investing REFINING NZ ANNUAL REPORT 2012 Investing in nz s future

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1 07 Investing investing in nz s future

2 Te mahi hou In 2012 the Company embarked on a $365 million project to replace an aging semi-regeneration platformer with a CCR unit. The Te Mahi Hou project will lift Refining NZ s share of the country s petrol market to around 65%, making New Zealand even more self sufficient for high quality transport fuels. The highlighted area shows the Te Mahi Hou location which will require the removal of two tanks.

3 09 Chairman's Report informing David Jackson Chairman Chairman s Report 2012 The ability of Refining NZ to continually lift its operational performance has been critical to the Company achieving a better than expected financial result for the full year. During 2012 we faced increasingly difficult business conditions, marked by the ongoing weakness in the US dollar and volatile refiners margins market factors that weighed heavily on our performance. However through retaining a focus on the safe and reliable running of our refinery we were able to capitalise on improving refiners margins and post a profit after tax of $32.7 million for the year ended 31 December Earnings before interest, tax, depreciation and amortisation (EBITDA) were $113.5 million, down 14% on the previous year s result (2011: $132.3 million). This result is a credit to our team of talented and committed individuals, and justifies our policy of continued investment in a reliable manufacturing operation that customers can depend on for high quality transport fuels. The Company s ability to generate strong cash flows from operations continues to underpin a strong balance sheet and in 2012 this was further bolstered by our prudent approach to managing debt. Borrowings at the year end stood at $62 million (2011: $25.6 million) and careful management of debt leaves substantial room in our facilities to meet the future capital commitments of the Company. SAFETY The commitment of our people to safe working through the Safety Action Plan, meant that between May 2010 and July 2012 there were no incidents requiring staff or contractors to be off work as a result of a work related injury. Over this period we achieved 2.7 million hours without a lost time injury. Our safety performance was rewarded with the Safeguard New Zealand 2012 Health and Safety Award for the Best Initiative to Encourage Engagement in Health and Safety. The Company was also at the forefront of promoting awareness of process safety initiating a cross industry forum for New Zealand manufacturers, and working to establish a technical advisory group for the Business Leaders Health and Safety Forum. Despite our safety achievements we had three recordable cases, all of them avoidable, and we fell short of our aspiration of a world-class health and safety performance. As part of the Company s Safety Action Plan we are striving to ensure such incidents are not repeated. The safety of our people and processes will receive continued focus in 2013 as we undertake two planned shutdowns and construction on Te Mahi Hou gathers pace. Investing in RELIABILITY Investing cash in the integrity of the refinery s processing assets through inspection, maintenance and refurbishment, ensures our refinery can continue to run reliably and safely. Reliable performance also underpins our ability to compete with imported product from around the world especially the newer, larger Asia Pacific (Asia Pac) refineries. In February 2012 the Company carried out a seven day shutdown on the hydrocracker unit for emerging maintenance and a 17 day shutdown, in April 2012 sustained the processing performance on the platformer and crude distiller units. Both shutdowns were executed safely, with no personal or process safety incidents, within budget and to the timeframe agreed with the Company s customers. In 2012 good operational performance saw the Company achieve a number of records: overall throughput was ahead of the refinery s previous best; unplanned

4 10 Chairman's Report through retaining a focus on the safe and reliable running of our refinery we were able to capitalise on improving refiners margins. downtime, a benchmark of reliability, was better than targeted; and the volume of finished product was ahead of plan. When our customers can depend on us to meet their needs they are more likely to make us their supplier of choice for high quality transport fuel products ahead of imports. Competition in the global refining sector will increase, with capacity growth through to 2017 expected to exceed oil demand. We will need to lift our performance if we are to successfully compete in the Asia Pac region. TE MAHI HOU The $365 million Continuous Catalyst Regeneration Platformer (CCR) project approved by shareholders in April 2012, and officially named The New Venture Te Mahi Hou, is progressing safely and to plan. Te Mahi Hou will provide a significant step towards achieving the Company s aims. REVIEW OF PROCESSING ARRANGEMENTS In April 2012 the Independent Directors recommended that the processing arrangements with Refining NZ customers be reviewed by independent oil industry experts, Purvin & Gertz. Their report concluded that over the 15 year period from 1997 to 2011, the current processing fee arrangement between Refining NZ and the customers is considered to be generally reasonable to all parties, relative to the risks borne by Refining NZ and the customers. SHAREHOLDER RETURNS Taking into account the Company s strong balance sheet, especially in a challenging business environment, the Directors resolved to pay a final dividend of five cents per share with full imputation credits attached. The final dividend will be paid on 28 March 2013 with a record date of 21 March An interim dividend of two cents was paid on 20 September 2012 resulting in a total dividend payment of seven cents per share for the year. BOARD AND MANAGEMENT CHANGES During the year Director Mike McGuinness representing BP Oil New Zealand resigned and was replaced by Matthew Elliott. Glenn Henson representing Mobil Oil New Zealand also resigned and was replaced by Andrew Warrell. Thanks to Mike and Glenn for valuable contribution to Refining NZ during their time as Directors. Chief Executive Officer, Ken Rivers was farewelled in December He has been replaced by Sjoerd Post, who joined Refining NZ in January 2013 from Shell International Petroleum Company Ltd, where prior to his resignation, he was Executive Vice President, Downstream Strategy and Portfolio activities. BUSINESS OUTLOOK The Company will be reviewing the business strategy established five years ago. Since it was adopted we have seen significant structural changes in global refining, increased competition from refiners in the Asia Pac region and a customer change in New Zealand. The Board and management team have taken this into account and consider it appropriate to conduct a strategy refresh in We expect business conditions to remain difficult in 2013 with the volatility in refiners margins and the exchange rate likely to continue. However, the Directors consider the Company is well placed to counter this through strong revenue generation, supported by improved safety and operational performances.

5 11 CEO's Report informing Sjoerd Post CEO Chief executive officer s Report 2012 In the very short time in my role as Chief Executive it has been apparent that the performance of this business over the last 12 months is part of a longstanding culture of safety and manufacturing excellence. I would like to acknowledge my predecessor Ken Rivers for the outstanding role he has played in taking that culture forward. A culture of safety and manufacturing excellence is not something you create overnight or by yourself. It needs deep professional expertise, teamwork, talent, pride in a job well done, the will to do better and the modesty to learn from others. All these ingredients are in plentiful supply in Refining NZ and are at the heart of our ability to compete with the biggest and best fuel manufacturers in the Asia Pacific region (Asia Pac). competing in a changing world What does it take to compete in today s world of excess refining capacity and very large world-scale new builds in Asia Pac where our fuel marketing shareholders are tempted with attractive offers from as far away as India, China and Korea? Firstly, relentless focus on the safety of our staff, contractors and neighbours, respect for the environment and other matters that allow us our license to operate are key. The desire to be world-class in these matters will continue to be of paramount importance and simply makes good business sense. Secondly, we need to be a dependable supplier. New Zealand is at the end of a long supply chain and that means we have to be dependable for our customers. I would highlight two key factors in Refining NZ s performance over the last year: less than 0.6% unplanned downtime and consistently high fuel quality. Truly, a supplier s performance you can depend on as a customer and a credit to the Refining NZ team. In fact, we know from regular benchmarking by international industry experts, Solomon Associates, that our refinery is a top quartile performer in terms of availability. We have a long history of forward thinking investment in our reliability and production of quality cleaner fuels. The expansion in the 1980s added the hydrocracker and access to New Zealand s major market via the Refinery Auckland Pipeline; Future Fuels allowed us to produce cleaner fuels and Point Forward grew our capacity by 15% to the current 135,000 barrels per day. Te Mahi Hou will future proof our gasoline manufacturing capability.

6 12 CEO's Report We have what it takes to compete in the ultra-competitive fuels manufacturing marketplace of today. being price competitive Thirdly, we need to be price competitive with Asia Pac s best. Refining is an energy intensive business and with the price of crude, energy costs have continued to rise; excellence in contracting and procurement is key to manage this spend. A key driver for Te Mahi Hou is the improvement it will bring to our energy and CO 2 footprint. Interestingly, the above focus on reliability also plays a critical role in terms of being price competitive. In 2012 we invested $37 million on maintaining the integrity of our assets and as a result, were able to lift our operational performance with a record outturn of fuel. This in turn, led to a lower per unit fixed cost and being more competitive in the marketplace. I have been encouraged to see that Te Mahi Hou is not our only idea to improve the competitiveness of our refinery. Given the challenge ahead of us, we cannot become complacent, rather we need to look where we can for opportunities to make incremental improvements to our business. As you would expect with a crew as experienced as Refining NZ s, I have seen a myriad of small, organic improvement opportunities as well as the bigger game changing ideas. Exploiting this funnel of opportunities will be key to enhancing our margin and staying competitive. refreshing our strategy Finally, it is timely to refresh our overall strategy. Our current strategy was formulated ahead of the global financial crisis and has served the Company well as the business environment worsened. However, in the current, ultra-competitive and volatile business environment that we find ourselves in, it is prudent to take another look. What will remain in our strategy formulation is our desire to be the fuels manufacturing and supply partner of choice for the New Zealand industry. Te Mahi Hou will be at the core of that strategy: it will strengthen our operational performance especially our energy use and CO 2 footprint lift our margin and deliver significant value to our shareholders. Our strategy refresh will be based around our people, our customers and shareholders and look to how we deliver on our three aspirations: ff ff world-class personal and process safety a fuels offer that is competitive with Asia Pac s fuel manufacturers ff first quartile NZX 50 returns for our shareholders. The strategy work will need to reflect a balance between delivery of our aspirations on the one hand, and our engineering capability to execute and a prudent capital structure on the other. The strategy will need to plot a course of sensible debt levels, flawless execution of Te Mahi Hou, and other revenue enhancing projects while building shareholder value. The refresh will take place over the first half of 2013 and we expect to have more to tell our customers and shareholders at the half year mark. In conclusion, the business environment over the next 12 months will be challenging but we have the culture, the team and the ideas to succeed and continue to provide our customers and New Zealand with high quality transport fuels.

7 13 CFO's Report informing Denise Jensen CFO Chief financial officer s Report was a year of contrasting halves, underlined throughout by a very strong operational performance. A disappointing loss ($1.5 million) for the first six months of the year was turned around on the back of record processing. The profit after tax ($32.7 million) was a better than expected result set out by the profit matrix issued in August 2012 and was achieved in challenging circumstances. Refiners margins began weak and remained so through the first half of the year. This steadily improved and Refining NZ s margin showed a marked uplift over the Singapore Complex Margin in the last quarter of the year. The average GRM achieved for the year at US$5.77, was down on the previous year (2011: US$6.11). We do not expect this uplift to be sustained and consider it likely that the margin volatility experienced in 2012 will continue through The ongoing strength of the New Zealand dollar against its US counterpart has continued to significantly impact our processing revenue. In 2012 the average exchange rate for the year was US$0.81 (2011: US$0.79). The New Zealand dollar has been strong and we do not expect it to weaken appreciably against the US dollar in the short term. Past experience has shown that we are capable of weathering volatility, hence we have not pursued a policy of hedging our operational foreign exchange exposure, except where this is required for large capital projects. The processing fee floor, which is denominated in NZ$ provides an effective hedge against extreme unfavourable movements in the margin and US$ exchange rate. In April 2012 we protected Te Mahi Hou with foreign exchange hedges so that forward orders for key equipment and services could be placed and the project kept within its budget parameters. Despite the challenging business environment the Company continues to generate strong free cash flows ($55 million). This has allowed us to invest further in Te Mahi Hou, shareholder dividends and ensuring the integrity of the Company s assets. Reducing Company borrowings during the global financial crisis helped manage a difficult business environment and established a base for future growth. We think it appropriate to look again at the Company s longer term capital structure which will be done as part of a wider refresh of our business strategy. Reliability The ongoing reliability of our refinery is ultimately an important driver of our financial performance. A key measure of our reliability is the annual rate of unplanned downtime. In 2012 the rate achieved was 0.6%, better than the targeted 1% for the year and an improvement on the previous year (1.4%). The ongoing reliability of key process units was bolstered by the success of planned shutdowns on the platformer and crude distiller units.

8 14 CFO's Report Despite the challenging business environment the company continues to generate strong free cash flows and has allowed us to invest further. Crude throughput and blendstock (42.1 million barrels), was up 2% on the previous year (2011: 41.2 million barrels). Throughput on the refinery s crude distillation unit grew 16% in 2012 which was ahead of the 15% capacity growth business case for the 2009 Point Forward investment. These good operational performances contributed to a record distillate outturn of 33.6 million barrels, up 4% on the previous year (2011: 32.3 million barrels). Energy performance, measured via the Global Solomon Associates Energy Intensity Index, improved on the back of the excellent performance of key processing units and an optimum crude mix. Our aim is to continually improve and when normalised for the two shutdowns, the 2012 result represents a very good energy performance. Te Mahi Hou is progressing To date $70 million has been spent on the project, including the front end engineering and design costs. Detailed engineering is progressing, orders for long lead and key equipment have been placed and modifications made to existing equipment ahead of CCR site preparation towards the middle of Te Mahi Hou will provide a major impetus to our competitive position and generate sustained value for shareholders over the longer term: GRM is expected to lift by US$1.10 per barrel (2012 dollar terms); processing fee revenue by $70 million; EBITDA by $60 million; energy performance improves through reduced CO 2 emissions (approximately 120,000 tonnes per annum) and our share of New Zealand s petrol market will increase from 55% to 65% on the back of an additional two million barrels of petrol. Changes to depreciation The 2012 result accounts for a change to the Company s depreciation charge. The Directors considered the policy of depreciating refining assets over 20 years overly aggressive given our well maintained processing units. This review of the remaining useful lives of all items of refining plant (including the Refinery to Auckland pipeline) has lowered the depreciation charge by around $16.7 million for the year. NZX 50 listing In December 2012 a new liquidity test adopted by the New Zealand Stock Exchange saw the Company drop out of the NZX 50. Under the absolute liquidity rules the Exchange requires a company to trade at least 2.5% of its six monthly average market capitalisation over a six month period. Refining NZ fell short of this target with trading at around 2.2% of the average market cap over the previous six months. We should emphasise that this decision bears no relation to the Company s market capitalisation, the value of which places us near the middle of the NZX 50. The fact that our four largest shareholders are also customers provides Refining NZ a strong base to work together for the benefit of the business and ultimately all shareholders. We consider our free float of 27% of shares provides New Zealanders an opportunity to invest in infrastructure that is vital to this country s energy future. Our performance in 2012 has underlined Refining NZ s ability to operate a refining business capable of competing with the rest of the Asia Pacific region, safely and reliably in difficult circumstances, while continuing to meet the needs of our customers and provide ongoing value for our shareholders.