INFRATIL LIMITED. — Management Reports 2011

Feb 6, 2011

Infratil Monthly Operational Report

7 February 2011

Introduction

Infratil's businesses are maintaining their operational and earnings momentum with a lack of surprises. This does not mean life has been dull or even quiet, especially as a number of important developments are occurring in the markets in which Infratil operates. These developments may not have an immediate impact on operations, but will be important down the track.

In addition, perhaps because it is the summer holiday season or perhaps because of the lack of topical news, the “long term” is again receiving attention. In particular Standard Chartered Bank’s report www.standardchartered.com/media-centre/press-releases/2010/documents/20101115/The_Supercycle_Report.pdf is an interesting read about what may unfold in the world economy by 2030. Their core view is that the next 20 years will have above average economic growth, albeit punctuated by occasional volatility and uncertainty. Even if details of their forecast prove to be incorrect, the scale of wealth growth and its spread will have major ramifications.

The following maps encapsulate the scale of change forecast. The top one shows the location today and in 2030 of the world’s middle class population (people with income of US$10 to US$100 per day). Over the 20 years the global total is expected to rise from 1.8 billion to 4.9 billion people, with the Asian middle class increasing from 500 million to 3,200 million people, ie. from 27% to 65% of the global total.

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At a specific level, the forecast is for China’s GDP per capita to rise in real terms from US$4,166 in 2010 to US$21,420 in 2030 (from 9% of the US per capita level to 32%).

The second map below shows the regional changes in GDP over the same period. Today approximately 12% of the world’s population live in Europe, USA and Japan and produce about 60% of global output. Within 20 years these populations will come to make up about 11% of the world’s total and produce 29%

of its output. On the other hand Asia’s 50% of the world’s population who now produce 17% of its output will have become 53% of the population producing 42% of its output.

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These developments will have profound consequences for the price and consumption of food, energy and air travel. A lot of commodities are going to become more expensive, which will be noticed by both NZ consumers and producers. New Zealand and Australia do not register in the report (NZ doesn’t even make it onto the world map), but the consequences of this growth and shift in wealth can be inferred.

The report also carries forecasts for atmospheric carbon and global temperatures. A lot more people achieving affluence will have negative as well as positive consequences.

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Of more immediate note for Infratil has been the success of its offer of medium term bonds to the NZ market. With issuance approaching $100 million it was decided to close the 2016 bond and to open a new offer with a maturity date of June 2017. Both bonds offer a yield of 8.5% pa. infratil.com/content/view/1941/119/

When final processing of applications for the 2016 bonds closes it seems likely that approximately $75 million of bonds will have been issued to new investors and $25 million will have been reinvested from the maturing May 2011 Infrastructure Bonds. To date almost 700 of the approximately 2,500 holders of the May 2011 bonds have taken up the offer to reinvest.

This was Infratil’s first bond issue since 2006 and the GFC. It is clear that while the local capital markets remain tentative, investors have a good track record in corporate bonds over a long period and remain supportive. The majority of Infratil’s debt is sourced as bonds as this provides a certain annual cost and spreads debt maturities over many years meaning there is less pressure to refinance in any one period.

Another local development for Infratil was the payment in December of its interim dividend. This is the second dividend Infratil has paid since introducing a dividend reinvestment plan and on this occasion approximately 25% of shareholders chose to take their dividends as shares rather than cash, up from 21% in June. 1.2 million shares were issued at a price of $1.90. These shares had previously been acquired on market at an average price of $1.73. 3.8 million shares are still held by Infratil as treasury stock.

TrustPower

December saw a period of unusually high electricity prices which could be a precursor to an ongoing rise in price volatility. New Zealand’s high reliance on hydro power makes the country susceptible to shortage in dry periods and over the last 20 years almost no additional storage has been built. In consequence the reservoir capacity has come to represent fewer and fewer days of back-up. Although a number of gasfired back up power stations are being commissioned to augment water, greater fluctuations in price seems likely. The newly established Electricity Authority investigated the period of high prices and found they represented the effective and appropriate response by the market to a number of weather related factors. In particular, very low storage at NZ’s largest hydro power station, Manapouri, weather forecasts for a very dry La Nina summer, and very low levels of snow remaining on South Island mountains.

The last point no doubt reflects the pleasantly warm November and underpins the unexpected way an electricity system powered by rain, snow and wind can have its availability compromised. In the event, no sooner had prices peaked in mid December than it started to rain resulting in water flowing into the hydro lakes at approximately twice the usual rate for the time of year.

The following graphs show the price movements, the level of hydro storage adjusted for levels of snow pack, and how the hydro lake storage surged from late December.

NZ weekly wholesale electricity price index 2003 to 2011

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South Island hydro storage adjusted for average snow pack melt

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South Island hydro storage daily record (note the jump in late Dec 2010 )

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While managing the risks associated with volatile electricity prices has long been a core competence of TrustPower, the December events are likely to result in increasing conservatism. One day in December wholesale electricity prices were over $500/MWh, about ten times normal, and no retailer would want to be obliged to buy electricity at such levels.

TrustPower’s programme of generation development continues. The 36 MW Stage One of the Mahinerangi Wind Farm is on track to produce electricity in February and to be fully commissioned in May 2011. Each of the twelve turbines will supply sufficient electricity for 1,100 Dunedin homes and annually offset approximately 7,000 tonnes of greenhouse gas emissions. The average cost per turbine of Stage One is slightly over $6 million.

Work also progressed on enhancing South Canterbury’s Highbank station’s generation and irrigation capacity, and analysis and other preparatory work continues at TrustPower’s other consented wind and hydro sites.

Infratil Energy Australia

After 13 years of uncertainty and controversy NSW finally concluded the sale of the state owned retailing businesses and a part of the state’s generation capacity (joining Victoria which largely sold out in the 1990s).

TRU Energy is acquiring generation contracts for Delta West (2400MW) and the approximately 1.5 million electricity and gas customers of Energy Australia, predominantly in the east of Sydney, the Central Coast north of Sydney and the Hunter region around Newcastle.

Origin Energy is acquiring the generation contract for Eraring (2900MW), three development sites, and the 1.6 million retail customers of Integral Energy and Country Energy, predominantly in western Sydney, Blue Mountains, Illawarra, the NSW South Coast and generally around rural NSW including centres such as Bathurst, Orange, Tamworth, Goulburn, Lismore and coastal towns such as Port Macquarie.

The transactions appear likely to have positive consequences for Lumo Energy and the IEA group. The price per customer of between A$1,000 and A$1,300 also indicates an industry view that the long term value of customers is well above the costs incurred by IEA to build its retailing operations.

1. The shift from NSW government to commercial ownership is a significant step toward a more commercially rational market. Prior to the sale Energy Australia and Integral Energy actively pursued customer growth in Queensland and Victoria in a manner a commercial player is unlikely to emulate. Uncommercial or irrational competition can be highly disruptive for companies motivated by an intention to earn a fair return.

2. The industry structure resulting from the sales is likely to favour competition and organic growth. The other major eastern-state retailer AGL did not acquire any of NSW’s retailing and neither TRU nor Origin acquired a dominant position in generation. The Macquarie and Delta Coastal contracts, which together account for 7000MW, have not been sold and the political will may not exist to push their sale.

A vertically integrated oligopoly seems unlikely to develop in NSW. This was a concern for IEA as its operations currently rely on a liquid and efficient hedge and contract market. As things stand the NSW industry structure appears to favour wholesale market contestability and this is likely to reinforce the national trend in that direction.

1. In addition, while the NSW state government has put further major energy asset sales on hold, there is still the reasonable prospect that a number of development sites will become available. It would assist the further development of IEA’s procurement/generation strategy if it was able to procure a site consented for the construction of a power station.

While it is too soon to be definitive, the NSW asset sales and resulting industry structure appears positive for IEA/LUMO. They are better than the status quo or a scenario of suffocating vertically integrated oligopoly.

However, while the market structure (and the position of AGL) favours competition, that competition will be vigorous. LUMO’s recent experiences in Victoria illustrate how intense competition can become excessive (albeit, as noted above, inflated by the then state owned NSW retailers). Over the nine months to 31 December 2010 LUMO’s Victorian customer base declined 5% (while the customer base in the other states has grown at over 30%). Recognising that it is common for high rates of customer churn to co-exist with positive retail margins.

The evolution of the Australian state energy markets is occurring in a public policy climate with high levels of media and political interest in energy costs and the conduct of retailers. On the one hand this has resulted in regulation of retailers and limitations on their ability to pursue customers (for instance by allowing households to register as “no call” for telemarketers), while on the other there is intense focus on residential energy prices and the impact of price rises on household budgets. Ultimately, as shown by the NSW privatisations and the success of LUMO as a new-entrant retailer, the trend is towards an open rationally competitive market.

The extensive and serious flooding experienced in Queensland, northern NSW and rural Victoria has resulted in widespread property damage and business interruption and while no LUMO/IEA assets have been affected, business activity has temporarily ceased in these areas. In due course LUMO will be working with impacted customers to help them manage their energy accounts while they get back on their feet. Long term electricity and gas supply is not expected to be affected and IEA is well hedged for any price impacts that result from the flooding. To date the floods have not had a material impact on wholesale prices.

LUMO/Perth Energy Customer Accounts

2010	Victoria	NSW	Queensland	SA	WA
31 March	344,797	173	38,434	28,076	491
30 Sept	342,345	1,743	48,901	31,472	618
31 Dec	328,033	1,825	50,900	34,914	884

The Western Australian customers use substantially more than those of LUMO in the other states. In WA private companies are restricted from selling electricity to residential and small commercial customers.

Greenstone Energy

The three weeks from 20 December are the busiest of the year for Greenstone’s 229 retail service stations. In the most recent holiday season sales amounted to:

• •70 million litres of fuel

• •1,000,000 chilled drinks

• •170,000 pies

• •160,000 ice creams

• •17,000 car washes.

During Greenstone’s initial period of operation the Company’s fuel volumes have grown significantly, notwithstanding an overall market decline (approximately +4% as against -1%). At times ensuring constant supplies to Greenstone’s over 300 outlets (retail and commercial) was a real challenge. In the South Island particularly the stock position in a number of fuels was at times tighter than desirable and work on systems and investment in facilities has been required. The success of this work was evident with Greenstone’s uninterrupted supply over the holiday season.

Fuel prices rose towards the end of 2010, with crude oil exceeding NZ$120 a barrel (almost a 100% increase over the price of two years prior). The $2.00 a litre retail petrol price also reflects a number of increases in government charges. In July 2007 when retail petrol cost $2, the government received 73 cents a litre, against 85 cents now. The factors which have driven up international oil prices seem likely to be ongoing.

As a part of its services upgrade Greenstone has contracted with local technology company Fusion Transactive to install a new payment system at all service stations and truck stops. The system will be installed from later in the year and will noticeably increase the speed of transactions, which will be appreciated by customers. The $10 million system will also enhance the efficiency of Greenstone’s operations and lower operating costs.

NZ Bus

Progress continues with the development of the new public transport contracting model. The importance of this is evident given that slightly over 40% of NZ Bus’ patronage income is derived from contract payments received from regional transport agencies for providing services. The slow progress on the review of the public transport operating model (PTOM) is generally resulting in difficulties for operators and regional transport agencies. As Greater Wellington Regional Council has noted, once the PTOM is finalised legislative changes may be required which will probably take until 2012, yet Greater Wellington is legally obliged to refresh its Regional Public Transport Plan before the end of 2011.

Public transport occurs in an interconnected and complex policy environment. In addition to needing to reflect whatever emerges from the PTOM and subsequent law changes, the Regional Public Transport Plan must also be consistent with Greater Wellington’s Long Term Plan, Passenger Transport Plan, Passenger Transport Operational Plan, Bus and Ferry Procurement Strategy, Regional Rail Plan and the Public Transport Asset Management Plan.

The same difficulties of sequencing also faces NZ Bus which is grappling with the need to have confidence in the regulatory and commercial environment alongside maintaining investment in fleet and system improvements.

In addition to its regulatory reviews, Greater Wellington is also undertaking an evaluation of bus services to enhance the connectivity of the region’s public transport network. It is also implementing a $10 million real time information system which is expected to “go live” on GO Wellington services next month.

Separate to any of the above, Greater Wellington, Wellington City Council and the NZ Transport Agency are also to undertake a separate study of “high quality” public transport options for the Ngauranga to Wellington Airport corridor, which is to cover matters such as a rail-based link between the Wellington Railway Station and the Newtown Hospital. That study is expected to be completed in 2013.

In December NZ Bus’ patronage was approximately 3% higher than the same month a year earlier. For the nine months patronage was up 5% or 2.2 million trips.

The Auckland region is continuing to perform well, while Wellington and Hutt traffic numbers have recently fallen away, in particular patronage seems to have been impacted by Greater Wellington’s October fare rises. NZ Bus analysis of the fare changes have indicated a mixed range of responses. There has been some move from cash payment to Snapper (the discount for using Snapper has increased and a patron previously paying cash could usually lower their cost of travel by moving to Snapper, notwithstanding the fare rises), but changes in travel demand have been inconsistent.

**Northernpassenger trips **	December	9 months to 31 December	12 months to 31 December
2009	2,359,914	25,629,682	34,363,910

2010	2,468,102	27,469,985	36,302,507
Change	4.6%	7.2%	5.6%

Southern passenger **trips **	December	9 months to 31 December	12 months to 31 December
2009	1,451,535	15,198,608	19,958,893
2010	1,422,588	15,545,914	20,437,674
Change	-2.0%	2.3%	2.4%

Snapper

Following December’s agreement with NZ Bus and Auckland Transport (the transport agency of Auckland Council) to progress installation of Snapper on the NZ Bus Auckland fleet, work has commenced at pace.

Preparation is well advanced on bus fleets of North Star, Waka Pacific, Go West and Metrolink and Snapper is engaged with Auckland Transport to ensure coordination between both party's customer service teams. Snapper will be available in April 2011, with installation completed by July 2011.

In Auckland over 80 shops now signed to accept Snapper for payment and to provide reload services. The objective of having Snapper available for use on major national branded outlets is also progressing.

Coincidentally Auckland Transport is developing a similar ticketing system with the French company Thales and the NZ Transport Agency is leading a project to develop national standards for integrated ticketing.

Wellington Airport

In December Air NZ and Virgin Blue gained conditional regulatory approval for an alliance linking their respective NZ and Australian domestic networks. For Wellington the key condition to the approvals is that the two airlines lift their Wellington-Australia capacity from the current level of approximately 510,000 seats per annum to 600,000 seats.

Wellington’s second domestic carrier, Jetstar, also indicated major increases to its services when it announced it was joining the Oneworld airline alliance. The airline CEO said they were planning for 30% growth in its Australia and New Zealand domestic markets after adding 14 A320 aircraft in the past year.

December also saw publication of the Commerce Commission’s report on the information Wellington, Auckland and Christchurch airports must now disclose to show their operational and financial performance. The report is the culmination of an extensive consultation process which included the Commission using several, mainly UK based, regulatory experts.

The Commission had an unenviable task given the disputes that have arisen between the airports and airlines over the last 15 years. Also, the legislation they are obliged to operate under has an untested

“Purpose Statement” which requires the Commission to regulate so as to “promote outcomes consistent with workable competitive markets”. As one of the Commission’s experts noted “”[an industry/market] may be competitive …in ways that might vary from those of another industry/market. It is not to be expected, therefore, that a workable … competitive standard will be narrowly prescriptive … Indeed, there has been considerable debate in the literature…” ie, there was vigorous debate over the objectives of the exercise, let alone how best to achieve those objectives.

The Commission “solution” to this conundrum seems to have been to attempt to find a middle ground. Recognising that can mean that everyone is displeased in some way, it remains to be seen if any party’s displeasure will result in appeals. The desire to find a compromise is understandable in the context of the issue and the legislative uncertainty. Wellington Airport has a lengthy track record of arriving at concession solutions with its airline customers. In 1997 there was agreement on airline charging and for the construction of the new terminal on the condition that there was a “rent holiday” for the new terminal until 2002. In 2002 Wellington and Air New Zealand entered into a “growth agreement” which resulted in a $14 million rebate to the airline when its new “Express” services encouraged above trend passenger growth. In 2007 Wellington released the airlines from having to pay for the provision of many aeronautical facilities while its charges rebated all expected asset revaluations as well as providing a wash-up against any unexpected increases property values.

As shown by the Wellington Airport supported alliance between Air NZ and Virgin Blue, agreements of mutual benefit do happen when regulatory processes encourage commercial dialogue.

However, even if the Commission’s report is implemented, it will not result in complete clarity and certainty as a further review is intended for later in 2012. The report also illustrates two fundamental failings of regulatory agencies; the tendency to impose expensive regulation notwithstanding likely modest consequences, and the tendency for regulators to look in great detail at every issue other than the actual price being charged and the service offered. That Wellington Airport’s charges are comparatively not high and its facilities are well regarded, were not significant in the Commission’s analysis.

Operational figures

December was Wellington’s busiest month ever for international passenger movements following a 7% increase relative to the same month last year. Over the nine months 476,744 international passengers used Wellington Airport, from 458,102 the prior year.

In December good results were achieved on all of Wellington’s links with Australia. Melbourne traffic rose 10%, Sydney 8% and Brisbane 5%. The average airline load rose slightly to 80.6% from 80.5%.

	December Domestic December International Total Passengers 9 months to 31 December 2008 376,412 57,934 3,984,895 2009 375,682 60,323 3,830,022 2010 365,432 64,760 3,887,572

For the month domestic passenger numbers were down 3% due to trunk capacity still being restricted following Pacific Blue’s withdrawal. Growth on regional routes remains robust at 10%.

Domestic load factors increased from 78% to 84% as a result of the capacity reductions. The capacity constraints will be lifted later this month with the service increases announced by Jetstar and Air New Zealand. For the nine months of the year to date Wellington catered for 3,410,828 domestic passengers, 1% ahead of the same period the prior year.

Glasgow Prestwick Airport

	December
	Freight	December	Total Freight 9 months	Total Passengers 9
	Tonnes	Passengers	to 30 December	months to 30 December
FY10	877	106,160	9,913	1,384,524
FY11	1,220	63,948	9,781	1,320,979

Passenger numbers were down 40% on the same period last year as a result of Ryanair’s continued capacity reductions across their network of UK domestic and Irish routes. Freight volumes were 39% ahead of the prior year with scheduled services continuing to show improved loads combined with a very strong performance in ad hoc traffic in part due to weather diversions from other airports.

Manston Airport

An active debate is underway in London about the location of future airport expansion. It seems that the Cameron Government and Mayor Boris Johnson agree that none of Heathrow, Stansted or Gatwick will be materially expanded, but there is no agreement as to whether expansion will come via the construction of an entirely new airport or by expansion of an existing facility.

Manston Kent’s passenger traffic continues to develop with over 2,200 passengers using the new scheduled services to Manchester and Edinburgh during the month.

	December
	Freight	December	Total Freight 9 months	Total Passengers 9
	Tonnes	Passengers	to 30 December	months to 30 December
FY10	3,674	0	27,230	4,185
FY11	1,591	2,247	19,513	26,300

ON the other hand freight tonnages continue to be impacted from a lack of aircraft capacity serving the African market, exacerbated by severe weather resulting in diversions in December, which impacted all the UK’s south east airports.