MB 16th International Iron Ore Symposium

Vertical integration challenges & opportunities

5 - 6 May, 2010

David Tucker, Managing Consultant, London

Hatch Beddows
VERTICAL INTEGRATION CHALLENGES & OPPORTUNITIES
Contents

Hatch, Hatch Consulting & Hatch Beddows

Introduction
Historic Perspective
Challenges & Opportunities
Conclusions

Hatch Associates Limited, 2010 2

Our organisation
Hatch supplies business, process and technology consulting, design and engineering
and construction, operations and project management to the mining and metals, energy and
infrastructure industries worldwide
Established 1955 and employee owned
8,000 highly skilled people serving clients worldwide
US$40BN of projects now under management in 80 countries
Our values
Safety
Quality
Innovation
Sustainable development
Effective risk management

We deliver unprecedented and sustained results for our clients

Hatch Associates Limited, 2010 3

HATCH
Hatch Consulting is the leading management consultancy dedicated to the
metals and mining industries

Hatch Consulting is the worlds leading management consultancy specialising in the steel, metals and
mining industries and provides high level support services, ranging from corporate and business strategy
development through strategic market studies to implementation of new technologies, management and
operating practices

Hatch Consulting is organised into specialised practices by industry and service, combining to provide
precise solutions, expertly delivered to the exact needs of each individual client

Hatch Beddows is the strategy and market development practice, specialising in steel and related
industries, and providing strategy development and implementation services

Investment and Business Planning (IBP) provides economic, environmental and technical
evaluations of minerals properties and processing facilities, due diligence, pre-feasibility and
feasibility studies and related investment planning and appraisal services

Performance and Risk Management provides high performance management, asset performance
enhancement and optimisation, process and facilities benchmarking, and risk management services

Hatch Corporate Finance (HCF), a FSA-regulated joint venture company, provides corporate financial
advisory and transaction execution services

Hatch Associates Limited, 2010 4

 HATCH
Hatch Beddowss experience spans the whole of the value chain from
raw materials to finished steel to processed products for a comprehensive
perspective

Raw materials and consumables Reversing mill / Steckel mill plate

Iron ore, pellet and sinter
Coking coal and coke Strip mill products
Metallics: scrap, pig iron, DRI / HBI HR sheet / plate
Ferroalloys: Cr, Mn, Ni, Si CR sheet
Refractories Electrical steels
Galvanised sheet
Semi-finished steel Organic coated sheet
Slab Tin mill products
Billet and bloom Tailor-welded blanks

Long products Pipe and tube

Rebar OCTG and line pipe
Merchant bars Seamless and welded tubes
Structural sections Hollow sections
Wire rod and wire products
Engineering bars Stainless steel
Rails
Grinding balls Speciality steels and special metals

Hatch Associates Limited, 2010 5

VERTICAL INTEGRATION CHALLENGES & OPPORTUNITIES
Contents

Hatch, Hatch Consulting & Hatch Beddows

Introduction
Historic Perspective
Challenges & Opportunities
Conclusions

Hatch Associates Limited, 2010 6

INTRODUCTION
From an academic perspective iron is relatively abundant and requires little
enrichment to reach economic grades compared to other minerals

Economic Concentration of Minerals

100,000
Enrichment required for viable grade (times)

Mercury
10,000
Tungsten Chromium
Molybdenum Cobalt
Gold Lead
Silver 1,000 Tin
Zinc Manganese
Uranium
Nickel
Vanadium
100 Copper

10 Iron
Aluminium
1
0 0 0 1 10 100 1,000 10,000 100,000
Average crustal concentration (ppm)

Source: Camborne School of Mines, University of Exeter, Hatch analysis

Hatch Associates Limited, 2010 7
INTRODUCTION
The iron ore business is intractably linked to the fortunes of the integrated
steel industry

98% of iron ore production is

consumed in the production of

steel from the integrated route

2% of iron ore production is

consumed in niche applications

Same boat, same crew but different levels of industry attractiveness

Hatch Associates Limited, 2010 8

VERTICAL INTEGRATION CHALLENGES & OPPORTUNITIES
Contents

Hatch, Hatch Consulting & Hatch Beddows

Introduction
Historic Perspective
Challenges & Opportunities
Conclusions

Hatch Associates Limited, 2010 9

HISTORIC PERSPECTIVE
In real terms the iron ore benchmark prices fell at 1.4% CAGR between 1967
and 2002, whilst seaborne trade increased 3.3% CAGR

70 Real Australian Iron Ore Fines Price, 19672002 (2005 $s) cents/unit

60

50

40

30

20

10

0
67

69

71

73

75

77

79

81

83

85

87

89

91

93

95

97

99

01
19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

19

20
Iron ore was not unique, falling real prices were typical for most commodities

Source: Abare, US BEA and Hatch analysis

Hatch Associates Limited, 2010 10
HISTORIC PERSPECTIVE
Falling real prices drove business strategies to minimise cost

Efficiency
Consolidation to achieve economies of scale
Operational efficiency - productivity
Capital efficiency

Divestment of non-core iron ore assets

Hatch Associates Limited, 2010 11

HISTORIC PERSPECTIVE
The iron ore industry experienced a period of flux during the last decade with
annual benchmark prices coexisting with spot prices

China spot Indian iron ore minus freight & actual Brazilian SSF FOB Asia Benchmark U$/Mt

160

140

120 settlement
100

80

60

40

20

0
05

06

07

08

09

10
Ju 5

0
M 4

D 5

M 5

D 6

M 6

D 7

M 7

D 8

M 8

D 9

M 9
-0

-0

-0

-0

-0

-1
-0

-0

-0

-0

-0

-0

-0

-0

-0

-0

-0
n-

n-

n-

n-

n-

n-
ar

ar

ar

ar

ar

ar
ep

ep

ep

ep

ep
ec

ec

ec

ec

ec

ec
Ju

Ju

Ju

Ju

Ju
D

S
SSF FOB $/t Benchmark $/t

Source: Tex Report, UNCTAD, Drewry Shipping, SBB and Hatch

Hatch Associates Limited, 2010 12

HISTORIC PERSPECTIVE
Demand, predominantly from China, has exceeded supply and driven up the
price of iron ore

Demand, predominantly from China, has exceeded supply and driven up the price of iron
ore
Spot market was direct result of the Chinese mills seeking additional ore
Steel production was constrained by ore availability in 2007/8 and again in 2009/10
The fall in demand from Q4 2008
Caused miners to close capacity and shed workers
Added uncertainty to the numerous projects being promoted

Globally steelmakers are investigating upstream integration with iron ore assets
Security of supply
Price participation
Iron ore supply and pricing is now a strategic issue

Perception that miners now hold a disproportionate share of the value created by the industry

Hatch Associates Limited, 2010 13

VERTICAL INTEGRATION CHALLENGES & OPPORTUNITIES
Contents

Hatch, Hatch Consulting & Hatch Beddows

Introduction
Historic Perspective
Challenges & Opportunities
Conclusions

Hatch Associates Limited, 2010 14

CHALLENGES & OPPORTUNITIES
There is no common agreed definition of Tier-one or World Class assets, but
they are generally, large, long-life, high quality and low cost

Size
Reserves and Resource
Annual production
Quality
Chemical
Physical
Metallurgical
Cost
OP/UG
Ease of beneficiation
Greenfields or Brownfield's with access to existing infrastructure
Proximity to markets
Host country

Tier-one assets are scarce

Hatch Associates Limited, 2010 15

CHALLENGES & OPPORTUNITIES
Mining differs from manufacturing in key regards, mineral resources are non-
renewable, site specific and depleted over time

Source: Xstrata Company Presentations

Hatch Associates Limited, 2010 16
CHALLENGES & OPPORTUNITIES
The scale and capital intensive nature of iron ore mining means that the major
producers are best position to develop new tier-one assets

This is not a homogeneous industry, marginal RTIO underlying earnings contribution, US$M
7,000
players coexist with highly profitable producers

6,000
Export tonnage and profitability dominated by
Vale, Rio Tinto and BHP-B
5,000

These companies are making supernormal profits,

4,000
largely on the basis of their resource base and
depreciated infrastructure
3,000

But these profits are also being reinvested in

2,000
expansion projects to maintain market share

1,000
Rio Tinto Iron Ore invested nearly US$9bn
in capacity expansion since 2003
0
2004 2005 2006 2007 2008 2009

There is no shortage of companies with strategic intent and capital wishing to enter the iron ore
industry
Source: Rio Tinto Company Reports 17
Hatch Associates Limited, 2010
 CHALLENGES & OPPORTUNITIES
Producers have doubled or tripled production over the last decade and need to
increase their reserves by the same factor

Schematic Resource & Reserves Iron Ore Exports by Company 1999 vs 2009, Mt
250

200
Feasibility of economic recovery

Reserves

150

100
Resources

50

0
Vale Rio Tinto BHP-B
Degree of geological certainty
1999 2009

A doubling of output requires a doubling of reserves to maintain the same development horizon.
Noting that approval process mean that it can take five years to bring a new mine to market

Hatch Associates Limited, 2010 18

CHALLENGES & OPPORTUNITIES
One consequence of the sudden expansion of seaborne demand has been a
reduction in chemical and physical grade

Lump as % of total production

14% Mining is not strictly a sustainable activity as it
12% deals with extracting ore from a non-renewable
10% resource
8%
One consequence of the sudden expansion of
6%
seaborne demand has been a reduction in
4%
chemical and physical grade
2%
Increasingly Pellet Feed is replacing Sinter
0%
1996 1998 2000 2002 2004 2006 2008 Feed and Lump availability is also reduced
Lump
(see charts)
Reduced availability of natural sinter fines is a
SF & PF as % of total production challenge facing the industry:
60%
Investment in processing
50%

40%
Pelletising
30% Sintering
20%
Investment in new iron making technology
10%

0%
1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Sinter Feed Pellet Feed

Seaborne capacity has increased, in part, by decreasing grade. New capacity is increasingly
based on ultrafine pellet feed material
Hatch Associates Limited, 2010 19
CHALLENGES & OPPORTUNITIES
Investors prepared to accept the associated risk, can look to enter projects
early in their development

Project risk and value through the stages of mine development

Declining production potential

Steady state production
Project construction
Project value / Investment risk

Reserve definition

Pre-production gap

Production gap
Commissioning
Resource definition

Feasibility
Prefeasibility

Environmental rehabilitation
Management Selection

Target definition
Exploration

Discovery

Closure
Stages of project development and mining

Source: Diamond core resources (2004), AIM Mining Research Limited

Hatch Associates Limited, 2010 20

VERTICAL INTEGRATION CHALLENGES & OPPORTUNITIES
Contents

Hatch, Hatch Consulting & Hatch Beddows

Introduction
Historic Perspective
Challenges & Opportunities
Conclusions

Hatch Associates Limited, 2010 21

VERTICAL INTEGRATION CHALLENGES & OPPORTUNITIES
Vertical integration, advantages & disadvantage from a steelmakers
perspective

Advantages Disadvantages
Assuming the right asset, acquired at the New business with new risks, requires
right time for the right price new skills
Relieves an anxiety, security of supply Assets may not be ideal
Captures cashflow margin quality
Favourable positions the company for the location
next downturn Market valuation (highly regarded assets
within a less appreciated industry)
Assets capable of operation in a less
benign pricing environment

It must be the right asset, acquired at the right time, for the right price
If successful likely to see a spin off to separate the raw materials business from steel

Hatch Associates Limited, 2010 22

VERTICAL INTEGRATION CHALLENGES & OPPORTUNITIES
The critical success factor in mining is access to quality resources

Mining is a different business from manufacturing

It is the site specific, extraction of non-renewable resources
This may have implications for what is considered an acceptable degree of
concentration of tier-one assets

World class mineral assets are scarce

Large, long life
High quality
Low cost

Capital markets will not reward investment into mining unless there is a compelling strategy
to demonstrably lower costs or address security of supply

Investment involves the management of risks. These can be mitigated through

Using a defined review process and appointing specialist advisors

Hatch Associates Limited, 2010 23

 VERTICAL INTEGRATION CHALLENGES & OPPORTUNITIES

Hatch Beddows Strategy Consulting

Hatch Consulting Hatch Beddows
310 East Ocean Center 9th Floor, Portland House
David Tucker Bressenden Place
A-24 JianGuo Men Wai Road
London, SW1E 5BH
Hatch Beddows Chaoyang District, Beijing UK
9th Floor, Portland House P.R.China 100004
Bressenden Place Hatch Consulting
London, SW1E 5BH Hatch Consulting 1600 West Carson Street
2800 Speakman Drive Gateway View Plaza
Tel.: +44 20 7906 5103
Fax: +44 20 7233 1908 Mississauga, ON L5K 2R7 Pittsburgh, PA 15219
Email: dtucker@hatch-europe.com Canada USA
Website: www.hatch.ca/hatchbeddows
Hatch Consulting
Hatch Consulting
Building 14 Harrowdene Office Park
Western Service Road Stanislavsky Factory Business
Centre
Woodmead 2128
21, bld.3, Stanislavskogo Str.
South Africa
109004, Moscow
Hatch Associates Limited, 2010 24