Operations

Changing attitudes to energy use

Powerful forces worldwide are currently converging to make natural gas the most viable commercially available alternative fuel for vehicles.These forces include record high oil prices, increased awareness of the national security risk of dependence on oil as an energy source and heightened awareness of the impact of air pollution on the health and welfare of people particularly those living in large cities. Of particular impact on the company’s thrust into China is the opening of that country to outside technologies and expertise and its increased involvement as a global power exemplified by the unpegging of the Chinese currency.

The convergence of these forces has produced an environment in which the technology, products and expertise of the company are in high demand leading to future profitability.

Substantial progress was made during the year towards the further commercialisation of the patented AEC Natural Gas Vehicle System (NGVS). The company continues to develop strategic alliances with leading Original Equipment Manufacturers (OEM) of engines by which dedicated natural gas engines are developed for sale. Sales of the engines are promoted by co-marketing in the OEM’s country and by AEC forming strategic marketing alliances with partners to market these low cost, low emission, high performance engines in target regions. AEC also continues to develop its own patented components within its NGVS to offer for sale as part of its system or as components to other systems developers.

Australia and Europe

In Australia the company continues to provide technical support and spare parts for AEC NGVS powered buses in Perth, Adelaide and Canberra.

A contract for 25 Transperth DaimlerChrysler (Mercedes-Benz) buses was completed in May 2004 and AEC has warranty responsibility on a sliding scale until February 2007 and will supply spare parts for the 20 year anticipated life of the buses.

In France, AEC’s involvement with the 600 Irisbus AEC NGVS Renault engined buses continues, with these buses having travelled over 45 million kilometres in route service since the first bus was commissioned in 2002.

AEC is currently retrofitting the Closed Loop (Lambda Sensor) System enhancement to these buses and continues under the contract to supply spare parts for 20 years.

China and Asia

AEC entered into a co-operation agreement in October 2003 with First Auto Works (FAW) of China to jointly design, develop, test and certify a natural gas engine incorporating a FAW base engine and AEC NGVS components.

FAW is the largest engine and vehicle manufacturer in China with production of around 1 million vehicles per year.

A 6.6 litre 6 cylinder engine, the first engine produced under this agreement, recently completed the European Steady State Cycle exhaust emission procedure complying with Euro 3 standards. This standard is a generation ahead of the Euro 2 Standard currently applied by Chinese regulatory authorities.

FAW has installed a FAW/AEC natural gas engine in two specifically built chassis prior to building the bus bodies and commencing 30,000 kilometre road trials. FAW and AEC have a further nine, 6.6 litre, natural gas engines built or being built for various testing and commercial purposes. FAW in preparation for full engine production in 2006 have requested AEC to be in a position to supply components to the value of some $500,000 per month

The FAW/AEC co-operation agreement has proved very successful to date. AEC’s design and emissions testing of the smaller FAW 3.2 litre, 4 cylinder natural gas engine is complete and orders have commenced on a third FAW/AEC NG engine program on a 7.2 litre, 6 cylinder engine.

AEC entered into a product development agreement with Weifang Weichai Peterson Gas Engine Co (Weichai) in September 2004 to develop compressed natural gas (CNG,) liquefied natural gas (LNG) and liquefied petroleum gas (LPG) versions of a 9.7 litre 6 cylinder engine in a commercial arrangement under which Weichai would pay for the engine developments and ultimately purchase AEC NGVS components for these engines.

This agreement was amended in June 2005, substituting a 6.2L, 6 cylinder natural gas engine program for the LPG engine development part of the program. This substitution was made because Weichai believe that an additional natural gas engine product has more demand in the Chinese market than an LPG engine.

On 29 June 2005, Weichai ordered 9.7L and 6.2L engine components, generating future revenue for the company of the order of A$1.2 million.

Engine design, development, testing and certification on the 9.7 litre engine is well advanced. The collaboration design work between AEC and Weichai on a prototype base Weichai engine was completed, and the natural gas prototype engine incorporating AEC NGVS components dynamometer tested prior to sign off in Perth by Weichai engineers in October 2005. Subsequent testing, certification and production will be done in China. Design work has commenced on the 6.2 litre engine, which will also be tested and certified in readiness for production in China.

AEC appointed Mr David Wang as General Manager of its Chinese operation, on 1 June 2005. Mr Wang is a Canadian-trained engineer, resident in Beijing. His role is to manage the e ngine development and component supply agreements with FAW and Weichai, manage the localised procurement and manufacture of AEC components in China, manage co-marketing with FAW and Weichai of NG products and seek out export opportunities for AEC/Chinese NG engines.

NGVS Component Development

AEC continues to develop components for its NGVS.An AEC designed and patented natural gas injector to replace the imported product is nearing completion, with certification to the world standard ECE R110 expected before the end of 2005. Initial assembly will be done in Australia and assembly migrated to China early 2006.

A new and more powerful generation of AEC ECU 5 is well advanced for manufacture in China by mid-2006.

Other Agreements

Advanced Fuels Technology

The company has expanded its alliances in the Asian region with the signing of Memorandum of Understanding (“MOU”) with Advanced Fuels Technology Pty Ltd.

Advanced Fuels Technology (AFT) is an Australian based company with over 28 years’ experience supplying alternative fuels technology, training and equipment to projects in Australia and most Asian regions.

AEC and AFT manufacture complementary equipment for natural gas engines using proprietary technology. The MOU provides the opportunity for both AEC and AFT to market and utilise the other party’s products globally.

The benefits to AEC include the opportunity for AEC’s designed and patented products, including injectors, engine control units and ignition coils, to be used in AFT’s vehicle conversion programs throughout Asia and Australia. In addition,AFT has established markets and business contacts throughout Asia. The MOU provides for AFT to market and distribute AEC, FAW and Weichai developed natural gas engines, together with AEC developed natural gas conversion systems, throughout Indonesia,Thailand, Malaysia, Myanmar and Singapore.

Automobile Corporation of Pakistan

The company has also expanded its alliances in the Asian region with the signing of Memorandum of Understanding (“MOU”) with Automobile Corporation of Pakistan.

Automobile Corporation of Pakistan (ACP) imports and distributes various international vehicles, including FAW vehicles, into Pakistan, together with the manufacture, fabrication and complete after sales services for specialised vehicles. The development and marketing MOU provides for ACP’s design, manufacture, marketing and after market support of natural gas-powered trucks and buses in Pakistan using AEC (FAW) natural gas engines, technicians and expertise.

The AEC/ACP MOU will enable AEC to benefit from the Pakistan Government’s promotion of environmentally friendly technologies and use of alternative fuels. The Pakistan Government’s promotion of natural gas includes setting up refuelling stations and providing incentives to switch to natural gas-powered vehicles. Pakistan ranks third among natural gas use, and has huge, proven gas reserves.

AEC and its two MOU partners are committed to the development of natural gas as an alternative fuel source. Worldwide, there are now four million vehicles powered by natural gas, a figure that has increased by 30% in the past year. It is clear that, as an environmentally friendly, economical and secure long term energy source, enjoying the support of Government’s throughout the Asian region, the use of natural gas in the transport sector is set to expand significantly.

International Conferences and Fairs

AEC participated at ANGVA 2005, the first International Asia Pacific Natural Gas Vehicle Conference and Exhibition, organised by Petronas in Kuala Lumpur 25-28 July 2005.

Managing Director Antony Middleton and Engine Development Manager Barry Neumann jointly presented a paper entitled “CNG Engine Technology for Fleets – Performance, Emissions and Cost Effectiveness”. AEC exhibited at the exhibition displaying a FAW engine, and the AEC ECU and injectors.

AEC will assist FAW at a Clean Vehicles Fair to be held in Beijing in November 2005. FAW plans to exhibit a 6.6L AEC/FAW natural gas engine and a natural gas powered bus.

Quality Certification

The company continued its certification as a Quality Endorsed Company certified to AS/NZS IS0 9001:2000 Quality management systems – Requirements. In addition the Company is now also certified internationally with certification to the International Quality Network Certificate (IQNet), which is recognised by, amongst others, AFAQ in France and CQC and CQM in China. These certifications are requirements for most international contracts.

Summary

In summary, the company will continue working to expand its European, Chinese and Australian contracts and to pursue a number of interesting opportunities in the Asia Pacific Region. At this stage AEC is positioning itself to be the preferred NGVS component supplier to Chinese natural gas engine manufacturers producing bus and truck engines for domestic use and for export.

AEC is also progressing the manufacture and patenting of its NG injector and other components and will supply these not only to manufacturers using the AEC NGVS but also those using other natural gas systems.