update Energy Fuel Distribution Transport

Transcription

1 Energy Fuel Distribution Public Transport Airports March 21, Issue No. 31 update In April Infratil and the New Zealand Superannuation Fund are purchasing Shell s New Zealand fuel distribution business and 17.1% interest in the New Zealand Refining Company for $696.5 million. This Update outlines the transaction and provides a detailed description of the industry and the business being acquired. The investment is attractive because SNZ is in a structurally attractive industry. It is expected to deliver good returns to Infratil shareholders. Shell New Zealand Fuel & Chemical Distribution SNZ purchases crude and refined fuels and chemicals in the international market, has the crude refined and distributes the refined products to individual and commercial customers throughout New Zealand. Each year SNZ distributes approximately 2.5 billion litres or 3% of New Zealand s total fuel requirements, and earns an average net margin of about 5 to 6 cents per litre. The business comprises the infrastructure required for this supply chain and the associated working capital. Infratil s Investment Infratil has purchased 5% of the SNZ business and 5% of the 17.1% interest in the New Zealand Refining Company. Infratil is to pay $21 million. The other 5% is being acquired by the New Zealand Superannuation Fund. Additional funding is being provided by banks. The purchase is being undertaken through a holding company. Since 31 March 29 Infratil has realised $393 million from the sale of assets and businesses and has invested approximately $45 million either internally or in new businesses such as SNZ. Following the SNZ investment Infratil s net debt will be approximately $1,2 million, down from $1,21 million at 31 March 29. The divestment and investment transactions were undertaken with the simple objective of improving the returns to Infratil s shareholders in the economic and financial environment which is expected over the medium term. To give a sense of scale to the activity, approximately 8% of Infratil s assets are unchanged over the year. When deciding to invest in SNZ it was recognised that an alternative application of the funds was a return of capital to Infratil shareholders through a share buy back or immediately higher dividend. In the very short term it is possible that buying back Infratil shares could lift the Infratil share price more than investing in SNZ, but for the 9-95% of shareholders who are still holding their shares in a year s time, management believe that the SNZ transaction will be more rewarding. In any case, Infratil s financial circumstances and the robust cash flow of SNZ means that Infratil s shareholders can reasonably anticipate increased cash returns. The price negotiated by Infratil s management for SNZ is believed to be a favourable reflection of the difficult financial market and the vendor s strategic decision to exit from these activities. SNZ is the largest supplier of motor fuels to the New Zealand market and the company has good prospects of earnings growth. The fuel distribution business in New Zealand is undergoing change. It has been dominated by four major oil companies (Shell, BP, Caltex, Mobil) for over a generation and both Shell and Mobil have now either exited or have signalled an intention to exit. New owners will bring differences of approach and perspective. Local ownership of the SNZ fuels distribution business has considerable potential to be good for New Zealand and to result in a better managed more successful company. There are advantages when head office and owners are on their customers doorstep.

2 The New Zealand Motor-Fuel Industry Fuel sales in New Zealand amount to approximately 8.5 billion litres per annum, sourced roughly 6 billion litres through the Marsden Point Refinery and 2.5 billion litres as imported refined product. Each of the four major fuel distribution companies (SNZ, BP, Caltex, Mobil) purchases crude and distillate feedstock for processing by the Refinery for which they are charged a fee set from an international refinery benchmark. New Zealand s incremental fuel needs are imported as processed products, again mainly by the four major fuel companies. Half of the Refinery output is piped to Wiri in Auckland with most of the remainder distributed by road tankers to local markets or by coastal tankers around New Zealand. There are port facilities to unload and store fuel at each of Marsden Point, Wiri/Auckland, Mt Maunganui, New Plymouth, Napier, Wellington, Nelson, Lyttelton, Timaru, Dunedin and Bluff. International imports of refined fuels are also landed at these ports. The four major distribution companies own the two coastal tankers which move fuel between the ports and the relevant handling and storage facilities at each of the depots and ports. At Mt Maunganui Gull Petroleum also has facilities. Fuel is distributed from the ports, in the main, by contracted road transport or relatively short distance pipelines. In order to lower costs, the four major fuel companies have a number of agreements which make parts of their individual storage and distribution facilities available to the other companies. For instance Mobil owns the only pipeline linking Port Lyttelton to Christchurch. The other companies can truck fuel from Lyttelton to Christchurch, but leasing pipe capacity from Mobil gives a lower distribution cost. The New Zealand Automobile Association and Ministry of Economic Development independently monitor the margin between the retail price of petrol and its estimated landed cost, including taxes and international freight. The MED calculation of the margin is shown in the graph at the bottom of this page. The average is about 15 cents per litre with a day-to-day range of as much as +/- 1 cents. This is the gross margin between the estimated imported cost of fuel and the pump price. The net margin of a company such as SNZ also reflects the cost of distributing the fuel within New Zealand. The net margin for SNZ has averaged about 5 to 6 cents per litre over the last five years. It would be possible for a new entrant fuel distribution company to build port, storage and distribution facilities, but in addition to the cost of construction, the new company would also have to manage the risks associated with fluctuating oil and fuel prices and the need to fund inventory. Supermarkets, which sell fuel now, source that fuel from one of the existing distribution companies, presumably because it is cheaper and lower risk than developing their own distribution channels. In other markets, such as Australia and the UK, supermarkets have expanded into fuel retailing in competition with fuel distribution companies. They have been able to do this because plentiful local sources of supply (whether from independent importers or refineries) have meant they could compete with traditional fuel companies. These supply options are not readily available in New Zealand and it is notable that even in Australia the situation has changed with the number of independent traders declining markedly over recent years (from 7, companies in the 197s to 12 in 28). 35 Fuel Distribution Company Gross Margin - Regular Petrol (one week lag) 3 25 cents per litre Jan 8 Apr 8 Jul 8 Oct 8 Jan 9 Apr 9 Jul 9 Oct 9 Jan 1 Long-term average Source: Ministry of Economic Development 2

3 3,5 New Zealand Demand for Motor-Fuels 3, Annual Consumption (million litres) 2,5 2, 1,5 NZ Petrol Demand and Projected Demand MED forecast petrol demand, upper and lower bounds 1, New Zealand Consumption of Diesel (litres) New Zealand Consumption of Diesel (litres) NZ Pump Price of 95 Octane Petrol ($) Total fuel demand in New Zealand has been relatively stable despite the recession and, at times, very high prices. It is widely anticipated that in future hydrocarbon based fuels will become more expensive and vehicles will become more efficient and maybe even electric or hydrogen powered. The viability of electric vehicles is demonstrated in Wellington which has electric trolley buses. Nevertheless, New Zealand demand for diesel and petrol is not expected to fall substantially for several decades. The Ministry of Economic Development forecasts are graphed at right. They are approximately in-line with the forecasts developed for Infratil in its assessment of the value of SNZ. The notable trends over the period to 225 are an expected gradual decline in petrol demand and increasing use of diesel. Diesel use is rising because private motorists are switching from petrol and because commercial transport, and its associated fuel demand, grows in line with the economy as goods have to be moved. Annual Consumption (million litres) NZ Diesel Demand and Projected Demand 14. 4, 12. MED forecast petrol demand, upper and lower bounds 1. 3,5 8. 3, ,5 2. 2, , NZ Pump Price of 95 Octane Petrol ($) 1, NZ Petrol Demand and Projected Demand Annual Consumption (million litres) US$ fee per barrel of oil processed 3,5 MED forecast petrol demand, upper and lower bounds NZ Refining Gross Margin and Operating Profit 3, 12 2,5 1 2,8 6 1,5 4 1, NZRC operating surplus GRM US$/bbl NZRC Operating Surplus High Forecast Low Forecast New Zealand Consumption of Diesel (litres) 35 3 NZ Pump Price of 95 Octane Petrol 3

4 SNZ SNZ s operations and assets comprise all the parts of a business which purchases crude and refined fuels and chemicals from the international market and distributes fuels and chemicals throughout New Zealand. In addition, Infratil and the New Zealand Superannuation Fund are buying Shell s 17.1% shareholding in the New Zealand Refining Company. Procurement & Inventory Each year SNZ purchases approximately 1,75 million litres of crude oil and 75 million litres of refined product. The crude oil is delivered to the New Zealand refinery in approximately 15 cargoes of 11 million litres each. Refined product arrives in New Zealand in smaller consignments of 3-4 million litres. SNZ s inventory comprises the crude which has been purchased and loaded on a ship all the way through to the refined fuel in a petrol station storage tank. It fluctuates in quantity between 3 million and 65 million litres worth over $6 million. Refining, National Distribution SHZ has a contract with the Refinery to process crude for a fee determined by reference to an international refinery margin benchmark. Approximately 7% of the fuel distributed by SNZ is processed by the Refinery. Half of the Refinery output is piped 17 kilometres to Wiri in Auckland with most of the remainder distributed nationally by coastal tankers. The Refinery Company owns the pipeline and the Wiri storage facility. SNZ, along with BP, Mobil and Caltex, own the two coastal fuel tankers which deliver refined fuels around New Zealand. Facility Location SNZ BP Caltex Mobil Gull Refinery Coastal tankers Whangarei Auckland Mt Maunganui Napier New Plymouth Wellington Nelson Christchurch Timaru Dunedin Bluff 4

5 Terminals, Storage and Regional Distribution At some terminals each oil company owns storage, while at others storage and facilities may be leased from one company to another. SNZ operates some facilities, while others are operated by joint ventures. These arrangements minimise over-capacity and operational duplication. SNZ distributes from the storage terminals by contracted road haulage to its retail stations and truck-stops and directly to commercial customers. In Auckland jet fuel is delivered to the airport by pipeline. Marine fuels are distributed directly from port storage as well as by road tankers and barges. Retail & Commercial Delivery SNZ has 229 retail service stations of which 111 are owned freehold, 13 are leased and 15 are independent. The service stations are located throughout New Zealand. 7 in Northland/Auckland. 47 in Waikato/Bay of Plenty. 1 in Poverty Bay/Hawkes Bay. 16 in Taranaki/Manawatu. 21 in Wellington. 12 in Nelson/Marlborough. 34 in Canterbury/ West Coast. 19 in Otago/Southland. In addition SNZ has facilities for distributing fuel to commercial users, including 95 truck-stop sites expressly for commercial vehicles. SNZ has leadership in most of the market segments in which it operates and because many of the industry s costs are fixed, its higher volumes mean lower unit costs. The service stations are operated on a franchise model which is explained on page 8. SNZ has storage and distribution facilities at 12 sites. At each terminal facilities vary depending on regional needs for individual products; 91, 95 and 98 octane petrol, diesel, jet fuel, aviation gas, chemicals, fuel oil, etc. Marsden Point Wiri Auckland Mt Maunganui New Plymouth Napier Nelson Wellington Woolston Lyttelton Timaru Dunedin Bluff 5

6 Supply & Refining Approximately 7% of New Zealand s 8.5 billion litres per annum of fuel consumption is sourced from the Marsden Point Refinery. A recent upgrade of the Refinery will lift its output from 6. to 6.6 billion litres or 75% of national demand. Product NZ Consumption Refinery Output Petrol 38% 34-35% Diesel 35% 33-34% Aviation Fuel 18% 19-2% Fuel Oil 7% 1-12% Other 2% 2-3% Contracts between the four major fuel distribution companies and the Refinery mean that the refining fee is set at 7% of an international benchmark with a maximum fee of US$9 per barrel and a minimum of approximately NZ$3 per barrel. During periods of high refining margins, the discount the distribution companies receive under their contracts can amount to up to 3 cents per litre although it is usually approximately 1 cent per litre. At present with refining margins depressed the benefit is minor. However, even when refining margins are low, there are still efficiency advantages and freight savings from using the Refinery as opposed to those in Australia or Asia. The Refinery s processing capacity is allocated between the four companies each calendar year based on their market shares for each product over the previous three years. Based on the capacity allocations each of the four companies must then undertake to provide the Refinery with crude of specified quality at specified times to enable it to achieve its agreed outputs. On average SNZ procures 15 crude cargoes a year of an average 11 million litres (approximately 7, barrels). The following tables show the Refinery s normal types and sources of input. Type of Crude Source of Crude High sulphur crude 41% Middle East 52% Low sulphur crude 37% Asia 24% Condensates 11% New Zealand 14% Residues 11% Australia 5% Other 5% SNZ retains ownership of its oil through the refining process and once it has taken receipt of petrol, diesel, etc from the Refinery it tops up its requirements via direct imports. The average size of an imported cargo of refined product is 3-4 million litres. The New Zealand Refining Company Limited The Refining Company is listed on the NZX and is 17.1% owned by SNZ with other shareholders being BP 24%, Mobil 19%, Caltex 13%, Emerald Capital Holdings 13% and the public 14%. The Refining Company assets comprise the refinery, the 17km pipeline to the Wiri terminal in Auckland and the terminal facilities at Wiri. The Refinery s tolling operation where it refines crude provided by the four distribution companies means it has no requirement to buy and sell product or manage inventory and it can rely on a minimum level of income. However, in keeping with other refineries, its fees are set in an international market and when there is too much capacity, those fees can be low. US$ fee per barrel of oil processed US$ NZ Refining Gross Margin and Operating Profit NZ$ million NZRC operating surplus The graph shows the relationship between the Refinery s profitability and its gross margin. The graph also shows projections of refining margins out to 22. Ultimately actual margins will be a function of refinery supply and demand, both of which are subject to high degrees of uncertainty GRM US$/bbl NZRC Operating Surplus High and Low Forecast GRM 6

7 SNZ Commercial Sales Fuel sales in New Zealand are split approximately 5/5 between retail and commercial users and SNZ s sales are also in the same proportions. Commercial customers are categorised under the headings of Commercial, Aviation, Marine, Chemicals and Bitumen. Commercial sales and distribution mainly involves diesel and encompasses Truck Stops and direct delivery of fuels. The Truck Stops are a national network of un-manned roadside refuelling facilities for commercial vehicles. Direct delivery is by tanker to user sites. The aviation fuel market comprises jet fuel and aviation gasoline, with 8% of the former sourced from the Refinery with the balance, and all aviation gasoline, imported. The supply at each airport tends to be defined by local infrastructure and logistical factors and nationally the market shares of the four suppliers have been reasonably equal and stable for several years. Marine customers are approximately 5/5 international and domestic and are fuelled via specialist port facilities. The primary drivers of market share are price, security of supply, and the access infrastructure. Three fuels (diesel and light and heavy fuel oil) are provided with marine use being the major application of the Refinery s output of fuel oil. Bitumen is a refinery output after more valuable products have been extracted from crude oil and the Refinery is currently changing its operations which may reduce its bitumen production. As approximately 85% of New Zealand s bitumen is used by three road contracting companies, which already undertake direct imports, it is possible that the fuel companies will cease trading this product. SNZ operates a small specialist chemicals business. Unlike its competitors, SNZ is active in all markets and is New Zealand s only comprehensive fuel distribution company. The one exception is with regards to supplying competing retailers which SNZ does not do, whereas BP, for instance, supplies both Foodstuffs and G.A.S. outlets. There are several different approaches to each commercial market which makes for a competitive offering. SNZ tends to deliver to its customers whereas a more come to our depot and pick it up model is available elsewhere. 7

8 SNZ Retail Sales Nationally there are approximately 1,26 retail service stations, of which 1,81 (86%) are one of SNZ, BP, Mobil or Caltex, which distribute about 9% of all retail fuels. Gull Petroleum, established 1998, has 33 sites provided with fuel from its own terminal and storage facilities in Tauranga. Foodstuffs entered the fuel market in 22 and has 34 sites supplied by BP. There are another 114 retail sites which are supplied by the four distribution companies. Almost half of New Zealand s total fuel sales (approximately 4 billion litres), occurs through retail service stations and retail sales also make up about 5% of SNZ s throughput. SNZ s 229 service stations have the industry s highest average fuel throughput due to their good locations, past closure of low throughput sites, high quality fuels, competitive pricing, the FlyBuys loyalty programme and a discount voucher scheme operated with Progressive Enterprises supermarkets. 45% of SNZ s retail sales involve FlyBuys or a supermarket discount. 2% involve the Shell Card. New Zealand s two leading supermarket chains, Foodstuffs and Progressive, each has links with fuel distribution companies which means that a supermarket shopper can use their docket to get a discount on fuel, usually of 4 cents per litre. In Australia, where details of the sharing of the docket-discount are public, 1 cent is borne by the supplying fuel company and 3 cents by the supermarket. These are essentially arrangements to drive business to the relevant supermarkets rather than a way for supermarkets to develop standalone fuel businesses that compete with distributors. Of SNZ s retail stations, 111 are freehold, 13 are leased and 15 are operated under Shell branding by independent dealers. 11 stations have Select Shops (over 1 square metres) and 97 have Shell Shops (6-7 square metres). A small number of stations have sub-leased space to car wash and fast food outlets. Most of SNZ s stations (over 9%) are managed by a contracted retailer who is paid a cents per litre fee on fuel sales and receives a share of the gross margin on non-fuel sales. The contractor employs and pays station staff and is responsible for normal operating costs. None of the retail staff are employed by SNZ. Average annual sales at SNZ s service stations amount to 5.2 million litres of fuel and approximately $1.2 million of shop goods. SNZ is the market leader as regards per site fuel sales with the rest of the industry having average sales of about 2.7 million litres per station. However SNZ s shop sales have been flat over recent years and the potential to do better is illustrated by BP s Wild Bean outlets which are New Zealand s leading coffee distributor. Market Shares While total industry fuel volumes are made public by the Ministry of Economic Development, sales by individual companies are not readily available. However, the Refinery discloses its allocation of capacity and this is a reasonable proxy for market shares and it is known that independents have 4-5% of the total fuels market or about 8-1% of the retail market (their commercial sales are negligible). Company Share of Refinery Output Retail Service Stations Total Market SNZ 3% % BP 28% % Mobil 21% 38 19% Caltex 21% % Other 181 4% 8

9 Setting the Fuel Price for Consumers The Refinery provides most of New Zealand s fuel needs with residual demand imported as finished product. Studies of New Zealand retail fuel prices show that the prices seen by consumers closely relate to the price of fuels in the international wholesale market. The following graph shows the Ministry of Economic Development s record of the annual average price of regular petrol in New Zealand since 1997 and their calculation of the components of that price, being: The cost of fuel delivered to New Zealand which they calculate from public information on Singapore refinery prices and freight and handling costs. New Zealand taxes. The New Zealand distributor margin, which is calculated by MED as the residual once landed fuel and tax costs have been deducted from the pump price. NZ$ NZ Pump Price of 95 Octane Petrol Landed Cost of Fuel Taxes Distributor s Margin Most of the change in pump prices has come from fluctuations in the imported cost of fuel. Distributors margins have been relatively stable. The following graphs, also from MED, show a weekly calculation of the distributors margin since January 27. The distributor margin shown in the graphs is before any of the distributors costs incurred in taking fuel from the port to the motorist. It has been reasonably stable except for the one sharp dip in mid 27. The landed price of imported fuel seems to be setting the New Zealand pump price, presumably because of how participants in the market compete. Each distribution company knows that its competitors are buying fuel on the international market and will increase purchases and sales if local margins became attractive. On the other hand, there are several reasons why the local market margins are stable and not subject to independent parties buying cargoes of cheap fuel in Singapore and dumping it on the local market. New Zealand fuel is subject to detailed local specifications which means that fuel usually has to be made especially for New Zealand use. It is not practical to just buy a cheap off the shelf cargo in the international market. Any independent party which imported a cargo of fuel would have to arrange storage. A small cargo of 4 million litres would be sufficient for 3-4 service stations for six months. A large commercial diesel user such as NZ Bus (with over 1, buses travelling over 45 million kilometres a year) would take two years to consume one small cargo of imported diesel. A single cargo of fuel which was purchased at one moment and then sold over an extended period of time creates substantial price risk. If market prices fell just after the cargo was purchased the fuel would no longer be relatively cheap and would be sold at a loss. In effect the local market appears to be in equilibrium with prices set by reference to international markets because each distribution company knows that fuel is available to a competitor at that price. However new entrants and one-off cheap deals are not commercially viable at current margins. Ministry figures show that distributors margins (when smoothed out for short term fluctuations) have been reasonably stable since 2. This stability presumably reflects that while the industry s costs will have risen, this must have been off-set by increasing efficiency. An example is the decline in the number of service stations from 3,4 in 198 to 1,265 in 28, which would have substantially lowered the industry costs. The Ministry of Economic Development constantly reviews fuels prices in New Zealand and it has undertaken a number of competition studies. There was also the 21 approval by the Commerce Commission of Mobil s purchase of the Challenge retail fuels operation. In all cases the regulatory agencies found no evidence of collusive behaviour, nor that there were persistent long run barriers to entry. Retail price movement of regular petrol versus landed cost based on Singapore benchmark Regular Petrol Importer margin over time New Zealand cents per litre Mar 7 Sep 7 Mar 8 Sep 8 Mar 9 Sep 9 Mar New Zealand cents per litre New Zealand New cents Zealand per litre cents per litre Regular Petrol Importer margin over time Mar 7 Sep 7 Mar 8 Sep 8 Mar 9 Sep 9 Mar 1 New Zealand retail price of regular petrol (LHS) Landed cost based on Singapore Mogas 95 Unleaded with one week lag (RHS) Source: Ministry of Economic Development Mar 7 Sep 7 Mar 8 Sep 8 Mar 9 Sep 9 Mar 1 Source: Ministry of Economic Development 9

10 SNZ Operational & Financial Data Over the last five years SNZ had stable sales volumes while its net earnings per litre of fuel distributed rose slightly. However, the calculation of earnings depends on which accounting rules are followed; Historic Cost (which uses the cost of fuel sold on a first in, first out basis), or Current Cost (calculated on the basis that as fuel is sold a roughly similar amount will be purchased and a distribution company s income margin should be measured accordingly). International accounting standards require that reported results are shown using Historic Cost, but fuel distribution companies tend to be financially assessed on the basis of Current Cost. On the following page the difference in measurement is further explained. Year Ended 31 December Market Indices Average NZ$/US$ Exchange Rate Crude price at year end (NZ$per barrel) $76.85 $8.95 $ $64.49 $13.76 Average crude price NZ$/bbl $7.15 $94.95 $92.61 $ $95.12 Crude price range NZ$/bbl $49.18 $84.3 $8.95 $ $71.44 $ $64.49 $18.75 $65.13 $ SNZ Operations Sales (million litres) 2,519 2,479 2,538 2,61 2,58 Sourced from Refinery (%) 67% 7% 64% 67% 7% Distributed to retail (%) 49% 5% 49% 47% 5% Inventory at year end (million litres) SNZ Financial (NZ$million) Revenue (excluding tax) $1,788 $2,26 $2,174 $2,942 $2,152 Gross margin $289 $315 $288 $399 $368 Operating costs ($171) ($24) ($28) ($245) ($23) Current Cost EBITDA $118 $111 $8 $154 $138 Stock value adjustment $55 $47 $7 ($16) $38 Historic Cost reported EBITDA $173 $158 $15 ($6) $176 Depreciation ($27) ($23) ($2) ($21) ($22) Capex ($25) ($3) ($33) ($31) ($25) NZRC contribution $41 $41 $33 $32 $3 Group Reported Earnings Before Interest & Tax $187 $176 $163 $5 $157 Gross Margin (cents per litre) EBITDA (cents per litre) To explain the SNZ financial figures for 29 (the same explanation holds for the other years): SNZ s total revenue was $2,152 million. This excludes fuel levies and GST and reflects a net contribution from shop sales at petrol stations. The Current Cost earnings (EBITDA) differ from Historic Cost earnings as a consequence of how the periods opening and closing inventory is valued. This difference is reflected in the stock value adjustment which in 29 was $38 million. SNZ had depreciation of $22 million and equity accounted income from the Refinery Company of $3 million, meaning that total reported earnings before interest and tax were $157 million. 2,58 million litres of fuel were sold that year so SNZ s gross margin (including the benefit of using the Refinery) was 14.7 cents per litre and the net margin after deducting SNZ s operating costs amounted to 5.5 cents per litre. 1

11 The valuation at which SNZ was purchased was based on projections of the future cash income the new shareholders anticipate deriving from ownership. However cash income, Historic Cost earnings (the basis of reported earnings) and Current Cost earnings can differ especially in individual reporting periods. For reasons explained below, while SNZ is projected to provide stable Current Cost earnings (ie to sell relatively stable amounts of fuel and to achieve relatively stable margins per litre sold), reported earnings and cash flows are likely to be more volatile. SNZ reported earnings (EBITDA) conform to accounting standards which require cost of sales to reflect the Historic Cost of the fuel sold. However in reality SNZ constantly sells fuel and buys product to replenish its inventory. Consequently Current Cost earnings are a more accurate measure of the company s performance. Over time, the two measurements should be approximately the same, but there will be differences in any one accounting period and generally Historic Costs earnings will be more volatile. While Current Cost earnings should be a reasonable indicator of the Company s performance, operating cash flows will reflect both the income from buying and selling fuel and changes in inventory and what is owed to suppliers or owed by customers. Comparing Earnings & Operating Cash Flow Year Ended 31 December $ millions Current Cost EBITDA $118 $111 $8 $154 $138 Reported Historic Cost EBITDA $173 $158 $15 ($6) $176 Total operating cash flows $11 $88 $215 ($147) $275 The tables at right show the reconciliation of reported Historic Cost earnings, Current Cost earnings and actual operating cash flows. The second table covers only 28 and 29 to allow a more explicit depiction of two contrasting years. These figures do not include income received on the shareholding in the Refining Company, interest, tax, divestments or new investments. Reconciling Current Cost earnings, Historic Cost earnings and Operating Cash Flows Year Ended 31 December $ millions Current Cost Earnings EBITDA $118 $111 $8 $154 $138 Stock value adjustment $55 $47 $7 ($16) $38 Reported EBITDA $173 $158 $15 ($6) $176 Change in Historic Cost inventory ($133) $4 ($13) $145 ($29) Change in receivables and payables $7 ($11) $168 ($286) $128 Total operating cash flow $11 $88 $215 ($147) $275 Inventory $388 $347 $45 $35 $334 Net receivables/ payables ($173) ($62) ($23) $56 ($72) Reconciling 28 & 29 Current Cost earnings and Operating Cash Flows Year Ended 31 December $ millions Revenue (excluding tax) $2,942 $2,152 Current Cost of goods sold ($2,543) ($1,784) Operating costs ($245) ($23) Current Cost Earnings EBITDA from buying and selling product, less all operating costs $154 $138 Net use/(purchase) of inventory at Current Cost ($15) $9 Cash flows from fuel distribution $139 $147 Net change in receivables as customers paid their bills or increased what they owed SNZ $13 ($6) Net change in payables as SNZ (reduced)/increased the amount it owed suppliers ($299) $134 Total operating cash flow ($147) $275 11

12 Despite 28 and 29 being two years when oil and fuel prices were extremely volatile, cash generated from distributing fuel was reasonably stable ($139 million in 28 and $147 million in 29). There were significant total cash flow differences from one year to the next because what SNZ owed to suppliers (payables) and was owed by customers (receivables) fluctuated, almost certainly due to factors such as when crude was loaded on a ship and other normal seasonal events. Working Capital: Inventory, Receivables & Payables SNZ s investment in working capital has fluctuated markedly over the last five years. The timing of a single cargo of fuel (which can cost over $1 million) can significantly change the figures at year end. Year Ended 31 December $ millions Inventory volume (million litres) Inventory value * $388 $347 $45 $35 $334 Receivables $129 $141 $165 $152 $158 Payables ($31) ($23) ($395) ($96) ($23) Net working capital $215 $285 $22 $361 $262 * valued at the market price of the various fuels held in inventory as at the relevant 31 December Over the last five years the quantity of SNZ s inventory has ranged between 3 million litres and 65 million litres and its value by between $2 and $65 million. Value (NZ$m) Quarterly inventory levels (volume and value) Mar 4 Sep 4 Mar 5 Sep 5 Mar 6 Sep 6 Mar 7 Sep 7 Mar 8 Sep 8 Inventory Value (LHS) Crude Volume Refined Fuels Volume Volume (m litres) Receivables (money owed to SNZ by its customers) has usually been less than payables (mainly what SNZ owed for product) because usually SNZ pays for product about a month after it was loaded on ship, while customers buying product from SNZ pay within a shorter period. The following table illustrates the payment and product cycle for one consignment of fuel. Illustrative Purchase & Sale Timetable When Transaction Cash Out Cash in Jan Oct Nov Dec Jan Feb Refining and SNZ agree a year ahead schedule of production, meaning that SNZ knows in advance its requirements for crude for Refinery processing and residual fuel needs. SNZ contracts with a producer or trader for a shipment of crude of a specified quantity and quality and sets a margin relative to an agreed benchmark. Crude placed on a ship and the US$ price fixed. Crude arrives at NZ Refinery and is refined. Refined product delivered around NZ and purchased by private and commercial users. SNZ pays the US$ cost of the shipload of crude (one month after it was placed on the ship). Cash income at service stations. Cash income from commercial customers granted terms. The table covers the progress of a single crude shipment and its associated flow of money. In reality SNZ is constantly buying and selling product. About 7% of its purchases are of crude (average cargo 11 million litres) of which there are about 15 a year. About 3% of SNZ s purchases are of refined product in average cargoes of 3-4 million litres. Individual payments for a single cargo can be up to $1 million. 12

13 SNZ Assets & Funding Shell is selling 1% of the shares in its New Zealand fuel distribution and processing business along with its 17.1% interest in New Zealand Refining Company. An approximate break down of the assets is provided in the table. Funding structure Assets being acquired NZ$million Land, buildings and plant, equipment and other fixed assets 229 retail and 95 truck stop outlets (118 freehold) Distribution, storage and processing facilities The associated land is typically leased $298.5 Working capital Inventory (crude and processed fuel) Receivables (mainly commercial customers) Payables (mainly crude suppliers) $28 Total SNZ net assets $56.5 NZ Refining stake 47.9 million shares at market value $19 Total net assets being acquired $696.5 $21M equity investment Holding Company 17.1% 1% $21M equity investment $6M debt facility for core funding and working capital SNZ Banks The values shown in the table are approximate allocations of the $696.5 million purchase value derived from the accounts of the businesses being acquired. Infratil undertook its own valuation of the 17.1% interest in Refining. The figure shown in the table is the approximate market value of those shares. There will be an inventory adjustment payment once the settlement date inventory volumes and values are identified. The $28 million working capital figure reflects estimated inventory of 4 million litres valued at $323 million which is approximately $42 million less than normalised inventory levels. Excluding the Refinery stake Infratil and NZ Super are paying approximately $548 million ($56.5 million + $42 million inventory normalisation adjustment) to acquire the SNZ fuel distribution business which last year had Current Cost earnings before interest, tax and depreciation of $138 million and reported earnings of $176 million. Infratil and NZ Super will each provide $21 million to acquire the Shell shareholdings with additional finance provided by bank loans, which are mainly to fund working capital. On settlement day, the two shareholders and the banks will provide funds to the Holding Company which will acquire the shares in the Refining Company and SNZ from Shell for $696.5 million. There will also be an up-front payment to Shell in respect of licencing royalties for use of the brand and, as noted, there may later be an inventory wash-up. The bank facilities are substantially more than was required at the time of acquisition. The additional borrowing capacity ensures headroom in future if inventory values rise. The total funding of over $1 billion (ie the total of the money actually paid to Shell and additional bank facilities to cover peak working capital demands) was an important reason Infratil and NZ Super were able to secure the SNZ businesses. Few parties in New Zealand can arrange that level of finance. In due course alternatives to conventional debt and equity may be used to fund some of SNZ s assets. In particular, service stations can be sold and leased back and inventory is amenable to supplier funding. Such arrangements free up money but increase costs (eg. rent has to be paid on leased properties) and will be judged on their merits in due course. 13

14 Forecast Over the next two years, SNZ s operations, volumes and margins are expected to be in line with 29, although reported results may fluctuate in individual accounting periods because of changes to fuel prices and refining margins. Over the medium term it is believed that SNZ will be able to increase earnings due to changes now happening in the industry and because localisation of decision making is expected to result in greater efficiency, improvements to services, and the identification of growth areas where it is productive to invest. In particular, investment is likely to yield increases in returns and value in areas such as increasing fuel storage facilities, providing a better offering at retail service stations, and developing bio-fuels. Increasing SNZ s Earnings Under Local Ownership SNZ is the market leading New Zealand fuel distribution company. Because of the fixed nature of many costs this means it is probably the lowest cost distributor. It has also been part of the global Shell network, sells technologically advanced fuels, and is a well respected brand. How will local owners do a better job and increase earnings? A number of areas are prospective. SNZ has been a division of a multinational and its various parts have reported to chief executives based outside of New Zealand. Some benefits are expected to come from greater flexibility, some from investment in better facilities. There are also areas such as bio-fuels where SNZ is likely to be more active locally than was the case when the company was part of a multinational. Increased local storage capacity is one particular field where investment may be warranted. Naturally any incremental investment will depend on the relevant economics and the availability of funds. What Infratil (And NZ Super) Are Not Buying From Shell In addition to its fuels distribution business, Shell also owns substantial oil and gas assets in New Zealand. These are all being retained by Shell. When the media covers the latest discovery of gas off Taranaki, that will have nothing to do with the SNZ businesses being acquired by Infratil and NZ Super, nor will the associated legal and environmental arguments which seem to be part and parcel of that industry. The new owners of SNZ are undertaking the investment following comprehensive due diligence of the businesses being acquired. In general the uncertainties and opportunities of SNZ are being transferred with its ownership although a small number of specific historic risks are being retained by Shell. SNZ s Transition From Multinational To Local In the short term motorists refuelling at a Shell station will be hard pressed to notice any changes. The brand will be the same. The fuel and its associated technology will be the same. The arrangements behind procurement of crude and refined product will be the same. Shell has agreed to work with the new owners to ensure their New Zealand customers experience a seamless transition. Commercial customers will notice some visible changes as the Shell brand will only be used on retail service stations. Commercial fuel deliveries will come from a tanker with a different logo. Internally SNZ will be required to make some adjustments as its financial and information systems have to be brought on-shore. Gradually SNZ s new senior management and directors will instigate changes to both improve the efficiency of the Company and to enhance its delivery to customers. 14

15 15

16 update Whilst all reasonable care has been taken to ensure the facts stated are accurate, neither Infratil Limited, Morrison & Co Infrastructure Management Limited, nor any of their directors, officers or employees guarantee the accuracy or completeness of the information stated herein.