11.14 It should be noted that the Schedule is only applicable to the MEA and no such schedule has been prepared for either MCC or PGT, which are governed by the decisions taken by their respective boards of directors. Legislation relating to delegation of authority 11.15 The legislation relevant to the delegation of authority is the Statutory Boards Act 1987 ("SBA 1987'). The SBA 1987 deals with the exercise of functions of statutory boards in Schedule 2. Section 3 of Schedule 2 states that the Board may arrange for the discharge of any of its functions by the following: • A committee of the Board; • Any member of the Board; • • Any officer of the Board; or Any member of the Board and any officer of the Board acting jointly. 11.16 However, the following functions must be exercised only by the Board: • The acquisition or disposal of land; • • Levying or issuing a precept for a rate; • Borrowing money; or • Making any public document. 11.17 The Schedule includes the four above matters within decisions reserved for the Board and/or . Government as appropriate. - 11.18 Schedule 2 Section 4 states that the Board may constitute committees and that these may include persons that are not members of the Board, provided one member of such committees is a Board member. The procedure of such Board committees is to be determined by the Board. 1 July 2005 Review of Board minutes and delegation of responsibility 133 Manx Electricity Authority PKF 11119 The MEA has the following committees: 4' Audit committee comprising Messrs T Mackay, J McCallion and C Fargher, al11)'f whom are MEA Board members; • Remuneration committee comprising Messrs J McCallion, J 'Taylor and C Fargher, all of whom are MEA Board members; and • Health and safety committee headed by Mr T Ferrer, a MEA Board member. 1 July 2005 Review of Board minutes and delegation of responsibility 134 Manx Electricity Authority Pkr Review of bank tendering process Midland loan 12.1 The Midland Bank plc ("Midland") loan was signed by MCC on 15 April 1999 to fund the debt element of the construction cost of the Isle of Man/England interconnector and fibre optic cable. ' 12.2 The tendering process to secure this loan was outside the scope of our review. 12.3 The total loan facility was £36 million. Each of MEA and National Grid ("NGC") had subscribed £4.5 million for shares in MCC, the proceeds of which had been used to part fund the construction of the Interconnector. We note that in January 1998 the then Chief Executive of the MEA, Mr Brian Machin, requested Treasury approval for the raising of £5-10 million in respect of the MEA's share of the equity investment in MCC as debt. So far as we are aware Treasury were not consulted or involved with the subsequent Midland loan taken out by MCC and that neither the MEA nor MCC sought Treasury approval or consent for the loan. • 12.4 Interest was payable on the loan at.LIBOR plus 0.65%. 12.5 The loan was repayable in a bullet repayment five years after the first drawdown against the loan. 12.6 • Early repayment was all6wed with no penalty other than if HSBC Capital Markets had offered to arrange a bond issue at or below terms offered under the loan whereupon a 1% repayment penalty Was payable. As referred to at paragraph 12.13 below an early repayment fee was paid. 12.7. The loan was subject to an arrangement fee of 0.75%, £270,000, and a quarterly commitment fee in respect of undrawn amounts at a rate of 0.35% per annum. 12.8. 'MCC warranted that it was not in breach of any law applicable to it and that, other than any debt • incurred in connection with the construction project, it was debt free. • )2.9 , The loan was secured by a fixed and floating charge over the assets of MCC. 12.10 The loan was not subject to any positive financial covenants, e.g. EBITDA, net asset cover etc. 12.11. Neither the MEA. nor NGC were parties to the loan agreement. Hdwever, both parties agreed to subordinate any amounts due to them from MCC in preference to amounts due to Midland. In addition, both MEA and NGC provided Midland with a first charge over their shares (including any . rights thereon, e.g. to dividends, conversion etc.) in MCC in order to secure amounts due to Midland. 1 July 2005 Review of bank tendering process 135 Manx Electricity Authority Pkr • 12.12 Under the loan agreement MCC agreed to maintain and operate the interconnector - project in accordance with the project documents, one of which is the Use of Intercorinector Agreement ("UIA"). The UlA states that the MEA must use and operate the interconnector within its technical' specification of a nominal operating capacity of 40MW with an emergency short term overload capacity of 60MW. MCC is not permitted to make any modifications to the interconnector (which includes upgrading) without the prior written consent of Midland. 12.13 The Midland loan was repaid in full in July 2003 with the total payment being £30,531,000 including a early repayment fee of £302,000. There is no record to show that a variation in the terms of the Midland loan was discussed with HSBC. Barclays loans 12.14 MCC has two loan facilities with Barclays Private Clients International Limited, an Isle of Man company, ("Barclays") for £70 million and £50 million respectively. The £70 million facility was agreed on 8 July 2003 and the £50 million facility on 25 March 2004. • 4 12.15 In assessing the decision to take out loans directly with a bank rather than via the Government the MEA consider it necessary to understand that they estimated that at the height of the prOject a days delay could have cost the MEA £100,000. When the first Barclays loan was taken out the figure was £50,000 and the second £33,000. If a delay had occurred cost increases could have quickly escalated and had a significant impact on the performance of the MEA. • The MEA considers that the loans taken out can best be viewed as bridging loans, quickly and conveniently arranged to allow for a longer term solution, involving the Government, to be planned without putting at risk the Capital Projects and hence the electricity supply to the Isle of Man. . 12.16 The above is not a view shared by Treasury. The MEA board was aware by March 2003 that the cost of the Capital Project was likely to significantly exceed the original amount put before Tynwald. On this basis Treasury considers that the Board had sufficient notice to discuss the funding requirerrient with 'them without endangering the Capital Project. Tendering process 12.17 Each of Isle of Man Bank '("IMB"), HSBC and Barclays were asked to provide an indicative offer for the provision of a bank facility of £70 million to MCC. Each bank was given the same information and a brief that cost was the overriding factor affecting the outcome. 12.18 We have reviewed the tendering process for the first loan and held discussions with representatives of each bank and, whilst it was relatively informal, ie carried out by email, telephone conversation, and 'informal meetings, we have no reason to consider that it was not an arms length process. The process was led by Mr Clive Wilcox and there is no evidence to suggest that the Chief Executive played any role in influencing the choice of banks. 1 July 2005 Review of bank tendering process 136 Manx Electricity Authority PK 12.19 ,- The MEA Board minutes of 3 July 2003 state that: "The Chief Executive had declared his interest as Chairman of APCI and had not been part of the selection process or negotiations, and Mr Fargher confirmed this to be the case." 60 ' :12:20 The Board of the MEA has subsequently confirmed to us that the Chief Executive played no role in influencing the choice of banks. 12.21 . In our discussions with the banks it is evident that there were different views as to the quality of the information provided to them. For instance, HSBC asked for a significant amount of additional information. As both 1MB and Barclays offered facilities that met Mr Wilcox's criteria this request for further information from HSBC was not followed up. Barclays have stated that they consider • that the information they obtained in relation to the transaction, in addition to their existing knowledge of the utilities market, meant that they were sufficiently informed for the purpose of their decision making. 12.22 Both IMB in their offer letter and HSBC in their letter requesting further information indicated that they would want the Government/Treasury to be involved in the process either in the form of consent (1MB) or a guarantee (HSBC). a 12.23 We are informed by Barclays that the credit papers relating to both facilities have recently been reviewed by Barclays Group Internal Audit and that no issues were raised in respect of Barclays' policy or procedures. 12.24 Barclays offered a lower interest rate if a Government guarantee was provided. This was not taken up by MEA/MCC and Treasury was not consulted over the Barclays loans. We are informed by the MEA that the reason for not pursuing this option was that Treasury backing was only considered to be an option for long term finance. The Barclays loan was not considered to be long term finance and that seeking Treasury approval would result in delays to the finalisation of the facility as it would require a formal resolution and debate on the floor of Tynwald (see the response to question 12 at appendix 2 for full response). • • • 12.25 Barclays have indicated that Barclays Capital, part of the UK entity, played a significant role in the decision to advance facilities to MCC but that the final decision was taken by Barclays in the Isle of Man. 12.26 . In an internal IMB email, dated 8 May 2003, from Ian Hodgkinson, Mr Hodgkinson indicated that • the debt was likely to be repaid out of the proceeds from a Government bond issue. Mr, Hodgkinson has subsequently left the Bank and we have been unable to confirm the basis of this • • statement. • • • 12.27 Mr Wilcox recommended the Barclays facility on the basis that, excluding the lower rate for . Government backed facilities, it was cheaper than that offered by 1MB. -. 1 July 2005 Review of bank tendering process :137 Manx Electricity Authority PKF 12.28 No tendering process was carried out in respect of the second loan on the basis that it was a relatively short period of time after the first loan had been drawn down. • Purpose of the loans 12.29 In his correspondence with Barclays and IMB Mr Wilcox indicated that the proceeds of the £70 million facility would be applied for the following purposes: • Refinance MCC debt - £32 million; • MEA cash flow requirement £25 million; • JP Morgan contingency - £13 million. 12.30 HSBC were verbally infortned that in addition to the refinancing of the MCC debt, the likely use of - the funds was natural gas distribution, Skyward related activities, and the windfarm , land the refinancing of MCC-fUrried.pail of the-capital-programme.relating to the borrown o £185 rt 11110n-in (paragraph 9.5 above):. • 4 12.31 The refinancing of the MCC debt was initially included in the use of the £185 million. bond' proceeds. The JP Morgan contingency is in respect of the performance bond due on the collapse of the Enron main contracting company. At the stage that the loan was being requested the final, receipt of this was being contested by. J P Morgan. Mr ,Wilcox. notes that to the extent that-the JP _ . Morgan funds were receivd the monies would be used for_the windfitn and/or,telndecoms a gas?. tThe funding of The windfarm was included in the0te of proceedS'Orthe'original £185 million. 12.32 In a note to Barclays dated 15 January 2004 Mr Wilcox stated that the additional £50 million was for the following purposes: • £30 million capex (of which the stated £17 million should have been identified when the original £70 million loan was drawn down); • £10 million for operating shortfalls caused by higher fuel prices, loss of export profits and higher staff costs; and - • £10-million. for - Skyward:, £1.7 million was spent on Skyward by 31 December 2004: 12.33 in providing the £50 million facility Barclays asked for written confirmation of the following: • A mandate letter to appoint Barclays Capital as lead managers on a bond issue. The signed • letter required MEA to use their "best efforts" to procure the appointment of Barclays; 1 July 2005 Review of bank tendering process . 138 Manx Electricity Authority PICF • Confirmation that the MEA had the ability to ensure that the Government does arrange to take out finance within the 18 months period of the new loan. A comfort letter was provided by the Chief Executive on behalf of the MEA. 12.34 Neither of the above were discussed with Government - or the ;-Treasury..,, Both the above letters were approved by the Board of the MEA at the meeting held to approve the new facility-on , 25 .c-March 2004 ,The comfort letter referred to above stated the following: "I confirm the ability of the MEA to arrange repayment of all amounts due at the facility maturity date. The,MEA is a-Statutory Board of Government, and is likely to arrange-future takeout finance in the . . . ..narn e_of4sle _Of Man Gavernmenrratherjhan its own. natne.—`1-Idwever: in-either event the liability-3 - _ - UWoulcl be a Government liability diie to the fact that a StatutoriBoard is a part of GovernMent.:j - 11 .■••••••••••■••••Mn...... • 12.35 Barclays accepted the above letter and did not consider it necessary to discuss its wording with the Isle of Man Government. In the absence of a bond issue it is not evident how the loan facilities would be repaid given that the projections drawn up to stipport the original loan showed that the MEA would not have sufficient cash resources to fund any material repayment until March 2012. 12.38" We are informed by Barclays that their understanding was that MEA had always considered long term finance as a potential cash resource for the repayment of loan facilities. Barclays consider that it is entirely normal for utilities to borrow long term interest only funding in the long term markets recognising the very long term nature of their assets, and for banks to lend short term fUnding pending issuance of longer term debt instruments. Barclays considered that the interest repayments payable by MEA to Barclays would not cause any cash resource difficulties for MEA a pending the, restructuring of these short term loans altho^ u h they were not resented .,with any jt revised forecasts by the MEA to_support .this view. 12.37 • We understand from. Barclays that there was a delay in acceptance of the £50 million facility and, . in order to ensure that MEA could meet its obligations, a temporary overdraft-of £5 million was - granted to the MEA. This was to be repaid out of the proceeds of the £50 million loan facility. The facilities - 12.38 In both cases MCC is the borrower and MEA the Guarantor. 1 July 2005. Review of bank tendering process .139 Manx Electricity Authority PKF 12.39 Summarised below are the principal terms of each facility: £70 million facility £50 million facility Purpose Refinancing existing facilities and general General corporate purposes corporate purposes Tranches A £50 million A £15 million B £20 million B £35 million Fees 0:15% facility fee 0.15% facility fee 0.12% commitment fee on undrawn amounts 0.12% commitment fee on undrawn amounts Positive None None financial covenants Repayment Bullet — 8 July 2008 Bullet — 25 September 2005 Conditions Confirmation from MCC that: Confirmation from MCC: precedent include It has the necessary authority to borrow Of no change in constitutional the full amount and that all necessary documents since the previous facility approvals have been obtained was agreed That there is no restriction preventing it That utilising the facility will not breach from borrowing under the facility of any borrowing limit That utilising the facility will not breach Confirmation from MEA: of any borrowing limit Of no change in constitutional Confirmation that the MEA has the documents since the previous facility. necessary power.and authority to enter into was agreed its obligations under the facility and that it is not in breach of any limits or restrictions That utilising the facility will not breach imposed by any other agreement. of any borrowing limit Board resolution from MCC and MEA Legal opinion from Cains accepting the terms of facility as borrower Letter of comfort from the MEA confirming its and guarantor respectively ability to arrange for repayment of amounts - • Legal opinion from Coins, due the facility on the repayment date Interest 4.515% on tranche A for the life of the loan 5.115% on tranche A LIBOR +0.3% on tranche B LIBOR +0.3% on tranche B Fixed Fixed interest option for the whole of tranche interest A and any part of tranche B option 12.40 In connection with both loans facility the MEA provided a letter to Cain Advocates, in their capacity as advisors to Barclays, confirming that the monies would be used by MCC solely for purposes • within the power of the MEA, being: • Those stated in section 2 of the Electricity Act 1996 (as amended) and/or section 4 of the Gas - and Electricity Act 2003; • Necessarily and properly required for MEA to carry into effect the purposes of its incorporation; • Incidental to or consequential on the MEA's authorised activities under the Statutory Boards Act 1987, the Electricity Act 1996 .(as amended) and the Gas and Electricity Act 2003. 1 July 2005 Review of bank tendering process 140 1. 7 . Manx Electricity Authority PKF • h . 12,41. In addition, a legal opinion was provided by Gains to Barclays based on Manx law confirming that the borrowing was within MCC's powers as was the guarantee provided by MEA (appendix 5). We note from the response to our question 9 to the MEA Board (at appendix 2) that the latter considered that the Gains legal opinion (for which the MEA paid) showed that in their view.there was no doubt whatsoever as to the validity of the loan. We discuss the Cains legal opinion further in section 13 ("Review of legal opinions"). fp. 1 July 2005 Review of bank tendering process 141 - Manx Electricity Authority PKF 13 Review of legal opinions 13.1 As part of our brief we have been asked to review the legal opinions surrounding the issues. The only legal opinions that we are aware of are as follows: • QC's notes based on English law regarding the legality of the formation of PGT and potential. provision of guarantees by MEA to sub-contractors; • Cains legal opinions based on Manx law to Barclays dated 9 July 2003 and 25 March 2004 on the legality of loans to MCC and provision of guarantees by MEA. • 13.2 ''''''— KPMG-have_written to_the-MEA setting out their view, based on QC advice, that there is a case. for •...... the .Barclays -loa-niind related guarantees by the MEA being .:"contrary to law". The Board:ofhe t MEA refute this. W eer-urTel -Sta-ria that this matter is ongoing and has not yet beehreibliee; t,--.....--;..... 13.3 • The QC's note is not directly relevant to addressing the legality of the Barclays' loans, it being prepared for the MEA Board some 18 months earlier in the connection with the formation of PGT. However, it does raise some issues that are relevant to the legality of the loans. The Gains opinions were paid for by the MEA and addressed to Barclays. The Board, working in cooperation with Barclays, viewed the Gains opinions as independent and considered professional advice based on Manx law, on the legality of the Barclays loan to MCC and related provision of the MEA - guarantee. QC's notes 13.4 Ms Elizabeth Appleby, Q.C. of 4-5 Gray's inn Square, London provided a written response to the - Board of MEA in January 2002 (attached at appendix 6). Her views were sought in connection with the formation of PGT and it assuming the responsibility for the Nepco power station contract. Ms Appleby was asked to advise under English law on: i) The power of MEA to have a subsidiary company; ii) The power of MEA to grant guarantees to a third party in respect of its subsidiary; iii) The risks that arise if the subsidiary is ultra vires on the contracts between PGT and the subcontractors; iv) Generally. 13.5 The receipt of Ms Appleby's response is referred to in the January 2002 PGT Board minutes. 1 July 2005 Review of legal opinions -! 142 v Manx Electricity Authority PKF 13.6 - In respect of (i) above Ms Appleby is of the view that MEA had the power to create a subsidiary (this was before the Gas & Electricity Act 2003 had been passed which required DTI approval for this to occur) provided that that subsidiary was created to carry out activities that are within MEA's statutory powers. 13.7 At. paragraph -13(i) -of her notes Ms Appleby states "However, the subsidiary of the MEA can doo n more-than:the- _MEA'itif'can do. The creation of a subsidiary does not widen the powers of the . v ., . • 13.8 This view would appear to be of relevance in considering the ability of MCC to enter into the MEA\ \ guaranteed loans without Treasury consent, if such were the case. The MEA considers that it had ) 1 on-going Treasury consent both on their ability to form MCC and as regards the finance raised as Treasury approved both in the 1999 accounts and these were passed by Tynwald. " We note that accounts including the Barclays loans have not been formally laid before Tynwald. 1. . . .. — • .1 `13.9 At paragraph'14(a) of her notes a Ms Appleby states that "there is a risk that MEA is exceeding its authority in granting guarantees to third parties." 13.10 She goes on to state "I am unable to read or interpret any part of the 1996 [Electricity] Act that could be said to empower the MEA to guarantee third party losses." 13.11 These views would appear to be of relevance in considering whether the provision of the MEA guarantee to Barclays was within MEA's power. The MEA considers that this issue has been addressed via the Cairis legal opinion under Manx law. 13.12 Ms Appleby went on to state, specifically in the context of the relationship between.the MEA and PGT: "WhilSt I am concerned about the validity of the guarantees, t would be surprised if the MEA had entered into these arrangements without advice. It may be that whilst guarantees to third parties (i.e. a party with whom the MEA has no contractual ,relationship) appear to be outside the powers of the MEA, they could be indirectly tied in with the MEA contract with PGT, and therefore their validity protected." . Cains • . 13.13 Gains were instructed in connection with the first Barclays facility to provide an opinion based on Manx law to Barclays on, amongst other things, the legality of the loan to MCC and the provision of a guarantee by MEA. 1 July 2005 Review of legal opinions 143 • Manx Electricity Authority , PKr 13.14 On the basis of the matters described in paragraph 13.15 below, Gains expresSed the opinion in their letter dated 9 July 2003, attached at appendix 5, that, in summary: • The Company [MCC] has the corporate capacity to execute, deliver and perform its obligations under the Loan agreement; • The MEA has the capacity to execute, deliver and perform its obligations under the Loan agreement; • • 6 • The execution of the loan agreement by the MEA will not: contravene any existing law or regulation of the Isle of Man to which it is subject; or exceed the MEA's statutory powers or contravene or conflict with the provisions of Schedule 2 of the Statutory Boards Act. 13.15 It is to be noted that the opinions expressed by Gains are subject to a number of assumptions and . qualifications, and are based On a review of certain documents only, as set out in their letter dated 9. July 2003. In particular, in respect of the Guarantee, Gains qualified their opinion at paragraph. 8.7.1 of their letter by noting: - "Whether the Loan Agreement constitutes primary obligations of the MEA will depend upon its • construction." 13.16 We have requested clarification of the meaning of the above from Gains but they have declined to provide any interpretation on the grounds that it could represent a conflict of interest. The absence of such clarification limits our understanding of the Gains opinion. 13.17 Opinions, based on certain assumptions, qualifications and documents, in substantially the same terms as those set out in paragraph 13.14 above, were prOvided in a Gains letter dated 25 March 2004 in relation to the second Barclays facility. 13.18 In a written answer dated 3 May 2005 to a question in the House of Keys the Treasury Minister, Mr Alan Bell, stated that the'Attorney.General of the Isle of Mn. has subsequently reviewed the issue of the Barclays loans with particular reference to the ability of a subsidiary company of the MEA to enter into borrowings and whether borrowings from a subsidiary to the MEA transgressed the Electricity Act 1996. 13 : 19 The Attorney General gave advice to the Treasury on 15 November 2004 and concluded that • (subject to the assumption'that MCC bears the relationship of subsidiary to the MEA): "The restrictions on the power to borrow money, which are imposed upon the MEA by virtue of section 5 of the Electricity Act 1996, do not extend to a company such as the Manx Cable Company which is deemed to be a subsidiary of the MEA. Clearly, however, any borrowing by the MEA from its "subsidiary" would require the Treasury's consent." 1 July 2005 Review of legal opinions .-„.14.1 . Manx Electricity Authority PKF 14 Skyward Skyward Committee History and background • 14.1 r As part of the process of laying the sub-sea electridity interconnector cable between the Isle of Man, 12 fibre-optic cables were also laid down to transmit and receive telecommunications data. MCC and the DTI signed a lease in September 2000 whereby the DTI leased the cables from . MCC for a period of 30 yez-sat ai1 1annual... rental of £375,000 plus £15,000 for maintenance (both increasing in line with Isle of Man inflation). As part orthe agreement the DTI had to make three of the fibre-optic cables available to MCC to control and monitor the electricity interconnector. 14.2. The minutes of .a meeting in July 2002 state that the B6ard of MCC was asked to. consider possible fibre optic business applications. The minutes of a meeting in NoCiember 2002 state that the Chief Executive advised the MCC Board that agreement had been reached with the DTI toterminate the lease and return the nine unused cables to MCC's control. In view of the revisions to the • •-- E'ie-cty Act 1996 ("EA 1996") by the draft Gas and Electricity Act 2003 ("GEA 2003"), whereby the MEA would be authorised to provide telecommunications .services with DTI consent, it was agreed to establish a company (Skyward) within the MEA for the purpose of developing a business plan and budget in relation to the use of fibre-optic cables. At present the MEA does not have DTI consent to provide telecommunications services (see fi!irther paragraph 14.68 below). The view.of the MEA is that it operated under the assumption that consent would be provided upon passing of the GEA 2003 and that the DTI were aware of this. The DTI's view is that they have not_made any representations to lead the MEA to hold this view. The GEA-2003_.was_passed..in_October 2003 and received its appointed day order in December 2003. 3 In March 2003 the Chief Executive of the MEA and the Chief Executive of the DTI (Ken Bawden) Worked together to produce a draft 'Memor ndum of Understandin ' letter " OU") setting out the position with regard to the lease. The MOU states that and the MEA agreed to terminate the ' lease on passage of the GEA 2003. For consideration to be agreed upon MCC would take ownership of all intellectual property concerning the fibre-optic cables and any related business ry plans developed by the DTI or Manx Optical Agency. The DTI had prepared its own business case for lighting the fibre-optic cable which did not receive Treasury approval and this led to discussions between the respective Chief Executives as to the possibilitraTh-e-klEA pursuing this option Ir\-Ale are informed that thl i-VIOU has not been formalised and thatt e lease has knot been j - • 'legally terminate •E• 1 July 2005 Skyward 145 Manx Electricity Authority PKr 14:4 In June 2003 the MCC Board resolved to establish the Skyward Committee to develop the MEA's • 4 telecommunications business as the GEA 2003 had . yet to receive royal assent. It was noted that :, 1, the Skyward Committee would 136:7 reydunerated in accordance with levels recommended by El=1>ns7--err-eeis.„-a U.K._execsearch -4aer 1c?_s.,specialising, in the placement of non-executive dirtorsec. Hanson Green had been consultedlon a one o one basis by Mr Chris Spencer, a MCC director, in order to obtain independent adviCe on appropriate remuneration levels. Mr Spencer has informed us that, amongst other things, the meeting with Hanson Green discussed the • following (Hanson Green did not issue a formal ! report): A full description of the interconnector prOject; • The background to the . ownership of the interconnector, including the change from joint venture to 100% MEA ownership; • The history of the fibre-optic cable, including the lease to the DTI and the MEA's desire (through MCC) to fully evaluate and "cam' mercialise" the opportunities arising from ownership of the fibre; • The establishment of the Skyward ComMittee; • The proposed membership of the Skyward Committee; • The need to recognise that the business was at the 'start-up' phase and not cash positive, balanced with a need to attract high calibre candidates. This resulted in Hanson Green's recoMmendations that. fees should be pitched at "lower quartile" plus periodic bonuses (subject to cash flow) until such time as the business became established; • The importance of good governance moving forward, including the need for a remuneration committee comprising non-executives and an audit committee at the appropriate time. 14.5 The Hanson Green recommendations were as follows, compared with MCC's suggested levels: MCC Hanson Green £000 £000 Chairman (John McCallion) : 20 30 i Managing Director (Mike Proffitt) 50 65 Finance Director (Clive Wilcox) J 30 50 Non-executive rs-Oreife- Ckkeif... and Eddie Stiallcros)' t:--1715 4 25 14.6 The above rates were on the basis that the Skyward roles were deemed wholly additional to existing duties with the MEA and would involve the individuals concerned taking on additional workload and responsibilities. 1 July 2005 Skyward 146 Manx Electricity Authority PO' '14.7 The Skyward Committee was established as 'a sub-committee of MCC to exploit the telecommunications infrastructure and held its first ,meeting on46:jt.M20932,The_last meeting ittwas.:51:orill_11FebruaY 2096. From 20 August' 2004- meetings-have 'b6en -held as Skyward. Limited (paragraph 14.64 below). Further meetings have been suspended subject to resolving the status of the Skyward project. Function and purpose 14.8 The main objectives of the Skyward Committee were as follows, as set out in the Vision 2010 business plan issued in June 2004 and developed bybr—Re-tie'f: (5\1° • To commercialise the MEA fibre-optic connection between the Isle of Man and the United Kingdom, by selling bandwidth to an on Island Telecommunication service providers; • To develop the ability to transmit broadband internet data via MEA owned electrical power ! - lines (power-line technology or "PLC"); • To research the potential for satellite communications on the Island; • To investigate the potential acquisition of Manx Telecom. 14.9 T-Mobile have indicated that they may be prepared to enter into a strategic partnership with the MEA to become a second mobile operator on the island (after Manx Telecom). F. • 1* 14.10 The members of the Committee are as follows: 1 ■4 • • W McCallion; • M Proffitt; • C Wilcox; • C Spencer; • Dr J Retief; • 1Mrs-1 CaCkett (replaced by Mr D North in October 2004};-and E Shallcross. 1 July 2005 Skyward 147 Manx Electricity Authority PKr 14.11 Mr McCallion is the Chairman of the MEA, Mr Proffitt is the former Chief Executive of the MEN, Mr KWilcoxis the Director of Corporate Services of the MEA and Mr Spencer is a director of MCC.[ Retief was employed :by Jhe MEA from May 2003 as a'Cb -m—rrierdial-Dire-EtiSt[to commercialise the , sub-sea fibre-optic cable link to the UK. Mrs tackett / Mr North and Mr Shallcross are non- executive directors. Dr Retief, Mr Proffitt and Mr Wilcox were all MEA employees, but Dr Retief was specifically employed for Skyward therefore was given no additional salary for his work as a member of the Skyward Committee. The MEA informs us that for Mr Proffitt and Mi Wilcox the .. work was additional to their existing commitments and so involved increased remuneration. ,a14-:12 The progress of the Skyward Committee's objectives has been summarised as follows by Dr Retief. In respect of the first three objectives the research and development phase is now complete and we are informed Skyward is ready to commence commercial roll-out. The Skyward Committee has investigated the possibility of acqUiring Manx Telecom but have been told that it is not for sale by its owners, mm02, unless a signifiCant premium is paid. 14.13"..tr, The DTI were asked by the Council of j Ministers ("CoMin") to review the MEA's telecommunications business case. The Vision 2010 document containing the business case was presented to the DTI in June 2004. The DTI conducted its own review and then passed this on to Treasury for their input prior to reporting to !CoMin. Treasury appointed GOS Consulting (telecommunications consultants) to review and comment on the MEA telecommunications business case. The GOS Consulting review recommended that consent to light the fibre-optic cable should not be given until further and more detailed work was undertaken, inter alia, in relatibn to revenue projections. A copy of their report was provided to the MEA by the DTI. As a result on 7 March 2005 the MEA presented an updated business case to the DTI relating to the lighting of the fibre-optic cable as well as ontisland fibre networks, which was shared with Treasury. 4 1 July 2005 Skyward 148 Manx Electricity Authority PKF 14.14 . We are informed by the MEA that this business case projects, in the first five years of commercialisation, worst case revenues of £5 million and eipected revenues of £9.7 million with an expected profit of between £900,000 and £5.5 million. The MEA considers that even if the DTI does not give MCC permission to undertake telecoMmunications services directly, the expertise can be sold on. We have not seen or reviewed the MEA business case presented on 7 March 2005 or any of the supporting data contained therein.! This was examined by GOS Consulting who issued a final draft report on 26 May 2005. We have been provided with a copy of this report which concludes in respect of the revised MEA business case that: "we still have considerable concerns regarding the robustness of the business analysis underpinning the plan and hence the commercial viability of the business as described.• - Primary areas of concern in the revised MEA businesS plan include: • Demand forecast and market share assumptions • Pricing assumptions • MEA Telecommunications Expertise" 14.15: A detailed telecommunications licence application has been prepared with the assistance of Herbert Smith but has not yet been submitted. Herbert Smith has also prepared all documents to "ring :fence" Skyward. The MEA informs us that this has been done to ensure that there is no cross-subsidisation by the MEA. All of the documentS (including the business case) have been prepared in accordance with DTI's wish that Skyward shall only be allowed to sell capacity to • existing service providers. The DTI slates that it has simply advised the MEA on• several occasions that the MEA would more easily obtain consent for its proposals if • they were approached in stages rather than attempting them in full immediately. Exploitation of fibre-optic cables 14.16 We are informed that this project has developed into two sub-projects: - • Connectivity from Douglas to Manchester (a major telecommunications hub). via the sub-sea fibre optic cables by lighting the sub-sea cables and arranging the necessary contracts to provide links tram Bispham (UK entry point) to ManChester; and • • Enabling the MEA fibre-optic cables on the Isle of Man for high speed data transmission purposes. 14.17 - We are informed that the complete network to undertake the above has been designed, tenders issued and evaluated. Fully resilient fibre-optic networks have been designed taking data to/from the UK and across the Isle of Man. Suppliers have been selected and orders can be placed once DTI consent is received. It is anticipated that it would take nine to ten months for the service to - become operational. , • 1 July 2005 Skyward 749 Manx Electricity Authority PKF Power-line communication ("PLC") technology 14.18 PLC technology provides broadband internet communications from any electric plug via a special modern. Visits to utility companies and suppliers of PLC equipment have been undertaken to research the technology and the preparatory technical work and initial network design has been completed. .14.19 In order to test the technology, Skyward has performed various measurements and tests on specific segments of the MEA electrical network, including characterisation of the MEA electricity network with reference to 'PLC. Workshop models have been built to demonstrate custom design aspects. 14.20 Skyward has PLC enabled the MEA Ballacottier Headquarters and is in the process of enabling two buildings in Douglas with Domicilium (using their telecommunications licence) to test the technology. We are informed that Skyward is technically ready to perform customer trials, although these cannot proceed until DTI consent is received and a licence is issued by the Communications Commission'. Skyward staff have been trained to perform installation, maintenance and commissioning of equipment in homes. Skyward has filed patent applications for signal injection and extraction methods as well as repeater couplers developed for this technology. Satellite communications 14.21 The MEA has commissioned a study with a large US corporation ("the US Corporation") for the purpose of evaluating the possibility of building a new teleport (geostationary orbit satellite communications dish) on a MEA site. There is an existing teleport on the Isle of Man (owned by Manx Telecom). However, this is now in a state of disrepair and we understand that it has not operated for approximately 17 years and that it' is more cost efficient to build a new one. 9 Unless the MEA was to act under the licence of an existing ISP provider whose licence affords them such permission. 1 July 2005 Skyward 150 Manx Electricity Authority PKF "14.22 The study is now complete and we understand that it: • provides sufficient information to make the necessary teleport site selection; provides a 'Concept of Operations' which includes a breakdown of the major teleport components, maintenance and recommendations for implementation; • provides an 'Architectural Design' which covers network, hardware and software approachet, data storage applications and specific design information; • includes a brief discussion on services that could tie provided to customers; • provides approximate costings for the various stages of construction and implementation; and • provides a five year revenue forecast. 14,23 The new teleport could be utilised to bring in or take out additional data traffic through the sub-sea.' fibre optic cables to/from the teleport and transmit this data to/from geostationary satellites as an alternative to an existing teleport in London which is o ierused and expensive. Tenders to quote for the construction of the Teleport have been prepared. 14.24 The potential for using the Isle of Man as a Storage Area Network (in essence a disaster recovery site) has also been investigated. Acquisition of Manx Telecom 14.25 The possibility of acquiring Manx Telecom ("MT") was first raised by the Chief Executive at a Skyward Committee meeting in July 2003. He was subsequently authorised to ,approach m rn02 •••• (parent company of MT) and to set up an acquisition team (comprising himself, Dr Retief and.Mr Wilcox) and a strategic think-tank (comprising Ms Cackett, Mr Shallcross and Mr Spencery to support the acquisition team. • 14.25) The, Skyward.•Comrttee minutes ,of. 22 August 204 state - that7Mr:rMecallion , and -The-..Ch EkecutiVe- apprOach&Ithe Chief Minister, Treasury Minister" a. DTI Minister ("the Miriisters"):fd inform them of their plans and that all ministers expressed theiF.-4:111.-support for,the -propqial) We are informed by the DTI that the Ministers consented to the MEA,...having- confidential-discussions with mm02 to determine whether and- under what conditionsme the y may have been prepared to sell. • I If MT was not acquired, Skyward Could compete-in its owis ribfit or alternatively via partnership-with the:likes Of Donticilium. 1.1 1 July 2005 Skyward 151 . 2-1 Manx Electricity Authority PKr 14.27 VThem` inutjs of 23 January 2004.state that acquisition.of MT would - avoid' the MEAlo:' obtain a telecommunications licence under the TelecommunicationtrACt.7.-1984 .,--(seefurthel . paragraph 14.68 below). In March. 2004 the.-Ministers-.. gave Ahe.MEA- cautious apptovalito approach mm02 to understand the circumstances under which MT ma be, sOld -anIllhe possible purchase price, as recorded in a letter frorri - the.Chief 1‘.4inister:to-1he-MEA-Chairman.!' . In May 2004 mm02 advised the MEA in correspondence that MT was not for sale:although this position -. $ may be reviewed if a significant premium was to be offered. ,„ bTLiia-igon meetings: and DTI involvemeht-in the Skyward project " i • 14.28 Ehe :.MEA and ,the DTI -have „held approximately quarterly liaison meetings.,from .19961 These meetings were initially' part of the officer / politician -par-dineter setting procedures but became purely for liaison purposes from 2001/2002. There have also been a number of ad-hoc, informal 'lmeeting pericid•to discuss specific issues. 14.29 The main points arising from these meetings :(both liaison and ad-hoc) were as follows: 8 November 2002 — Following from the decision of the Treasury not to allow the DTI to light•, the fibre-optic cable the possibility of returning the cable to MCC was discussed, as was the practicality of the MEA or a subsidiary company operating the cable commercially. It was noted that the DTI was making changes to the draft Gas Supply Bill to enable the MEA to operate as a telecommunications provider; • 11 March 2003 — The DTI was informed that Skyward was operating as a division of the mEA'''.'"! • . • 5. and provided with an outline of the potential benefits of 'lighting' the fibre-optic cable and of satellite communications; • 13 June 2003 — The DTI was informed of the potential refurbishment costs of the existing teleport site at Tromode and the outline timetable for the set-up and development of Skyward; • 10 September 2003 — The Chief Executive agreed to proVide an .up to date financial summary for the power station project! We note that this was provided to thepTI —O-n441 Oc- tatiej720031p47:Only- :dealt. with the power station contract cost . andingt,ancillarKikirgl Discussions were held around the issue of 1Mansat/Manstar Isee — further paragraph 14.57 .. I below) and the possible utilisation of the fibre-optic sub-sea cables to provide b6siness to the company. The Chief Executive noted that the MEA believed it could provide the infrastructure ' for the proposals at a better rate than Mansat; • 14 November 2003 The Chief Executive noted a few ideas that he had with regards to the future telecommunications usage of the fibre-optic cable; • 12 January 2004 — The DTI made clear to the Chief Executive that it had yet to receive a business case for the provision of telecommunications services and that their aspirations . should be scaled down to only 'lighting' the cable; July 2005 Skyward • 152': Manx Electricity Authority PKF • 18 March 2004 — The Chief Executive stated that the final power station contract cost was £80 million with an additional £11 million cost to the MEA for staffing etc. This was after netting the potential performance bond recovery from JP Morgan Chase in relation to the Nepco contract, ie. a gross cost of £90 million, which equates to total costs on.the power station (including site and system works and operating 'arid' commissioning costs) of £129 million (section 9 ("Review of contractual relationships")). In September 2003 the MEA had stated to the DTI that expenditure to date was £90.4 million against a "£88m budget". It is unclear to what this figure of £88 million relates. Possible usage of the fibre-optic cable for on-off island telecommunications was discussed. The DTI noted that it was waiting for "a 'real' business case" before it could comment further . which was noted by the Chief : Executive. The US Corporation's proposals for a teleport on the • Island, Mansat/Manstar and the proposed acquisition of Manx Telecom were also &cussed; • 4 October 2004 — The Chief Executive noted that both GT set combustors had been replaced • in the power station under guarantee and that the main problems related to software.' Discussions were held around the paper the DTI had produced for the Council of Ministers in relation to the fibre-optic cable. The Chief Executive stressed that the . issUe of telecommunications was a real issue for himself and the MEA Board; •••, • 19 January 2005 - Discussions were held in respect of the surrender or assignment of the lease for the sub-sea fibre-optic cables from the DTI to Skyward Limited. The DTI questioned whether the lease could be so assigned as it had been incorporated without DTI consent and was in breach of the GEA 2003. Chris Corlett of the DTI noted that the GOS Consulting report (paragraph 14.13 above) concluded that there is merit in pursuing the concept of lighting the fibre-optic cable subject to .the MEA providing further information in relation to customers and cash flows. Mr Corlett also noted that given the review of the MEA, it was unlikely that Treasury would support the • approval of the MEA's telecommunications proposals but that should not delay further analysis to answer the points raised in the report. i4.30. The minutes of the liaison meetings suggest that the DTI and the MEA discussed the possibility of allowing the MEA to seek Treasury approval for lighting' the fibre-optiC cable after the DTI failed to gain approval. This resulted in the MOU to terminate the fibre-optic cable lease (paragraph 14.3 • . above). The DTI states that it did not directly request the MEA to investigate the commercial -4 - applications of the fibre-optic cable. The MEA does not agree with this view. 1 Jufy 2005 Skyward 153 • Manx Electricity Authority PKF • .. 14.31 To.:± DTI employee, Dave-Morter, was in regular contact with' Dr -andRetie his.tearn of consultants to gii■e advice.based•on the 'DTI's own business Cen...There is significant disagreement between the * , --....."...... „ --..- - ..--. ...,, ... / . MEA and Mr Morter over the extent of his involvement in the Skyward . project. The MEA considers that through the regular contact between Mr Morter and Dr Retief the DTI were fully informed (and . r thereby gave ongoing consent) as to the development work being, undertaken on the Skyward 7P ' .\ project including the setting up of the two subsidiary Skyward companies (paragraph 14.61 below). . Mr Morter's view of this was that his contact with the MEA was principally by telephone, though some meetings were held with Dr Retief at Heywood House when specific information was ' •• requested and available on file, and restricted to matters that had previously been included in the ' DTI's business plan. Both parties agree that the MEA did not inform the DTI of the actual expenditure on the Skyward project and, in the opinion of both the MEA and DTI, was not under any obligation to do so. . - 14.32 (Th'e-,r;iriutes -orthe -Meetings suggest that the DT1-was aware frorn early 2003 that thel Ul...--ywirCiliii-Ojecib-eirig- Undertaken by the MEA and also of possiblefuture commercial applications of the fibre-optic cable, PLC technology and the teleport project. We are informed by the DTI that it did not receive or approve any budgets, nor did it receive any financial information • relating to actual expenditure for the Skyward project. 14.33 The minutes of the liaison meetings also suggest that the DTI, under instruction from the Council of Ministers, requested the MEA to produce a 'real' business case in March 2004. This resulted in the production of the Vision 2010 document (paragraph 14.8 above). In January 2005 the DTI noted that the MEA should not delay in providing a response to the points raised in the GOS Consulting report on the MEA telecommunications business case forming part of the Vision 2010 document. This resulted in the production of the current business case in March 2005 which is being reviewed by the DTI (paragraph 14.13 above). 4 1 July 2005 Skyward 154 Manx Electricity Authority PKF • • Skyward Committee expenditure 14.34 In July 2003 Mr Wilcox presented a budget for Skyward expenditure to the Skyward Committee. This was increased by ,20% to cover any contingencies. Total budgeted expenditure to March '2004 was £1.5 million. The budget was to be controlled by Dr Retief, following the standard MEA - rules of monetary authorisation limits. All expenditure above £5,000 was to be authorised by the Director of Corporate Services as well as the Chief Executive. Actual Skyward expenditure to the end of January 2005 has been £1.7 million, analysed as follows: Period to 10 months to 31 March 2004 31 January 2005 Total £000 £000 £000 Direct staffing 395 317 712 Indirect staffing 104 57 161 Administration costs 515 111 626 Establishment costs 30 81 111 Capital expenditure 11 71 • 82 Repairs and maintenance 8 - • 8 637 -"` 1,700• 11. " r 1 July 2005 Skyward 155 Manx Electricity Authority PKF Direct staffing 14.35 Direct staffing costs of £712,000 are analysed as follows: Total to 31 Jan 2005 E000 £000 Basic pay Skyward Committee: J McCallion (Chairman) 1 48 M Proffitt (Managing Director) 1 103 G Wilcox (Finance Director) 1 79 C Spencer (Non-executive director)' 40 • C-J -Retief (Commercial .Director) - 282 I Cackett (Non-executive=director) 3 31 E Shallcross (Non-executive director) D North (Non-executive director) 4 2 MEA employees: D Nel (Electrical and electronic engineer) 5 33 618 Employers national insurance. 48 Other costs and overheads 46 712 1 Represents remuneration for 19 months 2 Paid via the MEA. Refer to paragraph 14.37 3 Represents remuneration for 15 months 4 Represents remuneration for 3 months 5 Paid via the MEA. Refer to paragraph 14.40 Skywards Committee remuneration 14.36 The basic pay of Messrs McCallion, Proffitt, Wilcox and Spencer above is at rates set by reference to the Hanson Green recommendations approved by the MCC Board (paragraph 14.4 above) from July 2003 to January 2005 inclusive. a. 1 July 2005 Skyward 156 Manx Electricity Authority PKF 14.37 The Dr Relief's starting salary in May 2003 was £100,000 per annum, increased to £103,500 from 1 April 2004. He was also entitled to a relocation allowance of £60,000 on joining the MEA and receives an annual discretionary performance bonus (set by Mr Proffitt and approved by the Remuneration Committee). Prior to May 2003 Dr Retief was working for the MEA as a consultant on an hourly rate during which time he travelled extensively to the United States. We are informed that by the time he submitted invoices to the MEA he was an employee and so the invoices were paid through the payroll. Therefore his total remuneration of £315,000 is analysed as follows: Total to 31 Jan 2005 £000 11 months' salary @ £100,000 p.a. (May 03 to Mar 04) 92 10 months' salary @ 103,500 p.a. (Apr 04 to Jan 05) 86 . • Relocation allowance 60 • Performance bonus (March 04) 20 Invoices / expenses 24 282 '14.38 Ms Cackett was a non-executive director of the Skyward Committee from July 2003 to September 2004 (15 months) at the Hanson Green recommended remuneration of £25,000 per annum. She was replaced by Mr North from November 2004. Mr North has agreed to be paid £10,000 per ie annum for his services. 14.39, The amounts paid to the Chief Executive and Mr Wilcox are in addition to their salaries as full-time employees of the MEA. MEA employees 14.40 Mr Nei was an MEA employee until 6 May 2005. His total salary was £26,000. He has a degree in electrical engineering and was recruited to add value to all Skyward projects. 1 July 2005 - Skyward 157 Manx Electricity Authority PKF Indirect staffing 14.41 Indirect staffing costs of £161,000 are analysed as follows: Total to 31 Jan 2005 • f000 Directors fees 39 Off-island travel and accommodation (MEA) 74 Out of pocket expenses . 14 Training and education 9 Recruitment and relocation 24 Other 1 161 Director's fees 14.42 Director's fees relates to Eddie Shallcross, a non-executive director of the Skyward Committee. He invoices through RSE Consultants and therefore his remuneration is categorised as indirect staffing rather than direct staffing. His total remuneration to date of £39,583 relates to 19 months' fees from July 2003 to January 2005 at the Hanson Green recommended level of £25,000 per annum. Off-island travel and accommodation 14.43 Off-island travel and accommodation largely relates to Dr Retief / Mr Net and Fiberbridge Communications ("Fiberbridge") (see further paragraph 14.50 below). Dr Retief and Mr Nel have undertaken several fact-finding visits to utility companies worldwide who have experience of PLC and visits to chipset and modem manufacturers which transfer broadband signals onto the electrical power networks. They evaluated 25 manufacturers, from which a shortlist of seven was drawn up, who were asked to produce tenders. We are informed that Mr Nel is continuing to visit the manufacturers to make a final decision between DS2 (based in Valencia, Spain), Toyacom (Madrid, Spain), Mitsubishi (Madrid) and Schneider Electric (Grenoble, France). 14.44 In addition, trips have been made to negotiate with the likes of Telewest, BT and Cable & Wireless to take and bring broadband traffic from Bispham to Manchester and/or London. Dr Retief has also been invited to speak on PLC technology at international conferences in South Africa, France, Spain and the USA. Mr Nel or a member of the MEA Network Services division usually accompanies Dr Retief. MEA staff have also attended telecommunications conferences. 1 July 2005 Skyward 158 Mani Electricity Authority PKF 14.45 Dr Relief has also visited the US Corporation on several occasions to discuss the design of the teleport and the utilisation of the Isle of Man as a SAN (Storage Area Network). Dr Retief visited T-Mobile and other telecommunications providers to discuss the possibility of a partnership with Skyward. Dr Retief has a MEA company credit card which he uses f orl out of pocket expenses, travel expenses and entertainment of clients. Out of pocket expenses 14.46 Out of pocket expenses relate largely to Raj Balendran (a Fiberbridge consultant who was retained in his own capacity as a consultant after the arrangements with Fibe irbridge terminated) and to meal costs. Training and education 14.47 Training and education relates to a CISCO Systems train ng course to develop telecommunications knoWledge and expertise. Recruitment and relocation 14.48 Recruitment and relocation costs comprise £10,000 for Dr . Retief which have been ,repaid but which we are informed have been posted to the MEA nominal ledger in error. In addition; £14,000 was spent on renting three flats for the Fiberbridge consultants for six Months (the duration of the Fiberbridge agreement). 1 July 2005 Skyward 159 Manx Electricity Authority PKF Ad ministration costs -14.49 Administration costs of £626,000 are analysed as follows: Total to 31 Jan 2005 £000 £000 Consultancy fees Fiberbridge 287 The US Corporation 73 ie 'Kish Telecoms Consulting 48 DS2 12 Other 421 Legal and professional Herbert Smith 109 Deloitte & Touche 15 Other 1 125 TraVel and accommodation (non-MEA) 66 Hospitality and entertainment 14 626 Consultancy fees 14.50 The MEA signed a contract with Fiberbridge in July 2003 for the peOod 1 May 2003 to 31 October 2003. The CEO of Fiberbridge is James Valle. The scope was to assist with the development of the MEA's potential telecommunications business. The MEA- did not. haVe sufficient in-house knowledge of the telecommunications industry and marketplace and therefore used Fiberbridge to share both technical expertise and industry awareness / contacts. We are informed that the DTI was aware that Fiberbridge had been retained by the MEA but was not aware of the costs involved. 4 1 July 2005 Skyward 160 -" • Manx Electricity. Authority f PKF . 14.51 In addition to Mr Valle, the following consultants were also to work on the Skyward project for the three months to September 2003: • David Martin (US based consultant working on linking the sub-sea fibre optic cables at Bispham to the UK broadband traffic hubs in Manchester and/or London); • Raj Balendran (UK based telecoms transmission engineer specialising in fibre-optic networks. Mr Balendran • worked on the design, management and maintenance of the fibre-optic networks and connections and was retained as Kish Telecoms Consulting after the contract with Fiberbridge terminated); Sheer Machanda (PLC network specialist whose contract . was terminated at the end of August 2003 and was replaced by Dian Nel); Derek Foxwell (a retired ex-BT high-level network expert; available should his expertise be needed); and • Rod Seville (a UK based consultant who conducted market research on telecommunications services in the Isle of Man). 14.52 In total the MEA paid Fiberbridge some £261,000 for services under the consultancy contract and £26,000 in respect of travel, subsistence and entertainment expenses (taking into account. ' I ":!. 0 • . exchange differences). • r 14.53 The US Corporation were paid for the design of the new teleport and also for sales and marketing efforts. The MEA entered into a "teaming" agreement with the US Corporation to market and sell the new teleport to US customers. We understand the US Corporation has produced a report on ' :the teleport design, site location, potential customer base and revenue forecast.. 14.54 Kish Telecoms Consulting is the personal service company of Mr Balendran. He was retained by •i°• the MEA at a cost of £8,000 per month for six months. 14.55 DS2 are a chipset manufacturer (paragraph 14.43 above). DS2 produced a report on network characterisation which determined that the MEA electrical network was suitable for PLC . 4 ' 4. .. . 4, technology. Legal and professional 14.56 Herbert Smith have advised on the drafting of agreements with TeleWest for providing broadband connectivity from Bispham to UK hubs, the US Corporation "teaming" agreement, service agreer'nents between MEA and Skyward to ensure there is no cross-subsidisation and have also 4 " provided advice on telecommunications licence applications. We are informed that various agreements are in draft.form but remain unsigned pending DTI consent. • July 2005 Skyward 161 „ Manx Electricity Authority PKF • 14.57 We are informed that Deloitte & Touche conducted due diligence on the potential acquisition of ManStar and interviewed ManStar, the US Corporation and Manx Telecom. ManStar had an existing teaming agreement with the US Corporation which was due to expire in respect of building a new teleport on the Isle of Man. We are informed that the issue oracquiring ManStar was raised in September 2003 by ManStar and that the due diligence investigation concluded that such an • acquisition would add limited value. The MEA did not proceed with the acquisition of ManStar and k. entered into their own teaming agreement with the US Corporation. Travel and accommodation (non-MEA) 14.58 This largely relates to Fiberbridge, Mr Valle and Mr Balendran. Establishment costs 14.59 Establishment costs of £111,000 are principally for computer equipment and related costs. Capital expenditure 14,60 Capital expenditure of £82,000 principally relates to PLC test enabling. These costs are recharges from MEA for the civil and other work necessary on the MEA electrical network to enable the PLC . r. technology to be tested. Legal status of the MEA's telecommunications activities Subsidiary companies 14.61 The MEA has incorporated two subsidiary companies for the purpose : of carrying out telecommunication activities. These are Skywards Telecommunications Limited and Skyward Limited. rSkywarcig-Teleabhimunicaliets) 14.62 Skywards Telecommunications Limited ("Skywards Telecoms") was;incorporated in the UK as a shell company on 15 January 2003. Its shares were held by Peregrine Secretarial Services and .... transferred to the MEA on 15 November 2004. Its directors are Messrs Proffitt and Wilcox and it is a wholly owned subsidiary of the MEA. It has not traded since incorporation and filed dormant accounts with UK Companies House for the period to 14 July 2004. 14.63 At the time of Skywards Telecoms' incorporation, the relevant legislation governing the activities of the MEA was. the Statutory Boards Act 1987 (as amended) ("SBA 1987") and the Electricity Act 1996 (as amended) .("EA 1996"). Neither the SBA 1987 or EA 1996 cover the issue of the incorporation of subsidiary companies by the MEA. However, the shares in Skywards Telecoms were transferred to the MEA in November 2004 when the Gas and Electricity Act 2003 was in force (paragraph 14.65 below). 1 July 2005 Skyward 162 Manx Electricity Authority PKF . Skyward Limited • <. 14.64 Skyward Limited ("Skyward (IOM)") was incorporated in the Isle of Man on 12 August 2004. Its directors are the members of the Skyward Committee. It has not traded since incorporation, althoUgh board meetings have been held since 20 August 2004. It is minuted in the first meeting of the Skyward Committee that Skyward (IOM) (at that time planned to be called Skyward Telecommunications Limited) would be incorporated as a company-totally independent of the MEA once the proposed GEA 2003 received royal assent, to develop the ten fibre-optic cables available 3 for telecoms purposes. 14.65 The GEA 2003 was passed on 22 October 2003 to enable the MEA to supply gas, provide telecommunications services and export electricity and to make further provision as-to the MEA's finances. Section 6(2) of the GEA 2003 states that the following should be inserted after section 3 of the EA 1996 as section 3C(1): "The Authority may, with the consent of the Department [DTIJ, for the purpose of carrying on the whole or any part of any of the undertakings referred to in section 3A(1) • (a) subscribe for or acquire any. securities of a company or other body corporate, (b) promote the formation of a company, or (c) participate in the promotion of a company." 14..66 . One of the undertakings referred to in section 3A(1) of the revised EA 1996 is the provision of telecommunication services. Telecommunications services are as defined in the Telecommunications Act 1984 ("TA 19841 1° . The TA 1984 defines telecommunications services as including services consisting in the conveyance by telecommunications system of speech, music,•sounds, visual images, signals other than in sound or visual form or signals serving for the actuation or control of machinery or apparatus. The provision of broadband internet through the fibre-optic cables would appear to fall within the definition of telecommbnications services. ••• 14.67 C711.71Era37e7-that,..the. consent-of the,DTI was not sought pricirto inccirporation of .Skyward,..1 (lOM) but thattheTompany was set - up in anticipation of reCeiVinTsubsequent co----nserin•The GEA - • 2003 does not state how formal consent should be given, nor whether consent can be provided retrospectively. The DTI's view is that formal consent would be given under the authority of the Minister for Trade and Industry and that under the legislation there is no provision for retrospective consent. . 10 Section 4(3) of the GEA 2003 1 July 2005 • Skyward 163 Manx Electricity Authority PKF Telecommunications activities 14.68 The legislation gdverning the MEA's te lecommunications activities is the GEA 2003. The GEA 2003 states at section 4(1) that: The Authority may — (a) with the consent of the Department [DTI], provide telecommunications services, and (b) for that purpose install, repair, maintain or remove telecommunications apparatus." 14.69 Section 4(2) of the GEA 2003 states that: "Nothing in this section affects the Telecommunications Act 1984." 14.70 Telecommunications. services as defined by the TA 1984 are referred to at paragraph 14.66 above. Section 3(1) of the TA 1984 makes it an offence for anyone to run a telecommunications system unless authorised by a licence provided by the Communications Commission (a statutory board of the Isle of Man Government). 14.71 The need for DTI consent under _the GEA 2003 is obviated by the fact that the MEA would not appear to be providing any telecommunications service to third parties. 14.72 The MEA's activities- that could fall under the definition of telecOmmunications systems are the . PLC test enabling at the MEA headquarters in Ballacottier (paragraph 14.20 above) and the sending of signals across two of the fibre-optic cables from the Isle of Man to Bispham, UK for telemetry purposes in monitoring the electricity interconnector. The fibre-optic cables to be used for transmission of broadband internet and other traffic are at present inactive. 14.73 However, in the case of a business, sections 3 and 4 of the TA 1984 exempt the need for a licence from the Communications Commission on the conditions that: • Nobody apart from the person running the business is concerned in the control of the system; • No service is rendered to a third party; • Sounds or visual images or similar signals conveyed are' only for the use of the person carrying on the business or the business' employees; and ' • Signals for the actuation or control of machinery or apparatus are only for such machinery or . apparatus used in the course of business. 1 July 2005 Skyward 164 Manx Electricity Authority PKF 14.74 The MEA considers that the PLC test enabling falls within the exemption granted by the TA 1984 as the MEA are using the licence granted to Domicilium (an Island ISP) and are testing the PLC technology within the domain of the landlord and on an MEA owned infrastructure. Domicilium are providing the service. We have not verified the MEA's view with the Communications - Commission. • 1 July 2005 Skyward 165 • Manx Electricity Authority PKF Appendix 1 Scope of PKF engagement letter dated January 2005 May 2005 Appendix 1 REVIEW ON BF.LIALF OF THE ISLE OF MAN 'GOVERNMENT INTO THE RECENT AFFAIRS IFIL. AttNX ELECTRICITY AUTHORITY AND "SUBSIDIARY COMPANIES" Introduction The Isle ofNian Government wishes lo engilge the services of .a suitably qualified firm or agency to undertake review Urine all -airs 1)1- the Manx 17.1efaricity Authority (IviEA) and subsidiary corripanie.s, The team undertaking the rev ielry should he capable or produciniz an interim report wi 20 working days of accepting the brief and a full _report within 30 days_ Attached to the main report should be appendices dvailhig relevant correspondence Anil documents relating to loan transactions and legal opinions re furod to within lhe report.. A scope of work is set out below. However, should any issues arise that are considered by the ageriB appointed it, conduct this invc-stigation to be worthy of inclusion within the report..such items should be included. • Ii mai Lern arise that recitiire further investigation and review, such obSesiations 'should be disclosed and if nepeessary, revisited after p on or repori, . ..Scope of Work 1. Cash tow generation By reference ro the audited financial statements for previous years, the unaudited accounts for the ycar ending 31" March 2004 and the management aecourm rot the period endv..1 31 December 2004 make enquiries of management into, and report cm: analysis of cash inflows and outflows acrwi Group Lompkm ies including Mans Cable Company - LW, Skyward Ltd. and any other "subsidiary" companies..Comparison with profits; t •- capital expenditure and asset disposals: authorisation procedures including Treasury approvals; - detailed. .analysis of' all capitiil expenditure by project and reconciliation with published in formation: rriainten4nCe, Strater:sic kind discretionary e.npenclilitin:,. and - fixed asset disposals; ■ identification of cash floi:v .s used TO finatice discretionary, eictiv i ties; • capillA receipts and payments, including significant changes: in debt and equity and comparison with quarterly returns provided to Treasury; • current adherence to banking and statutory covenants.; • world rig cap i Lai manaw.ernent_ 2. Historical ISS els and liairiTitic.s, reference to the audited financial statements for previous !ycru-'6, the unaudited financial sulternen I s for the year cadcd 31 March 2,0U4 and the management accounts for the perirk ended 3 l December 204 make enquiries of management intO, and rep4-ra on, the following items: ■ fixed assets (including details of the c.:apillalisation and depreciation policies); • investments and goodwill; • cr.-a balances; bank and other interest hearing debt; • inter c4-rrnpany bulanects; • share capital and reserves (including asset replacernent reserve): • off balance l,e tliabilities:tnd contingent liabilities; • stocks and work in progress, track and other debtors, creditors and pensions: • _accounting pol ici es and 'compliance with Ci!itAl'. 3. Historical trading 0:r-fur-malice ray •rekruncc to the audited firianC.ial staters -mats for previous Years. the unaudited - financial Stutemni_Ai for the yearended 31 March 2004 and the management accounts for the ptriixt 4.-:ndc..d 31 December 2004•rnake enquirims olmana gement into, and report on: x". ;a' • a], analyis of trading income (includlng treatment of performance.•bond receipts and other relevant revenue:), groxs profit. operating profit and KFIl's with • comments on trends_ This analysis to be done by business unit (energy supply, energy exports and retail); • C:keeptibnallextTaotdinaiy items; an illustrative estimate of the underlying trading postilion hayed on 4441ju5iments for oT11-of and non recurring items and abnormal provision movernenoi; • trading beiween group companies; any hedging pr rOrward contracts incepted by the Authority; • ;0•:accounting policies and compliance with GA AF. 4. Prospects • • In respect of the•Company's management's projections for the year erta4c1.31 March 2005 .,and the year ended 31 March 2006 including prufils, cash flous, balance sheets and u-ssurniitions ("thy Projcetions")., Make .enqui ries of management into and comment on: • past forecasting accuracy With refercmce lo actual versus budget; bases of preparation of the pro jections, review of systems used for forec rtAing: • compilation of the projections on the of the assumptions and compliance . with CIA AP; the limes shown in the projections and the underlying 2S.SUrripairn F.c0:.-ing to identify any that appear to be materially unrealistic: the hea.drooth proi,ided- by banking facilities and the impact of banking and statutory covenants for the period coverecl by the projections., the ability ;117. Meet interest and capital C4rn-LMiLmenL-5 going forward; - other borrowing faci l iii es, imlnd in g,klit,ts of credit and guarantees;' • Illustrative semi.iti vit.!: -analysis addressing the key forecast identified as a rmlt of discussions with Treasury and MEA management and any siynilieani potential upsides which come to your atl eniion and which are nor - •- disclosed in the nrqiectiom. 5, Cuintrueleralinimmereial Review contrae in. re:.-;pecl or Pu.lrose Power Station; • Review contract for construction and onzoing Fie and supply arrangements in respect_ of as pipeline with 'Fiord Gu.s iiirean and any other applicable parties; • Review aareementin,respeet of purchase orNutional Grid :shareholding re Manx Cable Company T,,imiLed; Review any other significant partnership arrangements/dependencies, • Review the ongoing working capital requirements for both contrauted and (=- contracted. expenditure, 6. Other • Review and coma-nem. upon the effectiveness of financial reporting procedirre,5 including the itigh level control environment (review and anillemr2e (if hudgeLs, external and internal audit), financial nueourning procedures and management rcporling framework; • Review of Board :minutes to understand decision rnak•ing procezlures around capital expcndi.luru, long Lerm loan and other debt, arrangements in respect of Government proceduro; • • Review and Ctittliiller11 upon the delegation of authority by ithe Board to .senior manager-neat and Ongoing monitoring of such delogatcd powets.: • Liaison with the external auditors, KPNICi. to ensure access to findings of audit work urAkrtaktm to chk, inelutlink all legal opinions obtained by the MEA: larclays flank; • Liaisoon with Barclays Bank to assess mariner in which borrowings and future funding strategies were negotiated; • Review of u-ansactions in respect of telecommunications activities to establish whether i'VlEA. and/or "subsidiary companies" WcEC acting within current • - Review of transactions involving MEA and MCC: with regard to responsibilities of Board Members and Directors in relation to requirements of Companies Acts and other relevant hie of Man legislation; r - • Recommendations in reipeet of appointments of key senior cxectitives and .Flour 41 positions_ Manx Electricity Authority PKr. Appendix 2 Board response to PKF questions 4 z „ May 2005 Appendix 2 4. IF _ MANX ELECTRICITY AUT1710RITY - Lught-reill LectraghyS manninagl-; PO Box 177 . Douglas . Isle of Man . 1M99 IPS Tel 101 624) 687798 • Fox )01624) 68763 Corporate Governance 1. Could you provide an overview of the corporate governance role of the Board and the process by which it monitors the performance/activities of thq,IEA and its subsidiaries? The current Board was appointed in January 1997, and at the request of the Department of Trade , • Industry was charged with addressing Government concerns about the adequacy of strategic planning for future supplies of electricity. It can he seen from they Mertz & McLellan report into the Scottish Power Bid in 1991 that MEA were forecasting load growth of 1 to 1.5 Megawatts per year. In 1991 the system load was 56 Megawatts and the forecast was that by 2014 the load would be 82 Megawatts. In fact we reached that load of 82 Megawatts by 2002 which is some twelve years alicad.of the original forecast. This radical change was brought about by the economic strategy adopted by the Government; the success of which has achieved a huge improvement in the economic wellbeing of the Island. The impact of this on the MEA was a dramatic increase in power demand that required a commensurate response from the Board to ensure this increasein :p-Osperity was not jeopordised by an inability to provide supplies of electricity and to ensure compliance with the Electricity. Act. The following graphs show the growth demand plan' of the early 90's linked to what has actually been delivered. Pace I of 42 Units Sent Out GVVh 450 400 - 350 300 Actual 250 - 91 Forecast 200 1990 1992 1994 1998 1998 2000 2002 2004 Year Power Demand I ■ • 1 1990 1992 1994 1996 1998 2000 2002 2004 Year - . Each member of the nevi Board was appointed because of their proven commercial experience and strengths within .industry. The new Board very quickly picked up the issues that were of concern, the most serious being the lack of generation capacity to meet the rapidly increasing. commercial and industrial demand - on a number of occasions we were perilously close to a "lights out" situation. Other areas of concern were the lack of an internal audit department, weak, 'corporate governance and no management succession planning, all of which arc fundamental to - any business. All these issues have been successfully addressed. " The sirnple solution with regards to capacity would have been to put two AC subsea electricity - cables to the UK — this was turned down by Government as they were adamant we retained generating capacity and remained independent of outside control. A second option was to build a new, ereen-field site power station because the then current Pulrose Power Station had sonic serious environmental issues for the surrounding population. Unfortunately, we know that to obtain planning permission for the new green field site facility could have taken many years (egf Page 2 of 42 New Prison — 10 years, Incineratbr — 20 years) which was out of the question. It was therefore decided to build a new facility on the existing site with the declared policy of making it both environmentally acceptable and a state of the art facility, complementing the neighbouring National Sports Centre, and at the same time linking into the existing MEA high voltage circuit and the subsea cable link into the National Grid to provide a safe and secure supply of electricity to the Island. At this stage Mike Proffitt an ex isting Board Membei l was appointed Acting Chief Executive and -"aereed to • oversee the project management because of previous project manaeement expertise. To do this the Board felt he should resign his Board position and consequently be answerable to the Board for all Executive rationale: • The Board sought a commitment from Mr Proffitt to successfully implement the laid down 5 year plan. it was at this stage that we were approached by Government to study the feasibility of bringing Natural gas to the Island Which was a previously aborted prOject of Government. 1 On Mr Proffitt's, appointnientlhe:•developed a very close working; relationship with both the Department of Trade and Industry and the then Chief Executive of the Treasury (Mr Cashen) for 3 years and they jointly with Clive Wilcox, Director of MEA Corporate Services negotiated the Bond with the .clear understanding that at some future date it would be tapped for additional funds. During the course of the ongoing development the Board have seized the commercial opportunities which became available to the MEA in both securing a continuity of supply and at the same time broadening the revenue opportunities which is in keeping with many utility companies within the UK and Europe. In addition to the specific references to the Corporate Governance of MEA listed below there is of course the separate statutory involvement in the Governance of the MEA botliof the Treasury and DTI as set out in the Electricity Act 1996. Corporate GoVernance of the MEA at all areas is covered by very many tlocuments(about 1,000) and a sample of which is provided herewith numbers TED 001, 002, 003, 004. 005.it is important to emphasise that Corporate Governance is considered to affect every employee of the MEA and •.* every customer for which there is responsibility. • I Pane 3 of 42 During the construction of the Power Station and Gas Pipeline, MEA have ! implemented a large number of Health, Safety & Environment procedures which in themselves are new to the Isle of Man. This emphasis on Health & Safety has enabled MEA to be awarded i4 Stars following the British Health and Safety Council Audit, and enabled the MEA to cascade a strong Health and Safety culture to sub contractors to the benefit of the wider Manx construction industry. As part of MEA's commitment to its staff and their development MEA have taken part in the investors in People Initiative and have received formal accreditation. See Appendix 1 Board Members Profile See Appendix 2 MEA Corporate Governance See Appendix 3 - MEA Subsidiaries Corporate Governance See Appendix 4 Board Delegation of Responsibility Sec Appendix 5 TLD 001 - TLD 005 1 Capital 'Projects 2. How. firm did you think that the capital estimates supplied to the Treasury/DTI to support • the £185 million bond issue were? It goes without saying that the Isle of Man is an Island and all conventional energy has to be • brought 'here one way or another. The harbours are restrictive to operate large tankers ' to economically deliver the heavy fuel oil that had been the traditional energy source for the • .separate .diesel engine power stations at Douglas and Peel. Today's energy demands would require • a sea-tanker delivery per week. A potential tanker disaster %vas therefore a •further, consideration with the appalling pollution and environmental catastrophe that could follow. • By 1998 there was a real likelihood that if a radical solution was not implemented quickly the lights would start going out over the Isle of Man. The MEA does not have the luxury of the Water Authority to ask for planning permissions to be turned down because they can not supply the water; by statute we have to supply what electrical power is demanded. The constitution of - • the MEA was changed by the Electricity Act 3996 and a new entrepreneurial Board appointed charged with safeguarding the future electrical supply for the Isle of Man. The Isle of Man Government wished the Isle of Man to be self sufficient in electrical power generation so it could never be held to ransom by political or commercial counter forces. l'aize 4 of 42 The new MEA Board therefore decided to: I. Bring a cable from the UK and link into the UK power grid providing fuel diversity, i commercial energy trading opportunities as well as increased capacity. 2. Bring gas to the Island to run the new power station — achieving fuel diversity and major environmental benefits. 3. As there were no obvious green field sites available to build a new power station and the likelihood of impossible planning permission- delays, the existing Douglas power station had to be rebuilt to the high standard necessary for a town site, using the existing Grandfather rights for planning purposes. The 20 year planning process for the Incinerator begs comparing. 4. Install dual fuel gas turbines to enable a strategic reserve of fuel oil to be kept on the Island in case of short tent restriction in the supply of gas. The high cost of diesel generation from obsolete technology and the escalating cost or ruel oils together with the problems of getting it to the island, when set against the cost of natural gas and the advantages of the latest technology from the aircraft industry showed that the whole project • was viable and indeed, essential for the Island. • With an average of 3 1/2-4% growth, but with growth in double figures in one year during the 1 . planning stages, the future power station had to be considerably larger than that necessary to just meet the present demands. With economics of scale working to Our advantage in the future the extra capital costs were easily funded in the medium and long terms. We would not have saved any money by trying to establish costs in minute detail for engineering projects that had never been undertaken before. Indicative costs showed the whole necessary project was viable. We mitigated the risk by taking on partners who guaranteed to- make their sections of the project work. Even when working with one of the largest company in the World we insisted on a Bank Guarantee. We were correct in our foresight; the Enron business worldwide collapsed. Of the numerous projects Enron had in Europe only the Isle of Man power station has been completed through the MEA taking Over and completing the work themselves via a subsidiary company, POT Ltd. The several capital projects necessary for the MEA to provide a new power station, with a completely new fuel supply chain and integrate them into the' existing MEA live systems' required an enormous engineering design, procurement and construction effort. If all was to be Page 5 of 42 achieved then a large working capital was necessary before a fully worked up specification could be prepared. There were sienificant engineering issues that had to be addressed if the Whole - was to work in a coherent and secure manner. This engineering design effort was far greater than an 851v1W power station might at first glance demand. Firm costs could not be ..allocated until the design was finalised. The 185m bond was always perceived as a large but not the total proportion of the funding that would be required,. as solutions to the various aspects of the different projects were found, and a more complete•pieture of costs involved emereed. 3. Based on our review of the information supplied to the Board it was evident that capital projects were expected to significantly exceed budget at a relatively early stage. Who was responsible for monitoring this expenditure? The concept was not based on budget bia on by mitigating risk with business partnerships. The expenditure was monitored at many levels up to the full detailed reports reviewed by the Board _ on a. basis.; Capitalspendaswas also- reported to Tynwald':'ia'th-e Atirrual Report and on a _ . q uarte r -57:anand gift 1 basicasis's to the -TreaSUry. 4. • Who approved the various increases in expenditure? All the expenditures were approved by the Board. ,This was all part of the 'ongoing projects and the necessary resources were released, as required. ortino the.cost-overruns to -Tria.curv.corsidered?_. ILo212ere Was no cost overnth. The actual spend was determined by the scope of the work • defined during the detailed construction engineering review phase. Tith6e,A the • —capitarprojects N.,;as reported"-c1"-to- the Treasury by the quarterly- capital -spend reports7annuall • .-reports and:the auditcd 7.aCeounts submitted to the Treasury ,ancVjaid=rb-ZIO-re- . _ Tynwald each year: this is a practice that haS been place for many years. F On a previouS occasion in 2002 there was a serious disagreement between the Treasury and 'c.—MBA over compliance with- financial regulations and capital procedure notes. : . The Treasury' edthat their. content-kb-if about the applicability of_the;fireasuq_Act 1995 wiis -"A • Page 6 of 42 j • 6. What was the Board's view- of the need to obtain additional funding for the capital projects? The Board were and are still of the view that the funding for the final capital cost figure would be carried out at the end of the works when all of the actual costs were established. ThiS funding would be via a number of possible routes which include a further tap on the original bond, a sale and leaseback arrangement of the capital assets or the obtainment of long-term funds from the North American Market. Barclays Loan 7. What is the basis for the statement that the Board thought that Treasury approval for the loans had been obtained? Again, the Electricity Act is being misconstrued; the Board do not need Treasury approval, dilly _ consent.- At all times the Board considered they had the necessary Treasury consent. An analysis of'Paee 19 of 2001/02 Accounts show that the total group borrowine , rose front ...- f 13million in 2001 to 1218million in 2002-elt was clear to the4Treasury at ,that -time`that the) . ...... r...0,----- . . . group borrowing was in excess of f 1 85million. The Barclays funds were used to repay the ! 0 '"---...... —...... „_ cable borrowing at HSBC and as finance for further development: The Treasury would also be :, • e '4 ----.I°-""•"°"~"-•-k-----„-.....Per', .7.!!q---....e :veil'. aWarc of--the-extra orroving by virtue of the quarterly return- mfro theM EA .-to I-1-easury:i . • um- An exarninationof these forms would show clearly that funds werelbeialc:Tyed -iii-excess -Of7 1185million bond and the £36million used in respect of the cable. The course of dealing between the two organisations and the information sent every quarter ifroin.the , MEA:to the Treasury put the Board in no doubt that there was no objection whatever to these developments. The conduct of the Treasury clearly demonstrated both implied:acceptance_of the position and: estoppel. We also refer to the capital commitments figures on Page 32 of the 2001/02 accounts and Page 34 of the 2002/03 accounts. These total /89million and 135million respectively. Thus the Treasury knew of the extensive capital commitments at both dates. The Isle of Man public also knew of these capital commitments. At Pane 19 of the 2002/03 accounts, the Auditors report, it clearly states that the financial statements haVe been audited and properly prepared. It is notable that the Auditors report is addressed to both the MEA and The Treasury. The Treasury were clearly -well aware of these financial statements and their contents. In respect of a meeting between representatives of Government and the Board of the MEA on the 25 November 2004 ; it is clear that the Board of the MEA were treated very unfairly. An yt initial meeting between the then Chief Minister. the Treasury Minister and three members of the Pa.e of 42 MEA Board took place in the Chief Minister's Office. The Chief Minister 'then suggested that the meeting, move to another room. where unbeknown to the Board, the Chief Secretary,.. the Chief Financial Officer of the Treasury, the Financial Controller and the Attorney General were Waiting. The Board clearly had no knowledge of this ambush, and it had no legal representation or advice. At the meeting the unfair position that the delegation from the MEA was subject to. was recognised by the Attorney General who warned the Chief Minister that the line of questioning by the Treasury was unfair, in the absence of the Chief Exectitive Officer. It is clear that the Board strongly maintained that at all times they presumed they had Treasury• compliance and the required Treasury consent. It is scarcely surprising that the trust of the Board in the good faith of certain personnel in Government was seriously diminished. 8. Was Treasury approval discussed at. board meetings? , Approval wasn't discussed. Consent was discussed during the process of putting in place the. original Bond. which was a joint activity undertaken by the Treasury and IAEA. luring the process there was a road-show in London (presentation to Bankers and Financiers, etc.) where it was clearly understood that this Bond was an initial amount and a further tap would come later. The Board believed that their activities and the activities of the MBA clearly had the consent of Treasury for at no staue and at no time during receipt of the quarterly figures was any issue raised by the Treasury of any lack of consent. It was implicit to the Board that the Treasury was .., • .supportive"and was at one with them on the financial and technical developments. As the Board believed consent existed, and they clearly did, it was not a matter for discussion: Was legal advice obtained? The MEA paid for the Cairis legal opinion and a copy of the final draft of such opinion was sent to the MBA on email. In view of this there was no doubt whatsoever as to the validity of the loan. This seeking of a legal opinion by Barclays is a normal activity in their due diligence process. : N. What was the reason for : taking the loans out in MCC given that a large. part of the . fundiug.was going to be used for funding the capital projects? • Initially MEA were looking at a £50M facility, the bulk of which (f30M+) would he used to repay HSBC. The MEA/MCC cable rental agreement was considered a suitable asset against which to secure borrowing. The agreement had already been fully lam, ,yered so as to secure the - HSBC. financing. and was therefore seen as timely and cost effective. It had be'en established • some years ago in respect of AMA assets in the UK and the seabed, that there was no sovereign Page S of 42 immunity to protect these assets from adverse English litigation. It was essential to separate the cable operations into another company — Manx Cable Company Lirnited (MCC). • 11. Did you know that the bulk of the money [borrowed by MCCJ was passed on to MEA — was the legality of thisconsidered? Any transfer of money through MEA bank accounts was purely a .facilitation and no loan to MEA by MCC was ever contemplated or intended nor is any such agreement in existence. The bulk of the money was used to buy assets that would be eventually leased to MEA by the subsidiary using the same commercial environment as the use of interconnector agreement. r 12. Barclays offered a significantly lower rate if Treasury backing was obtained for the limn — was this discussed and what was the reason for not pursuing it? Treasury backing was only considered when any tapping of the existing long-dated bond was arrived at. Intermediate Treasury backing for the short-term borrOWings was considered to be neither timely nor appropriate. It has never been done previously. • Unlike other lenders the Treasury requires formal resolution and debate on the floor of Tynwald. This was not considered practical as a basis for interim finance. Whereas . the . Tynw,ald petition would be a realistic option at the.end of the project it was not considered feaSible for there to be separate Successive Tynwald applications. .Once the work began the Board could not afford hitches or delays in the financial arrangements for its payment. 13. WheO was it identified that further borrowing would he required to fund the MEA and complete the capital project? It was always known that further borrowing would be required, the Board were constantly appraised of the design and costs elements of the project. 14. The second loan was for-18 months only — how was it expected that this would be repaid? The Board expected to refinance all of its debt once the investment programme had been completed and the outturn costs were known. The loans obtained from Barclays were of an interim nature, intended only. to run until debt restructuring was coniplete. They would be repaid by restructured debt. "VtamilNftTily~~ 0411•114610601frolv.. IS. What was the Board's view of the 'comfort' letter provided Ito Barclays for the second loan? Was a draft reviewed by the Board prior to submission to Barclays? Did you think 4 that legal advice had been obtained on the contents of the letterr? Page 9 of 42 The Board cannot say at a distance of over a year whether they were aware of a specific letter. the statements would appear to be of fact and not law and it is difficult to see how legal advice on these statements of fact would be relevant 16. Was the 'best efforts' letter discussed by the Board? . Yes. During the borrowing process Mr Proffitt absented himself from the meetings in view of a possible conflict of interest with Barclays. The whole process was dealt with by the MEA in his absence.- Four competitive tenders were- sought and Barclays were chosen due to the overall 'quality of their offer. 17. A budget for Skyward of £1.5 million was approved in July .2003 by the Skyward Committee. Was this discussed by the MEA board? The budget was put in plaCe to support the activities of the team charged with exploiting the fibre optic asset as requested by the DTI in- return for the surrender of the Cable Operatina Lease from the DTI to the MEA. The DTI was paying an annual rent Of circa £400,000 per annum for these dark fibres but had been unable to find a commercial use for them and therefore asked the .1v1EA to investigate whether they, as a commercial organiSation; could actually light the fibres and find a better use for this asset to.generate further business for the Isle of Man. To encourage the MEA to find a speedy commercial result the DTI immediately stopped payment of their contracted £400,000. The DTI also introduced enabling legislation,to allow the /V1EA to enter the Telecoms business. The opportunities found by the Skyward committee have exceeded all expectations: • Broadband over MEA power lines to give 2 MHz bandwidth from any 13 amp plugiin the home, school or office (this at least 10 times faster than the service currently provided over standard telephone wires.) - • International telephone calls via the intemet at local rates • Real time video confercncing for Company meetings j-9; . • Huge new employment opportunities for the Isle of Man to set up international data storage for Disaster Recovery. Since introducing legislation takes time, the Board of the MEA had to find a way to carry out • the DT1's request whilst the DTI passed the necessary bills through Tynwald. With DM's "knowledge a similar set up to the Manx Cable Company was proposed and a shelf Manx company formed. Skyward .Ltd. To undertake the important work to find a commercial use for the fibres to generate incoine Lo more than replace the DT1's f400,000 rental, a considerable amount of work was necessary. The MEA incurred costs of approximately £21/2million in the development of this project. This work was outside the normal competence of other Government Agencies, and indeed• of the MEA, and so the necessary expertise was recruited. i. Skyward activities were discussed at both MCC and MEA Board -Meetings. 13. MEA has not received DTI consent to carry out telecoms actMlies — was legal advice obtained before approving a budget of ii.5 MBA has never carried out telecom activities. The R&D was carried out by MCC at the request of DTI to determine that a commercial exploitation of the asset was'feasible. tyrrhad 7s7 %ember on the R&D team DI Were the payments to the Skyward Committee members discdssed / approved by the Board. Min t was the justification for these payments? The Committee payments were discussed and approved by the MCC Limited, owner of the asset and counter party to 'the DTI Lease. Justification was on the basis of commercial value for money judgement: Skyward was always intended to move rapidly into a commercially viable company requiring staff to operate it. The shortest possible 'time to market' of such high technology is crucial if the competitive edge is to be maintained. To oversee and orgimise this - work the Skyward Committee was set up by MCC. External manageMent consultants, Hanson : Green were engaged to recommend remunerations to those involved for these • new • responsibilities. This was specifically done to avoid any con flietHof interest with existing contracts with the MEA.' • • • Page 11 oI'12 ;.. . 4 tiliMEMS commaramasosseasommessmipswou _ _ - • -*:4 1 • 4+ canassmaloassemansms 7.0. Was Mr Proffitt's Lnienioranduni•of understanding' letter reviewed by the Board? The Memorandum of Understanding had the clear approval of MEA and MCC. ; • ; ' MEA BOARD MEMBERS' PROFILES APPENDIX 1 JOHN McCALLION spent 40 years with the Shell Group, including periods in Singapore and Japan where he had responsibility for large numbers of crude and liquid natural gas carriers. In 1978 he returned to London as Senior Engineer Superintendent before taking control of fleet operations in Japan. In 1987 he moved to the Island as Chairman and Managing Director of Shell Personnel Services, providing manpower for the whole of Shell's UK .fleet, and Chairman and Managing Director of Shell Ship Management, with responsibility for 14 ships. He became Chairman -of the MEA in January 1997 and is also a member of the Audit Committee, Chairman of the Remuneration Committee, Chairman of the Joint Coordinating. Council : and President of the MEA Sports & Social ,Club. Also Chairman of PGT Ltd and Chairman of Manx Cable Company Limited. TERRY MACKAY established his career in design and production engineering before moving to the Island in 1968 to join Marown Engineering, a Company involved in the aircraft industry. In 1972 he established Kenmac Controls Ltd which developed a range of instrumentation equipment for the oil, eas and petrochcmiCal'induStries. He sold the company in 1987 but remained as Managing Director.until 1994 and became Chairman in October 1997. He has served as Chairman of the Petrol Commission,. Chairman. of the Manufacturing Committee of the Chamber of Commerce and is .a non-executive Director of Gerrard Private Bank (IoM) Lid. sits on the Advisor) , Board of Noble'.s Hospital and waS a member of the Energy Commission. He joined the Board of the IAEA in January 1997 'and is al -so Chairman of the Audit Committee. - TREVOR FERRER held a number of senior posts while spending 15 years with the Central Electricity Generating Board, working in power stations at Fulham, Hinkley Point, West Burton, Pembroke and Drax: He spent 17 years with the China Light &Power Company in Hong Kong and, immediately before moving to the Island in 1996. was Engineering Manager at Hong Kong's Castle Peak Power Station, the world's largest conventional coal, oil and gas-fired power station. He joined the Board of the MEA in May 1997 and is also a Director of both the Manx Cable Company and POT Limited. He also serves as the Board's Health, Safety and Environment Member. CHARLES FARGHER is a Manxman and was born and educated in the Isle of Man. Alter graduating• from Nottingham University, he qualified as a Chartered' Accountant in Liverpool, before returning to the Island - in 1975 to join the practice of which his late father was Senior Partner. He has been in practice for over 20 years and now specialises in business advisory services, largely to Isle of Man based clients. His other commitments include, currently, those of Chairman of MB (IoN1) and Chairman of the Isle of Man Children's Centre. He also holds directorships of several other Isle of Companies within • the commercial, finance and charitable sectors. He is also a Magistrate and Captain of the Parish of Marown. He joined the Board of the MEA in August 2000 and is also a member of the Remuneration Committee, Audit Committee and a Director of POT Ltd. JOHN TAYLOR was educated at King William's College on the Island and graduated from Corpus Christi College, Cambridge. lie started in business as a Graduate Trainee with Otter Controls Ltd of Buxton Derbyshire in 1959 and became Chairman 12 years bier. In 1976 he joined Casiletown Thermostats Ltd on the•Island as a Director later Chairman, guiding the company to independence and changing the name to Strix Ltd. His time at Strix included the design of many kettle controls that have changed the face of domestic electric kettles — Strix kettle controls now operate approximately 1 Billion times each day throughout the World! Recognition of Stria: pre-eminent position started with the Manufacturing Excellence Award ParN. 13 or42 in 1995 and by being named British Manufacturer of the Year. His inventions helped Strix to attain 4 of the coveted Queen's Awards — in 1995, 1998 and again in 2002 for Export Achievement and in 2000 for Technical Innovation. In 2000 his personal achievement of over 150 successful inventions patented in the British Patent Office, and several hundred corresponding patents overseas was recognised through the award of an Honorary Doctorate of Engineering by UM1ST. Dr Taylor remains a Director of Strix Group Ltd. He is a Visiting Professor at the Manchester Science Enterprise Centre and an Honorary Fellow of Corpus Christi College -Cambridge. He joined the Board of the MEA in August 2000. Pag.e 14 of 42 . MEA CORPORATE GOVERNANCE APPENDIX 2 The purpose of this paper is to set out the way the Board of the Manx Electricity Authority (MEi\) has applied the principles of corporate governance. The MEA is a Statutory Board of the Isle Man Government with the following responsibilities: • To develop and maintain an efficient, safe and economical system of electricity supply for the Island • To promote, as far. as practicable, the use of all economical methods of generating, transmitting and distributing of electricity, and • To secure, as far as practicable, the provision in rural areas of supplies of electricity. The Board is mindful of the guidance issued by the Council of Ministers to assist members of Statutory Boards in fulfilling their responsibilities, and committed to maintaining high standards of corporate governance. Where practicable, the Board follows the revised Combined Code that includes changes arising from the Higgs Report and the Smith Review. Board composition and proceedingi • The Board comprises of a Chairman and four other members, all of whom have been appointed by the Council of Ministers and subject to Tynwald approval since 1997. All members are appointed for a specific tcnn as contained in information issued by the Council of Ministers. The Combined Code indicates that the Board should include a balance of executive directors and non-executive directOrs so that no one individual or small group can dominate decision Making. In the case of the MEA, the Board consists of appointed members only and does not include the Chief Executive or other executive directors. All the members of the Board consider themselves to be independent and free from any relationships with the MEA (other than as customers for the supply of electricity) that could influence their judgement. All members were appointed by the Council of Ministers because of their commercial background and business experience, both on and off the Island, and each recognises that they share a corporate responsibility for the decisions of the Board. The Board meets each month: In May 2002, the Board approved a schedule of matters reserved for its decision, recognising that it needed to identify those areas of the business that it considered important, and to help decide what other areas it could considered to delegated to others, including .. Board committees, the Chief Executive, other executive directors, and senior managers. The schedule is intended to ensure the Board retains full and effective control over the organisation and monitors the executive and senior management of the organisation. It identifies key aspects of control over Board affairs, strategic issues, finance and accounting, the publishing of statements and other documents, audit and internal control, contracts and . procurement,, personnel issues and outlines the limits of decisions and actions that can be taken by management. Where financial , authority is delegated to management, it is on a structured basis ensuring proper oversight at an appropriate level. The Board meetings involve reviews of financial and business performance. Any significant matter requiring Board approval is supported by a Board paper from the Chief Executive analysing all relevant aspects of the proposal, and proposed management action. Board members do challenge and ask searching questions of the Chief Executive in order to understand issues facing the MEA, Page 15 of 42 and to supplement the information provided by management, which may draw attentionto potential areas of risk. The Board is supported in its role by the Audit and Remuneration Committees which operate within written terms of reference approved by the Board. .• Chairman of the Board There is an established division of authority and responsibility through the separation of roles of the Chairman and Chief Executive; this being in keeping with best practice. The Chairman is responsibilities for the working of the Board, and ensuring the Board collectively and members individually perform to their highest standard. Chief Executive The Chief executive is directly accountable to the Board for the operation of the organisation, for implementing the Board's policies and resolutions and for the effective management of the Authoriy's staff. Audit Committee The Audit Committee was established in 2000. The most recent Terms of Reference was approved by the Board in September 2002. The Audit Committee consists of three members of the Board which includes financial expert'. The Human Resources 'Manager acts as secretary to the Committee. Committee meetings are held quarterly and are normally attended by the Chief Executive, Director of Corporate Services and the Head of Internal Audit. At the July meeting each year. the Committee meets with the external auditor without executive management being present, to enable the external auditor (currently KPMG) to give frank and honest opinions on the results of the statutory audit, and to raise issues and concerns either on the co-operation given by management and staff, or weaknesses in business processes and activities. The Committee has been.delegated authority to monitor the work of internal audit, and ensure there is a review of internal control arrangements. The Committee approves the internal audit charter, the annual operating plan and considers reports on the work undertaken and matters raised, The Chairman of the Audit Committee meets regularly with the Head of Internal Audit and audit staff without executive management being present. Control weaknesses and findings included in reports are discussed with the f Iead of Internal Audit to ensure there is an understandings of management failings. In some cases, these issues are discussed further at the next Audit Committee meeting. Internal Control The members of the MEA recognise that they have overall responsibility for establishing and maintaining an adequate system of internal control, and for reviewing its effectiveness. The effectiveness of internal control arrangements is examined by the IVIEA's internal audit function, which was set up in the mid 90's. Initially, the function's remit was restrictedto the review of cash and stock arrangements, with the internal auditor at that time reporting into the MEA's Chief Financial Officer. During 1998, the Board reviewed the situation and this culminated in the set-up of the present internal audit function. The current function gives ongoing assurance to the Board and senior management on the operation Page 16 of 4 2 . of financial and operational controls, and the adequacy of monitoring procedures. Internal audit has had an audit charter in place since 1999, and operates under the supervision of the Head of Internal Audit, The Head• of Internal Audit reports to Chairman of the Audit Committee and Chief • Executive, and has access to the Chairman of the ME-A. The Head of Internal Audit prepares an annual audit plan of assignments to be perfornied, based.on a process of assessing risks to the MEA and the result of discussions with the Chief Executive, senior management and the external auditors. In February 2004, the Board approved the implementation of a risk nianatiement stratetty and framework within the MEA in line with best practices, as outlined in the Smith Report.. The framework is being introduced over a two year period and is designed to ensure that key controls are embedded into business processes and procedures. Page 17o142 ••••-••g- • 1.• 1 • - 1, .0• .. • ' . MEA SUBSIDIARIES CORPORATE GOVERNANCE APPENDIX 3 The MEA has the following subsidiary companies: Manx Cable Company POT Limited Skyward IoM Board composition and proceedings The Board of Directors of the subsidiary companies is made up as follows: Manx Cable - Company ' ' PGT Limited Skyward . Chairinan John McCallion John McCallion John McCallion Executive directors Mike .Proffitt Mike Proffitt • Mike Proffitt Clive Wilcox Non-executive - Chris Spencer. Trevor Ferrer Chris Spencer directors • Trevor Ferrer . • Charles Fargher Eddie ShalIcross . David North All directors were appointed because of the wealth of knowledge and experience that each could bring to the businesses, and each is fully aware of their corporate responsibility for the decisions of 4 • the respective Boards. 'rhe non-executive directors do consider themselves to be sufficiently independent so as to make objective judgements. The Boards of the subsidiaries meet regularly (Skyward — Monthly and PGTJMCC Quarterly) and involve the review of financial and operational performance. As small evolving companies with no salaried staff, the directors exercise a hands-on approach over the small volume of transactions that take place, and consequently, as all decisions are taken by them for execution by an .executive director, the need for delegating responsibilities beyond the directors has not yet been consideredc appropriate. Chairman of the Boards The Chairman of the subsidiary. companies is the Chairman of the MEA. There is an established separation of the roles and responsibilities of the Chairman and Chief Executive. The Chairman is responsible for the workings of the Board and for ensuring each director actively contributes to discussions. Chief Executive The Chief Executive is accountable to the Board for implementinE, Board decisions. • Internal Control PaRc 13 4 The directors of the subsidiary companies acknowledge that they have overall responsibility for establishing and maintaining adequate systems of internal control, and for reviewing its effectiveness. The MEA's Head of Internal Audit prepares an annual operating plan of assignments to he performed, based on a process of assessing risks to the MEA and the result of discussions with the Chief Executive, senior management and the external auditors. The decision was taken some time ago that because of the scrutiny, of business transactions by the directors, the necessity for the IYIEA's Internal Audit to review financial control processes and transactions of subsidiaries did not arise. The planning schedule_s maintained by the MEA's Internal Audit function do include operational areas associated with topics and activities of the subsidiary companies. These operational areas are subject to . the same selection process as any other activity for potential inclusion into the annual operating plan. The operating plan for 2004/2005 includes a review of management control of Interconnector maintenance, the responsibility of which rests with the Technical Services Manager; Technical Services being one of the core departments of the MEA. • Tg Page 19 of =12 MEA BOARD DELEGATION OF RESPONSIBILITY APPENDIX it MANX ELECTRICITY MEMORANDUM To: Jim Crombie, Director — Generation/Procureme nt John Bevan, Director — Electricity Network Services Clive Wilcox, Director — Corporate Services Ashton Lewis, Director — Capital Investments Cc: Board Members Paul Dewar, Manager, Internal Audit From: Mike .Proffitt, Chief Executive Date/Ref: 10 September 2002 / CE/ajc10910-01 Subject: BOARD DELEGATION OF RESPONSIBILITY SCHEDULE The Board of the MEA is committed to implementing good aovernance practices to demonstrate effective accountability and probity throtighout the orsanisation. Whilst the Board has clearly defined duties under Statute is has to consider best corporate practices in the discharge of those dtities. The Board has therefore decided to introduce a Delegation of Responsibility policy to give it assurance that business processes and controls systems are adequate. At its May 2002 meeting, the Board approved the implementation of a Delegation of Responsibility Framework within the M EA. The framework consists of two elements: 1. a structured document that records roles and responsibilities 2. - a management process for maintaining and reviewing the framework I attach a copy of the Delegation of Responsibility Schedule for your information. The schedule sets out matters specially reserved for the Board's decision and those delegated to its committees and senior management. In many areas the schedUle formalises what should already be the .existing decision making and consultation processes within divisions. I would ask that you review the schedule in the light of your current working practices to ensure that these_are within the scope' of the schedule. Any differences between existing practices and the seheddle,_ which are impractical for you to adopt, arc to be brought to my attention as soon as possible. This policy document will be reviewed at Board level annually and in this regard you can bring changes considered relevant into focus. Regards Michael 3 Proffitt Chief 'Executive Enc. Pap: 20 of 42 - • • Manx Electricity Authority Board Delegation of Responsibility Approved by: \V John McCallion Michael.' Proffitt Designation: , • Chairman . Chief Executive Date: May 2002 Page 21 of 42 .4, Manx Electricity Authority Delegation of responsibility framework Delegation of responsibility framework I. The Board has agreed to introduce a delegation of responsibility framework within the MEA's management system. The purpose of the framework is to identify those persons responsible for developing and maintaining control procedures and promoting a control culture within the MEA. The framework consists of a structured document that records roles and responsibilities. and the nomination of an individual responsible for managing and maintaining the framework. 2. The role and responsibilities of a Statutory Board and its members are set out in various Acts passed by Tynwald and in Council of Ministers guidance. The MEA Board performs the following important functions: • • setting the direction of the organisation within the overall policies of Government and the organisational.control framework in which business is performed • identifying those matters which are specifically reserved for the Government, the Board and those that are delegated to management • ensuring financial stewardship, financial control and overseeing the delivery of planned results • ensuring standards of corporate governance and personal behaviour are maintained in the conduct of the business • receiving timely information regularly which monitors business activities, management responsibilities and business direction. 3. The attached Delegation of Responsibility Schedule sets out the specific responsibilities reserved for the Board, and those responsibilities'delegated to Board Committees, the Chief Executive and senior management. The schedule demonstrates compliance . with legislation and guidance in that: • the Board sets the direction that the MEA wishes to_adopt • there are matters specifically reserved for the Board to deal with • there are arrangements in place to show responsibility is delegated to senior management • the Board's business is conducted efficiency and follows best practice • the Board regularly receives and monitors managernent responsibilities. The schedule represents guidance and does not cover every eventuality. Where there are omissions or clarification on interpretation is required, this would need to be brought to the attention of the Board. 4. The person responsible for managing, and maintaining the schedule is to be nominated by the Chief Executive. 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X e der ter ■ a -• d ag to a l n l i Eva LU Op app con ten Sig m up a E3 Z t;—:. 6 ,C. 0 0 7. Lei 0 ..- ' .:.1 kil •••••, ...:-^ -C. -0 z :-. ,.... * !b- * = H. 4..., MEA BOARD DELEGATION OF RESPONSIBILITY APPENDIX 5 MANX ELECTRICITY CORPORATE POLICY AUTHORITY DOCUMENTATION (a ,,,a,,, TLD / 001 LEVEL ONE DOCUMENT MANX ELECTRICITY AUTHORITY COMMITMENT TO HEALTH AND SAFETY OUR VISION To achieve a workplace that is free from all injuries and work related illness and where safe and healthy working is a way of life for everyone involved in our business. OUR BELIEF That all work related injuries and occupational illnesses are preventable, and we will never be satisfied until • we have eliminated these from the workplace. OUR APPROACH • To create a culture where everyone accepts personal responsibility for their own health & safety, and for that of others. To establish clear line management accountability for driving continuous improvement in health & safety performance. • To work to the highest standards for the safe operation of equipment and facilities. • To involve everyone in the task of improving health & safety performance. • To develop, train and motivate every member of staff so that working safely becomes much more than a condition of employment. • To encourage and support everyone to improve safety outside the workplace. • To actively encourage our contractors to share our vision, belief and approach. • To monitor ourselves against our vision belief and approach, and report our health .& safety performance regularly. to. W John McCallion Michael J Proffitt Chairman Chief Executive ISSUE. No. / ED. No. DATE l'AGE ISSUE 0 1 31 / 01 / 03 Page 38 of 42 MANX ELECTRICITY CORPORATE POLICY AUTHORITY DOCUMENTATION /6€) ■,.A., TLD / 002 LEVEL ONE DOCUM ENT - Manx Electricity Authority Health. Safety and Environmental Policy We, the NIE,A., being . a responsible employer are committed to providing a healthy, safe and clean environment for employees, customers and the public. A policy on Health. Safety and Environment (1-15E) is endorsed and our principles are: • Recognise the responsibility to protect employees, customers, public and the environment • Meet all legal requirements, regulations and exceed where expedient • Provide a healthy and safe workplace • Provide a clean business environment • Adopt a balanced approach in the business operation • Achieve high standards of operational integrity, make continuous improvement, minimise hiSE risks and impact on the environment • • Encourage and train employees for HSE concerns and responsibilities • Encourage and formally require partners, suppliers and contractors to comply with our policy . • Monitor compliance and disclose all relevant information W John McCallion Michael J Proffitt Chairman Chief Executive ISSUE No-/ ED. No. DATE PAGE ISSUE 01 31 101 1 03 • Page 39 of 42 • ! MANX ELECTRICITY CORPORATE POLICY AUTHORITY - DOCUMENTATION (54) ...... t, TLD / 003 LEVEL ONE DOCUMENT Manx Electricity Authority Environmental Management System Policy We are committed to protecting the environment and will take a robust approa•zh in this.commitnient by demonstrating sound environmental policies, procedures and actions. We aril I adopt an 'Environmental Management System' (EMS) based on ISO 14001. which will consist of a framework for implementing, monitoring • and controlling our impact on the environment and provide confidence that this impact will be managed in a responsible and reliable manner through the process of continuous improvement. The EMS provides us with an internationally recognised standard with which to assess and measure our performance and in particular will: • Adopt and aim to apply the principles of 'sustainable development', that is, development that meets the needs of the present, without compromising the abilities of future generations to meet their own needs • Strive to adopt the highest available environmental standards in all areas of operations and business • Adopt a 'cradle to grave' assessment of responsibility for products and services • Aim to minimise the use of all materials, supplies and energy • Wherever possible, use renewable or re-cycled materials and components • Minimise waste used in all parts of the business and aim for 'waste free' processes • Expect similar environmental standards from all third parties, (i.e. contractors, suppliers, etc.) involved with the business, as apply to us • Publicise our environmental position • Encourage employee involvement in environmental action • Regularly liaise with the local community • Adopt an environmentally sound transport strategy • Aim to include environmental considerations in investment decisions • Regularly assess the environmental impact of all operational and business activities • Assist in developing solutions to environmental problems, and support the development of Government/public policy W John McCallion Michael J Proffitt Chairman Chief Executive ISSUE No. ED. No. DATI; PAGE I ISSUE 01 31 /1_11 03 PatLe 4001'42 MANX ELECTRICITY CORPORATE POLICY AUTHORITY DOCUMENTATION 64E - ...A., TLD / 004 LEVEL ONE DOCUMENT Mans Electricity Authority Health, Safety, Environmental and Quality Policy Statement We are committed to providing a quality power supply and services to our customers in a manner that ensures a healthy, safe and clean business environment for our employees, customers and the public. OUR goals are 'Zero Accidents'. 'Zero Non-Compliance' and 'international Standard . Products and Services'. OUR Principles are to: • Exceed the service reqUirements and expectations of our customers,10 ensure we are their preferred. energy service supplier • • Operate to the highest standards in Health and Safety • Conduct our business in a mariner that strives to balance the sustainable environmental social and economic needs of the community • Develop a competent, innovative, responsible and motivated work force • Encourage and require, wherever appropriate, our business partners, suppliers and contractors to adopt equivalent principles We will continue to systematically identify, monitor, review and control our health and safety risks, environmental impacts and quality issues to ensure continuous improvement. Health, Safety, Environmental Protection and Quality is every persons responsibility. W John McCallion Michael 1 Proffitt Chairman Chief Executive ISSUE No. ED. No. DATE PACE ISSUE 01 _1'01/03 Page 41 of 42 MANX ELECTRICITY CORPORATE POLICY AUTHORITY DOCUMENTATION .....s,, TLD / 005 LEVEL ONE DOCUMENT Mans Electricity Authority Health, Safety, Environmental and Quality (HSEQ) Policy for Business Partners, Contractors and Suppliers We are committed to continual improvement of the company's high standards of occupational health, safety, environmental protection and quality (HSEQ) in the company's operations. In achieving this commitment, we will foster partnerships with business partners, contractors and suppliers who can ,t- demonstrate excellence in HSEQ performance with their providing of services and products. We will adopt a risk-based 'partner, contractor and supplier performance management system' based on significant FISEQ commitment by our business partners, contracted services and suppliers. In particular, we will: • Seek to inform and educate business partners, contractors and suppliers of our I-ISEQ policies, requirements and approach • . Identify the significant HSEQ impacts and business implications of our contracted s ervices and - purchased materials to ensure a satisfactory implementation and operation of a risk-based contractor and supplier performance management system • Define HSEQ performance requirements in tender and contract documentation for significant ilS8Q risks - • Implement a formal system for evaluating and selecting contractors and suppliers, which includes a review of their past performance thus ensuring that HSEQ is considered on equal terms with technical - and commercial criteria Purchase materials and goods to specifications which are compliant with relevant legislation and our requirements, to minimise any HSEQ impact • Develop long-term partnerships with business partners, contractors and suppliers who can demonstrate HSEQ competence and who can consistently deliver their scrvices•and products . tO our. • requirements • Review the HSEQ performance of business partners, contractors and suppliers, providing feedback aimed at correcting - any deficiencies identified and for constructive comments • Keep abreast of market trends and developments so as to continue acquiring quality services and products • W John N fcCallion Michael J ProlTitt Chairman Chief Executive • , ISSUE No./ ED. No DAVE PAGE I 1 ISSUL' 01 3 I / 0 1 01 Page 42 of- 42 Manx Electricity Authority ' PKF Appendix 3 Letter from the MEA to Barclays dated 26 February 2004 May 2005 Appendix 3 MANX ELECTRICITTAUTHORITY Lectnagbys manrainagb Box 177 • Douglas • Isle of Man - 1M99 IPS Tel (01624) 687798 • Fax (01824) 687611 Direct Dial 687798 . e-mail mike.proffitlemea.gov .im ATTACEMENT 3 Barclays Capital IBL Energy & Utilities 5 The North Colonade Canary Wharf LONDON E14 4BB CE/MIP/ajc/0226-01 26 February 2004 Dear Sirs In connection with the facility to be provided by Barclays Private Clients International to Manx Cable Company Limited, and the related guarantee to be provided by the Manx Electricity Authority, I confirm the ability of the MEA to arrange repayment of all amounts due at the facility maturity date. MEA has historically arranged its own financing, although infrastructural bond financing was arranged in the name of the Government so as to take advantage of the Isle of Man Government credit rating. MEA were informed that if they were to seek a rating in their own name it would lead to a less attractive interest rate. The MEA is a Statutory Board of Government, and is likely to arrange future take out finance in. the name of Isle of Man Government rather than its own name. However, in either event the liability would be a Government liability due to the fact that a Statutory Board is a part of Government. Thetiming of take out financing will to some extent depend on a number of external factors,' and these will become clearer as we progress, but the timing currently envisaged is within the IS month period of the new facility. Yours faithfully Michael J Proffitt Chief Executive CHIEF EXECUTIVE. Michml 1 rredlla FCA Manx Electricity' Authority PKF Appendix 4 A. MEA business plan for the five years to 2005 • .J May 2005 Appendix 4 fi BUSINESS PLAN 2000 to 2005 • • t I INTRODUCTION 1 2 MISSION STATEMENT 2 3 STRATEGIC OVERVIEW 3 3.1 Critical success Factors 4 3.2 SWOT Analysis 5 3.2.1 Strengths 5 3.2.2 Weaknesses 5 3.2.3 Opportunities 6 3.2.4 Threats 6 3.3 Personnel 7 3.3.1 Staff Numbers 1999 to 2005 7 3.3.2 Organisation Charts 7 4 ELECTRICITY GENERATION/PROCUREMENT 8 4.1 Introduction 8 1 4.2 Assets 8 4.3 Staff 8 4.4 Aspirations 8 1 4.5 Concerns for the future 9 , 4.6 Phase V 9 1 4.6.1 Manx Cable Company Limited - 9 , 4.6.2 Gas-Fired Power Station 9 4.7 Cable Operating Division 10 4.7.1 Interconnector Trading Strategy 11 4.8 Objectives 12 .4.9 Plans and Financial Projections 12 ). 1 5 ELECTRICITY NETWORK SERVICES 12 5.1 Introduction 12 5.2 Assets 13 5.3 Staff 13 5.4 Aspirations 13 5.5 Objectives 14 5.6 Plans and Financial Projections 14 5.7 Stores 15. 5.7.1 Introduction 15 5.7.2 Aspirations 15 5.7.3 Future Plans & Objectives 15 5.8. Transport • 15 !!! . 4,4 7. I 6 CORPORATE SERVICES 15 6.1 Introduction 15 6.2 Assets 16 6.3 Liabilities 16 6.4 Staff 16 6.5 Aspirations _ 16 6.6 Financial Control and Treasury 17 6.6.1 Introduction 17 6.6.2 Objectives 17 6.7 Human ResoUrces and Administration 18 6.7.1 Policy 18 6.7.2 Health & Safety - 18 6.7.3 Staff Appraisal 18 6.7.4 MEA Terms-& Conditions 18 6.7.5 Training 19 6.7.6 Administration Services 19 6.7.7 Non-Operational Buildings Policy 19 63.8 Management of Non-Operational Buildings 19 6.8 Legal ServiCes 20 4 6.8.1 Introduction 20 6.8.2 Objectives 20 6.9 Information Technology 20 6.9.1 Introduction 20 6.9.2 Aspirations 21 6.9.3 Objectives 21 7 INTERNAL AUDIT 21 7.1. Introduction 21 7.2 Aspirations 21 7.3 Objectives 21 7.4 Operational Plans 22 7.5 Training & Development 23 8 RETAIL & MARKETING 23 8.1 Introduction 23 8.2 Staff 23 8.3 Objectives 23 8.4 Commercial Development Plan 23 8.4.1 Showrooms 23 8.4.2 Appliance Repairs & Deliveries 24 8.4.3 Head Office 25 8.5 Manx Energy 25 9 • PUBLIC RELATIONS 25 - - 10 FINANCIAL INFORMATION ,• • f- • BUSINESS PLAN 2000 to 2005 I INTRODUCTION The Manx Electricity Authority (MEA), is a statutory body charged with providing the people of the Isle of Man with a safe, reliable and economic electricity supply.' The Authority has responsibility for generating and distributing electricity and for billing and collecting of revenue from these activities. In addition, these services to the customers are enhanced by the provision of retail service centres where modern electrical appliances and authoritative advice on their use is available. The MEA Headquarters are situated at _Ballacottier. The Power Stations are situated at Pulrose, Peel, Ramsey and Sulby and Retail Outlets at Douglas, Ramsey, Port Erin, Peel and Castletown. The MEA also provides contracting services for the provision and maintenance of public lighting and electrical installation work. The introduction of the cable link during the first year of the plan will inevitably change the .- way the MEA operates and move the organisation towards a supply company which is customer services orientated together with a generation company which will obtain power on a least cost basis. This is in line with electricity supply industry best practice. Manx Cable Company Limited was incorporated on 6 May 1998 as a joint venture company set up on a 50:50 basis between the MEA and National Grid (Isle of Man) Limited. The company will own the cable link to the UK and the MEA will make rental payments for its use. R, -1- 2 MISSION STATEMENT The MEA'recognises a skilled and flexible staff as its most valuable asset and a progressive personnel policy is therefore being implemented. • The MEA is a quality company which is committed to meeting best practice in all areas of electricity supply. • The MEA will provide a safe, secure, efficient electricity supply to the Isle of Man having due regard to amenities. • The MEA is committed to maintaining the highest standards of customer care and service with maximum reliability and minimum cost. • The MEA is committed to providing a work environment to the highest standards of health and safety. The MEA is committed to reduce the cost of electricity by 25% over the three years to 31 March 2004. These reductions are to be obtained by operational efficiencies (4.5%), import and trading benefits from the cable link (9.5%) and the commissioning of on-Island natural gas fired generation (11%). -2- 4- 3 STRATEGIC OVERVIEW ti The adoption of a new Organisational structure will facilitate achieving the overall goal of reducing tariffs by 25% over the three years to 31 March 2004. . The continuing economic growth on the Island provides both challenge and opportunity for the MEA. Major strategic objectives in securing up to date generation facilities have been achieved and this, combined with major investment in renewal of the network services infrastructure, has resulted in the MEA achieving equal or better performance regarding security of supply when compared with UK Regiimal Electricity Companies. The move towards monthly direct debit for all customers and key meters for domestic customers as the preferred payment methods will continue with tariff incentives increasing. This will improve cash flow, facilitate debt collection procedures and - reduce physical meter readings to one per year. The present policy of change management will continue to be developed in order to achieve greater flexibility throughout the workforce. This will include introducing working practices to allow costs which are currently fixed to become variable both within and between divisions. The 4 year pay deal introduced in 1999 will provide ,, the benefit of stability during this period. In securing the source of electricity supply for the future, fuel diversity will be sought as a means of reducing the base cost of electricity whilst addressing environmental issues and enhancing security of supply. The search for a suitable site for a small . wind farm will continue and a successful outcome is expected during the early years of the plan_ L Manx Cable Company Limited has proceeded with the installation of the cable link to the UK. The contract to manufacture the cable was placed in January 1999 and it is due to be installed and commissioned by 30 October 2000. A feasibility study, by the Department of Trade & Industry (DTI), into the provision of a natural gas supply to the Island is continuing and a decision on whether to proceed is expected before the end of the first plan year. Options for supply lines to the West and East coasts of the Island are being considered together with the MEA initiative. The MEA initiative is to construct a pipeline to a East Irish Sea Natural Gas reservoir and deliver Natural Gas to a Combined Cycle Gas Turbine Power t Station to be developed at the Pulrose site. This initiative is to be recommended to the DTI in the first plan year. The provision of renewable energy sources are being actively considered as a means ti of meeting Rio and Kyoto Energy Convention guidelines to shift 10% of output away from fossil fuel derived sources. The most probable way of achieving this target will be by wind generation. -3- 3.1 CRITICAL SUCCESS FACTORS 4 ♦ ReduCtiotila eleetricity tariffs by 25% over three years ♦ No total loss of Generation ♦ Minimise average minutes of Supply Lost due to Faults per Customer per Annum. - ♦ Improve communications with Staff ♦ Reduce the dependency on-a single fuel source for Electrical Energy Supplies for the Island ♦ More visible and effective Customer Services IY -4- 3.2 SWOT ANALYSIS f. Monopoly position on electricity supply Develop position to economic advantage of customers Modern efficient diesel generating plant Optimise planned maintenance- to ensure continued efficiency and security of supply Transmission and Distribution System Maintain and develop to meet system developed to latest standards with installation requirements of fibre optic 'linked protection systems for control Skilled and responsive workforce Continue the development of staff to meet . the changing needs of the business Modern purpose built premises .. .,; _;-.?-,1:-: • ',- 3. '/'"-fr • : JOIESSES-yr. ":. • --": f!.;t:`• ---- aka- - .. , : t.-- O• f.V.L. Single fuel dependency Strategy to change to alternative fuel or energy supply Limited generation capacity in the longer Provide cable link with UK by October 2000. : term Feasibility study into future gas fired plant High fuel cost of diesel generation Maintain pressure on oil suppliers to reduce costs Non-integrated Information Systems Develop strategy to provide fully integrated IT Systems for both operational and management needs Outmoded working practices inhibit Introduce a programme to improve the interchantieability of staff between divisions understanding of staff of the necessity for . change I mai h 5 • •-,-.df • .;:0WW-40111- Undervalued assets Develop financial solution which optimises generation initiatives Successful and effective utilisation of the Develop processes and controls for effective cable link to the UK - operation of the cable link Development and effective operation of Infrastructure to be owned and operated by natural gas fired generation MEA Load management Review and develop tariffs to meet customers needs which assist in altering the load profile to enable more efficient operations Develop wind generation Continue feasibility study Introduce cost reduction programme Continue policy of change to provide increased staff flexibility ..y1API 7 : I.--,- Ige4MA,Z4242 EPAM:749- -.:.!--Eartir-, .742-10•P Fuel oil price volatility. Reduce dependency on fuel oil Large scale Loss of generation Review contingency arrangements Changing legislation/directives Maintain ongoing compliance with current legislation and monitor and evaluate the effects of proposed changes When importing only, loss of the cable link Retain operational generation capacity on will lead to an Island wide loss of supply Island sufficient to meet local demand at all times Private generation could lead to potential loss Review tariff structures of revenue Failure to maintain cooperation of staff as Ensure staff are fully involved as changes changes in operations occur. develop. . Terrorism Attack Review security systems. _6 3.3 PERSONNEL i - ,.,. , Ongoing control of staff costs will be achieved by a combination of factors. including staff , rs by natural wastage, the implementation of a change management programme to ' Y reduction produce greater staff flexibility and by moving fixed to variable costs wherever possible. ... , 3.3.1 STAFF NUMBERS sd The table below indicates the changes in staff numbers at the end of each year, account of retirements with 1999 and 2000 being actual totals. i 1 II Ma Z iti * , . i . L: .` ftr ,„ IV6 t ••• ‘; z ,.. Isf . ., W m ..i s "1 n iii ) „ igen • cap? in 4 .: .,, 4.1 „.... - : t:3 3' V' 0 Av.. „• c A To ' xty*91,-*,-4V..,_ --'. i • 1 .4 k a o1 ." e 7 . 1 1' ,,i * 3 j • arch ' ,= ' ;,, .4 0 . ;,, , „.....„,ob, - le t " , -' n , le r .. rt 1 . • , N t ,, 71 c ,. ,4 1 s ,iikiwA,--.,e-lts- •if - r , LI gl . f' ,4 . .• ,,,,...6.,..ft, ■ .' s , lIC11 ,1 1 , , • 260.4 258.7 256.9 249.9 246.9 2389 228.9 ,v,i31 c-... 3.3.2 ORGANISATION CHART The following chart shows the overall structure of the MEA and that of the individual divisions. (Separate Enclosure) r .4 4 - 7 - 4 -. ELECTRICITY GENERATION/PROCUREMENT 4.1 INTRODUCTION Electricity Generation/Procurement is responsible for proViding a safe, reliable and economic supply of electricity to the transmission and distribution systems which is within statutory limits and meets the needs of MEA' s customers. 4.2 ASSETS • The division has generating capacity in 4 Power Stations, located at Puirose, Peel, Ramsey and Sulby. • Pulrose Power Station. D Station - Operational since 1988 and completed in 1990. 5 Diesel Generating Sets, total .48 MW. This station generates about 55% of total output. C Station - Operational since 1972. 3 Diesel Generating Sets, nominal capacity 12.5 MW. B Station - Operational since 1966. 3 Diesel Generating Sets, nominal capacity 9 MW. • Peel B Power Station - Operational since 1995. 4 Diesel Generating Sets, total 38.4 MW. This station generates about 44% of total output • Ramsey Power Station - Operational since 1960 and extended in 1982. 4 Diesel Generating Sets, nominal capacity 7.4 MW. • Sulby Hydro Station - Operational since 1981. 2 Water Turbines,- nominal capacity 1 MW. The station contributes about 1% of total output • The effective total capacity of the plant is 95.2 MW which is less than rated capacity. 43 STAFF The division employed 79 staff at 31 March 2000, deployed as required in the stations. 39 staff, including reliefs, work on a three shift five cycle pattern, with the remaining staff on day working. A significant development during 1999 was the recruitment of two engineering apprentices. Over the next five years the number of staff will reduce by fourteen through retirements. Staff cost increases are to be within the annual percentage increases applied to the tariff. Efforts will continue to achieve increased flexibility and move fixed to variable costs to gain greater versatility from the existing work force. • To use existing resources more effectively • To provide a more efficient and economic supply of electricity • To optimise the energy trading return on cable investment • To develop a successful CCGT Power Station - 8 - 4.5 CONCERNS FOR THE FUTURE 4.5.1 FUEL OIL SUPPLIES AND COSTS Over the previous year, the cost of crude oil has doubled which emphasises the , need for fuel diversity. At times there has been a 50% increase in the cost of refined fuel when compared with the lows experienced during the previous year. There may be economic benefit in pursuing contracts which allow the application of a price cap to assist in containing costs. The time at which fuel contracts are renewed is critical and risk hedging measures need to be explored. 4.5.2 MIRRLEES BLACKSTONE DIESELS LTD Uncertainty over their future continues following the decision by Alstom to put their industrial division on the market. This includes all of their diesel engine manufacturers. Prior to this, Mirrlees Blackstone were making , significant headway in the development of their product range. News of their ' sale has led to a decline in sales. 4.6 PHASE V The Island's demand for electricity continues to grow with a 20% increase in units generated and a corresponding 13% rise in maximum demand over the last five years. The introduction. of the cable this Autumn will secure firm capacity at all times =0. beyond 2005 assuming-present growth rates. 4 The decision of the DepartMent of Trade & Industry with regard to providing a natural -4: gas supply is expected before 31 March 2001. This will greatly assist with planning to secure future firm electricity supply capacity on a timely basis and further diversify the Island's energy sources. Continued growth and the ; need to replace 19.4MW of obsolescent firm generating plant sited at Pulrose B&C Stations and Ramsey, means that further capacity will be .i) needed in the near future. . 4.6.1 MANX CABLE COMPANY LIMITED The Manx Cable Company Limited placed the order for the cable link in January 1999. Manufacture of the cable and auxiliary equipment is proceeding. Cable laying will take place during Summer 2000 and commissioning is scheduled for completion by 30 October 2000. 1 4i 4.6.2 GAS FIRED POWER STATION The preferred site for the gas-fired station is Pulrose. The station would 4. contain 75MW CCGT and would be constructed on the site of Pulrose A, B C Stations. The key to . progress in this direction is the decision by -1;;:" Government on the provision of natural gas to the Island This would set the timescale for the development, the first stage of which would be to establish 1 IMO the gas supply infrastructure. For the immediate future, diesel generation Will .9 . possibly continue to be used for both supply and energy trading, followed by the gasification of the Pulrose A diesels. 4.7 CABLE OPERATING DIVISION A 40MW interconnector link between the Isle of Man and Fngland and Wales (E&W) is scheduled to be commissioned at the end of October 2000 and will enhance security of supply to the Island as well as present the MEA the commercial opportunity to import and export electricity to reduce its own internal costs of generation. At the same time, new electricity trading arrangements (NETA) will be introduced into E&W at the end of October whose aims are to reduce electricity prices by introducing more competition, greater market choice, incentives to manage risk and pricing transparency. It is hoped that this will dilute large-generators' ability to influence final prices for electricity and enable suppliers and large customers to become more fully involved in the trading of electricity in the marketplace. The impact of NETA is already having a significant effect on electricity supply contracts currently available to large customers in E&W, with wholesale electricity prices being discounted at 10-15%.below contract prices available last year. NETA will be based on bilateral trading between generators, suppliers, traders and large customers and will include: Forwards and Fixtures markets that will allow contracts for electricity to be negotiated for up to several years ahead; • A short term bilateral market which will be managed by a number of power exchanges and operating from at least 24 hours to about 3 V2 hours (the gate window) before a trading period to allow traders the opportunity to fine tune their trading position; A balancing market from about 3V2 hours before real-time in which the system operator, National Grid Company, (NGC) can balance the system by accepting a range. of bids to buy and offers to sell electricity from generators, suppliers, traders and large customers. MEA's plant flexibility will provide it withthe ability to 'swing' from import to export mode (in theory this could represent a swing of 80/4W) across the interconnector and therefore provide the MEA the opportunity to generate incremental income from participating actively in the Balancing Market; A Settlement process for calculating a price to recover the System . Operator's costs of dealing with the outstanding imbalances prevailing in the Balancing Market and for levying appropriate charges to those generators and suppliers responsible for causing the imbalance. The Cable Operating Division (COD) has been established to capitalise on the trading opportunities afforded by the interconnector and allow the MEA's customers to benefit from cheaper electricity prices in E&W. The option of securing long term bilateral electricity supply contracts with one or more established generators/suppliers in E&W is being investigated, and also the possibility of generating incremental income streams from actively participating in the Day-Ahead Power Exchanges and Balancing Market. Additional income may arise from negotiating an ancillary service contract for Standing Reserve either directly with the National Grid Company (NGC) or a third party intermediary. - 10- The flexibility of MEA's diesel generation will enable maximum exploitation of the Balancing Market which favours sources of generation and demand that can respond quickly to NGC's instructions as the latter attempts to balance the national transmission system in E&W during a short time window to safeguard security of supplies. This strength is recognised by potential partners and examination of suitable forms of contract to reflect this benefit is underway. 4.7.1 1NTERCONNECTOR TRADING STRATEGY The Interconnector is anticipated to be commissioned at about the same time as NETA is introduced in England and Wales and almost at the start of the Winter season when electricity prices are anticipated to be both higher than MEA's marginal costs of generation as well as being subject to wide volatility. To allow the land/undersea cable time to properly . 'bed' down, the MEA are presently reviewing the option of procuring a competitively priced electricity supply contract from an established player in E&W. A number of leading L generators and suppliers in E & W have been approached to offer their best prices for supplying the Isle of Man with electricity at their lowest prices with imports being capped by the maximum transfer capability of the interconnector of 40MW. Such a contract is expected to be of 12 months duration, which will enable the MEA to familiarise itself with the operational and technical limitations of the Interconnector and gain further insight into the commercial trading opportunities presented by NETA and adapt to any other possible future modifications to these new trading arrangements. A fixed price electricity supply contract is expected to provide the following benefits: a stable and predictable revenue stream across the interconnector and a reliable benchmark for comparing with MEA's internal costs of generation during the day and night; ii) the freedom to actively participate in the diy-ahead and balancing markets to replace imports with more lucrative export opportunities; iii) establish a strong commercial relationship with one (or more) suppliers • who could act as MEA's principal agent in formulating our trading tactics in the day-ahead and balancing market; iv) gain experience in trading working with and using the Energy ' Management Centre of an established player,- extend the operating life of our own diesel generation plant and reducing associated repair and maintenance costs; vi) allow more time to identify and secure other contracts related to ancillary services, Triad and Pool Avoidance and possibly emission trading permits in the future. - I 1 Upon the commissioning of a 75MW CCGT as a base load generating strategy the Modis Operandi of COD changes to that of export and the .provision of resilience. 4.8 OBJECTIVES To meet projected demand (see chapter 9), whilst ensuring sufficient capacity so that the maximum demand can be met with a security margin of two of the largest sets being unavailable. The present requirement for spinning reserve is to have spare capacity on the running plant to absorb the loss of the highest loaded set without interruption of customer's supplies, but the plant is to be run as efficiently as possible within that constraint. • To continue to move fixed costs to variable costs by integrating the operation and maintenance functions. This will require inore flexible working practices in both operations and maintenance. Suitable training will be provided as necessary to achieve this aim. The introduction of the cable link to the UK will render separate operations and maintenance staffing obsolete. To use Information Technology to provide, within the constraints of spinning reserve, more efficient control of the running plant at both Peel and Pulrose.' To continue to provide more management and maintenance information by linking the Supervisory Control and Data Acquisition, (SCADA), system to other systems, (Financial and Maintenance) and to provide a common interface for the various control systems which are currently in use and for any futUre systems that may be part of a turnkey plant package. To extend service intervals on plant and equipment whilst retaining reliability and availability by introducing cost effective condition monitoring and reduced planned maintenance. 4.9 PLANS AND FINANCIAL PROJECTIONS To continue to engineer the move from fixed to variable costs will require a culture change to achieve total flexibility between operations and maintenance. The advent of a UK interconnector provides added impetus to this process. Extensive consultation and training is planned_ Where appropriate, use may be made of consultants to facilitate the change programme. • The process of interconnecting the SCADA systems and providing enhanced plant control is ongoing. The provision of an automatic load shedding facility is a priority. • The process of extending service intervals of the MB430 engines is ongoing. The auxiliary plant needs to follow this process with the implementation of appropriate condition monitoring systems. 5 ELECTRICITY NETWORK SERVICES 5.1 INTRODUCTION The Electricity Network Services Division is responsible for all aspects of the transmission and distribution of a safe, secure, reliable and adequate supply of electricity throughout the Island to 40,220 industrial, commercial and domestic customers. - 12 - it 5.2 ASSETS The assets of the division include: • High and low voltage overhead lines totaling 721 km • High and low voltage underground cables totaling 1,240 km • Plant and equipment including 987 transformer substations • Data logging, control, metering and protection systems • 43,000 consumption recording meters • 78 Vehicles 5.3 STAFF The division employed 91.6 staff at 31 March 2000, in sections including distribution development, operations and maintenance, metering and protection, engineering support services, contracting and facilities support. Staff training and retraining programmes will continue towards providing a multi- skilled work force to improve efficiency, to make more effective use of the business units resources, new technology and new techniques. 5.4 ASPIRATIONS To increase energy sales at off-peak periods and reduce the peak system - demand relative to the average demand. ► • To make bettei use of existing resources and improve supply availability. • To ensure the system is capable of meeting the projected load growth as indicated in . Chapter 9.. • To integrate,all Distribution systems onto a common platform which fits into the overall MEA IT strategy. • A. - 13 - 5.5 OBJECTIVES • To improve the quality of electricity supply. Upgrade. 3.3kV overhead line systems to 11kV to provide additional capacity, reduce losses and en-able statutory requirements to be met. Convert all overhead section to 11kV by 31 March 2001. • To continue staff training to achieve a multi-skilled work force by 31 March 2001. This will lead to more efficient working and an improved response time to new supply requests, the target being 22 days compared with the present 30 days. • To minimise disruption of supply due to system faults. Monitoring of the semi-automatic fault isolation system on the Bride 11 kV feeder will continue for a further year. Subject to satisfactory performance, the system will be extended to other feeders. • To implement an integrated comprehensive customer information system and Electricity Network system by 31 March 2002, preferably on Navision Financials, (Navision). • • To extend the Geographic Information System (GIS), to enable the issuing of supply interruption notices and assist in system voltage studies. • To consider a pilot sclieme for remote meter reading. 5.6 PLANS AND FINANCIAL PROJECTIONS • Costs as budget for 3.3kV overhead line reconstruction. This is necessary because of the age and condition of the lines and to ensure statutory requirements are met. Work to be carried out by MEA staff. • Make use of specialist training facilities available from Regional Electricity Companies and other specialists to provide the required skills tuition. Total budget, £ 150k including IT training. • Monitor the fault isolation system for a further year to assess performance. Scheme to be extended to other feeders if it proves effective. Integrated Customer Service Information and Network System by 31 March 2002 preferably on Navision. • • To prepare for issuing notices for supply interruption, data will be transferred into the GIS. Updating software and data capture at a cost of £30k. Complete by 31 March 2001. • Network Services to provide technical support including delivery, installation and meter installation for Comfy Heat and Economy 8 Tariffs. Wiring work to be subcontracted. Uptake may improve with the reduction in the off-peak rate from April 1999 and the confirmation of the cable link which will allow further reductions in tariff. • Reinforce supplies along Douglas Promenade to meet load growth and upgrade the 11kV network at a budgeted cost of £132k. Ducts for a 33kV circuit are to be installed at the same time. • Establish a 33kV primary substation in the North Douglas area to meet increased demand by April 2001. To secure supplies in the Douglas area, a 33kV switching station will be established on MEA land associated with Pulrose Power Station commencing April 2000. An additional 11.5/33kV step-up transformer will be installed as part of this programme to overcome the restrictions imposed by the two existing step-up transformers on the output from Pulrose Power Station. e - 14- 5.7 STORES 5.7.1 INTRODUCTION 4 Presently a centralised stores function exists at Ballacottier which holds stocks and materials for both the Retail and Network Services. Generation/Procurement stores are operated separately 'Avith stocks held at Pulrose and Peel. 5.7.2 ASPIRATIONS To provide a professional; centralised stores system to meet the MEA's day to day and major project requirements. 5.7.3 FUTURE PLANS AND OBJECTIVES • To maximise usage of space with continuous business expansion. • To obtain best purchase price for all stock items whilst ensuring quality of goods is not compromised.' • To undertake training for all stores staff involving Purchasing, Storage and Health & Safety. • To maintain stock levels to an absolute minimum and to avoid stock becoming obsolete. • To develop the stores operation so that, by 31 March 2001, its activities will be split between Retail and Electricity Network Service areas with staffing appropriately allocated. 5.8 TRANSPORT POLICY The MEA will manage its vehicle fleet on the most cost effective basis possible consistent with maintaining standards of service at the highest level. The objective is to reduce the vehicle fleet to 60 by 31 March 2002 and also increase the pool mechanism by a nigher 10% by 31 March 2001. It is intended to continue with the vehicle replacement policy of reviewing the overall general condition, maintenance history and operational use of each vehicle prior to purchasing a replacement. 6 CORPORATE SERVICES 6.1 INTRODUCTION Cotporate Services is to develop as part of the new organisational structure which will provide expertise and support services to Generation/Procurement, Network Services and Retail in the following areas: • Financial Control and Treasury • Human Resources and Administration • Legal Services • Information Technology - 15 - CORPORATE SERVICES ASSETS Value at 31 March 2000 £000's Ballacottier. Headquarters, Warehouse and Distribution Buildings 4,662 Heywood House (including value of Showroom £425k) & Car Park 1,597 . 4 Retail Premises Valuations provided by Black Grace Cowley to be reviewed every three years. • Douglas (ground floor and basement only) 425 • Ramsey 135 • Port Erin (including garage at rear) 130 • Peel (including flats) — 160 • Castletown (including flats) 90 Housing at Close Chiarn, Peel 480 • 63 LIABILITIES 3 Leasing and borrowing arrangements amounted to £8.6M as at 31 March 2000. 6.4 STAFFING A total of 47.5 staff are employed in Corporate Services at 31 March 2000. ASPIRATIONS To become a Centre of Excellence by providing accurate, timely, relevant, professional advice and support in all areas of Financial Control, Treasury, Human Resources, Administration, Legal Services and Information Technology that will assist all divisions in meeting their objectives and improving our Customer Focus. • -16- 6.6 FINANCIAL CONTROL AND TREASURY 6.6.1 INTRODUCTION Responsibilities include providing treasury and financial expertise and technical support, as well as recording all the financial transactions of the MEA in both its day to day activities and on major projects such as Phase V. 6.6.2 OBJECTIVES • To implement financial controls which assist Divisional Managers in ensuring that Capitatand Revenue programmes are met within agreed budgets. To manage the complete Treasury function by ensuring that adequate finance is in place for Capital and Revenue programme_ s and to safeguard the Cash resources of the MEA. • To report on the performance of the different business divisions in a relevant, accurate and timely manner to enable informed business decisions to be taken. To assist Generation/Procurement, in accounting, for trading within the Pool. • To provide comprehensive Management Information Systems to the MEA Board, Chief Executive and Divisional Managers in a timely, accurate and professional manner. • To ensure the smooth, efficient and accurate production of monthly management accounts and other management information such as cash flow forecasting within seven working days of the month end, signed off by the Divisional Managers and sent to all Board Members 7 days before the Board meeting To provide financial information that supports Phase V and other projects. • To replace the existing Financial and Retail systems with the introduction of an integrated financial system i.e. Navision by 1 April 2001. • To maintain the newly developed Fixed Asset Register in an accurate and professional manner from 1 April 2000 onwards. To actively increase the promotion of Direct Debit payment schemes in conjunction with the provision of prepayment metering systems for customers to maximise cash flow and minimise slow payment and bad debts. The target is to have 12,500 monthly Direct Debit customers by 3 I March 2001. • To ensure that the MEA is fully prepared to carry out its business in Euros and to meet any dual currency re quirements as detennined by relevant legislation. • To instigate the financial planning process on an annual basis to ensure that the capital and revenue budgets and tariff propoSal are presented to the Board in October of each year and that the Business Plan is presented to the Board in February of each year. • To arrange the most competitively priced financial solution, providing funds for capital projects during the next 5 years. - 17 6.7 HUMAN RESOURCES POLICY The MEA will continue to seek to establish an efficient, flexible, highly motivated workforce with the optimum degree of technical and administrative expertise, underpinned by effective general and specialised training, in order to meet the operational needs of the business. Staff will alSO be encouraged, by means of general guidance and financial assistance, to pursue personal and professional development through further education and secondments with appropriate institutions. The MEA will continue to maintain a safe working environment for its staff, and foster the understanding of the safe use of electricity by its customers. The MEA will aim to achieve the Investors in People accreditation by 31 March 2001. HEALTH & SAFETY The MEA will maintain the highest standards of Health and Safety. Actions arising from the AON Risk Services Health and Safety Report has identified areas of work where risk assessments need to be undertaken. These actions will be completed by 31 March 2001. The effectiveness of these measures will be monitored by reviewing accident statistics and a particular objective will be to achieve a whole year without a • three day lost time accident. It is intended to continue using the Safety Committee as the vehicle for implementing safety initiatives. Develop and implement a Drugs and Alcohol policy. STAFF APPRAISALS The MEA will operate an effective staff appraisal system on an annual basis. It is intended that, in consultation with the Divisional Managers, checks will be carried out on a sample basis with a view to ensuring that the process has been carried out in accordance with the MEA's procedures and that, in particular, the targets set are objective and challenging but achievable. 6.7.4 MEA TERMS AND CONDITIONS The 4 year terms and conditions agreement has facilitated the establishment of a comprehensive staff benefits scheme which became effective from December 1999. It is intended to continue to develop and improve the scheme on an ongoing basis by encouraging other companies to provide discounts or services to staff at preferential rates. -18- It is intended, where appropriate, to introduce a productivity scheme.. The 4 year terms and conditions agreement allows for the removal of the roster day arrangement and overtime multipliers. Salaries will be increased with effect from 1 April 2000 until 31 March 2003 in accordance with the MEA agreement. 6.7.5 TRAINING The objective is to continue to develop and implement a formal induction scheme for all new appointees which will include a one day familiarisation course incorporating information relevant to their intended activities and a general overview of the MEA. The MEA is committed to the policy of continuous development of its staff. The MEA expects employees to recognise the need for everyone to develop t their skills on a continuous basis and to undergo agreed training with a positive and flexible outlook. It is intended to develop and implement a formal corporate training policy which will provide guidance and development to all staff by 1 April 2001. The policy will also provide guidance to line .• managers to , identify, during appraisal interviews, staff training needs. Training arrangements will be coordinated to ensure maximum benefit both financially and operationally from the courses provided. It is proposed to continue with psychometric testing in order to further improve recruitment. 6.7.6 ADMINISTRATION SERVICES The objective is to offer a wider range of administrative services on a basis which meets the requirements of internal and external customers. A review of insurance cover will be conducted, in conjunction with our insurance advisers and Government, on an annual basis. 6.7.7 NON-OPERATIONAL BUILDINGS POLICY The MEA will manage its resource of non-operational buildings on the most cost effective basis consistent with providing efficient work bases for its staff and commercially attractive premises for its tenants. It is intended to redevelop the Castletown premises site to allow for improved facilities within the Showroom area and the creation of an additional flat which will maximise the rental income of the property. 6.7.8 MANAGEMENT OF NON-OPERATIONAL BUILDINGS The objective is to seek to obtain full commercial value for leased premises. An agency will continue to be engaged to seek tenants for the third floor of Heywood House. It is proposed to extend the contract with the agency to take responsibility for the administration of thetenant car parking at the Lord Street site. - 19 r. Alternative arrangements will be made for the medium to long term storage of documentation, following the granting of planning consent for the development of a general stores building on the site of Peel A Power Station. 6.8 LEGAL SERVICES INTRODUCTION The Legal . Services Section maintains all the legal services required for the everyday running of the MEA including obtaining the necessary Leases, Wayleaves and Easements required to secure our Electricity Network Services and to ensure that the MEA complies with the Electricity Act 1996 and all other relevant primary and secondary legislation. The Legal Services Section gives or obtains legal advice on all aspects of the MEA's business, including areas such as contracts, purchase and sale of land, VAT, retail legislation, resale price maintenance and data protection and liaison with the MEA's professional advisers and Government departments. The Legal Services Section also deals with complex insurance, customer, revenue protection and debt recovery issues. k • OBJECTIVES • To ensure that the Board, Chief Executive, Directors and Senior Managers obtain prompt and pertinent advice on legal and statutory issues. • To ensure that all MEA staff receive prompt and pertinent advice on legal and Statutory issues affecting their areas of work_ • To introduce a new Wayleaves computerised recording system using NavisiOn software. • To create and maintain an asset register of all land owned by MEA. • To identify and secure all necessary LeaseS, Wayleaves and Easements for our existing underground High and Low Voltage network. To ensure that all necessary land, leases, Wayleaves and Easements are obtained to allow new network developments to proceed on a timely basis. To liaise with the DTI and other Government bodies on statutory and other issues. To monitor all new and proposed Manx, UK and EC legislation and comment accordingly. To ensure compliance with all statutory and regulatory requirements, including VAT and data protection legislation. INFORMATION TECHNOLOGY 6.9.1 INTRODUCTION The MEA relies heavily on a sound computer base and IT infrastructure. As we move - into the new Millennium it is imperative that IT solutions are found that best meet our business requirements and objectives. -20- 4; 6.9.2 ASPIRATIONS • To provide technological support and solutions to meet the needs of the . different business users. • To ensure that the MEA is at the forefront in all aspects of Information Technology. 6.9.3 OBJECTIVES • To deliver a programme of planned maintenance, replacement and systems development agreed in the annual budgetary process. Deliver a proactive response for maintenance and support of software, hardware, communications systems and training to standards agreed annually during the budgetary process with the different divisions. To implement an e-commerce strategy to meet the business requirements of the MEA. This will include Internet, Intranet, Extranet, e-mail. • To provide relevant, cost efficient IT training to all staff as and when required. • To integrate all MEA Financial and Retail based computer systems onto Navision by 31 March 2001. • To assist Network Services in implementing Navision where applicable by 31 March 2002. . • To assist Generation/Procurement on implementing a package that will best meet their electricity trading arrangements prior to the commissioning of the cable on 30 October 2000. To ensure that appropriate IT staff are fully conversant with Navision programming language and report writing by 31 March 2001. 7. INTERNAL AUDIT 7.1 INTRODUCTION Internal Audit is an independent appraisal activity with two staff, established as a service to the Board and management of the MEA and is an integral part of the Authority. It is a control ftinction designed to review and evaluate the adequacy and effectiveness of all Systems of internal controls and compliance with statutory and regulatory requirements. The role, responsibilities and scope of Internal Audit are documented in the approved Audit Charter. The Internal Audit remit covers all financial and operational activities across the MEA including system development, ad-hoc enquiries and special investigations. 7.2 ASPIRATIONS • To make a positive contribution to business efficiency and effectiveness. • To be the provider of advice on control issues in managing risks in the business environment. 7.3 OBJECTIVES • To ensure the Audit Charter remains appropriate to the needs and aims of the MEA. -21- • To complete the agreed audit operating plan within the budget. • To issue audit reports promptly in a clear, concise and easily readable style, format and structure. • To follow-up preViously agreed management actions arising from reviews: To work with management and staff to improve the control environment To monitor the efficiency and effectiveness of the audit process 'through bench-marking against comparable organisations. To comply with standards and guidelines issued by the auditing profession in managing the Internal Audit function to provide a high quality service. • To introduce good practice in the review of internal controls. • To liaise with external audit to minimise duplication of effort. 7.4 OPERATIONAL PLAN Internal Audit maintains a programme of auditable activities from which an annual operating plan is prepared. The programme of auditable activities is revised annually to take account of changes in the business environment, business opportunities, proposed implementation of new systems and ongoing developments. The annual operating plan is put before the Board for approval. Activities are - included in the plan based on overall risk and the relative importance of each by: • quantifying the financial significance to the company • having discussions with senior management to identify their concerns • assessing the stability of the business area • identifying areas which impact on the MEA's finances or reputation. The audit strategy is to give priority to those processes that support corporate and divisional objectives. In this way Internal Audit adds value in providing assurance to management that internal controls within the activity being examined are effective so that objectives can be achieved. The strategy is reviewed at least annually as part of the annual planning cycle. - The internal audit report is the core audit product The issue of the final version of audit reports will be monitored from completion of the fieldwork to ensure these are released in a timely manner. Follow up audits are to be carried out within six months of releasing the final report to management. The scope of these audits will be to ,, ensure previously agreed management actions documented in the final report have or are being implemented to realise the benefits. Operating processes and procedures for planning, conducting and reporting on audit findings are documented in the Audit Manual. The Manual provides the means of - monitoring the quality of service and will be kept under review as Internal Audit develops over time to ensure operating procedures and working methods remain adequate. As Internal Audit is a service to management, the views of management will be sought on the quality and effectiveness of the audit service to identify any aspect for improvement. Feedback and comments obtained will be used to address any shortcomings in the level and standard of the service. 22 - The ongoing training and development programme will continue to build upon existing skills and knoll/ledge base. Training is to cover auditing techniques, interpersonal skills and the understanding of business applications to assist in completing the plan. Training will be responsive to the changing needs of the business: The audit IT strategy will continue to promote IT literacy and improve access to data and infotination. The use of electronic working papers and interrogative tools for data retrieval and analysis will be developed to improve performance and productivity of internal audit staff 8 RETAIL DIVISION 8.1 INTRODUCTION MEA Retail Division operates five retailing showrooms plus an after-sales appliance repair service which provide sales and service of high quality domestic electrical appliances Island-wide. In addition, the showrooms provide direct customer service facilities in support of the MEA's core electricity supply business, whilst generating a profitable income stream for the MEA. STAFF The Retail Division employs 32.6 full-time and part-time staff in all areas of its activities including shop operations, appliance repairs, appliance deliveries and head office administration. OBJECTIVES • To increase annual shop turnover to £2.85M by year 2005 with a minimum gross margin of 29%. • To create a surplus of 10% on retail sales achieved. To - increase the income of the appliance repairs department to £325k per annum with a surplus of £40k. • To maintain Divisional stockholding requirements below £400k. • To increase the profitability of the Hire Purchase register by 5% per annum. To maintain payroll costs within Manx inflation. • To contain or reduce establishment costs in real terms over the next 5 year period. To provide affordable high quality customer service in all areas of operation. To continuously seek and review alternative trading premises for our main outlet in Douglas. COMMERCIAL DEVELOPMENT PLAN •8A.1 SHOWROOMS • A programme of continuous minor refurbishment will ensure shop presentation is maintained at the highest affordable levels. 23 - • The dictates of the market-place will continue to formulate the future shop opening hours and emphasis will be placed on affordable staffing arrangements designed to meet customer needs on both a daily and hourly basis. • The operation of in-house franchise arrangements will be continuously reviewed and amended as required. • Display and support will be apparent for the MEA's ComfyHeat off- peak tariff heating systems and Manx Energy. Additional emphasis will be given to energy efficiency matters, including both electrical appliances and energy conservation at home. With the need to achieve the best possible trading results from our main branch in Douglas, the potential of a prime, affordable High - Street position continues to be sought with an emphasis on leasehold - opportunities. • The acquisition of, or amalgamation with other similar product related companies will feed the necessity for future growth and diversification. Such arrangements will be quietly examined on an ongoing basis. • The attributes of e-commerce will be pursued as an aid to sales in all product related areas. • The use of computer Internet facilities will be sought to streamline activities with both suppliers and customers. • Increase training activities, funded where possible by suppliers to ensure retail industry best practice. • Major refurbishment of the MEA's property in Castle Street, Castletown will enable complete re-organisation of the Castletown showroom. Modern fixtures and fittings will be' applied to enable complete modernisation of displays and the business will be marketed accordingly. Local temporary premises may be sought to ensure continuation of business during the period of refurbishment. The continuing market trend of multi-fuel cooking will be followed with limited displays of electric cookers with gas hobs made available to the public. Suitable after-sales service facilities will be organised to ensure compliance of the gas regulations. 8.4.2 APPLIANCE REPAIRS & DELIVERIES • Workshop charge out rates will be examined to ensure the best possible returns for our activities whilst maintaining value for money for all customers. .• Our spare parts stockholding will be reviewed continuously to allow potential reductions in stockholding values whilst the speed of UK mainland supplies will be enhanced. Emphasis will be given to increasing daily performance of both the repair and delivery departMents by whatever means are available to us. InCreases of the in-guarantee repair fees from all manufacturers will continuously be sought. • • Technical product training will be ongoing, utilising the training facilities of our main brand suppliers to offset costs. 24 - 8.4.3 HEAD OFFICE • The introduction of Navision retail systems is planned for late Summer 2000 and current manual administrative operations will be further refined to enable greater efficiency of transaction. • All trading margins and agreements of supply with major suppliers, including local wholesalers, will be reexamined' to enable enhanced gross profitability and improved service to • customers. ' Alternative sources of supply will be considered, where appropriate, to assist in this objective. • The quality of our advertising and promotions will continue to strive to attain the highest possible levels and extended promotional funding budgets from suppliers will be sought • Assistance will be given to all areas of the MEA's operations requiring showroom facilities to achieve their overall objectives. 8.5 MANX ENERGY This function will continue on the basis of providing an Energy Advice Centre to promote energy saving devices and information to customers via the Retail Showrooms. Technical support will be provided by Distribution when necessary PUBLIC RELATIONS; A newly created Public Relations Division will conduct internal and external communication initiatives together with building a positive relationship with all Media. The Division is run by one Manager with back-up being received from representatives of all MEA Divisions. Specific issues are • Staff Awareness \ • Procedural Problemsxelating to Communication • Production of a Monthly Staff Newsletter • • Production of the Bi-Annual Current Affairs Newsletter • Sponsorship and Charitable Donations • Corporate Identity Standaici (iicluding the proposal for a new corporate identity for the MEA) • Liaison with IT regarding the creation of an MEA Website • Review of all Leaflets:Periodicals, etc. issued by the MEA - 25 - IANCIAL INFORMATION OFIT AND LOSS ACCOUNT ACTUAL Assumptions Year to 31 March 2000 2001 2002 2003 2004 2005 E'000s E'000s £'000s £'000s £'000s r000s fER y Supply 29,206 29,965 29,492 28,625 29,388 32,028 come-gross 0 1,362 1,378 1,634 5,887 5,887 Services-Cable 0 104 250 250 250 250 ontracting and Rental Income(net) 686 685 713 741 771 802 Profit MCC Limited 44 9 2 36 27 22 from MCC limited 0 350 750 750 800 850 8 ;orTie 29,936 32,476 32,585 32,036 37,123 39,838 riNG COSTS on costs-Oil 8,592 7,389 3,720 1,290 835 1,270 on costs-Gas 0 0 0 2,400 4,700 4,700 Oat CoSts 0 2,624 5,975 2,686 339 343 :;osts 0 181 434 434 434 434 3 ports 0 797 806 562 2,024 2,024 inerabon costs 4,091 3,916 3,760 3,087 2,904 2,450 Services 2,725 2.545 2,545 2,545 2,500 2,500 e Services 2,965 2,885 2,885 2,885 2,800 2,700 intal 0 2,173 5,319 5,479 5,643 5,812 tion 4,165 4,316 5,500 5,500 6,300 6,500 11 erating Costs 22,538 26,826 30,944 26,868 28,479 28,733 st payable 1,433 1,055 200 3.600 3,000 1,800 9 it 5,965 4,595 1,441 1,568 5,644 9,305 s (millions) 307 331.56 364.72 401.19 441.31 485.44 Price per Kwh(pence) 9.51 9.04 8.09 7.14 6.66 6.60 Tariff Reduction % since 31/031200P .5% 15% 25% 30.00% P1TAL BUDGETS ACTUAL Year to 31 March 2000 2001 2002 2003 2004 2005 ty Generation/Procurement 153 310 200 200 200 200 y Network Services 2,564 3,127 2,967 3,312 2,105 3,205 :e Services 98 495 286 246 266 246 3 20 50 20 20 25 0 0 46,000 Ner 0 0 0 10,000 2,818 3,952 3,503 59,778 2,591 3,676 10.3 BALANCE SHEETS ACTUAL Year to 31 March 2000 2001 2002 2003 2004 2005 ixed Assets at cost 69,275 68,911 67,914 122.542 119,283 116.859 tevaluation Increment 130,000 130,000 130,000 130,000 130,000 'bred Assets at Market Value 198,911 197,914 252,542 249,283 248,859 .oan to MCC Limited = 0 40,000 39,669 39,322 38,957 ivestment in Manx Cable Company Limited 4,552 4,561 4,563 4,599 4.626 4,648 let Current Assets 6,234 8,006 67,684 12,300 18,709 29,484 Ieferred Income -5,624 -4,519 -3,329 -2,054 -684 0 oan Finance -10,105 -8,032 -6,464 -5,120 -3,676 -3,042 fond Finance -100,000 -100,000 -100,000 -100,000 reserves -64,332 -198,927 -200,368 -201,936 -207,580 -216,886 0.4 CASHFLOW FORECAST 2001 2002 2003 2004 2005 rofrt 4,595 1,441 1,568- 5,644 9,305 'epredatlon 4,316 4,500 5,150 5,850 6,100 lotional Interest 595 580 525 480 and Issue 100.000 oan Reprayments -MCC Limited 331 347 365 ,etalned Cash 9,506 106,501 7,574 12,321 15,770 tending Charges 1,700 1,750 1,800 1,850 apital Expenditure 3,952 3,503 59,778 2,591 3,676 oan To MCC Limited 40,000 0 an Repayments -Gas Turbines ease Repayment Capital 1,971 1,466 1,242 1,342 532 DA Government Loan 102 102 102 102 102 otal Spend 7,725 46,821 62,922 5.885 4,310 ASH GENERATED 1,781 59,680 -55,348 6,436 11,460 pening Balance 1107 2,888 . 62,568 7,220 13,656 losing Balance 2,888 62,568 7,220 13,656 25,117 ctricity Generation/Procurement e Budget ACTUAL Year to 31 March 2000 2001 2002 2003 2004 2005, Nines 1,291 1,276 1,269 800 600 500 Machinery 743 996 920 750 750 650 uildings 220 281 298 307 316 250 ;osts 1,654 1,750 1,650 1,600 1,600 1,500 Costs 46 117 122 124 127 100 ids 137 246 251 256 261 200 tion ' 2,387 2,400 2,450 2,800 3,500 3,500 ciency/Price savings -750 -750 -750 -750 -750 Costs 0 181 434 434 434 434 sport Costs 0 2,624 5,975 2,686 339 343 • l ' `come 0 -1,362 -1,378 -1,634 -5,887 -5,887 exports 0 797 806 562 2,024 2,024 on costs-Oil 8,592 7,389 3,720 1,290 835 1,270 on costs-Gas 0 0 0 2,891 5,782 5,782 .1 15,070 15,945 15,767 12,116 9,931 9,916 ctricity Network Services Budget ACTUAL Year to 31 March 2000 2001 2002 2003 2004 2005 & Maintenance 2,178 2,000 2,000 2,000 2,000 2,000 Costs . 254 245 245 236 200 200 ing Support ServiCes 293 300 300 309 300 300 preciation 1,444 1,566 1,700 2,000 2,000 2,250 4,169 4,111 4,245 4,545 4,500 4,750 porate Services r Budget ACTUAL Year to 31 March 2000 2001 2002 2003 2004 2005 rig/Billing/ Meter Reading and LT. 1,480 1,373 1,373 1,373 1,300 1,200 kdministration(incl F.xec Payroll) 1,485 1.248 1,248 1,248 1,236 1,236 Wayleaves 0 172 172 172 172 172 udit 0 92 92 92 92 92 tion 334 350 350 350 350 350 3.299 3,235 3,235 3,235 3,150 3,050 •••.• • 10.8 Retail, Contracting & Rental Income(net) ACTUAL ' Revenue Budget 2000 2001 2002 2003 2004 2006 Retail Marketing Net Profit 308 320 333 346 360 375 Rents ( Net Income) 196 204 212 220 229 Manx Energy 27 0 0 0 0 0 ;ontracting 155 161 168 174 181 TOTAL 686 685 713 741 771 802 : JiiiirrnONS ales grow at 10% per annum for 2001/2002 to 200412005 will be commissioned on 30 October2000 & Gas model summary VOLUMES 2000101 2001/2002 200212003 2003/2004 2004/2005 KWh KWh KWh KWh KWh Demand 342,576,000 356,279.040 370,530,202 385,351,410 400,765.466 3eneration 'Oil 258,819,755 130,301,054 44,476,109 29,259,286 44,509.092 Generation -Gas 0 0 262,800,000 525.600,000 525.600,000 -Imports 111,674,993 254,225,234 114,302,993 14,452,124 14,616.374 - Exports 27,918,748 28,247,248 51,048,900 163.960,000 183,960,000 las+imports 370,494,748 384,526,288 421,579,102 569,311,4W 584,725.466 Import Ratio(%) 80% 90% 40% 5% 5% Export Ratio(%) 20% 10% 18% 64% 63% 2000101 2001/2002 2002/2003 2003/2004 2004/2005 E 3eneration -Oil 7.389,283 3,720,085 1,269,789 835.350 1.270,731 Generation -Gas 0 -0 2,400,000 4,700,000 4,700,000 - irrlicifP1 2,624,546 5,974,711 2,686,308 339,649 343,509 -Exports(Profrts) -565.357 -572.009 -1,072,027 -3,863,160 -3,863,160 b Costs 433,800 433,800 433,800 433,800 433,800 9.882,272 9,556,587 5,717.871 2,445,639 2,684,880 pence per unit pence per unit pence per unit pence per unit pence per unit 3EN PRICES 2.85 2.85 2.85 2.85 2.85 ve Import Price 2.35 2.35 2.35 2.35 2.35 2e Export Price 4.88 4.88 3.2 3.2 3.2 rice(p/k'Wh) n/a n/a 0.9 0.9 0.9 ition Ancilliary Servuicese Income associated with eg Triad Benefits and Standing Reserve assumed :250k per annum Cant will be' commissioned on 1 Novemeber 2002 I Bond will be Issued on 1 June 2001 at 6% coupon ads of Bond to be used as folows:- for Gas ProjecL £1 Om for Wind Power and £40M as a loan to MCC Limited tional Cost Savings of El M per annum ation E750, netwirk Services £180, Corporate services £80 come from Retailing,Contracting and Rentals is expected to grow by 4% per annum from 2000 nd and share of Profit is as per five year plan for MCC Limited terest Payable Calculation 2000/01 2001/2002 200212003 200312004 2004/2005 • i E'000s E-000s E*000s C000s COOOs ank Leasing '. 451 308 209 109 16 at Interest 595 560 525 480 0 ovemment Loan 130 120 110 100 90 Merest 4) 6%(note 5) 0 5,000 6,000 6,000 6,000 it from MCC Limited -1,800 -2,400 -2.400 -2,400 it Receivable -116 -3,754 -433 -819 -1,507 - 1,060 434 4,011 3.470 2,199 1055 200 3600 3000 1800 7.s by Commissioning Gas and Cable 2000/01 200112002 2002/2003 200312004 2004/2005 r0001 E'000s £000s C0008 £'OOOs ation costs if no Cable or Gas is commissioned 9,781 10,172 10.579 11,002 11,442 ation costs with Cable and Gas 9,525 9,307 5,488 2,195 2,634 7s by Commissioning Gas and Cable 255 865 5,091 8,807 8,808 nation increases due to reflecting market values of assets and Gas and Wind Power additions. tate is 6% dation is 3% • • availability assumed for Cable and Gas post commissioning. late change levy assumed. Manx Electricity Authority PKF.* '4 1', . • r SP!' . •`1 v•- Appendix 5 Cains letter dated 9 July 2003 • . : P. ry w I- ... • . May 2005 Appendix 5 Yr CA :N A 6:..\:cr...s7ic:f...• •rr.. -.17-.- : 7E.Ln MONS. - 44 112 4 C.? ' 7 -.Y. - 44 1524 E.? E/X NIE:/trae'21's3ti.D0211 Diancr -44 1-',;,2:4 t 3;.37.*:i Vii. July 2003 Barclays Private Clients. Internalional Eagle f...ourt 25 Circiular Road Douglas Tole of Man . Dear SLrs, Manx Cable Corn taxmitcd (the "Cow.•any'l and The Manx A.uthoritv. (the "M:F..A") Preliminary . 1. We arc 4:4- Enza of .advocates practising in am Islc of and arc qualified to give yob this legal opinion under It;lt. or Nfa.n 1}nv. •-., 1• e- undees. tand that Barclays•Private Clients International Lirnitied 4ho -Bank') is to ritak.e a luau ay..ilable to the Company and. the s:TA i5 da gan.. a4.7,arantce in favour 4.317 the Bank in respect of the obi i 8iations- of the Corn:pi-my to the Bank. DOCUMentS Examined 3. For the purpose of giving this opinion we have examined copits '1.?w followinE, doctiments (but no othcrs): 3.1 a facitity agrecrucnt. dated 8 July 2003 made berween the Flank, the Company and the !AMA "Loan Af4reeinerey, the cl-zicirt i'delficFrandurn ,of Ass-ociation of the Convany appearing on the file of the .C.ompazy raain(ainf.id by the Is (If 'Mall Firraryzial Supervisiorl Cc...I.:II-nisi:Aim (the -SSC1 ") L.t its Companies orr s.earch ate' (as cle.11-10:1boiaw); 3.3 the SIALL.Liory' 2.0,5: -13S Act 19,7 ithr. "SI3A—.1 a-.1d ihc Elivi-icit-v Act (as ,urne-2(3(1,..•..3) (the "1.-7'7:4; 3.4 2 July 2003 from dre Tv1-1:.A Advoc-ate. e.. ;.} i P.1 AO L; : F iji r7 ri "Kr ! 1;16 'e'er J WA' Tee. ; = • 1 I ..t=i;":.F.T . . ,:-.urolLi .1. 1—L " ; V.% r. 14 L'..iNt/1.1- 1.1:7 t /ri,: ,:.•7r.7•% ,-"" 4 C, - 7, ■ • 71 -r. .•,, a: : To -7. ,• • fIrkEr. . .. e. 1:.•; • 1 . 3.5 c=: rack of mnutca: of a mee-',iryi:. Or the board of directors of the Compuly held 4 July 201::13 (the "Company \-linutcs"); and 3.t c.xtr.1 or I-nit-Jut:es of a ruixtinz. of the fC..z held up JUly 2.003 (the ''.1%.4.E!', Starnes 4.1 On 9 July 2003 (the '"seareh date) we proc.ure<1 a seara or the f..1.e 1mi:in -a:filed by the FSC in relation to file Company. Please note that our scareh only refleeted documentation which had been pPmesse(1 by the ESC and placed on the Company's file, and not reflect rnarteEs which had been iod.ied.for hrrt rii L a/ALally been placed on such file. 4.2 0-n the search date, we also proct.red that, a search in rmspe4Lt of the Company be undertaken at the. Rolls Office o the High Court of Justice in the Isle of Man. W would ask you to note that the search at the:Rolls Office is a manual geardl and cannot Ire i-elied..upon to reveal whether or not a particular entity' is a pazly to litigaion in the Isle of N.farL -The Roll is updated less than once a wock and it is not updatal if third . pa ,ie8, or noticed parties are added to or removed ..from -proceedings a rte.7 commoneemmt. In ile of its deficiencies, a search at the Rolls Office is the only meam of chcchng whetha or not an individiJal or entity is a party to litigation in the - • Isle of Man_ Isle of Man Law 5 . Ihrc hwe not irivmtii7,41tx1 Lhc lawY-1 of any jurisdiction other thaii -thc Isle of Man alld this opinion is given only with respect to the currently applicaNe laws of the Isle of Man and is even Ori 1_)e basis that it will be governed by and construed in accord; noe with such laws. Assumptions 6_ For the purposes of giving L1,is apiniun, we have asst.unt 6.1 the genuinc=s of a:',1 signatures; the r.:4-lacity of all signaitorics; the authenticity and completeness of all documents si1.7mitte..d to us as originals; the cov_ortnit-y. with atigival docLuncurs and complet.eness of all documents s)thaiitted u.;-; as 6_ 1 the correc.trins (-r ali 5Cuie-1 lrl , COrillrEllatiOnSIX11. and repr...t.dentatioris made in the Loan Ag•ommmt :.Tad ih LftriNtr oxprvz5:;:ly opined upon herchil; . r). hr.ve boen. wiLb 01- ginals oI =ll flocurn€:nts to the transt4ction by, pr .tzletrred n i.n, 111e . Aian or Irrltil-h1Ii eitt affect the opinions rher.:.., is auy ....2.•,- -2c.tir1m-:.5 of e nc.o. :At 71± z'al, jr. i, is ..r7Pritr. 6.5 that the Bank is duly organised ,Ind existinzy Ly, at the date (If the Loan A.La-z!ement and has full -c3pa ,z1:y. alithority and all etifi rcgulatoly and other anprovak, exemptions, Lieenees and authorisations to . cleliver and perform ea:rh of its cillitation Load. Auoement; 6.6 that the Rant has 1 1 exot..;ged nod deli,eiled the same in actx.:talani:.; such authorisations: 6.7 that ale ex;J:css,e0. 13 be ;A:7;surntez1 by the. B;inme are vaHd and legally binding; 6.8 • that no provision of any am-commit, mortgage, charge, trust deed or licence (excluding the_ Loan Al2reernent) to which any of the parties to the Loan. Agreement ic, a. party or 'by which any such party is bound would be contravened by the execution or delivery the Loan A &Teem era; 6.9 that no provisions of the laws of any jurisdictions outside the L1C- of Man would 'be .contravened by the execution OF delivery of the Loan Agreement; - 6.10 that, in...ofaz- 4-is any oblig,ation under the Loan Agreement falls to be performed in any jurisdiction outside the Isle of Man, its performance would not be unlawful by virtue of the laws of (h-L1 juri$cliction -, 6.11 that no laws (other thou ,of the isle. of Man) which may apply with respect to the Loan AEI-cement or the transa.cdons and matters contemplated thereby would be such as to of any of the opinions stated herein; 6.12 that the loan A;4-cement is valid, binding and effective and imposes legafly binding and enforceable duties and liabilities' on the parties thereto in • . accordance with its terms under Lhc laws by which it is cx.pres -.56d LLD he go:verned and any other applicable law (excluding the ia.ws of the Isle of Man); - &13 dial, ILS at the search date, the file raajualsiirttd by the FSC in relation to ti-► t: •.. Company 2c:4:i:rattly and eorriploely recorded and reflected all resolvtionj •• pa..5.5:111,:-g-id other actions or events in relation to the 'Company whieh give rise. to obligation on the part of the Company or any other party to deliver fcirms or -- documents to the FSC or, previously, the R:=E:i6trar of Companit8 in the Isle G Man; 6..14 that the resolutions F. t L out in the Company Minutes wcrC duly pa.ssed at proper)}' r.4,mvencd and laeld meeting of appointed directors at the Co;7tpany arld resolutic.-ao have 11-.)t bccin varicd, rtrnoudcd or and 1,..1.main . cc the d re.artli is letter; in Ell force and effect )3.ii that a12 of the requirernr.1".:: 01 Schedi:le 2 oir.he relation .0 tie mc-,e6-niz of The NITA in kfinu=les relate: 6.16 that the ,execufion del ivory' tai i iC 7, flan ALr,retT:7Lcrit b.y Ile rOillpally MIC, the exercise of its r.ihts anti Cie nt.Tforrhanee oF ilk obji!..ratiCa3 . platClia12"./ LiEue:ftt d.0 CQmpany - ;..nd that the Lori &It is ent.crey.i inn - .L-toodizith. by the Cornilary a ic1 [ .or perpo..,:cf; on t.i.17 that neither Company nor the lvfLA tiD pay its Heil:; - meaning of Seecian 163 or the Isle of Man COIriDalieS Act 1924 when' it '• :-..,xcoited the Le[in_=....-eorarmi lind did Tot beaTrne-so nr.able IITInsE:cuence_ of — the ex:ecution of 1.o ....-reeinent; tc..1 that ,a1.1 iecoriais, publications, notifier:tions .and are necessary' for the purposes of protcc-ang the inter:C'6L5 Lei be created by ihE. Loan. Agreerneol or :au may be minired to permit the perfoirnance thereof by any patty Lh.trcin and aoy pc.r5c.m derivirt2. an interest through any of the panics thereto have been. made or obtliined within the Lirrle permitte or will have been made. or obtained within the time permitted, in alljurisdietions other than the Lie of Man; 6.19 the accuracy and currency of the records and filing systems maintained at the • P Lib] i ollic=q where we 'have se.....-shed or inquired or have eau.sed searches or inquirizs 'to be conducted; 6.2.1) that all necessary consents or approvals oi and all necessary re eisaations or other action by or with., any regulato7 authority or any other person or entity outside the Isle of Main have been or will be obcained, performed or -taken hi relaton to the ex-ecution, delivery and performance of the Loan IL.grcenient each rthe trcLo; 6.21 that thc: dirwtors of the Company 4....nd the members of the hoard or the MEA . arc acting bona fide in the best interests of the Company and the respectively; .6.22 lbaa thrz arc Do vitiating factors of which we are unaware such as fraud,. undue influence or duress, which tnigl-it affect the opinions eXpr2SS.1 in this lett er. Opinion?. On the basis of the abov'e assumptions and subject LO any maths riot disclosdd tO US and to the qualifications se out below, we are- cif the opinion Iliac: Status The Carman y if: a company Emitted by shales duly incorporated anri validly ed.Sling under tie 1aW....; ()I- the isle o 1. Man and possesses the c.-..anacity to sue. ara to bc.sted in . 7.2 The.. M7.4. ukupo7al.ksn and validly caiisliny. und:x the :laws tho isle of Wiz its C011,5llifItiM. s SUI Ihe 513A and EA and th:-.; provisions of lc Companies Acts 19 7:1 to I99 and hk 4r f Man. cOmpAry gellCraits: do not apply 1-a The pl-.1.sse:c.5es ibe sue an:i be 5iled in its own nalic ..A Far a; Laz, c, al the ESC: no steps have Lac r_ or ar.c being taken to at:pr.:lit a rryzciver • per:oii 1:01:1:: o: towind :IF c.rdisse.lv ...s. t:an. xripany Or to ;kit,..•= ando:21:•1s acti.:: =oft: ;rit- tli r:3iagr3 3114.1 , Cop witv 7.4 Compzny the c..•177< rate Lic:)„.iver perlDrrri obligations under the L.1.):1-ri A.Lr.reenienc. Ile Nil hA cagy.ity to Lii_tliver and perfcwin it obl.:garicitis under Lhc Lo:in 7.6 E.ach of the Company and thc all rlece ary resolutions to Authorise the e.:5ecution, and pc.xfounaricz...• of Pat! E.Dart A8reement_ Director 7.7 According to the. tie of the Comptmy niainutirkx1 by the _FSC scardi Michael Joseph Proffitt i5 diredor of the Compny. However,. ple.ase .note the • • contents of paragraph 4.1. M J Pro.F.E.ri bas been duly aufhori.wd by the Comp.may Minutes to .si gn the Loan Ageettamt on behalf of tht Curl -Tarty and C J Wilcox has bcon duly authorised by the 'MEA Ntinutcs to sim the [On A O'etrn EMC behalf of the IAEA. 1..t.L..al V alidiry- 7.S The Loan .A1:.weement consrinites 1cga1. valid an .hinding c.,bligations of the Company •L'Ind the M.E.A. enforcz.g)1,2 accord.anou with its RInn.S. No .Linlitntion 7.9 it 'MerclOraficillzil and ..Nr6cics of Ass:).c,istion cif the Company contain limitation ou the powers of the CA-..liciparry or the atithori7y of the dirccion-; borrow. •on eys. .A.poroval.5 ;Ind Cork s ; 7.10 No 313thori.5.aticlas, -approv44.13 (inetuding vriCaoio. limitation fly e7Coltan.8e contol cottsents) from au v .;!.overnmental tole of Man arc ri-.;quircd to bc• obtriincd-hy the Co cripany or the /+-1EA. ir, relaiOn ant: dr.eh'ely each of them of [he 117. r3): '1} aand ft per 171:Tr r: z:1-1. their ObligY.if.ria.;•crt,arid-2-::". • 7,1.1 Thc.. excr.:-Lrhian, tik. Loan dN.:.5 not arid will it,golation tlie v-. 5:,.l7j=c1...: • any provision die tLontp::••.ny'.:1 -:',..leitto::::itilt.::ii of 71'2 cv-cution : defliiiery pe!forrrmilLe 1..:NitiAiuecri.....tni 1) _NT EA doe5 :nor, and v..ill not: ccrirravene any exisrir:2 taw rc regulation or the Lild of Man h? AIich it is subject:, of. excetii i1s statutory pow.:.Ts or cmAl iv3nc Or C.OlifliCt Wq11 ih6 provi Rion"; of SehE,dule 2 of the :4-ad Re.izi.31rations 7.13 IL is not liCCeSSary or advisable tuider the laws of tilt Isle of 'Man, in orda to onsure the validity, effectiveness and et ,tforcealliliry or the Tzan Agreement, that the gimebF Eltd. registered or recorded in any public office in the Is1c .of Man. • StanaD and ltezistration .EhlLitS; 7.14 Thic.. Loan Agreerneradoes not give nxe to .aay re8istration duly or :t'Crap day in hy the of Man or any authority or .;fgoney tlicreof. immt rni L y 7,15 Each of the Company and the lvfl7A i.5 FahjexP. lo Lb: inrisciict.ion of roe Co -inti or the Isle of- Mar) and is nut traiLltul Eci claim any in-tirlimity from sail or exietALLidn • of any judgment on E7.-oimii of zove..1-cisaitv or (slhcr,vi5c-, Clioic-:t of Laws 7.16 The choice ofl-n ilrovii;ion Tkan Agreement (providing for the same to be govenied and cot-Estrum] in OCC4..Tdalice with the laws of England) a valid and binding obligai On crC Llit Corapany and flit VEA. Submission co Jariskiiction 7.1 .7 The submission by en..± a I. the Uonipany and the MEA to the Juriaiiction of the -outs of England cc-..rit.t.-ifitd in the TAF-.JI A , ,rt...... e7rten •i:-; a val id F47.filrcttr...ent Enzlisb tudt7:rner it judt2,rnetil for a :.± 8_ NT-withstanding the foregoing. this opinion is subjt.....d. ;CI the ft.:.11owiniz. qualifications: 8.1. Insolvency and Equitable Defences S..1.1 The peribrmance and enforcement or the T...oan AP:rem:tent may be limited by • laws relating to bankruptcy, insolvency, Liquidation arid reorganisas:ion or simliar laws of general application relating 1.0 01 - affecting the right; of creditors. 8.1.2 Enforcement may be limited by general principles of equity: equitabit remedies a.re. available only at the discretion of the Court and are not available where damages arc considered to be an adequate. rimetly .., .nothing in this opinion is to be taken as indicating that the equitable remedies of specific performance or .iniunction would be available in respect of any of the obligations of any or L1iC parlir.-; to the 'low' A siTeetnent. .. Limitation Acts The enforcement. of claims arisi pLn7.5u.arit to Lbr..• Ulm may beeomc. barred under the Limitation Act 1984 (as amended) or may he subject to set-off or counterclaim_ Fg.tallJes and Costs 8.3.1 Any provision ofthe Loan Agreement providing for the payment of additional moneys by any party consequent on the breach of any provision .thereofhy any such party, whether expressed by way of penalty, additional interest, liquidated Linmagm or otherwise, would be unenforceable if such provision were held to constitute a penalty and not a genuine and reasonable pre- estimate of the loss likely to be suffered as a result of the bread! iii qtestion.. We express no. opinion as to whether any such provision in the :Loan .• .A.8.1'ee,Lhent does in fact .constitate such a genuine and rtammahl pre -etdimate. 8.12 The validity under Isle of Man law of any provision which purports to impose an obligation on one party to meet the costs of another on a full indenmity basis will be subject to the rut or the Isle of Courts to .override such .? Jr vision and award or a less than fill indemnity basis. 8.4 Jt1 k icti r1. f rcfiireernerit andForH ,714ws • 8,4.1 Vaere. obligation.s under the Loan ..A.,.gcCinein arC to . pertbnur:0 :a jurisdiction sits de le. Lsle of Mt-Li, they may clOt be enConiea:ile in the Isle of Man Con= to the extent that their DtTrorrnarice would be :ILL:4;a! under ihv laws of that other jurisdiction o coDtrary to tht2 ricE?fic policy and in the Lk! of Man. 8.4.2 The go.,;:erraing of Cry: Y Dan ApTccalmi would be &tern-lilted by al: isle of M%C.t Court the of conution piinciples of eonfj-ets of law; wLere pines have eIpressly cho.sen the 1 .c.,w pailizaiur juri.5dieLion LO g.ivc:-.1 Ibi5 would generally be de..t.Trr:.intd to be. the -p7O1er law'. of tie • con.tract; hov..cver, thcri. arc ccrtain limits on the freedom - elf the parties to choose the 2_ovel-niR2, [ac• (for example ; the -::-.11oier: must bc.bo-ria fide and legal . and net c.-ontrary to public .policy). • . 8.4.3 'No twithslanding any provisions .of the Loan .ikEitetnent contai cling an apa, -*:-...ottient that the Isle of Man Courts arc, or waiving anti.* claim that the Isle of Man Courts a not, .iipprtnriate forurn or purporting to permit concurrent pri?ce-edings, an Isle of Man Court in certzixt circus Lances ro.;ty cnieriaiu . for stay of .prozeedings. on the basis that an Isle of . favoura.hiy an application .proceedings if Man Court is not the appropriate forum zntl mzy stay concurrent prorxedings a: -e being brought el&r .v..here. 8.4.4 A foreign judgment would not be enforced by an isle or .m.asi Court without a. re-trial or re-examination of the matters thereby adjudicated upon if such judrient were obtained by fraud or in a manner contrary to natural justice or if the enfotcetnent thereof were contrary to Isle of Man public pot icy and such enforcement may also be withheld if the relevant judgment were Tait a final and conclusive moneyjudgracat, being both unrctated to tiLl:ation and ate of conflict with any other judgment in the same cause of action.. 8.4.5 Our opinion is qualified to the extent that the Lo in Ap.t.,:cncti( 1.- 1ertract to statutes, reguial.ions or uoeics oilier than those of the isle of Man and., to the extent that provisions of the Loan Awyccrncnt art t..5cprz...,5c41 bymfercn,: :.e.- to any sod--h forciga statutes, regulations . or codes and to .the extent that grins in the Loan Aerocincrit are defined by Tefercucc to such foreign .statutes regulations or codes, we express tip opinion as to the meaning or .effect of such provisions • .. or of provisioits incorporating terms so defined. 8.5 Fact CND aGit v We express no opinion as to fact or as to the &Lancia! capacity of either the Company or the .1v1EA to perform its obligations under the Loan Ageernsnt. 8.6 5et-Orf • Provisions relating to set-off contained in the Loan ..kgrceinent will only be enforceable in a liquidation or the Company insofar as they do nor purport to contract out of the mandatory 5ct -(11:1 ruler, imnosed by the isle of Man Barikruptcy Code g92. 8.7 Cinarantee. Whether the Loan ,_:la-ectaient. constinitcs hrirriary ebilgations. of the IKLF-A de,pcnd upon ir_s construction. E .7.2 The enfo.roeirient of the •greeT,neni 1-,r,av h 5i1Fyi:r.1 to c...qtrl table defence:: relieving the NTRA from itz obkatio-oz: tinder it.; clic1viEA may be- rel5eve.:l from :dab:Ely undn- the TA-c- r; (as,i alts actiou ur conduct tF.,c; or action Or by the zreditor or debtor in respect of the EuaranLc=ii Qr m y ✓uz_rantez; eC.iinnv or other .,-:,..surarteo agLmit finan.z.iiii loss irt respect of sticli 1)11E0i-con or r. l•Gry harl faith or raisr:;p7esentar:cin Lei the pan such -.7_7N-Liior or fiCbtOf. .„, Miscellaneous ?_S.1 cifccevcric..r_:E- of iumis wt:cultrating, a party .aorm or duty othztwise owed is litraat ri by low in the Isle of Man. S.6:2 Any provi.jori in the Loan Aiatement. to the cffoet that calculations., determinations or ci.rirnfications b.;..‘ conclusive and binding will not effective in Isle of Man taw if such cali,nuations, detenninatiOns certifications are fraudulent or errontous on their face and will not necessarily - prevent judicial enquiry into the merits of any claim by aly party to the. Loan Agre•ment regarding any such calculation or certification, S.8.3 Were any parry to the Loan .4 ,--,,-r:_--ernent is vested with a discretion or may detemtinc a mailer in its the law of the isle of Man may rcquirt that 51Joh ilisL.retion is exercised reason:al-31v or that such opinion tr hinged on reasonable goklatts. • 8,8,4 Save where stave requires any document to be EsEccuted as a Ated or to be in writing wtuch event' any anw....ndrnera tie such document Litil,y nmr.tt ter he ins 'riling or he 8xe2uted as a decd.), a document may be amended orally by the poetics dicta() notwithstanding any pro\isions within it to die contrary. g_8_5 The. Isle of Man Courts win determine at their discretion -whether or .no-1. 'any. provisions of the Loan ATectrieTit which may be invalid on account of or otherwise nay be severed from the other provisions thereof -in order to Saw•. those oilier proyisions, notv,itkoAriding anyemprm5 -provision to that-effect 8. S.6 There are refareaccs in the Ixarir Agreement to tclocorranunicatiotis.Nor the avoidance of doubt, as at the date hereof the lq.b.LA. does not have the power to cr1-1.,74e in telecommunications, althouLti when the C3-as and Electricity' Rill 2003, A!=.5.,ent it will bave stiCh•powcr- • Reliance This opinion is -aticirvss,tcl to you and may be. relit-4 upon only by you .Euid.legal advi&c.rs. This opinion is limited to the matters expretisly stated herein and air-- snot cxiend to, and is not to. be read as C ttnding b y implication Les, any - otlicr matier ire ea:incelion with the Ixian A...r...... ernerlr or the transact•imo or do-L-i.1111CILts -re.1"- rred• tlicrc.in; . • CALNIS Manx Electricity Authority Appendix 6 I ' Ms Elizabeth Appleby QC's notes ' t, ; May 2005 Appendix 6 . • IC Qt.e..7_=*7.-EC.T. . -I • 2: 7- 1 A : Thie Chambers of Elizah;lb Appleby QC anti David Mole QC c5.• 21. '1_,&- `-'7 :711714,Tcre.24:Q.C.. •• ' • Pie. wadi Q, C. :an 4.11-c E.-7.7! Q-C. C.72 rk7 • •rig. lir: QC- *I.') D — EffS4W1 ' 141C- • dednihs num- teg-\ Q.C. nsgell 1 1- folfc-R. Straktu- jirlziFt; Fitte r'S-CJU Date: itddi it MCMArP.LE Q,C. • .211iiitic.7r1230E •Jcpuliota.su Q.C. . '04.11iett R4.93;.imon e7 • ' r .. s' JralEmc'C13Eches3r 47 • - Corner • I j t {..=dr...- • . . _ • • Pita StItAtinitir - l' • ;:tith-rirrF Hutt pls mys dkrrat: Eirra Ra.tosifem it 1 • 111•61P• C4Pel I r f Hit / - 6iDe . !Cklaia.d .Colrikg 2A111.1. 13 rows . kiiiirii4Tabstaiwk 1.'rmater-Urrphgai Itob'ect Whire Brit:dal • :'iiitrecIttio- -0.OeerT'Ntrie.r 1-4144:44.6kr6 Ambarff Math DOOP:Dthrr: Ek«. iE a gva51.1.-mfall cinumaikalionaThdl ow?. Strict CirzL pofessional Fr mat rim be vaar•, capicd, r:irr.Latzt or .4.verd Fiction TF. ' ' Ci4ir4li!7•04.13-1.1s.W Tr trey furl' c3b, pftrun t0 ws.-rm.0 i$ r,Liri!viimil. y-Ya kvi.r.r=c{.-rol sus cinzir.m iFc.-,7 &a • Kt+ ',..011501 tr:07, pitlie limey VS til*p/A5x- DS=iti Ptny 41-$ GraT'v Eno Saio.22, Crr,y'si T>taA Londur. Oltin 404 2:152 FaE. 242 7•1343 px LONDON E-114141: • Tn . P ro ITAnL.E....1,MRISM...A.UJELLO.RMY NOTES 1 Aux Electricity authority (MEAl h..d contral with a 1.31.C.nron Rub.sicliary company NEPCO (NERCO) to build a new pc wer statib4 itt he b•Ic of Man at koh-osa. NEPCO cz.:!ppscd :65 a , cooi.equeilec of .arntor,s inzoiver.cy. 2. NE.PC-0 had in places 5-cries cubconiractors to build the polver station ar Puirase_ 3 Section 6 of the Electricity At 1996 pwovidc.4 that (1).po gm:T.111:T station may be .constructed ..„. ar Oprrattd cxctpi. with the etrilitrit of the Eeepartrimit and (2) a OLMErcra shall be given tr2., order The-Deparnment of Trade and industr7 :, in the hie Man consermtd to tit_ cor.struction emd operation of the power station in tha Electricity Guaeration : -Putrose Gas Turbink • Power Station) °role: 2001. coasolit of to Governor vitts ziveri to th-e .cre_titio!I or the pawer station purswini to Scotian 13(1) of the Ele:etricky Act 1954 silbt.;:t to noise • lirnitS. inadveYicy of Enron meant 'that - the h trol:e alternative az -t-inkgcrixeri.11 for. . tht can chore ofriaa power statical Let ce.....zz s !-20rnpleiel\IE.PCOl; ch.c 63tc.. of r4:t ittsolverir had apyrolEimtt.tiy 1 i% C--411-532Ctiun ..12-.7:.,:-.20212 13: 2-E. To7; 2, 6. The. ME...k (....-ensidercd. whether to Crigagc a strc Er_h: rcplec,r.rrent. of.T.E.PCO or to rttake aitcrnat.h arrartgcrticniz.. The vir,c;pa I personal Intim/ cf NEPCO gaff. • .. The IVIEJ, ,-3ecieltd .to .ehliarri a new crwnpuar}. owned by the MEA- ii,inch -scrti.t4-1 hare novated ;a-them alb the cxisting (and .7..,...-ristLczry) sulwantracts.arid".1.14 eontracl with. the •ne• , company citabils'Ited by the ex FiE.PCO staff to till the pp left by t1.16 rcrno -41 NEKO from The pro_'.ect"_. The commercial justificatiot for estahlishi:!.g this new c„,,paroy ca.:a POT Limixd. Tess 1.11,9 1”, (a) N.F.PCO had core •mach work vu the project and it we_s not seen_ as nect!...isary ir• appropTiale amain" y;ir.h the substi-toTian of a rlice.et'.ailleroative NEPCO; :• W) coat it' (a) had not be.-::n :he case, t inTT-cduce. an sitomatiw3 rr ba.ve ro:c.ri•v.iitaied a Full reorgaatit-12.ton of all The cli1car4V1 and. En. incr-v.a.ae iti cCeCi: and much dela:1.! PGT Limited s.44411h1g in 1;'Dc ;goes of N127120 rftearg that ifie - 17-xj%iris . C- •alraCtS C.411.11d nuvaI into F•GT AithouT al-tteaotiatice the anbeolutracti-,4-s; pve•-t!!d:AiT4 .5-1-1,1 the. ..ruh.cotrr.r.y.trin ts. (for 67...2:rap3E7, the tizbicul iA Finland) uti. • Tn F.2:4 3 introduction of new advisors may have disrupted existing working relationships ti and involved a learning curve; (e) any 1:1Q.! a.Yconlip I Lation in the r ....P:1CT4-,,,voit!cl scvesely d.F. I ycd and increased east_ R. Ac-nrdingly, PGT Limited wa incorporated for the 'KEA. It is o shell company N4 -itli small paid op share copitA ittd no otheras..%1S. Eicrwcen Decennia 2001 to ,Sete vatinds 1, novatiOns have be= en! eted into berNeen.PGT Limited, NC=O (in adroir..ivtraf on) and the reievant .subcontratturs, En effect ?GT Litnized has -effeetively stood in the :ho c of NEPCO i provessing the project (IV.v,.'e that the design consultancy services to be provided by NEMO will be provided by an additional .subeoritraerOn), I aril .o.skel. to under English law on (1). the power of the MEA to have a subzillfarf company, t:tc power' of the MEA to grant .o.sarantess to third parties in resp.ect of its .3ubsidiety; (ji I) (lie 66:.2 :that it the Vin,* al OW .-Orn.racts 'bct-wEen PC1 and he stibactrriyadnis (iv) ;:ienerally. 1:7."1-11 - .112-N--2U-12 13 4 - 10, The MEA is a creasure of statute and therefore can only act pursuant to and in accordance . with powers giyen to it by.statute, 1. fa) The relevant -Aatute the Electricity Act 1996 which azghorised by Sevtior I , the. INIEAte be the electricity eititttor'.Ev ii t1-.,e Isle ci Man; - S ericrn 7, providg4, so far as retevamt Ni) It is thc dkav of the {AEA) (LI .arcl iraintein an eiztcient and econorni..t.-al aysit:rn of eleci oity supply fr..•r the .island, (2) The subiect to the foUoviing provisiorls of the see-tifm - .and its aceordince With any di em .,7.-iven to it urlderaunstption (8) . any CD3C4TH.en men tionid frt. subs-action (1 p:otnctle,so far as practicable, the use of ali cOnorttical methods 1;11 generating, ii7nsnIti'fflog and distributing (s-) The Dtvarunctit of Trade and Ituluscry may g=ive .to the Auti-cvity sueli &mations tivardinti the r_xerd:-vr, or its functions as the Drpam-x]it -thin6 fit." (c) providcd that "0) The (MEM shat] pe.iform it funnion5 So as. to EZ.Clittr that '4 pffveam is not less than 57-Ifficient to rn,:ct chartica- pi 1y chargclble. to reVcauc El; won!, Qne year with another, and to c.nable the A tittlTityo'inakt 311ch allovidi on Kt-C. '..:St-TV.CS, as it corisiders aclChoate or as tilc-Treas6r-y may direct under $016econ .2(b), The- Tmasuill ntly, wrier van.s,gtation the .6uitheair.,., aivls El; !htnklitharity direction? ;a) any matte: ref grin to the. mm.i.h.iishittfmTt or monvertzitt of mserve:34 . Oa) w alicoated to 'I';- re-se (c) the ztpplicaLivo of them-e 41-043 the KFA. thalI 0.ompr,,; with ally zw,:b ditrectiont." Ix, 21, Try n:.;7-i-7752.2 • 5 e,.d) Sc_cr:crld 7415 i'aea4OCIROITiCtic•Tri on LI i7.y.r,ordat,ure, provideii :ihriU with the approval ofttic Tritillro• .L.,ttk a u7Laal. progilreetot- . a,,crppril R.:rriott Pind • stevei 01-1153,ft .LC St7ly'5C4 Fie414,6414 or wori& the /YEA. bo:•.sui[ with tine T (c) zrLajs. seta an statutory ruNitirev,ents [ed- •bortavding - rit7:r[ teMpOrar:i • )01r1 bOciTotithig 1111. of the Tre33Ury. • • 1:77; tinier StinitorySo#Riii A.ut 19x'7 (i.e 4 9+57 . Ate/ 'he 3.4:k_o, is classified !is et :;i6tulory board. ThiR 7;rins e;i';3r6;r41 of mittbers ,,vtio ippo:n.....ed. by the - Cbuticii of i,viirliste.rs, EtitjitOtO)diC apprtY4a1 0 Tvn-wold-.ancl .. : . • .• ..,, . .. - • .. _ . . ,. those ineinters .:-.,a.n Lner.i apperntt offloml (Eleoiripit?wa.-... • .• . . 1.990.: Pa,,--dgitah 3 of . • • ..0 :-..';•.'.:-:,•• . . • Sc. :-Iedolo'l 'Fai'6,:-1.4 1o' .cic&.4.7.tions of tme.bpas (c.• t;ollimiftees, raembets 'etc, (b) f dr) Lic.t.tiinfc 0.111. trc i E9 At ci.Schcb.fic 2 prvioata Itctti ►q up. of iubsiliary.cocr.p.i.try. leAkeOtt.•d.binarcvr:, rcqvhz thaatd ,CG to mtisfy the 19K l'ecuh'emen.i.$ that the • - ..•. - 1 cipirriap; az):5wan. 1.:0.the wix.itions rai6ed de&e On:whether or trif.. the IAT.A., •7 .... • iS etrIppWe'Q'ta...thej (E) to crc a sift. :.3s'' company 2nd pFitiEn rnpoct .9: KTs united. in my opinion, M.Z.A to R. pc,wer tht- 151.96 sr. no othcx :-.0 SLLIKAdiZry give- guat b. pc.kr :1-ettfrp:,-;1.1.71--jon 167.1 caTmot be relied urine pc-Wth' 7?-TpN-zeo2 P.27 1 7 NO$ tht M.F.,&17121.4rr trLgrama_ultEicii=SPM141V Lin of tht... opiti-kin that the MEA have pc'!wer.to emte a stt-los5 -ii0-ty:oomparry. .•• . . explain uty :eazonitig; • (a) 'The 1446 Ac: requireq the MEA to devekp Frtair.tain en efficient. and, economical supply of clortncity 1 th..land (s.2(1) iF don, not uat DU t any code . , as to how the duty is to t; carried otit)- tt docs not rtviuire the lvirtA toLceary out the duty itself Co) Mac 1996 4c; rcrptirts the :AEA pry: the tu:c of orv•micti1 mt.-rhods of gencratEng eicctricity. Promote tw.-ms- furvard; cncoientgc.,. pToc-ws 'The MEAhas be.-Itta.givela by the GovenrrLent of Irla.iLsi. (the Densetnenr of 'Dada and Ltid-wttly) and the 03-overner ennient consttict -ai .! fpeo..te- the •17..AVEr • -113Eie.11:-. c.:i-mEczt yento.int-, (d) Thi MEA Wit.5 :.-irra?4•1-g.for 3L cc-ra.:;.c-tion Qf the .powcr ustion oogiractnagi 7 • With NERCO fez thg : 6311ein.4 atilt ridwz',1- ttation. That was cleptrly itt4 staiiimry powtri Sei'_•Oon. 2.(1) and possibly 2(2)(4 . • . MEA is yow*Tran.g.i7Ig .1-b:r the pornpletian of tli ,a c.;c7iti3.ct- 1.ky coritinuing the NEPCO contract tlizoliFft P$31" havilogdttip.rmitieti that 7.71:;■ - ;:zr...-;7251-32 7 this is the appropriate way of fulfilling its duties and completing the power station, having taken into account all the commercial factors set out in paragraph 7 above. (1) InZ...k 193 I 2 KB 3615 Cohen I-J 'Under the ordivtry nsic$ c Jaw. a p&-chii"cornpolly aid uhsi is y , company, even a 100 per cent subsidiary cony-any, aii•OtirxiSiniU ape: in tlie absence of an agency contract QCIMParlieA, one CanriOt be said to 'ET the agant Of the cthcr ernpha„sc the distinCtiun that io drover' (in.. the Act taiad fictwecn 'proviclin81 on the cute hand, abd i'icturing .0T promoting o tle other'', the provision dm-, s liici t iystem.o(tranVort. SettriS IL.?stze ilurt ThaSZ'A-crd.3 cl neity visil-ke the the gabonissiens may eithr frrolde system therr.4elves pr may secure” or inota its provision by °dim". f th;..n: a Sigiii• rr-a-Wrnin.5 appli w tht thr. IvIFA and in is entitled is st.ctLre ?"tor Ercr powrs Pc.i Liinitad Ns hr.en cri-Ate-d to cornpkte the velid eont-40 that. The MFA 1,41 with NEPCD to iL d the power—i:13EiCJI ThiS wry• different tr. .1.997 QB C,16 when Allerdele aorougb CD ^cii crtated a who;ly owned Ribs -if:Lary coda to du Std That it was not crpowcral $v do it+eilf arld .3 i Lit,S1 0.11-C TS tD-prrvvidC tHrt Sbnri: facilitir.s.. And s-n-niia:r1)., (tedit wothirig,.±-.2r4.3Ltic 1%7 (Pi 4.,11).ii:ti bele; th2.t ci..110ei. a iccai i301-.;!Fing 3.01101117 Dr. Nsdna:harm. ;11-• i.U;;CItierl] r)r .pri7oiLtir.:2, 401.1:5ing f-ci" th r;:firteis mc:174-, of a pitr.,:ly ccrapz_ny .3.s Section 9 of r. • . _Y.... F. 19$5 :IF...! local hou.sis-4:. Ottlif5 1.12 113'0S...int! Sok' ueetrinrnocialitsrt_ •• . • • 0.) I thfL‘'..k the n!,ctus fli.J•ilort a sti-Drig fell argument In faliour of thc,... • 7 1^avin4 creite a wholly owned 311.1-)Skila:y. (i.) T-towever, the Rtbsicf.iary the MFA tte, tht Talk itselfear. The thcr.: of grsub$i41 -4y do•-:s not thcpowers of the MEA., For t .„. e.c.. -st- :np 1-117fT Litdir4d coia)d 6r•ry OUT COhtrati oth.cr cicct` 31.111.6r:ides. Its a= Do ttir. [Lic cf the , Furibes, ii3ny cpirl'.ort tht Directc,r, of FOT should satisfy tile require:17E17m! •rd LEIL! 1596 Act_ the 1987 Ac E. Tilis ui triade el-eur 41, 14, 1)ere.:i jp,..4222_,:irandlLeitLtiLS mcpfs,.t. Qt iic kia.bidiary? • ti think J1Letr is a Tz3: ME.A .;•: ics grasttiza ipsraot4e4.0) thl.te fb) - w•;7,1thara Fon5t heic112.-mt tlis lor.x1 C•c -„;,-,-.•:1-. had no powt: T.,..)• • 8.-pavantx,"•'.!: ot>lig.e.i.Zop- of the =-- 5-roany.ei... i/lAst.tro.41, e,ecousg Lh.: ESOL131,1t- sza..4;_c.ir7; rodt of .i.iattAJty 4 • -.3i41-a-A2 2a 9 ( c) In my opinion, it is -....rguable, that Sections 3, 4 and 5 of the 1996 Act set out an express statutory code that prohibits the existence of a StalitOrY power outside diat code. I ain unable ta reed '..ntecitei any of the 1996 Acuthet could bt 5 aid la crrEpery....a. the tyfEA to 7.-Jaraittee load. cT xrly tbc "rfEA did RV. I give .f.;110.,--ari .1z,-t-n. : in its cu,itraet 9aith NIFP. CO_ cari unders .L.-7,d *fry the tlird parties who are u .ndertaking work with rpt a .shell (Imparty S.ilh no assets rquires guat'orits-: Nevertheis .ifithc ►1:18A ha 110 power In give guarrztees then the vuarancez!i provide considerably less' contort for the third parties. I say Tess comfort because the -guarantees nor be til&a in themselves. but .o7,1'y ultra ifsOdeclared ay the cow, lrt Forest the sAimnpt525 goeit, until the-Council renceedi cn awn]. Vie) .1N-lailst 1 t Cen,MitiOd about 6.: V3j iditY of gue-7--1 -Item, I Vecrald h r. 541rPri sd MEA !AM entered into these .ariugArrc.aita witherut Ecivir. It may be dm: tyhilsa. gttzr.at.:teris to th,irCl paztieF, party with w o n die li-CP—A Fees uo canntIvAl. rCiaTiCIIISIViP) appear to b outside the power: oft e. MEA, they could be indirectly tied in with the IAEA cirritect v-ith Fill, end therefore their Yacht' proltf-,rood. Fur et.v!tripTr., the MLA-will bet .t.-0.Ltrin to .honorlr its nori.mq. wit E-TIf. FCIT is merely the. %her mililernan Si211e.baZbeiVirWM th-210:Leir the third parties. 1;.. the-thirdiperties later' f:zatitell -E.A. 12 ef...-fitractually in P.GT, who will r mitra..m.tly bound to the third pertim, and '.7..bc ?GT is 'i-41-etied by die rvit'.=i anti its contact, : -it. may be possible to resolv -die problem. _ - • 2":—.7• ,1-Z.C417. 12: :isi; rr., 1• I Q (f) Even if. die goarn.7.tres were if at thq-ctld of the da• : Lt „ - MEA. took. the beret the third Pony crwr.... -act, it Es vtry tk • 4,:abcoiiu-,letr.rs would have actiun ag.ainsi MEA.baF.4d cril a quarzirn In o not aymic,jked the pct thrit d:•o MEA and PC.ir arc scpamti. I think however, that this may t a c:r.E..=1.1ere._ 'the ve irzetlemal" 3,3 t the MEA and-,POT may be Idled.: 5. .TN.TC10,s thatWi.91` if theitl%iiiiiliN virel,orLthe Ccritmci$ berwcv_agagaLthq . ff #hc subsidiary POT is ultra vires, which I du ilagaa all the trarisacEnn5 r.2f 1.N POT -would at he transactions which the had the ca city tr) enter inif1. Arty confrazt entered i-rIt.-11vnUkgiV4:: rim toTA le ai ckligaticis esrfarceable assinst the MEi\ in. Val-ticu1a.r, sibj4ct c•F coirs•E to any quantum. =trait tic .c.:-Jaraiatccs ..wouldbm:unertfarceabie. 16. 14.MtcadiM.t9Lwmcl (a) ( imagine that KT is er..Trainuios tol:Fuild ;hr. vii:wr7.1. !I:26cm_ It is Lyn:F.:cif:ant tlat the poiitirm of .PUT and panic: iar thr, psTante is Curty afielypc.d bcfrIA-r: dovbt is 4..v-stixrtt. than. tf.-..1:s should r.;le ?,!FeA fcc • yci F17.7.1.1 • .(i). a coop of the Mcnto and A rri.o:fs of Prii; (ii) a copy of tc Ciaaraltec with Third Parties. y le-sat adyiee re;eive.,LI by the MEA confirF.riing that the • .ME. has statutory , • authority 'thrg sub;idiarj and in p.srticuittr Eive. fir si.0-ralit' rts L 1 !bird , parties. Any advice ret eiyed frc= Tit se.ry or the Departiocnt of TraiLle. 17.: If I can bt: .^-.4-1y farthi.4 :Tv Iristracting .Soli6t6r should not hesitate to telephone Gray's Jria Square ELIZ-A2ET14 k PPLEM' se-ay`s Jun Lai:am WC II fimfl 300-2 c,31.ittatt.mt. t- 1 W;b1X2; FALESIEBATY.ALT.Einlilli NOTES :71 1 . ::1•1, P. r.