Seaborne steam coal market dynamics and future production ...

Seaborne steam coal market dynamics and future production costs

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

Resources Workshop “Long-Term Costs and Reserves of Coal, Oil, & Natural Gas”March 22, 2012

2DIW Resource Workshop - Bayer, Rademacher - March 2012

Seaborne steam coal market dynamics and future production costs

Utilities’s

requirements

Agenda

1 Security of supplyPredictable coal qualitiesStable fuel costs

Influencing

factors

Current exporting nations and seaborne coal flows

2

Mining costs and its development4

Reserves and resources situation incl. quality development

3

Development of global demand5

6

View on future origin of global seaborne coal and its quality

7 Conclusions


Mine(in Russia)

LoadPort $5

DischargePort $5

PowerStation

Rail $30

Stockpile

Shipfreight$8

InlandTransport

Stockpile

(FOB $92)

(Delivered(CIF ARA

$100)

Rail $10

Cap cost / profit maintenance labour royalties explosives supplies

(FAS $87)(AMP $57)

Site $115)

Key Terms:

AMP = At Mine Price

FAS = Free Alongside Ship

FOB = Free On Board

CIF = Cost, Insurance, Freight

Cost/prices in USD/tSource: EET-AMF

Talking about seaborne coal markets means talking about a complex logistics chain with a number of input factorsCoal Logistics Chain – Pit to Power Station – February 2012

0RECAP COAL VALUE CHAIN


Coal based generation is a long term business with a needfor predictable input parameters like costs or quality

1UTILITIESREQUIREMENTS

Currently E.ON operates some 20 GW of hard coal fired power stations in Germany,

Benelux, UK, Italy, Spain and France

These thermal power plants (TPP) consume next to domestic coal approximately

17 mn t of seaborne import coal annually

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

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 exportingnations on a mine/project basis (capacities and costs)


Middelburg, SAF

El Cerrejon, COLS. Kuzbass, RUS

Adaro, IND

Bailey, US

Source: EKW

$46.50/t$35.54/t$54.92/t

$96.34/t

$64.10/t

Each coal plant can take a spectrum of coal qualitiesThe wider the band and plant flexibility, the lower fuel and generation costs, though impact on plant efficiencyLow grade and off-spec coals offer opportunity for lower prices for plants in blends

Physical coal is not homogeneous like financial benchmarks

Variances in import coal specs & Est. Production Costs to Export Port (2012)

05

10152025303540

Total moisture [%]

HardgroveIndex

48

60

52

56

20

2824

26

Gross CalorificValue[MJ/kg]

2.0

0.5

1.5

1.0

Sulphur[%ar]

Ash[%ar]

510

15

05

10152025303540

Total moisture [%]

HardgroveIndex

48

60

52

56

20

2824

26

Gross CalorificValue[MJ/kg]

2.0

0.5

1.5

1.0

Sulphur[%ar]

Ash[%ar]

510

15

1UTILITIESREQUIREMENTS


Seaborne trade makes up just some 1/7 of global prod-uction – therefore E.ON model focused on export nations

**Est., **incl. MediterraneanSource: EET Market AnalysisData: CERA

2STATUS QUOEXPORT MARKETS

LatinAmerica

SouthAfrica

USARussia

China

Indonesia

Australia

Poland

Americas36 Mt

Europe**178 Mt

Asia533 Mt

15

21

2

4

56

2346

13

6

298

148

28

1355

7

“Asian market is now triple the size of Europe’s!”

-8% vs 2008

+30% vs 2008

Key Import Region

6 %4 37 4 77 0 4T o t a l

- 42 12 5o t h e r & s t k

1 73 11 4U S

- 861 4C h i n a

06 96 9S A F

47 77 3C o l / V

88 47 6R u s s ia

71 4 81 4 1A u s

1 93 1 12 9 2I n d o

G r o w t h2 0 1 12 0 1 0E x p o r t e r s

6 %4 37 4 77 0 4T o t a l

- 42 12 5o t h e r & s t k

1 73 11 4U S

- 861 4C h i n a

06 96 9S A F

47 77 3C o l / V

88 47 6R u s s ia

71 4 81 4 1A u s

1 93 1 12 9 2I n d o

G r o w t h2 0 1 12 0 1 0E x p o r t e r s LatinAmerica

SouthAfrica

USARussia

China

Indonesia

Australia

Poland

Americas36 Mt

Europe**178 Mt

Asia533 Mt

15

21

2

4

56

2346

13

6

298

148

28

1355

7

“Asian market is now triple the size of Europe’s!”

-8% vs 2008

+30% vs 2008

Key Import Region

6 %4 37 4 77 0 4T o t a l

- 42 12 5o t h e r & s t k

1 73 11 4U S

- 861 4C h i n a

06 96 9S A F

47 77 3C o l / V

88 47 6R u s s ia

71 4 81 4 1A u s

1 93 1 12 9 2I n d o


6 %4 37 4 77 0 4T o t a l

- 42 12 5o t h e r & s t k

1 73 11 4U S

- 861 4C h i n a

06 96 9S A F

47 77 3C o l / V

88 47 6R u s s ia

71 4 81 4 1A u s

1 93 1 12 9 2I n d o


6%43747704Total

-42125other & stk

173114US

-8614China

06969SAF

47773Col/V

88476Russia

7148141Aus

19311292Indo

Growth20112010Exporters

6%43747704Total

-42125other & stk

173114US

-8614China

06969SAF

47773Col/V

88476Russia

7148141Aus

19311292Indo

Growth20112010Exporters

Main seaborne trade flows in hard coal, 2011* (747 mt)


Financial markets follow rising Pacific physical trade

SouthAfrica

API#45

ARA

API#2

API#2: Steam coal ARA range (North Western Europe) , 6.000kcal/kg, ACPRS standardquality (Coal cargoes from Australia, Colombia, Poland, Russia or South Africa

API#4: Steam coal South Africa, Richards Bay coal terminal, 6.000kcal/kg

API#6: Steam Coal Australia, Newcastle terminal 6000kcal/kg, 1%S

Traded European Utility Spread (es. 2004)

Clean dark spread CDS: Price difference between coal (including CO2) and power

Atlantic Market Pacific Market

European Standard Trading Products (est. 2001)

New Coal Swaps 2011/12

South Chinese CFR:steam coal FOB 5500 kcal/kg NAR

Indonesian Sub-BituminousSteam coal FOB 4,900 kcal/kg NAR

Future?interest in off-spec coal qualitiesgrows from price sensitive Utilities(high sulphur, low energy, petcoke?)

API#6



Ongoing supply issues for utilities increase fuel risk

Infrastructure Bottlenecks delay new mine capacity and exports

Sufficient number of mine projects & expansions in planning across globe

Port expansions are underway in existing exporters; missing in new mining countries

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

Indonesian sub-bituminous dominates exports to China and in India

NSW Australia exports of high ash off-spec coal increasing

South African suppliers seeing off-spec export market as a viable option

High sulphur US cargoes offer high spot discounts in the market

Growing government intervention to manage local coal reserves & resources delays investment

Indonesia moving to secure domestic supplies; plans to limit foreign ownership of mines

Nationalisation in South Africa mining sector a possibility

Australia’s Resource Tax could return;

Increasing difficulties in permitting (USA, Australia)



E.ON analysis shows that coal market will become less competitive in mid-term – any impact on consumers?

High market concentration Moderate market concentration No concentration High competition

The share of “free coal” in the market, not controlled by utilities, state or steel companies is fallingMarket 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)Market concentration strengthens in 2015 versus 2010 increasing supply risksNew supply regions will be strongly concentrated (e.g. Mozambique). Source: EKW


2010 2015


BGR puts geological coal reserves at approx. 750 bn t globally - exceeding 100 years current annual demand

3RESERVES &QUALITITES

Coal reserves Coal resources

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


Coming from a mine‘s perspective, E.ON has identified specific reserves at mines/projects of almost 100 bn tCoal reserves Coal resources

1) Code for Reporting of Mineral Resources and Ore Reserves Source: E.ON Kraftwerke GmbH internal research


1) 1)


E.g. E.ON reviews exporting mine/project portfolio of com-panies like Xstrata to forecast future volumes & qualities

Source: Xstrata public sources, E.ON Kraftwerke GmbH internal research


Σ 4 bn t (JORC certified) Xstrata is a globally active miningcompany with 32 active mines and 30+ green & brownfield projects in thepipelineAnnual production sums up to some 90 mn t – theoretical lifetime of reservesclose to 45 yearsAdditionally approx 20 bn of resourcesidentifiedE.ON Kraftwerke allocates dedicatedcoal types/brands to mines/projects to be able to forecast future coal quality(besides capacities & costs)

Xstrata coal reserves


Hence, core of E.ON model is the constant tracking of newprojects/investments and running mines incl. expansions

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

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

Explanation of methodology for supply (1/4)

2

1



FOB cost positions for opencast and underground ope-rations vary significantly – impacting future development

4 MINING COSTS

Free on board (FOB) cash costs New South Wales [USD/t]

Source: E.ON Kraftwerke GmbH internal research

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

O/C Dragline + truck&shovel (Production Capacity 7,5mt) U/G Longw all (Production Capacity 7,0mt)

Royalties

Port fees

Transport

Processing

Labour

Mining costs

Subject to political influence

Subject to e.g. trsp. congestion, taxation and fuel costsSubject to future coal geology

Subject to innovation e.g. auto-mation, contracting

Subject to geology e.g. over-burden ratio, seam depth/thick-ness; mining method, fuel & explosive costs


Generic costs model e.g. allows for allocation of produc-tivity ranges to mine types in certain mining countries

0

5.000

10.000

15.000

20.000

25.000

AUS AUS -

NSW

AUS -

QLD

CAN CHN COL INDO NZ RUS SA USA VEN Ø

underground operations opencast operations

Productivity [t per FTE year] for mine types and countries 1)

1) 172 mines in total analyzed

4 MINING COSTS


Generic cost model developed incorporating oil component

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 dataE.ON expert knowledge distinguishes between general inflation related cost items of coal extraction and oil related cash costsMain 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)Ratio between excavated coal and overburden is essential in this respectOn 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

General distinction between cash costs

4 MINING COSTS


Fundamentally, oil correlation of mining costs only relevant for basis mining expenses and transportation costs to portsFOB cash cost item

Oil corre-lation Comments

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

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

Processing costs ✘ Coal type and reserve specifics

Transportationcosts ✔ Depending on transportation to export harbors via train

(diesel vs. electricity), truck or barge

Port costs ✘ Port specific handling costs

Royalties ✘ Country/state specific royalty charges

4 MINING COSTS


Future generic mine cost model incorporates mining specific characteristicsMining costs in relation to O:C ratio (Indonesia T&S)

y = 0.3924x - 0.053

R2 = 0.9192

0

2

4

6

8

10

12

14

0 5 10 15 20 25 30$/ t

m3/ t

4 MINING COSTS


When looking at producers cash costs, e.g. Australian merit order depicts large bandwidth of miner’s cost base

4 MINING COSTS

Source: E.ON Kraftwerke GmbH internal research

Free on board (FOB) cash costs [USD/t]


Assumptions on cost development combined with pro-duction generate country specific merit order supply curves

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

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 inflationassumptions to 2030

Create a merit order supply curve for global export production capacity weighting the total available annual mining capacity (mntpa) by production price (USD/t FOB) for each of the years in the sample


4 MINING COSTS

3a

3b

3c

4


In current situation coal is at a crossroads – demand to rise til 2020, but post?

Coal demand is set to slow – just how much depends critically on government energy & environmental policies, especially in China

World primary coal demand by region and scenario

47%

50%

14%

14%

2 550 Mtce

1 883 Mtce

2 000

3 000

4 000

5 000

6 000

7 000

8 000

Mtce

1980 1990 2000 2010 2020 2030 2035

Current PoliciesScenario

450 Scenario

New PoliciesScenario

Rest of worldIndiaChina

Coal fights energy poverty

Greenhouse gases limited

Source: IEA 2011

5DEMAND DEVELOPMENT


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

6FUTUREDEVELOPMENT

Source: E.ON Investor Relation Information, 2009

RECENT REVISION OF MODELLING

ASSUMPTIONS UNDERTAKEN, BUT PRINCIPLE

VIEW ON EXTREME POSITIONS REMAINS VALID


Production volumes are adjusted in terms of active mines in case a 15-20% capacity safety margin is not yet covered

Evaluate needed demand for seaborne coal capacity with the available merit order supply curve for each year to make certain enough capacity is availableAvailable 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.


6

5

FUTUREDEVELOPMENT

2008 2010 2015Region 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 178,2 233,5Australia - Queensland 74,1 346,0 Pacific Australia - Qu 93,2 369,1 Pacific Australia - Queen 219,9 405,5Canada 7,8 8,4 Mexico Canada 7,8 8,4 Mexico Canada 7,8 4,2China 0,0 70,0 Asia China 0,0 91,7 Asia China 0,0 142,0Columbia 91,6 7,0 Africa & Middle EColumbia 116,4 7,0 Africa & Middl Columbia 119,1 7,0Indonesia 203,9 12,6 Brazil Indonesia 229,4 16,8 Brazil Indonesia 268,8 21,0Mozambique 0,0 0,0 Russia and FrienMozambique 0,0 0,0 Russia and FrMozambique 4,8 0,0New Zealand 1,5 New Zealand 0,8 New Zealand 0,0Norway 2,5 Norway 2,5 Norway 4,5Russia 59,9 Russia 59,9 Russia 71,7South Africa 82,9 South Africa 95,7 South Africa 114,0USA 19,7 USA 19,7 USA 38,8Vietnam 0,0 Vietnam 0,0 Vietnam 0,0Venezuela 12,0 Venezuela 13,0 Venezuela 19,6

Total 727,0 638,0 830,1 690,7 1067,1 813,1Relationship 114% 120% 131%

xx xx xx

ILLUSTRATIVE

internainterna


Merit orders are matched in GAMS model with demandpoints and freight assumptions to determine volume flows

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 exportsources. These results are reviewed and optimised using the freight costs in theGAMS model.

Merit Order Curve for 2010 Capacity

0,0

100,0

200,0

300,0

400,0

500,0

600,0

700,0

800,0

900,0

L L L M H M L L M H H L M L M L M H H L L H M M M M H H H H

SAF NZL COL SAF SAF COL VIE IND VIE COL VIE RUS IND NSWNOR QLD RUS NZL IND USA CAN RUSNSW USA CAN QLD CANNSW QLD USA

Segment

Cum

ulat

ive

Cap

acity

(mnt

pa)

0,0

10,0

20,0

30,0

40,0

50,0

60,0

70,0

80,0

90,0

Segm

ent F

OB

Pric

e (U

SD/t)Cumulative Capacity 2010

Avg Price for Segment

Scenario Demand +20% FOB Price SourceSlow Recovery 625 750 65,2 QLD - MGreen World 651 781,2 71,6 NSW - HClimate Concerns 655 786 71,6 NSW - HUnabated Growth 691 829,2 83,6 USA - H

2010 Demand Levels

Outcome:


6

6FUTUREDEVELOPMENT

ILLUSTRATIVE


Merit Order Curve for Export Mine Capacity in 2010/11

0

20

40

60

80

100

120

0 100 200 300 400 500 600 700 800 900

Capacity (Cumulative mtpa)

FOB

Cas

h C

ost (

USD

/t)

NZ

-

,mid

Sout

h A

fric

a-l

ow

Sout

h A

fric

a-m

id Sout

h A

fric

a-h

igh

Indo

nesi

a -

low

Indo

nesi

a -m

id

Indo

nesi

a -

high

Col

umbi

a -l

ow

Col

umbi

a -m

id Col

umbi

a -

high

Aus

tral

ia

(NSW

)-lo

w

Aus

tral

ia

(NSW

)-m

id

Aus

tral

ia

(NSW

)-hi

gh

Aus

tral

ia

(QLD

)-lo

w

Aus

tral

ia (Q

LD)

-hig

h

Aus

tral

ia (Q

LD)-

mid

Rus

sia

-lo

w

Rus

sia

-m

id Vene

zue

laC

anad

a -

low

Can

ada

-mid

USA

-lo

w

USA

–m

id

USA

-hi

gh

Rus

sia

-hig

h New

Ze

alnd

E.ON forecasts conclude that sufficient steam coal capacity is available, if the coal chain functions efficiently

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

Source: EKW Internal Analysis

Merit Order Curve for Export Mine Capacity in 2010/11

6FUTUREDEVELOPMENT


With seaborne coal demand above 1 bn t in 2030, E.ON model predicts stable supply situation with usual suspects

6FUTUREDEVELOPMENT

1) Assuming specific scenario based on EKW mine based supply modelSource: E.ON Kraftwerke GmbH internal research

World seaborne coal supply 2030 in mn t1)

27DIW Resource Workshop - Bayer, Rademacher - March 2012 27Status world coal markets and their development

The magnitude is line with other experts which also expect

thermal coal export markets to grow significantly in the future

585

713

824

613

804

979

0

200

400

600

800

1000

1200

2006 2015 2025

WoodMac

Global Insight

EIA

IEA

Development of steam coal exports (Mio t)

Source: Various forecasts

6FUTUREDEVELOPMENT


Consequently no significant change in European coal import mix expected with somehow predictable qualities

6FUTUREDEVELOPMENT

As majority of demand growth Asia centered – Australia, Indonesia and Mozambique will supply this area with seaborne thermal coalSouth African coal exports will most likely shift direction towards India rather than to European consumersConsequently Columbian and Russian coal are seen as the natural suppliers for EU thermal power stations in the futureUS will remain swing supplier, gas squeezes coal domestically and increases export capacity Norway and Venezuela will make up only small remainder of import coalsFundamentally 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 schemesGiven 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.

Where will European coal imports come from?


Fundamental coal data on mine by mine and project basis becomes more difficult - modelling also challenging

Difficulties in procuring data are becoming a real issueFewer sources of information available in the market from coal experts/consultantsMovement towards information summarized at country level; mine level information limitedInformation on coal qualities by producer / mine not in public realmQuality of data for some large exporters (Indonesia, Russia) poor

Optimisation modelling difficultiesTheoretically, a mark-up function for market premium possible; quantitatively, no successful proven approach for traded market Measuring capacity availability / utilization means having a view of mine production capacity, inland transport and port capacity as restriction

7 CONCLUSIONS

Challenges for coal modeling

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