INFRATIL LIMITED. — Management Reports 2012

Mar 6, 2012

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Infratil Monthly Operational Report

7 March 2012

February saw the passing of Infratil founder Lloyd Morrison. Lloyd had tremendous creative energy with a remarkable ability to inspire performance and individual achievement. Infratil Chairman David Newman’s announcement is available here www.infratil.com

Infratil

Infratil closed its issue of November 2017 bonds with the offer fully subscribed. Over FY11-12 Infratil repaid $132 million of maturing bonds and issued $229 million of bonds to maturities in FY17 and FY18. All the bonds, those issued and those repaid, carried coupons of either 8.0%pa. or 8.5%pa.

In December Infratil paid an interim dividend of 3cps. 27% of shareholders chose to accept shares under the dividend reinvestment programme and 1,447,643 shares were issued at a price of $1.79. Shares issued in lieu of cash dividends are purchased on market.

A review of Infratil’s 82% interest in Perth Energy has been instigated. Infratil made its first investment in this company in 2007 and has subsequently backed its growth programme, including the construction of the 120MW Kwinana power station. The remainder of Infratil’s Australian generation and retailing activities operate in the National Electricity Market states. The review is expected to take a number of months and will identify Infratil’s options with an investment which contributed $5 million EBITDAF in the six months to 30 September 2011 on a net book value of approximately A$64 million.

Infratil has also been reviewing its ownership of Glasgow Prestwick and Kent airports, which have a combined book value of approximately $100 million. The aviation market has been challenging in recent times for the UK’s regional airports.

TrustPower

National hydro lake storage moved from being exactly on average in November (with average wholesale spot electricity prices 6.5c/kwh) to the bottom of the range by mid-February (and wholesale spot electricity prices over 20c/kwh).

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Not only has the immediate price of electricity risen to reflect the desire of hydro generators to conserve water, so too have the hedge prices for the next year. In November 2011 it was possible to hedge New Zealand electricity for the year to March 2013 at 8.5 c/kwh and for the following year at 8.9 c/kwh. The most recent hedge prices on the ASX are shown in the following table.

	Yearto 31 March 2013	Yearto 31 March 2014
As atNovember 2011	8.5c/kwh	8.9c/kwh
As atMarch 2012	11.0c/kwh	8.8c/kwh

The “weather effect” is evident in that prices over the next year are up markedly while prices for the period beyond that are unmoved by the current potential shortage of hydro lake water.

While it is extremely unlikely that the country will face an electricity shortage in 2012, high wholesale prices are required to encourage higher-cost coal and gas generation to supplement low-cost (but potentially unavailable) hydro.

The effect of hydro storage availability is illustrated by a comparison of two months in 2008 (which was dry) and 2011 (relatively normal).

Month	March	June
Spot price 2008	12.6c/kwh	26.6c/kwh
Spot price 2011	6.2c/kwh	4.2c/kwh
Thermal generation for themonth in 2008	39%	50%
Thermal generation for themonth in 2011	23%	21%

As shown in the graph above, in 2008 the prospect of a water shortage resulted in prices climbing, which in turn resulted in an increasing use of coal, gas and diesel generation. This year the price move seems to have happened sooner which is likely to mean that water conservation has started sooner, which was the aim of Government’s requirement last year that Genesis and Meridian swap assets. The restructuring may be working as intended.

TrustPower’s quarterly performance for the first nine months of its financial year is set out in the following table.

following table.
	Qtrto 30 June	Qtrto 30 Sept	Qtrto 31 Dec
Customers period end	220,000	218,000	214,000
Sales GWh	1,026	1,112	933
NZgenerationGWh	705	709	614
Av.Spot cost ofsales	$45/MWh	$85/MWh	$82/MWh
Av.Spotvalue ofgen	$42/MWh	$80/MWh	$74/MWh
Aust generationGWh	84	93	94

Aggressive retail competition has resulted in a 3% decline in TrustPower’s customer numbers over the year. However, as shown in Contact’s first half results, electricity retailing is struggling to be profitable in the current market, which may be why the most recent market customer switch data shows a 40% decline in churn from the peak of the last year.

Z Energy

At the end of February 125 of Z’s nearly 300 service stations and truck stops had been rebranded and at stations where the new food and coffee offering is available it is being well received. In the background national motor fuel demand remains depressed by continuing high prices and a sluggish economy.

High fuel prices are also resulting in a much higher working capital cost to Z, which now regularly has about $550 million of inventory, 40% higher than the levels of two years ago.

High inventory costs and tight market conditions featured in the 2011 results of the Australian downstream fuel company Caltex, which were released in February. In addition, Caltex wrote down the value of its refineries by over $1 billion which may be a precursor to further reduction in Australian refinery capacity. Two of Australia’s eight refineries have recently closed or been slated for closure. In comparison The NZ Refining Company’s recently released 2011 result’s showed a 6% increase in throughput and an indication that further investment in capacity is contemplated.

The diverging fortunes of the Australian and New Zealand refining industries is a consequence of both different industry structures and the NZ company’s on-going investment in maintaining efficient operations.

The long-life assets of the fuel processing and distribution industry allow investment deferral, but ultimately this means loss of resilience, reliability and capacity. Aggressive cost-cutting by the distribution chain in New Zealand has seen 1,800 petrol stations close over the last 20 years (60% of the total) and reduced storage capacity at some ports. For instance over 2011 capacity at Port of Timaru was constrained much of the time because of limited available storage.

Z is investing in areas of supply constraint recognising that the investment must generate a fair return and in some situations there are more effective solutions than just adding capacity.

Recent forecasters of oil prices have indicated an anticipation of continuing high price levels, but as a recent Scientific American article noted http://www.scientificamerican.com/article.cfm?id=has-peakoil-already-happened there are credible forecasts for both more and less oil, and higher and lower prices.

Infratil Energy Australia

Lumo continued to grow its customer accounts, which at the end of January were at their highest ever level of 429,000, 5% up on a year earlier.

25% of customers are now outside of Victoria, as against 20% a year prior.

Lumo is growing in each of the National Electricity Market states against a backdrop of lower market churn. For instance in Victoria customer switching was at 23% in January 2012 after running at 26% in 2011. Although Lumo’s churn is still higher than the market average, its relative position is improving due to the efforts put into lifting service to improve customer loyalty.

Lumo Customer Numbers

	Victoria		SA	Queensland	NSW
		Victoria Gas
	Electricity		Electricity	Electricity	Electricity
January 2010 203,330 137,259 28,540 38,804 0 March 2011 192,198 127,804 36,447 50,408 1,977 September 2011 191,663 127,047 39,225 52,548 3,917 November 2011 192,161 127,400 41,757 52,272 6,656 December 2011 192,814 128,230 42,948 52,670 8,656 January 2012 193,478 128,773 43,946 52,649 10,279 Annual Change 0% 0% +25% +4% +450%

Wholesale electricity prices in the National Electricity Market states continued to reflect expectations about CO2 pricing, gas costs, and supply and demand. An interesting illustration of the uncertainty over CO2 was the market response AGL’s announcement that it is to purchase 67% of Victoria’s massive Loy Yang A coal-fired power station for $450 million. If Australian carbon emission prices turn out to be high, the value of a coal-fired station (which emits a lot of CO2) will be low and vice versa if carbon emission costs are low. At present no one knows which way Australia’s CO2 regime will evolve so views over the merits of AGL’s investment are mixed.

The following graph shows how the price of one MWh of base-load electricity in NSW for delivery over the course of calendar 2013 has changed since January 2011. A year ago the market was pricing 2013 electricity at $45/MW, which rose to over $60/MWh once CO2 pricing became law. It has fallen back recently, but this may reflect expectations on any of CO2 prices, supply and demand, or coal and gas prices.

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As shown in the following table, prices for base-load electricity in the four National Electricity Market States currently show a healthy expectation of CO2 pricing from mid-2012. Indications that electricity prices are expected to then continue to rise probably reflects expectations that Australian gas prices will rise as export facilities come on-stream.

A$/MWh	Victoria	SA	Queensland	NSW
Calendar 2012 $38.11 $39.43 $40.25 $43.12 Calendar 2013 $53.74 $57.25 $54.21 $59.74 Calendar 2014 $55.50 $65.74 $56.00 $60.51

While indications are that base-load electricity prices are expected to rise (care of the pricing of CO2 and higher gas prices) the current excess supply situation is resulting in weak cap prices, that is the prices retailers pay to hedge against extreme price periods. This is a plus and minus for IEA as lower cap prices are a benefit for retailers, but not so good for peak-period generation. IEA owns approximately 155MW of such peak period generation which has revenue largely determined by the value of the price-caps it sells.

NZ Bus

Northern region patronage was up 8% over the three months to the end of January relative to the same period the prior year and 6% up over the last 12 months. For the Wellington region patronage was up 2% for the 3 months and flat for the last year.

In January 2012 NZ Bus services provided 230,000 more passenger trips than in the same month last year. In Wellington good growth occurred on all the major services, whether to the south of the region (Brooklyn, Island Bay, Miramar, etc), central areas (Karori, Khandallah, etc) or northern (The Flyer, Eastbourne, etc). Growth was also recorded across Auckland but a significant part of the uplift was on the new Link services.

Of the 198 new buses ordered last year 103 are now in service. 51 have replaced retiring vehicles while 52 are net increases required to meet rising demand. The fleet is now 1,102 buses.

Because bus public transport operates at near-capacity during peak times, growth in demand tends to require an increase in the fleet if people are not to be left waiting at the stop for the next bus. For instance Auckland’s Metrolink services are growing strongly at present and that fleet size has been increased accordingly.

Staff have positively responded to the new Onehunga deport which is the first major new facility commissioned by NZ Bus. Reviews of other depots are progressing.

Northern passenger trips	October	November	November	December	January
2010/11 3,092,977 3,146,179 2,468,102 2,153,851 2011/12 3,362,852 3,381,835 2,687,881 2,324,554 MoM Change 9% 7% 9% 8%
Northern passenger trips 10 Months to 31 January 12 months to 31 January 2010/11 29,623,836 36,295,246 2011/12 31,462,509 38,313,699 YoY Change 6% 6%
Southern passenger trips	October	November		December	January
2010/11 1,669,893 1,701,242 1,422,588 1,137,405 2011/12 1,676,523 1,739,950 1,397,671 1,189,152 Change 0% 2% (2%) 5%
Southern passenger trips 10 Months to 31 January 12 months to 31 January 2010/11 16,683,319 20,394,518 2011/12 16,642,545 20,318,489 YoY Change 0% 0%
	10 Months to 31		12 months to 31
Southern passenger trips
	January		January
2010/11 16,683,319 20,394,518 2011/12 16,642,545 20,318,489 YoY Change 0% 0%

The regulatory model continues to evolve. The new national public transport contracting regime was held up in Cabinet before the last election and it is assumed that it will be announced shortly by Minister Gerry Brownlee.

There will then be several implementation steps leading to the first tenders; disclosure of the contracts and processes, determination of sequence, etc. It is anticipated that the first of the new contracts will be tendered in the middle of the year, at the soonest, with routes in Auckland leading the way. The positive patronage and investment activity apparent in that market is indicative of how the new regime is already influencing behaviour.

In the meantime Greater Wellington Regional Council is undertaking a review of its region’s bus network in general and the role of the trolley buses in particular. Public consultation on the former of these has commenced. NZ Bus and Snapper have assisted the Regional Council by providing comprehensive information on passenger flows over the existing network.

Changes to the network and timetable should deliver more frequent and reliable services, which are the two key factors that will lift public transport use.

Wellington Airport

International passenger growth continues to be robust while recent increases on domestic services are also positive.

Traffic on both the Sydney and Melbourne routes are up about 20% over the last 2 years, while Brisbane is up about 5% over that period. The expansion of the Sydney and Melbourne traffic reflects generally better and expanded service offerings from Air NZ and Qantas. Under its alliance agreement with Air NZ, Virgin Australia now only operates to Brisbane from Wellington.

The scale of latent demand is most clearly illustrated by the increases on the Sydney route where over 1,000 more people are now travelling each average week than was the case two years ago.

Of particular note for Wellington, a significant majority of the Tasman growth is inbound, ie other than NZ residents.

International passengers	October	November	December	January
2010/11 59,491 55,683 64,775 65,966 2011/12 75,849 59,324 70,310 72,844 MoM Change 27% 7% 9% 10%

The recent good performance of domestic traffic is largely due to new services to Queenstown and growth on services with Auckland. Christchurch services have now stabilised with January’s traffic slightly up on January 2011. However, relative to 2010, in January 2012 approximately 16,000 fewer people flew between Wellington and Christchurch, an 18% drop off.

Domesticpassengers	October	November	December	January
2010/11 396,893 385,844 365,174 307,215 2011/12 386,387 393,547 384,194 326,996 MoM Change 9% 2% 5% 6%

10 Months to	Domestic	International
31 January 2011 3,718,475 542,702 31 January 2012 3,697,539 597,934 YoY Change (0.6%) 10.2%

After a year of consultation with its major airline customers Wellington Airport set its aeronautical prices for the period 1 April 2012 until 2017.

The new prices represent a change in the structure of Wellington’s aeronautical charges. Gone is the international departure charge and international charges have generally been reduced to bring them more in line with comparable domestic fees. Domestic charges have been increased but also restructured to reflect the Airport’s increasing peak-time congestion which will lower the cost to airlines of off-peak services, which tend to be used by more price-sensitive travellers.

Under the new price structure international charges will fall by $1.72 per passenger each year in real terms while domestic charges rise by an average of 74c each year. The new aeronautical charges are approximately half way between those of Auckland and Christchurch when measured on a perpassenger basis. Both of those airports are expected to conclude their own price consultations later in 2012.

Overall, Wellington’s average charges are projected to rise by 41c per passenger or 3.6% per year in real terms. However over the five year period the actual outcome will depend on the variables which go into the forecasts. For instance projected capital spending over the next five years amounts to approximately $65 million and if actual investment is less, this results in a rebate.

The consultation documents are all available on Wellington Airport’s website.

European Airports

Glasgow Prestwick’s passenger traffic continued to reflect Ryanair’s UK capacity reductions.

Prestwick’s freight is also down, but this has been offset by Kent’s good performance, largely driven by UK imports of food from Africa.

Glasgow Prestwick

Passengers	October	November	December	January
2010/11 177,280 75,094 63,948 60,993 2011/12 141,002 45,626 41,969 40,407 MoM Change (20%) (39%) (34%) (34%)
Freight tonnes	October	November	December	January
2010/11 1,186 1,026 1,220 894 2011/12 1,012 1,168 740 830 MoM Change (15%) 14% (39%) (7%)
10 Months to Passengers Freight 31 January 2011 1,381,850 10,675 31 January 2012 1,121,265 9,614 YoY Change (19%) (10%)
10 Months to	Passengers	Freight
31 January 2011 1,381,850 10,675 31 January 2012 1,121,265 9,614 YoY Change (19%) (10%)

Kent

Freight tonnes	October	November	December	January
2010/11 2,475 1,942 1,591 1,837 2011/12 2,726 3,000 2,804 2,353 MoM Change 10% 54% 76% 28%
10 Months to Passengers Freight 31 January 2011 28,248 21,357 31 January 2012 32,219 24,695 YoY Change 14% 16%
10 Months to	Passengers	Freight
31 January 2011 28,248 21,357 31 January 2012 32,219 24,695 YoY Change 14% 16%