Seaborne steam coal market dynamics

and future production costs

Dr. Arne K. Bayer, E.ON New Build & Technology GmbH
Maggi Rademacher, E.ON Kraftwerke GmbH, Hannover

Resources Workshop “Long-Term Costs and Reserves of Coal, Oil, & Natural Gas”
March 22, 2012
Seaborne steam coal market dynamics and future
production costs
Agenda
1 Utilities’s y Security of supply
y Predictable coal qualities
requirements
y Stable fuel costs

y Current exporting nations

2
and seaborne coal flows 6
y Reserves and resources situation View on future origin
Influencing 3
incl. quality development of global seaborne
factors coal and its quality
4 y Mining costs and its development
7 Conclusions
5 y Development of global demand
DIW Resource Workshop - Bayer, Rademacher - March 2012 2
 RECAP COAL
0
VALUE CHAIN

Talking about seaborne coal markets means talking about

a complex logistics chain with a number of input factors
Coal Logistics Chain – Pit to Power Station – February 2012

Cap cost / (AMP $57) (FAS $87) (FOB $92)

profit
maintenance Mine Load
labour (in Russia)
Rail $30
Port $5
royalties
explosives Stockpile
supplies
Ship
freight
Inland
$8
Power Transport Discharge
Station Rail $10 Port $5
Stockpile Key Terms:
(CIF ARA AMP = At Mine Price
(Delivered FAS = Free Alongside Ship
$100) FOB = Free On Board
Site $115) CIF = Cost, Insurance, Freight
Source: EET-AMF Cost/prices in USD/t
DIW Resource Workshop - Bayer, Rademacher - March 2012 3
 UTILITIES
1
REQUIREMENTS

Coal based generation is a long term business with a need

for predictable input parameters like costs or quality
y Currently E.ON operates some 20 GW of hard coal fired power stations in Germany,
Benelux, UK, Italy, Spain and France
y These thermal power plants (TPP) consume next to domestic coal approximately
17 mn t of seaborne import coal annually
y E.ON also invests in high efficiency blocks of 1.100 MW each – with 35-40 years of
operational lifetime as a basis for investment decisions – and engages in new
international markets like Brazil, India and Turkey
y Consequently to balance risk and optimize both existing fleet and new build, E.ON
has to be assured of security of supply and predictable coal qualities, as well as,
understanding the fundamental mining cost base and future trends

E.ON Kraftwerke‘s global coal database models major exporting

nations on a mine/project basis (capacities and costs)
DIW Resource Workshop - Bayer, Rademacher - March 2012 4
 UTILITIES
1
REQUIREMENTS

Physical coal is not homogeneous like financial benchmarks

Variances in import coal specs & Est. Production Costs to Export Port (2012)
Total moisture [%]
40
35
30
25
Adaro, IND $46.50/t
Gross
Ash
20
15 Calorific Middelburg, SAF $35.54/t
15
[%ar] 10
5
10
28
Value El Cerrejon, COL $54.92/t
5 [MJ/kg]
26
0
20 24 S. Kuzbass, RUS $96.34/t
0.5 48
1.0 52 Bailey, US $64.10/t
1.5 56
Hardgrove
2.0
Sulphur 60
Index
[%ar]

y Each coal plant can take a spectrum of coal qualities

y The wider the band and plant flexibility, the lower fuel and generation costs,
though impact on plant efficiency
y Low grade and off-spec coals offer opportunity for lower prices for plants in blends
Source: EKW DIW Resource Workshop - Bayer, Rademacher - March 2012 5
 STATUS QUO
2
EXPORT MARKETS

Seaborne trade makes up just some 1/7 of global prod-

uction – therefore E.ON model focused on export nations
Main seaborne trade flows in hard coal, 2011* (747 mt)
-8% vs 2008
+30% vs 2008

Europe**
178 Mt 56
4
Poland Russia
21
28
USA
15
Asia
55 533 Mt
13 China
Americas 6

36 Mt 7
2 298

Exporters
E x p o rt e r s
2010
2 0 1 0
2011
2 0 1 1
Growth
G ro w t h Latin Indonesia
Indo 292 311 19 148
In d o

Aus
2 9 2

141
3 1 1

148
1 9

7
America 23
A u s 1 4 1 1 4 8 7 46
Russia
R u s s ia 7 676 8 4 84 8 8

Col/V
C o l/V 7 373 7 7 77 4 4 South
S A F
SAF 6 969 6 9 69 0 0
Africa Australia
C h in a 1 4 6 -8
China 14 6 -8
U S 1 4 3 1 1 7 13
US 14 31 17
o th e r & s tk 2 5 2 1 -4
other
T o t a l & stk 7 0 25 7 4 721 -4 6 %
Total
4
704 747
4 3
43 6% “Asian market is now triple the
**Est., **incl. Mediterranean
Source: EET Market Analysis
Key Im port Region size of Europe’s!”
DIW Resource Workshop - Bayer, Rademacher - March 2012 6
Data: CERA
 STATUS QUO
2
EXPORT MARKETS

Financial markets follow rising Pacific physical trade

New Coal Swaps 2011/12
ARA
API#2
y South Chinese CFR:
Atlantic Market Pacific Market steam coal FOB 5500 kcal/kg NAR

y Indonesian Sub-Bituminous
Steam coal FOB 4,900 kcal/kg NAR

Future?
API#6 interest in off-spec coal qualities
South
Africa
grows from price sensitive
5
API#4 Utilities
(high sulphur, low energy, petcoke?)
European Standard Trading Products (est. 2001)
y API#2: Steam coal ARA range (North Western Europe) , 6.000kcal/kg, ACPRS standard
quality (Coal cargoes from Australia, Colombia, Poland, Russia or South Africa
y API#4: Steam coal South Africa, Richards Bay coal terminal, 6.000kcal/kg
y API#6: Steam Coal Australia, Newcastle terminal 6000kcal/kg, 1%S
Traded European Utility Spread (es. 2004)
y Clean dark spread CDS: Price difference between coal (including CO2) and power
DIW Resource Workshop - Bayer, Rademacher - March 2012 7
 STATUS QUO
2
EXPORT MARKETS

Ongoing supply issues for utilities increase fuel risk

Infrastructure Bottlenecks delay new mine capacity and exports
y Sufficient number of mine projects & expansions in planning across globe
y Port expansions are underway in existing exporters; missing in new mining countries
y Largest hindrance is in inland rail infrastructure due to high cost of investments and
permitting difficulties

Quality Management a growing challenge with global share of lower grade coals on the rise
y Indonesian sub-bituminous dominates exports to China and in India
y NSW Australia exports of high ash off-spec coal increasing
y South African suppliers seeing off-spec export market as a viable option
y High sulphur US cargoes offer high spot discounts in the market

Growing government intervention to manage local coal reserves & resources delays investment
y Indonesia moving to secure domestic supplies; plans to limit foreign ownership of mines
y Nationalisation in South Africa mining sector a possibility
y Australia’s Resource Tax could return;
y Increasing difficulties in permitting (USA, Australia)
DIW Resource Workshop - Bayer, Rademacher - March 2012 8
 STATUS QUO
2
EXPORT MARKETS

E.ON analysis shows that coal market will become less

competitive in mid-term – any impact on consumers?
2010 2015

High market concentration Moderate market concentration No concentration High competition

y The share of “free coal” in the market, not controlled by utilities, state or steel companies is falling
y Market trend is for miners to become “integrated” controlling supply chain or utilities to take a
direct share in mining projects at home and abroad (ex. MPX, Chinese)
y Market concentration strengthens in 2015 versus 2010 increasing supply risks
y New supply regions will be strongly concentrated (e.g. Mozambique). DIW Resource Workshop - Bayer, Rademacher
Source:- EKW
March 2012 9
 RESERVES &
3
QUALITITES

BGR puts geological coal reserves at approx. 750 bn t

globally - exceeding 100 years current annual demand
Coal reserves Coal resources

Source: Bundesanstalt für Geowissenschaften und Rohstoffe (BGR), 2009

DIW Resource Workshop - Bayer, Rademacher - March 2012 10
 RESERVES &
3
QUALITITES

Coming from a mine‘s perspective, E.ON has identified

specific reserves at mines/projects of almost 100 bn t
Coal reserves Coal resources

1) 1)

1) Code for Reporting of Mineral Resources and Ore Reserves

DIW Resource Workshop - Bayer, Rademacher - March 2012 11
Source: E.ON Kraftwerke GmbH internal research
 RESERVES &
3
QUALITITES

E.g. E.ON reviews exporting mine/project portfolio of com-

panies like Xstrata to forecast future volumes & qualities
Xstrata coal reserves
y Xstrata is a globally active mining
Σ 4 bn t (JORC certified)
company with 32 active mines and 30+
green & brownfield projects in the
pipeline
y Annual production sums up to some 90
mn t – theoretical lifetime of reserves
close to 45 years
y Additionally approx 20 bn of resources
identified
y E.ON Kraftwerke allocates dedicated
coal types/brands to mines/projects to
be able to forecast future coal quality
(besides capacities & costs)

Source: Xstrata public sources, E.ON Kraftwerke GmbH internal research DIW Resource Workshop - Bayer, Rademacher - March 2012 12
 RESERVES &
3
QUALITITES

Hence, core of E.ON model is the constant tracking of new

projects/investments and running mines incl. expansions
Explanation of methodology for supply (1/4)

1 Create a list of existing export mines and potential mining projects based
on AME database and E.ON proprietary information collected over 10+
years to identify potential mining capacity to cover demand needs over the
LTP period
2 For each mine, identify the start of production, annual saleable production
and years of future potential production based on provable reserves /
saleable production), incl. information on qualities if available

*for missing data, assumptions made based on similar mines and historical data
DIW Resource Workshop - Bayer, Rademacher - March 2012 13
 4 MINING COSTS

FOB cost positions for opencast and underground ope-

rations vary significantly – impacting future development
Free on board (FOB) cash costs New South Wales [USD/t]

50.0

45.0

40.0 Royalties Subject to political influence

35.0 Port fees Subject to e.g. trsp. congestion,
30.0 Transport taxation and fuel costs
Subject to future coal geology
25.0 Processing
20.0
Labour Subject to innovation e.g. auto-
15.0
mation, contracting

10.0
Subject to geology e.g. over-
Mining burden ratio, seam depth/thick-
5.0 costs ness; mining method, fuel &
explosive costs
0.0
O/C Dragline + truck&shovel (Production Capacity 7,5mt) U/G Longw all (Production Capacity 7,0mt)

Source: E.ON Kraftwerke GmbH internal research DIW Resource Workshop - Bayer, Rademacher - March 2012 14
 4 MINING COSTS

Generic costs model e.g. allows for allocation of produc-

tivity ranges to mine types in certain mining countries
Productivity [t per FTE year] for mine types and countries 1)
25.000

20.000

15.000

10.000

5.000

0
AUS AUS - AUS - CAN CHN COL INDO NZ RUS SA USA VEN Ø
NSW QLD

underground operations opencast operations

1) 172 mines in total analyzed
DIW Resource Workshop - Bayer, Rademacher - March 2012 15
 4 MINING COSTS

Generic cost model developed incorporating oil

component
General distinction between cash costs
y Initial AME set forms a sufficient sample for various kind of mining
countries and technologies – sample testing for prominent mines and
OEM suppliers by E.ON done to cross-check accuracy of data
y E.ON expert knowledge distinguishes between general inflation related
cost items of coal extraction and oil related cash costs
y Main mining costs rooted in fueling excavators like trucks as well as
explosives in open pit mining operations are exposed to trends in oil price
(truck employment in coal and overburden haulage)
y Ratio between excavated coal and overburden is essential in this respect
y On top; transportation costs are evaluated for respective mines as rail
carriage by diesel fuel trains has to be incorporated in comparison to
electrified systems line in SAF or to Indonesian barge transportation
DIW Resource Workshop - Bayer, Rademacher - March 2012 16
 4 MINING COSTS

Fundamentally, oil correlation of mining costs only relevant

for basis mining expenses and transportation costs to ports
FOB cash cost item
Oil corre-
lation Comments

Labour costs ✘ y Mine type and country specific labor costs on US$/t basis

✔
y Depending on mine type (opencast vs. underground), overbur-
Mining costs den:coal ratio (O:C) and technology (truck & shovel vs. dragline)

Processing costs ✘ y Coal type and reserve specifics

Royalties ✘ y Country/state specific royalty charges

Transportation
✔
y Depending on transportation to export harbors via train
costs (diesel vs. electricity), truck or barge

Port costs ✘ y Port specific handling costs

DIW Resource Workshop - Bayer, Rademacher - March 2012 17
 4 MINING COSTS

Future generic mine cost model incorporates mining

specific characteristics
Mining costs in relation to O:C ratio (Indonesia T&S)

14 t
m3/

12

10

y =0.3924x - 0.053
8
R2 =0.9192
6

0 5 10 15 20 25 30
$/ t

DIW Resource Workshop - Bayer, Rademacher - March 2012 18

 4 MINING COSTS

When looking at producers cash costs, e.g. Australian

merit order depicts large bandwidth of miner’s cost base
Free on board (FOB) cash costs [USD/t]

Source: E.ON Kraftwerke GmbH internal research DIW Resource Workshop - Bayer, Rademacher - March 2012 19
 4 MINING COSTS

Assumptions on cost development combined with pro-

duction generate country specific merit order supply curves
Explanation of methodology for supply (2/4)

3a For each mine, assign an estimated production cost (USD/t) based on historical
mine specific production costs (where available) or the clustering of similar mines
(type / region) for mines with no cost information

3b Estimate the impact of oil price on production costs for open cast mines to fit in
with E.ON oil scenarios

Adjust the fixed cost component of production cost curves for E.ON inflation
3c
assumptions to 2030

Create a merit order supply curve for global export production capacity weighting
4 the total available annual mining capacity (mntpa) by production price (USD/t FOB)
for each of the years in the sample
DIW Resource Workshop - Bayer, Rademacher - March 2012 20
 DEMAND
5
DEVELOPMENT

In current situation coal is at a crossroads – demand to

rise til 2020, but post?

World primary coal demand by region and scenario Coal fights energy poverty
8 000
Mtce

Current Policies
Rest of world Scenario
7 000 14% 1 883 Mtce
India
47%
6 000 China
New Policies
5 000 Scenario
14%
2 550 Mtce
4 000 50%
450 Scenario
3 000
Greenhouse gases limited
2 000
Source: IEA 2011 1980 1990 2000 2010 2020 2030 2035

Coal demand is set to slow – just how much depends critically on

government energy & environmental policies, especially in ChinaDIW Resource Workshop - Bayer, Rademacher - March 2012 21
 FUTURE
6
DEVELOPMENT

A look into crystal ball – E.ON positions itself for the future
by using detailed scenarios, also effecting coal models

L I N G L E
D E L N C I P
M O P R I L I D
N O F B U T V A
SI O N , I N S
E V I A K E E M A
N T R E R T S R
E CE U N D T I O N
R N S O S I
P T I O E P
U M RE M
S
AS ON EX T
V IE W
Source: E.ON Investor Relation Information, 2009 DIW Resource Workshop - Bayer, Rademacher - March 2012 22
 FUTURE
6
DEVELOPMENT

Production volumes are adjusted in terms of active mines in

case a 15-20% capacity safety margin is not yet covered
Explanation of methodology for supply (3/4)

5 Evaluate needed demand for seaborne coal capacity with the available merit order
supply curve for each year to make certain enough capacity is available
Available supply capacity should exceed demand scenario by at least +15-20% to
assure adequate supplies and minimize price volatiliy due to seasonality,
constraints, mining outages, weather, transport problems etc.
2008
xx 2010
xx 2015
xx
Region Production Demand Region Region Production Demand Region Region Production Demand
[mt] [mt] [mt] [mt] [mt] [mt]
Australia - New South Wa 141,2 194,0 Europe Australia - New 161,7 197,8 Europe Australia - New S 178,2 233,5
Australia - Queensland 74,1 346,0 Pacific Australia - Qu 93,2 369,1 Pacific Australia - Queen 219,9 405,5
Canada
China
7,8
0,0
I V E
8,4 Mexico
70,0 Asia
Canada
China
7,8
0,0
8,4 Mexico
91,7 Asia
Canada
China
7,8
0,0
4,2
142,0
Columbia
Indonesia

T R
91,6
203,9
AT 7,0 Africa & Middle EColumbia
12,6 Brazil Indonesia
116,4
229,4
na
7,0 Africa & Middl Columbia
16,8 Brazil Indonesia
119,1
268,8
7,0
21,0
na
Mozambique
New Zealand
LU S 0,0
1,5
0,0 Russia and FrienMozambique
New Zealand
in t e r 0,0
0,8
0,0 Russia and FrMozambique
New Zealand
4,8

in
0,0t e r0,0

Norway
Russia IL
South Africa
2,5
59,9
82,9
Norway
Russia
South Africa
2,5
59,9
95,7
Norway
Russia
South Africa
4,5
71,7
114,0
USA 19,7 USA 19,7 USA 38,8
Vietnam 0,0 Vietnam 0,0 Vietnam 0,0
Venezuela 12,0 Venezuela 13,0 Venezuela 19,6

Total 727,0 638,0 830,1 690,7 1067,1 813,1

Relationship 114% 120% 131%
DIW Resource Workshop - Bayer, Rademacher - March 2012 23
 FUTURE
6
DEVELOPMENT

Merit orders are matched in GAMS model with demand

points and freight assumptions to determine volume flows
Explanation of methodology for supply (4/4)

6 Evaluate what production cost (FOB) is needed from the merit order curve to
suffice global demand in each scenario. We have now identified the coal export
sources. These results are reviewed and optimised using the freight costs in the
GAMS model.

Merit Order Curve for 2010 Capacity

900,0 90,0

800,0 80,0 Outcome:

Cumulative Capacity (mntpa)

700,0 70,0
Segment FOB Price (USD/t)

Cumulative Capacity 2010

Avg Price for Segment
600,0 60,0 2010 Demand Levels
500,0 50,0
Scenario
Slow Recovery
Demand
625
+20%
750
FOB Price
65,2
I V E Source
QLD - M
400,0 40,0
Green World
Climate Concerns
651
655
T R
781,2
786
71,6
71,6 AT NSW - H
NSW - H
S
300,0 30,0

LU
200,0 20,0 Unabated Growth 691 829,2 83,6 USA - H
100,0

0,0
10,0

0,0
IL
M

M
H

H
L

SAF NZL COL SAF SAF COL VIE IND VIE COL VIE RUS IND NSW NOR QLD RUS NZL IND USA CAN RUS NSW USA CAN QLD CAN NSW QLD USA

Segment

DIW Resource Workshop - Bayer, Rademacher - March 2012 24

 FUTURE
6
DEVELOPMENT

E.ON forecasts conclude that sufficient steam coal capacity

is available, if the coal chain functions efficiently

Australia (QLD)
Merit Order Curve for Export Mine Capacity in 2010/11
Merit Order Curve for Export Mine Capacity in 2010/11

- high
120

USA -
Canada - mid

high
(NSW) - high
Australia
Australia (QLD) -
100

Zealnd
New
Russia - high
(NSW) - mid

mid
Australia

USA –
Canada -
FOB Cash Cost (USD/t)

mid
80

Indonesia -
(QLD) - low

Venez
Russia -
(NSW) - low

Columbia -

uela
low
Australia
Indonesia - mid
Columbia - low

Australia

USA -

mid
Columbia

high
low
N

high
Z

- mid
Indonesia -

Russia -
South Africa

60 -
South Africa

low

,
m
South Africa

low
- high

i
d
- mid

40
- low

20

0
0 100 200 300 400 500 600 700 800 900
Capacity (Cumulative mtpa)

y Actual plant costs must add freight, handling surcharges and a mark-up

Source: EKW Internal Analysis DIW Resource Workshop - Bayer, Rademacher - March 2012 25
 FUTURE
6
DEVELOPMENT

With seaborne coal demand above 1 bn t in 2030, E.ON

model predicts stable supply situation with usual suspects
World seaborne coal supply 2030 in mn t1)

1) Assuming specific scenario based on EKW mine based supply model

DIW Resource Workshop - Bayer, Rademacher - March 2012 26
Source: E.ON Kraftwerke GmbH internal research
 FUTURE
6
DEVELOPMENT

The magnitude is line with other experts which also expect

thermal coal export markets to grow significantly in the future
Development of steam coal exports (Mio t)
1200

979
1000

804 824
800 713 WoodMac
613 Global Insight
585
600 EIA
IEA

400

200

0
2006 2015 2025
Source: Various forecasts DIW Resource
StatusWorkshop
world coal
- Bayer,
markets
Rademacher
and their development
- March 2012 27
 FUTURE
6
DEVELOPMENT

Consequently no significant change in European coal

import mix expected with somehow predictable qualities
Where will European coal imports come from?
y As majority of demand growth Asia centered – Australia, Indonesia and
Mozambique will supply this area with seaborne thermal coal
y South African coal exports will most likely shift direction towards India rather than
to European consumers
y Consequently Columbian and Russian coal are seen as the natural suppliers for EU
thermal power stations in the future
y US will remain swing supplier, gas squeezes coal domestically and increases
export capacity
y Norway and Venezuela will make up only small remainder of import coals
y Fundamentally cost mining cash costs are not expected to rise significantly above
today’s levels given moderate oil prices (incl. freight rates) and current
taxation/royalty schemes
y Given the origin of future imports, quality bands for European utilities are not
likely to deviate substantially from today, but quality mix means this will be
premium coal qualities and = higher prices. DIW Resource Workshop - Bayer, Rademacher - March 2012 28
 7 CONCLUSIONS

Fundamental coal data on mine by mine and project basis

becomes more difficult - modelling also challenging
Challenges for coal modeling
y Difficulties in procuring data are becoming a real issue
y Fewer sources of information available in the market from coal
experts/consultants
y Movement towards information summarized at country level; mine level
information limited
y Information on coal qualities by producer / mine not in public realm
y Quality of data for some large exporters (Indonesia, Russia) poor
y Optimisation modelling difficulties
y Theoretically, a mark-up function for market premium possible; quantitatively,
no successful proven approach for traded market
y Measuring capacity availability / utilization means having a view of mine
production capacity, inland transport and port capacity as restriction

DIW Resource Workshop - Bayer, Rademacher - March 2012 29