• 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 1 July 2005 Introduction 2 • • 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.