Coal market outlook and impacts for Galilee projects


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Christian Lelong, Executive Director, Commodities; Resources Strategy, Global Investment Research, Goldman Sachs delivered this presentation at the Galilee Basin Coal & Energy Conference 2012. This two day event looks at the significant proposed investment in the Galilee area including coal mining, underground coal gasification, coal seam gas, geothermal, shale and much more, bringing together the wide variety of explorers, project developers, service providers and government representatives under the one roof. For more information about the annual industry gathering in Brisbane/Australia please visit the conference website:

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Coal market outlook and impacts for Galilee projects

  1. 1. Goldm an Sachs Research Thermal coal Coal market outlook and impacts for Galilee projects November 2012 Christian Lelong Goldman Sachs Australia Pty Ltd +61 (2) 9321 8635 The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to Analysts employed by non-US affiliates are not registered/qualified as research analysts with FINRA in the U.S.
  2. 2. The past decade was exceptional Strong demand from China put commodity supply – and prices – under stress    Prior to 2003, thermal coal prices were flat/declining in nominal terms. From 2004 onwards, that trend went into reverse – price inflation and volatility increased significantly, just as China started to drive seaborne demand growth. Between 2002 and 2012, China’s annual net seaborne balance switched from a 56Mt surplus to a 135Mt deficit. Average thermal coal import price – CIF Japan/Europe, US$/t 140 120 100 80 60 40 20 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 Source: International Energy Agency, McCloskey, Goldman Sachs Research Goldman Sachs Global Investment Research 2
  3. 3. The implications of slower growth in China Commodities demand in China is transitioning from above-GDP to sub-GDP growth rates     Global and seaborne demand growth has been supported by China and its transition from net exporter to net importer. Structural changes in the Chinese economy result in GDP growth that is less energy intensive. Targets to reduce energy use and carbon emissions per unit of GDP will impact coal demand from the power and industrial sectors. On the other hand, if coal production costs in China increase above the seaborne market price then imports will have further upside even if total coal consumption slows down. Chinese annual growth in electricity generation Global thermal coal demand growth - Mt 6,000 Electricity 18% GDP 16% 5,000 14% 12% 4,000 10% 3,000 8% 6% 2,000 4% 1,000 2% 0% 2000 China India US Source: IEA Goldman Sachs Global Investment Research other OECD RoW 2010 2000 2002 2004 2006 2008 2010 2012 ytd Source: IEA, IMF, Goldman Sachs Research estimates 3
  4. 4. The impact of environmental regulation Coal-fired generation is under pressure from environmental regulation – first OECD, next RoW?     Regulation can impact the competitiveness of coal in the short term: carbon pricing, emissions performance standards. The short-term impact on TWh has been limited, but the long-term impact on GW installed will be substantial. Investment in new coal-fired capacity in OECD countries has lagged in recent years while gas and renewable energy have increased their share of the fuel mix. Concerns about renewable energy (intermittency, costs, NIMBY, etc) have not prevented its growth. Installed generating capacity across IEA countries – GW 700 2000 2010 600 500 400 300 200 100 0 Coal Gas Hydro Nuclear Wind Solar Source: International Energy Agency Goldman Sachs Global Investment Research 4
  5. 5. Environmental regulation A year in the life of the Spanish grid Daily electricity generation by source – GWh 1000 900 800 700 Coal 600 CCGT 500 Wind 400 other 300 Nuclear 200 Hydro 100 0 Sep 11 Nov 11 Jan 12 Mar 12 May 12 Wind power: # of days at a given GWh output 35 Coal power: # of days at a given GWh output 40 30 Jul 12 median 35 median 30 25 25 20 20 15 15 10 10 5 5 0 0 20 40 60 80 100 120 140 160 180 200 220 240 260 280 300 320 0 0 20 40 60 80 100 120 140 160 180 200 220 240 260 280 300 320 Source: Red Electrica de España Goldman Sachs Global Investment Research 5
  6. 6. Transition from ∆ price to ∆ volume/ ∆ cost As demand growth slows, the industry will go through a paradigm shift  In the past decade, rising prices were a key driver of earnings growth.  When rising prices can’t be relied upon anymore, earnings growth has to come from volume growth and/or cost reductions.  Mining companies will have to be more discerning about their growth options; the quality of management teams becomes particularly important.  Aggregate earnings across the Australian bulk commodities sector may have peaked already? Australian thermal coal example – for illustrative purposes only 2011 Price Mt Revenue EBIT % EBIT Future US$121 US$100 148Mt 176Mt US$18 billion US$18 billion 34% 20% US$6.1 billion US$3.5 billion %  + 19%  - 42% Source: Goldman Sachs Research estimates Goldman Sachs Global Investment Research 6
  7. 7. Our view on coal prices Goldman Sachs Commodity Price Forecast Changes 2011A 1.03 (1.03) AUD/USD 2012E 1.02 (1.02) 2013E 0.97 (.97) 2014E 0.93 (.93) 2015E 0.88 (.88) 2016E 0.82 (.82) Long Term (2017 Nominal) 0.74 (.74) Hard Coking Coal3 US$/t 289 (289) 196 (199) 193 (193) 210 (210) 215 (215) 215 (215) 200 (200) Semi-soft Coal3 US$/t 214 (214) 118 (119) 123 (123) 130 (130) 135 (135) 135 (135) 130 (130) PCI3 US$/t 223 (223) 139 (141) 153 (153) 155 (155) 155 (155) 155 (155) 140 (140) Thermal Coal4 US$/t 121 (121) 97 (99) 105 (110) 105 (117) 102 (109) 100 (106) 90 (90) Notes: (1) CFR China, basis 62% Fe fines; (2) CFR China, basis 44% Mn; (3) FOB Queensland; (4) We show the spot market price for thermal coal (as opposed to contract), FOB Newcastle; (5) GS hybrid price series for bulk and bagged zircon, FOB Australia; (6) Our prices for rutile and synthetic rutile represent our best estimates of prices obtainable by major Australian producers, out of contract; (7) Chloride grade, FOB Australia; (8) LYC production mix; (9) Brent; (10) Henry Hub. Note: Forecast changes were published on October 15 (hard, semi-soft and PCI) and October 29 (thermal). Source: Goldman Sachs Research estimates  Short term: improvement in demand as well as a limited amount of production cuts and expansion deferrals help to bring the market in balance.  A gradual recovery in the Chinese domestic market provides headroom for seaborne prices.  Long-term outlook: inducement prices while seaborne demand is growing eventually gives way to marginal production costs when demand growth falls < 1% yoy. Goldman Sachs Global Investment Research 7
  8. 8. Competing sources of new supply Powder River Basin Sumatra Galilee Mozambique Surat  There are other thermal coal basins with significant supply potential (e.g. 30Mtpa+) to the seaborne market.  Investment in rail and port infrastructure is the key enabler to unlock large scale, low-cost production.  The timing of investment as well as the cost advantage on a CV adjusted, CFR China/India basis are critical factors. Goldman Sachs Global Investment Research 8
  9. 9. GS seaborne supply/demand balance 2007 2008 2009 2010 2011E 2012E 2013E 2014E 2015E 2016E Seaborne exports Indonesia Australia Russia Colombia South Africa US Other Total seaborne exports 191 112 60 65 67 11 57 563 196 125 74 69 68 18 47 597 229 139 82 63 67 12 28 621 287 141 75 68 70 16 23 679 319 148 82 74 69 31 17 739 344 156 79 80 71 46 17 793 354 162 75 83 73 34 18 799 368 169 72 85 75 41 19 829 383 176 70 89 77 38 20 853 398 181 69 92 79 37 21 877 Seaborne imports Japan China India Korea Taiwan Other Total Pacific 123 16 27 67 66 66 366 121 15 36 75 65 71 383 107 58 60 81 59 74 439 123 92 75 93 63 77 524 120 102 93 98 66 81 561 125 129 106 97 66 84 606 128 129 114 102 70 88 631 129 133 122 104 72 92 652 131 137 130 108 75 96 677 132 140 140 113 79 101 704 169 31 19 219 161 29 20 210 144 19 21 185 130 16 22 168 138 10 24 172 146 6 26 178 139 7 28 174 137 7 30 174 136 7 32 175 134 7 34 175 585 593 1.4% 624 4.9% 692 9.8% 733 5.6% 785 6.6% 805 2.5% 826 2.6% 852 3.0% 879 3.1% (22) 5,661 4 5,652 (3) 5,601 (13) 5,538 7 5,510 8 5,485 (6) 5,451 3 5,426 2 5,396 (2) 5,366 OECD Europe US Other Total Atlantic Total seaborne imports % growth Seaborne surplus/(deficit) Average CV - kcal/kg NAR basis Source: International Energy Agency, McCloskey, Goldman Sachs Research estimates Goldman Sachs Global Investment Research 9
  10. 10. Cost inflation trends - productivity Labour productivity in Australian coal – Kt/employee Productivity, input costs and FX  Productivity in terms of coal production per employee is declining; causes include geology (deeper mines, etc) but also regulation and a tight labour market. Underground 9 Opencast 8 7 6  Some input costs are rising above inflation (energy, wages). 5 4  FX has moved Australian coal to the top half of the cost curve. 3  Moderating/reversing these trends will not be easy... 1 2 0 2001 Labour productivity in US coal industry – Kt/employee 2003 2005 2007 2009 2011 Source: NSW Minerals Council 14 12 10 8 Underground 6 Opencast 4 2 0 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 Source: MHSA Goldman Sachs Global Investment Research 10
  11. 11. Cost inflation trends – input costs, FX Median annual packages in QLD coal industry – A$’000 Average weekly earnings in Australian mining sector $160 A$ 350 $140 US$ 300 $120 250 $100 200 $80 150 $60 100 $40 50 $20 0 $0 Drill operator Maintenance Supervisor Manager US avg 2000 2002 2004 2006 2008 2010 2012 Source: Australian Bureau of Statistics, Goldman Sachs Research Source:, US Dept of Labour  Costs (in US$ per unit of energy) are increasing as productivity declines, input costs rise and currencies appreciate.  Geology: calorific value is declining (partly by design) and strip ratios are increasing on average.  Input costs: wages and energy costs increase in real terms in many regions.  Regulation: can have a negative impact on productivity and costs. Goldman Sachs Global Investment Research 11
  12. 12. Cost inflation trends - China China is also subject to cost inflation  Growth in the labour market is slowing down – the working population will probably peak.  GDP per employee has grown rapidly – average wages rise in a tight labour market and China becomes a middle income country.  This trend presents significant upside potential for Australia – if seaborne imports become increasingly competitive against domestic supply, exports could continue to grow even as total consumption slows down.  Seaborne imports account for 68% of iron ore supply, for 7% of metallurgical coal supply and for 4% of thermal coal supply in China… higher upside risk in coal. Chinese labour force – annual yoy growth 2.5% Chinese GDP per employee – US$ PPP, 2000 = 100 300 250 2.0% 200 1.5% 150 1.0% 100 0.5% 50 0.0% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Source: IMF Goldman Sachs Global Investment Research 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Source: IMF 12
  13. 13. Miners as end-users – does it matter? Historical precedents in the bulk commodities sector  Japan helped to finance the development of Australia’s iron ore sector at a time when capital investment requirements were high and prices were moderate. Australia’s metallurgical coal sector also benefited from Japanese support during its development phase.  Involvement by end-users can provide certainty to new projects via equity participation, financing and/or longterm off-take agreements. Other factors at play  In deregulated power markets where the power price fluctuates according to fuel costs, the incentive for power utilities to lock in coal supplies at fixed prices is limited.  Conversely, in regulated markets where power tariffs are fixed, utilities are incentivised to secure coal supply in a way that ensures a positive margin for its power assets.  Visibility and control over coal supply costs can in turn enable the development of power assets. Goldman Sachs Global Investment Research 13
  14. 14. Summary The industry is transitioning to a world of slower growth  The past decade was exceptional in terms of demand growth and prices – largely thanks to China.  Future GDP growth in China is likely to be less energy-intensive. Moreover, the share of coal in the fuel mix is decreasing at the national level in many OECD economies partly as a result of environmental regulations. Emerging markets are also moving towards low-carbon energy sources.  Having said that, the outlook for seaborne thermal coal remains attractive in the short to medium term as a result of growing demand from India and China. Implications for the coal sector  Based on our industry view, the key criteria for thermal coal producers are: • Production growth profile: timing is key as there may not be enough demand for every potential basin. • Capital intensity, productivity and cost inflation: critical challenges for the industry in an environment of lower profit margins. • Stakeholder management: to ensure projects are developed on time and on budget.  Finally, direct involvement of end-users in the development of new coal basins can be a source of advantage. Goldman Sachs Global Investment Research 14
  15. 15. Disclosure Appendix November 5, 2012
  16. 16. Disclosure Appendix Reg AC I, Christian Lelong, hereby certify that all of the views expressed in this report accurately reflect our personal views about the subject company or companies and its or their securities. We also certify that no part of our compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed in this report. Coverage group(s) of stocks by primary analyst(s) There are no coverage groups associated with the analyst(s). Company-specific regulatory disclosures Compendium report: please see disclosures at Disclosures applicable to the companies included in this compendium can be found in the latest relevant published research. Goldman Sachs Global Investment Research 16
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