Coal and Freight Monthly Parachute

8/6/2019 Coal and Freight Monthly Parachute

1/21

COMMODITIES RESEARCH July 20

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 19

COAL AND FREIGHT MONTHLY

Parachute

Atlantic coal markets continued their lacklustre performance last month. We expectprices to drift lower in the short term, given the hydro situation improving in

Scandinavia, a seasonally low period of demand in Western Europe and ample

stockpiles at ARA ports, before a pick-up ahead of restocking in Q4. However, we

expect stock draws from ARA to pick up as the Rhine river levels improve, provided

the current wet spell across Europe continues, and this should protect the downside

to prices. We continue to hold our API2 price forecasts at $123/t.

The dearth in European orders for coal from Richards Bay continues as the marketremains well supplied from other sources. In Asia, a good part of the supply needs

are being met by Australia and Indonesia, while Europe is well stocked and getting

steady supplies from Colombia, Russia and the US. Further, Indian buying continues

to draw in coal from Indonesia, and we have revised our API4 price forecasts lower

from $122/t to $119/t for 2011. As such, the API2-API4 spread is likely to remain

moderately positive.

Newcastle prices have been trading in a tight range around $120/t. We expectprices to drift lower in the short term but the downside to be capped as the

underlying fundamentals remain strong. Post the Japanese earthquake, the situation

of ample supplies has resulted in prices trading lower than our expectations. As a

result, we have revised our price forecasts from $131/t to $125/t.

In the coming months, we expect freight rates to drift lower, albeit slowly. Weexpect the BDI to average 1250 in H2 11. In 2012, as the fleet size continues to

build, we expect a more balanced distribution of the fleet across both the basins,

and we expect rates to be stable, albeit at low levels.

Figure 1: European coal prices drift lower and now trading in a narrow range

0

50

100

150

200

250

Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

Richards Bay FOB

Newcastle FOB

ARA CIF

Coal prices, $/t

Source: McCloskeys, Barclays Capital

Miswin Mahesh

+44 (0) 20 7773 4291

[email protected]

Amrita Sen

+44 (0) 20 3134 2266

[email protected]

Trevor Sikorski

+44 (0) 20 3134 0160

[email protected]

www.barcap.com

We would like to thank Yingxi Yu for her ideaand invaluable contributions to this report.


2/21

Barclays Capital | Coal and Freight Monthly

19 July 2011 2

BALANCES AND PRICES

Figure 2: Global balances

Mt 2004 2005 2006 2007 2008 2009 2010 2011F

Japan 118 120 119 126 131 113 125 1

South Korea 56 59 60 66 74 80 89 93

China 10 16 31 41 31 82 111 97

India 14 23 28 35 35 60 75 90

Taiwan 55 55 56 59 59 53 57 59

Europe 160 156 169 167 165 153 138 144

Others 67 110 125 139 143 134 151 151

Total imports 480 538 588 633 637 675 745 750

Y/Y change (%) -1.3% 12.3% 9.1% 7.8% 0.6% 5.9% 10.4% 0.6%

Indonesia 105 129 183 195 200 233 291 302

Australia 107 107 111 112 125 139 141 145

China 74 61 54 45 36 18 14 6

Vietnam 6 10 20 24 16 23 17 16

Russia 45 49 70 74 70 79 71 73South Africa 67 74 67 67 68 67 63 65

USA 3 19 20 24 35 20 23 24

Colombia 51 55 58 65 69 65 71 72

Others 10 21 22 23 27 20 22 16

Total exports 470 524 605 629 646 665 712 718

Y/Y change (%) 8.6% 11.7% 15.4% 3.9% 2.7% 2.9% 7.1% 0.8%

Global trade balance -10 -14 18 -5 8 -10 -33 -32

Source: McCloskeys, Ecowin, Barclays Capital

Figure 3: European imports

Mt Apr-10 May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10 Dec-10 Jan-11 Feb-11 Mar-11 Apr-11

Germany 2.4 2.9 2.3 2.1 2.5 1.7 2.1 2.0 3.7 2.5 2.6 2.4 2.6

UK 1.3 1.0 0.9 0.8 1.1 1.9 2.1 1.5 1.7 0.8 2.1 2.2 2.1

Spain 0.8 0.6 0.5 0.4 0.6 0.8 0.6 1.2 1.0 1.2 0.7 0.8 0.8

Italy 1.1 0.8 1.1 1.1 1.1 1.1 1.4 1.3 1.4 0.9 1.0 1.2 1.1

France 0.9 1.1 0.7 1.1 0.6 1.0 0.8 1.1 1.0 0.8 0.7 0.7 0.7

Turkey 1.2 1.4 1.5 1.2 1.5 1.0 1.4 1.4 1.9 1.5* 1.8 1.5 1.9

Others 4.1 4.8 4.2 4.2 5.0 5.1 5.1 5.4 5.5 6.5 3.8 3.9 3.5

Total Imports 11.8 12.6 11.2 10.9 12.4 12.7 13.4 13.8 16.2 12.7 12.7 12.7 12.7

y/y change (%) -14% 1% -16% -15% -2% -12% -22% -32% 6% -1% -3% -9% 8%

Note: * Estimates. Source: McCloskeys, Barclays Capital

Figure 4: Price forecasts

Benchmarks 2004 2005 2006 2007 2008 2009 2010 2011F

API 2 (US$/t) 72 61 63 87 144 71 93 123

API 4 (US$/t) 54 47 50 62 120 66 92 119

Newcastle (US$/t) 53 47 49 66 128 72 99 125

Source: Barclays Capital


3/21


19 July 2011 3

THE GLOBAL COAL AND FREIGHT MARKETS

Atlantic basin: Air brake

Atlantic coal markets had a lacklustre period over June and the first half of July. During this

period, API2 prices remained fairly stable at $122.75/t, although API4 prices drifted well

below $120/t and settled at $115/t by the middle of July. In line with our expectations, the

API4 price premium to other benchmarks was eroded as the lack of demand for South

African coal finally caused some price reductions. The dearth in European orders for coal

from Richards Bay continues as the market remains well supplied from other sources. In

Asia, most of the supply needs are being met by Australia and Colombia, while Europe is

well stocked with imports from Colombia, Russia and the US.

In the Atlantic basin, we expect prices to drift lower in the short term before they regain

some momentum ahead of winter restocking, given the improving hydro situation in

Scandinavia, a seasonally low period of demand and ample stockpiles at ARA ports. We

expect Q4 11 contracts to perform well given restocking needs expected. However, we

expect stock draws from ARA to pick up as the Rhine river levels improve provided thecurrent wet spell across Europe continues and this should protect the downside to prices.

Further, we highlight that ARA stock levels are only close to seasonal averages and are well

below 2010 levels.

Given the above, we continue to hold our API2 price forecasts at $123/t. In the year-to-date,

API4 prices are averaging $121/t, $1 lower than our API4 price forecasts of $122/t.

However, given that Indian buying has been increasingly taking more coal from Indonesia,

thereby displacing volumes of South African coal, we are decreasing that average to $119/t

to reflect that change. Newcastle prices are currently averaging $123/t, lower than our

forecast of $131/t, given the oversupply post the Japanese earthquake. As a result, we are

revising that lower to $125/t for 2011.

Atlantic basin activity lacklustre

at present could pick up in Q4

Further pressure on prices as

hydro situation improves and

stockpiles are high

Figure 5: ARA coal stocks are high Figure 6: UK utility stocks are below the 5-year average

(in mt)

2.5

3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2010 2011 4 year average

(in mt)

8

10

12

14

16

18

20

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2010 2011 5 year average

Source: Clarksons, MCcloskey, EMO, OBA, Barclays Capital Source: McCloskey, Barclays Capital


4/21


19 July 2011 4

Atlantic demand: Weather, Rhine and Rhone

Despite the capacity gap created by the shut-down of 8.3 GW of German nuclear plant,

German coal burn remains limited, as the gap has been filled with generation from

renewable sources, including the 15GW of photovoltaic power plants and imports of nuclear

power from the Czech Republic and France. With the Rhine River levels deteriorating again

and now below seasonal averages, transporting coal from the ARA ports on barges or by rail

has resulted in increased costs to utilities. In France, the Rhone River levels are currently low,

and further deterioration could result in outages of French nuclear plant due to a lack of

cooling water. A drop in French generation would curtail exports of power to Germany and

would be positive for coal demand. This highlights the important role weather will play in

determining coal burn over the coming two months. If Europe is predominantly going to be

hot and dry, as suggested in the report by ENTSO-E (European Network of Transmission

System Operators for Electricity), there is a fair chance of cooling water restrictions in some

of the North Sea region countries for river located plants (especially in France). According to

ENTSO-E, in September, France could require imports of up to 6000MW to cover the

minimum required margin. As of April, French and German coal imports have

underperformed relative to our expectations; we have adjusted total German and French

coal imports for 2011 lower by 11% and 12%, respectively. Similar trends of lower thanexpected coal imports are seen in Italy and Spain. While in the UK, coal imports have been

on the low side, we believe this more to do with destocking rather than actual coal burn

being reduced. Overall, we adjust our European imports for 2011 down 5%.

Given that there are conflicting views on expected European weather, ranging from

continuous rain to a sustained period of hot and dry weather, the outcome for European

coal burn is complicated. If there were a hot, dry summer, the Rhone and Rhine River levels

would further deteriorate, and we would expect power station coal stocks in Germany to

run low due to higher demand feeding greater air conditioning use, less hydro and nuclear

availability and limited barges pulling coal from ARA ports. While this would be

supplemented by healthy output from the 15GW photovoltaic capacity, the demand for coal

would increase and the key issue would be the ability to move coal out of ARA ports and get

it to power stations. At the very least, this would support ARA prices, although upside might

be kept in check by limitations on the ability to move coal from port to power station.

On the other hand, if there were wet and cool weather across Europe, improving Rhine River

levels would mean barges functioning at full capacity and no additional cost to utilities to

draw stocks from ARA ports. While this does not promise increased coal burn, there would

be a more balanced distribution of stocks between utilities and ports. Wet weather would

not bode well for Germanys photovoltaic cells but would mean hydro levels across Europe

will pick up and nuclear output would not be threatened with outage. As there would be

less (or no) interruptions in the export of power to Germany and neighbouring countries,

ARA prices would see less support and further downward drift would be expected.

In terms of long-term fundamentals, Germany has been focussing on replacing some of thelost nuclear capacity with renewable generation capacity, particularly from wind and solar.

The German governments draft renewable energy act, due to take effect at the start of

2012, looks to promote 10GW of off-shore wind by 2020. Looking at the support

framework set by the governments draft renewable energy act, a report by offshore wind

agency WAB argued that the proposed guaranteed feed-in payments would not provide a

sufficiently attractive return on investment to attract new funds to the German offshore

sector. If only half the planned offshore target is achieved, or 5GW, coal generators could be

needed to generate an additional 15TWh (assuming 35% utilisation for offshore turbines),

the equivalent of extra coal burn of about 4.5mt/year.

Renewables and power imports

help to offset German coal burn

Scenario One: Dry weather

in Europe

Scenario Two: Wet weather

in Europe

Germany and wind energy


5/21


19 July 2011 5

Norwegian water reservoir levels have improved from the weak start to the year due to

heavy rains during the last three weeks of June. Hydro levels at 67% are now above seasonal

averages and well above the 52% seen last year. Available electricity output capacity is now

above 50,000GWh, or about 60% of the total installed capacity. The increased hydro levels

have moderated power prices and reduced demand for thermal coal across Scandinavia. We

expect the water levels to improve from here, provided the rainfall continues.

Turkish steam coal imports fell in May to 1.2mt, compared with 1.37mt in the same month

last year, as the take from Colombia fell to the lowest level since July 2010. However, total

steam coal imports for the first five months reached 7.8mt, up 30% y/y. Supplies from

Russia regained top spot from Colombia in May, with 0.81mt, compared with 0.74mt last

year and higher than Aprils 0.70mt. Year-to-date imports from there were 3.77mt, up from

3.53mt over the same period in 2010. Imports from Colombia saw a dramatic fall after

outperforming Russia in April.

In June, coal stocks at Northwest European ports were steady, with more cargoes arriving

from the Baltic ports carrying Russian coal, in addition to the high volumes from Colombia

and marginal supplies from the US. Among the ARA ports, Amsterdams OBA has stockpiles

totalling 1.6mt (unchanged m/m), while Rotterdams EMO terminal has 2.9mt of stockpiles

(down 0.3mt m/m). Rhine River levels had shown significant improvement in mid-June;

however, with rainfall receding, the river levels have declined once again below seasonal

averages but are set to improve with the oncoming rainfall expected in Europe.

Atlantic supply

South African coal exports totalled 4.78mt in June. South Africa exported 1.2Mt of coal to

India in June, little changed m/m. Indian exports accounted for 25% of the countrys total

exports of 4.8Mt, while China was the second largest importer of South African coal at

770kt, up from 320kt in May. Exports to India have declined during the first half of this year

due to high API4 prices, which have forced buyers to seek cheaper alternatives from

Indonesia and other lower spec coal. Indian imports from Richards Bay (RBCT) have fallen

21% in H1 11 on a y/y basis, while Chinese imports from Richards Bay have increased 18%

to 3.14mt in the January to June period. In H1 11, South Africa supplied 27.42 million tons of

coal globally with Chinese and Indian imports accounting for about 39% of exports (17.7mt,

up 1.7% y/y) and the Atlantic basin taking 9.55mt.

Over the past few months, disruptions to South African coal output were threatened by

possible strike action by the National Union of Mineworkers (NUM) over wages in the coal

sector. In the last round of talks, coal producers offered NUM a wage rise offer of 4.2% to

4.5%, well below labour demands of 14%. The difference is that food and fuel price

pressures are stoking wage demands, while the big mining companies say they can ill-

afford to offer increases far above inflation. The effect of any ensuing strikes will depend

on duration: a short strike of a week or two would likely have little immediate effect on

South African coal exports as RBCT stocks are ample to cater to present demand. A strikeof longer duration, say a month, would eventually curtail the supply of South African coal

into the market, eventually providing support and upside to API-4 prices and most other

coal benchmarks.

Russian coal output was steady during June. Russia is expected to emerge as Indias third

source of thermal coal imports after South Africa and Indonesia. Though still in an evolving

phase, coal imports to India from the Eastern Russian ports of Vladivostok, Vanino,

Vostochny and others on the Pacific are rising and re expected to exceed 1mt this year.

Major Russian miners are building large coal terminals on Pacific ports to meet the

Turkish coal imports fall in May

but up 30% y/y

European stock levels

Indian imports from

South Africa fall

South Africa coal mine strikes,

limited effect

Russian coal supplies steady

and India emerges

as a new destination


6/21


19 July 2011 6

additional demand pull from Asia. The coal volumes from Russia, though insignificant at

this juncture compared with our projected Indian import total of more than 90 mt for 2011,

may in the long run reduce the countrys dependence on current major suppliers (Indonesia

in particular). The first move in this direction was made by Indias largest coal importer and

infrastructure major Adani Enterprises in early 2011, when it brought a capesize coal cargo

from Vostochny to the privately run Mundra Port on the west coast of India.

Russian and Colombian supplies have found an increasing market for steam coal in Turkey,

which is expected to increase its steam coal imports nearly 30% between 2011 and 2013.

Turkish coal fired power plant capacity is expected to double in the coming years and usage

by the cement industry is set to consume a good amount of steam coal. Turkey is the

worlds largest exporter of cement and its fourth-largest producer. The reason Colombian

coal is entering Turkey is largely due to availability and limits to the export of coal from

Russia. In Russia, railcar freight rates have been increasing due to the decommissioning of

old railcars and the increased demand on rail for transportation of coal and construction

materials, particularly for the 2014 Russian Winter Olympics. We expect this railcar situation

to last until early 2012, as there has been a steady increase in activity in rail wagon

manufacturing in Russia. The costs and limits on rail freight have provided an opportunity

for Colombian coal to be provided at competitive price levels.

Colombian steam coal exports touched 35.63mt during H1 11, up 5% y/y. Among the

major mining regions, Cerrejon exports in H1 11 reached 15.21mt up 1.4mt y/y, while

Drummonds exports were almost flat y/y at 10.48mt. During H1 11, exports to Europe

touched 25mt a 50% y/y increase in the year-to-date. The Netherlands is the largest

destination for Colombian coal with 9.17mt exported during H1 11, followed by Denmark

which received 3.28mt, Israel with 2.64mt, the UK with 2.51mt and Turkey with 2.11mt.

French imports from Colombia declined to 0.6mt in the six-month period, compared with

1.03mt last year. The increase of exports to Europe has been offset by the fall in exports to

the Americas to 9.81mt from 11.56 mt in H1 10. Most of the reduction has been to the US,

which is increasingly exporting coal. Exports to Chile have grown 23% to 2.31mt in H1 11.

Exports to Asia have fallen 86% to 0.81mt, compared with the 5.79mt during the same

period last year. Exports to China were reduced the most, falling by 2.95mt to a mere

165,000mt during H1 11. Also shipments to South Korea were reduced almost 75% from

0.82mt in H1 10 to H1 11.

In the next four to five years, Colombia has few new capacity expansion projects coming

online such that Colombian output growth will run at a slower pace than expected due to

delayed delivery of large mining equipment from Japan.

The US has become a key supplier into the European market in 2011, with H1 11 US east

coast coal exports were up 32% from 22.9 mt in H1 10. Combined coal exports from

Hampton Roads and Baltimore ports in June 2011 were up 1.22mt to 4.72mt. Deliveries to

Italy almost tripled on a y/y basis in June, touching 0.63mt in the month. Although a good

portion of the increase accounts for met coal, steam coal volumes to Europe areincreasingly picking up. In particular, given the natural gas glut in the US, we expect the US

to slowly and steadily develop its export capabilities. US coal is attractive to Europe because

it is being offered at a discount. In particular, aggressive discounts have been offered for

high sulphur Illinois Basin thermal coal. Despite their high sulphur, chlorine and AFT levels,

they have become more popular with international buyers in recent months given that they

are priced at a $15-30/t discount to API2. As the specification of the coal limits its use in

Europe, it will take considerably more strength in API4 prices (or greater discounts to US

coal) to drive higher exports of steam coal. However, given the limited export infrastructure

in the US, we still expect that US exports of coal to be dominated by coking coal.

Russian coal supplies competing

with Colombian supplies in Turkey

Colombian steam coal exports

up 5% y/y

Colombian long term supplies

US exports into Europe


7/21


19 July 2011 7

Pacific basin: Balanced

Prices have been range bound around $120/t

Since the onset of summer, Pacific Basin coal prices have appeared comfortable trading

in a tight range around $120/t. The prompt Newcastle contract dipped below this level

briefly in mid-June, and though prices have rebounded since then, the momentum for

moving much higher has been weak. At the same time, Newcastle has remained at a

premium to API4 but stayed at a discount to API2, with a contango remaining along the

entire forward curve.

At current levels, we do not expect prices to push significantly higher in the near term, while

on the other hand still-robust demand should keep prices well supported. After a period of

re-stocking, consumers in main importing centres appear to be relatively well stocked.

Chinas improving hydro situation is easing concerns about power shortages, while the

import arbitrage window with Australia remains closed. Indian purchasing interest is being

dampened by the monsoon season, whereas demand from Japan remains lacklustre.

Anecdotal evidence suggests that some Atlantic coal has been sold at discounts into the

Pacific basin, increasing supply and further dampening price upside.

Pacific demand: Restocked

The uptrend in Chinas domestic coal prices has faltered, reflecting a noticeable

improvement in domestic supplies. After rising more than 10% since late March, FOB prices

of 5,500kcal/kg NAR coal at Qinhuangdao port declined in early July and have remained

largely stable since then. Supply of imported material has increased imports of thermal

coal rebounded by 57% y/y to 7.5mt in May, while exports plunged 53% y/y to just 0.36mt,

marking a sharp turnaround from the past three months when imports came in consistently

below 5mt in each month.

In addition to increased overseas supplies, good rainfall has helped bring about a recovery in

hydro generation levels and alleviate the tight power situation in the south. The earlierrestocking by utilities also means that coal stock levels at major utilities have moved back to

a comfortable 17 days of supply, while port stocks have also increased significantly, with

QHD stocks in particular moving towards 8 mt.

The domestic coal tightness has eased compared with a month ago, although seasonal

demand is likely to be strong and should keep the situation relatively tight, particularly given

the unpredictability of hydro. Nonetheless, there should be less impetus for the Chinese

authorities to make changes to the 17% import VAT, as originally anticipated. Without any

reductions in the VAT, the arbitrage window remains closed, offering no incentives to

import. This is largely in line with anecdotal reports that business between Chinese

consumers and regional producers have come to a standstill recently, with material sold

only if producers are willing to offer significant discounts to international markers.

The onset of the monsoon season in India has been accompanied by reports of softer

purchasing interest in recent weeks. Despite this, fundamentals remain positive as far as

India is concerned. Power generation is still growing at a robust pace of 8.2% y/y in June,

with thermal generation rising by 5% y/y. Indeed, the rate of generation exceeded its June

target by another 2%, after coming in 4% higher than target in May.

The rate of new generation capacity additions has continued at a solid pace. According to

data from the Central Electricity Authority (CEA), India added a total of 550MW in

generation capacity in May, of which 300MW was in thermal-fired plants. This was lower

Pacific basin coal prices have

been stuck in a tight range

around $120

Prices should remain well

supported although upside in the

near term looks limited

Domestic prices in China fell for

the first time in three months

and have been stable since

Chinas hydro situation

has improved

The import arb window

remains shut

Indias buying interest has

weakened during the monsoon

season, but underlying

generation still robust

New generation capacity is being

added at a solid pace


8/21


19 July 2011 8

than the original target of 825MW and slightly lower than additions in the prior two months

(735MW and 1700MW in April and March). So far this fiscal year, new capacity additions

have been about 66% of the target for thermal capacity and about 69% of the total target.

Meanwhile, domestic coal production grew by 1% y/y to 40.7mt in May, 4.4% lower than

the 42.5mt target set for the month. Production in the first two months (April-May) of the

current fiscal year has totalled 80.48mt, 3.4% below target and is unlikely to significantlyimprove in the near term given uncertainty about environmental regulations. A group of

ministers (GoM) has been formed to sort out differences between the environment and coal

ministries, but has failed to make much progress so far.

At the same time, Japans coal consumption continues to be hampered by damaged coal-

fired plants and the effect of the 11 March earthquake on overall electricity generation.

Electricity generated across the 10 major utilities fell by another 4.7% y/y in May, with

nuclear generation in particular plunging by 31.5% y/y, alongside a fall in the nuclear

capacity factor to 40.9%, lowest in our records (dating back to January 2006). Thermal

generation again rose to plug the nuclear shortfall (+18.6% y/y), with oil and LNG the

biggest beneficiaries, whereas coal demand declined. Over March-May, Japans utility coal

consumption has fallen by 1.5% y/y, while crude, fuel oil and LNG consumption by utilities

have gained by 150%, 18% and 14% y/y, respectively.

Eventually, together with the gradual restoration of transport infrastructure and coal-fired

stations, coal is set to benefit from the uncertainty about Japans longer-term nuclear policy.

In early July, a government announcement to conduct stress tests on all reactors increased

doubts about the safety of reactors and injected uncertainty into whether reactors can be

restarted without first undergoing the tests. This has already caused delays to the restart of

a few nuclear stations for instance, a withdrawal of decisions by the Mayor of Genkai to

restart nuclear plants on 7 July, as well as a delay by Shikoku Electric to restart its No. 3

reactor on Ikata (890MW).

Figure 7: The import arb window into China remains closed Figure 8: Japans nuclear capacity factor falls to a new low

Newcastle/China spread (incl 17% VAT)

-45

-40

-35

-30

-25

-20

-15

-10

-5

0

Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11

Newcastle/China spread (incl 17% VAT)

35%

40%

45%

50%

55%

60%

65%

70%

75%

80%

May-07 May-08 May-09 May-10 May-11

Capacity Factor (%) 12-month average

Source: CoalSpot.com, CCTD, Barclays Capital Source: FEPC, Barclays Capital

Domestic Indian coal production

still running below targets

Nuclear capacity factor fell to a

new low in Japan, but coal

demand also fell

But coal will benefit from the

likely long-term direction of

Japans energy policy


9/21


19 July 2011 9

Pacific supply: A price for carbon

The announcement of a carbon scheme has dominated attention in Australia. On 10 July 2011,

the government announced that a carbon tax of A$23/t will be introduced from 1 July 2012.

The starting price is some 35% higher than current EUA carbon prices. About 500 of the

highest polluting businesses will have to pay the carbon price, which will rise by 2.5% in real

terms every year until 1 July 2015, when it will be replaced by a market-based emissionstrading scheme. Legislation is expected to be brought into the lower House of

Representative in August, with a vote in Senate expected two or three months later.

If approved, this will be the worlds second national emissions scheme outside Europe and

will inevitably bring about some increased costs for the coal mining industry.

It is still early to fully assess the effect of the proposed carbon scheme on the coal mining

sector, but there are a few important points to note:

According to the government, this tax will add about $1.80/t to coal production costs,but the miners with higher methane emissions would face higher cost pressures.

A report commissioned by the Australian Coal Association (ACA) in June showed thatabout 4,700 jobs will be lost in existing coal mines, 14,100 jobs in the Australian

economy and loss of coal sales would exceed $22bn over nine years. In addition, by

2020, a cumulative 262mt of coal production could be lost from existing mines, while

almost 380mt of production from potential mines could be lost. The report was based

on an initial carbon price of A$20/t and assumptions that no concessions would be

given to any coal mining projects. However, such industry-based assessments tend to

overestimate the effects of proposed environmental legislation on their industry.

A $1.3bn assistance scheme would be offered by the government to the coal industry.However, according to the ACA, this would cover less than 10% of the carbon tax bill for

the coal industry, far below the 94.5% offered to other trade exposed sectors of the

economy, including aluminium and zinc smelting, steel manufacturing, flat glass making,

pulp and paper making.

In terms of actual shipments at present, data suggest that terminals in Queensland are slowly

recovering from the floods, though export volumes remain lower compared with last year.

According to data compiled by McCloskeys, the Dalyrymple Bay Coal Terminal (DBCT)s

throughput is likely to reach an annualised 52-53mt for the July-September quarter, a marked

increase from less than 45mt/y over January-May 2011, although still some way below the

66mt/y reached in the same quarter in 2010. Other major terminals are also showing

improvements, though a few obstacles pose short-term risks, including maintenance (11 July

21 August) at one of the berths at Hay Point and strike action at Brisbane terminal.

Meanwhile, most mines have lifted their force majeure declarations, although coal stocks

remain very low. On the other hand, Newcastle exports have continued at normal capacity.

While ship loading has continued to underperform targets, vessel queues have remained

manageable at below 20, suggesting there are no severe infrastructural bottlenecks at present.

A carbon scheme in Australia

has just been announced

The scheme will increase costs

for the coal mining industry

Queensland terminals and

producers are slowly recovering

from the floods


10/21


19 July 2011 10

Freight: Spinnaker

Freight markets drifted lower, albeit slowly, in June, with the BDI moving in a very tight

range of 89 index points. The movement is in line with our expectations, with the rebound in

May having slowed initially and now showing signs of softening further. The West Australia

to China route for Capesizes lent some support to the index over the month, but we expect

this to tone down over the coming months due to ample iron ore and coal stockpile levels inChina and demand continuing at moderate levels with the growth rate possibly losing

steam. Rates in the Atlantic basin remain healthier than those in the Pacific basin, yet they

are likely to balance out once bunker fuel prices average lower and allow for adjustment of

fleet size over the basins. We expect iron ore exports from Brazil to rebound in August, in

line with seasonal trends.

In the Atlantic basin, Panamax rates were boosted as low water levels on the Mississippi

River restricted load levels. The reductions are up to 10% on panamax loads with access

being limited to the deepwater channel on the approach to the port of New Orleans along

the lower Mississippi-Gulf.

The onset of the Indian monsoon has limited Supramax iron ore exports into China. We

expect Indian exports of iron ore to resume in September once the monsoon seasonsubsides and the removal of the export ban finally takes effect.

The month also saw the maiden voyage of the first of Vales Chinamaxes. The 400,000 dwt

ship carrying 391,000 tonnes of iron ore from Brazil was originally destined for China.

However, it was rerouted to anchor at the Taranto port in Italy incurring significant bunker

fuel prices. Vale stated commercial reasons, not political reasons, for its decision to reroute

its iron ore cargo all the way from China to Europe. Seven more of these ships are expected

to be delivered by the end of this year. There are currently 10 ports in the world that can

accommodate Vales 400,000 dwt ships, which require a draft of 23 meters. However, Vale

is also building a portable transhipment station in Southeast Asia that will help redistribute

iron ore at a cost effective rate to other consumers in the region who require smaller

amounts of iron ore and who have smaller ports. We expect the entry of these Chinamaxesto leave a lasting impression on Capesize trade routes.

Iron ore

Iron ore inventories for mid-July at ports in China are at record levels of 94.04Mt The

Chinese General Administration of Customs reported trade figures for the month of June,

disclosing iron ore imports of 51.1Mt, -4% m/m and flat y/y. The import figure was in line

with 2010 monthly average of 51.6Mt. While the headline figure is relatively soft, we believe

it is mainly explained by de-stocking activity at Chinese steel mills, as crude steel production

(CSP) remains high in China, and weaker iron ore exports from India affected by the

monsoon season. For 2011, our Latin American research team forecasts Chinese iron ore

imports of 669Mt, an 8% y/y increase.

According to the National Bureau of Statistics, Chinese domestic iron ore (ROM: run-of-

mine) output climbed for the fourth consecutive month to 124Mt in June, +21% m/m (we

calculate an implied grade of c.17% Fe). Domestic iron ore production is gaining share from

imported material, and we expect high cost domestic production (marginal tonnes above

US$150/ton) to support iron ore spot prices in the short/medium-term. Concurrently, our

Latin American Equity Research team views Chinese steel mills to have been aggressively

destocking in iron ore. We expect iron ore imports to pick up in H2 11.

Freight rates begin to

soften again

Rates in Atlantic basin

are healthier

Mississippi river and

Panamax rates

Indian Supramax cargoes limited

by monsoon

Vales Chinamaxes enter

the fleet

Chinese iron ore imports flat y/y

Chinese domestic iron ore climbs

for the fourth consecutive month


11/21


19 July 2011 11

On the end-user demand front, at 58.62Mt, Chinas crude steel production was flat m/m in

June, though up 11.5% y/y. Annualised total crude steel production in H1 11 now stands

12.6% higher y/y at 705.7Mt. Nevertheless, there are signs of improvement though the

first part of the month showed moderate production, Chinas daily output of crude steel

averaged 2.02Mt in the last ten days of June (record high figure and up 3% from mid-June)

according to preliminary figures disclosed by the Chinese Iron and Steel Association (CISA).

Resilience continues in Chinese CSP figures, which so far have been unaffected by energyrationing and slower demand. If we mark to market 700Mt in our Latin American Equity

Research teams seaborne iron ore S&D model, we arrive at an implied notional deficit of

84Mt (versus our base case deficit of c.40 Mt).

The Indian ministerial panel on mines unanimously approved the draft Mines and Mineral

Bill 2011 and has submitted it for final clearance to the Cabinet. According to Mr. Jairam

Ramesh (Environmental Minister), the new bill should require coal companies to share 26%

of their profits with local communities and other miners to pay twice as much in royalties as

they currently pay to the government. Mr. Siddharth Rungta (president of the Federation of

Indian Mineral Industries) stated that the resultant increase in costs from royalties should

increase total costs of iron ore miners by roughly 10%, reducing the competiveness of the

Indian iron ore exporters. On balance, the bill may eliminate the higher cost Indian exportcapacity, which we believe is supportive of iron ore spot prices.

Brazilian iron ore exports during June came in at 25.5Mt, a 3% m/m decline (previously

disclosed). The slight decrease was mainly attributable to lower demand from Europe at

5.8Mt (-7% m/m) and a strong deceleration of volumes channelled to Japan, at 2Mt, down

18% m/m and 35% below the monthly average of 2010. Shipments to China were robust at

13.2Mt, up 7% m/m. We expect a recovery from Japanese demand during the Q4 11 on

reconstruction efforts.

Figure 9: Brazilian iron ore exports low seasonally, but expected to rebound in August

0

20

40

60

80

100

120

140

160

Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11

10

12

14

16

18

20

22

24

26

# of ships (LHS)Dead Weight Tonnage (Combined - Mt) - RHS

0

20

40

60

80

100

120

140

160

Jun-10 Aug-10 Oct-10 Dec-10 Feb-11 Apr-11 Jun-11

10

12

14

16

18

20

22

24

26

# of ships (LHS)Dead Weight Tonnage (Combined - Mt) - RHS

Source: Barclays Capital Latin American Equity Research Team, Bloomberg, Barclays Capital

Chinese crude steel

production resilient

Indian mine royalties increased

Brazilian iron ore exports slightly

lower in June


12/21


19 July 2011 12

Fleet analysis: Current fleet, age profile and the orderbook.

Capesize

As of June 2011, the Capesize fleet consists of 1270 capes with a total volume of 230 million

dwt. The orderbook from the current month to early 2014 shows another addition of 436

capes, representing a further expansion of close to 35% of the current fleet. More than half of

the close to 450 ships in the orderbook is expected to be delivered within 2011. In terms of theage of the current Capesize fleet, close to 45% of the fleet is only up to five years old, while

ships older than 20 years is a very small 14%. Given the age profile of the current cape fleet,

our expectations on how many capes will be sent for scrappage are low. Scrappage levels

have only now started picking up, those that have been sold for scrappage are still operating,

and there is a considerable lag until the actual time of delivery into the scrap yard.

On the demand side, we do not expect a high growth rate, which leads us to believe that

rates will be capped at low levels until the end of 2011. Further, Capesize rates are expected

to be affected the most compared with Panamaxes or Supramaxes that have a slightly

lower rate of fleet growth. We expect the 400,000 dwt Vale ships to have a significant effect

on Capesize rates, given that the long and lucrative Brazil-to-China route will now demand

fewer charters from the biggest miner in Brazil. Also, the iron ore route from Brazil to Europewill receive less volume given that the 400,000 dwt ship was rerouted to Italy on its maiden

voyage, indicating that European demand for iron ore can also be met cost effectively

through the deployment of these big ships. Cape rates on the Brazil to China iron ore route

have now fallen to $20/t and far less than the nearly $100/t in 2008 when Vale decided to

place orders for its own ships to transport iron ore. At present freight rate levels,

transporting iron ore using the giant Chinamaxes may not really look as beneficial as in

2008; however, after analysing Vales cash flows and the amount allocated for the ships as a

percentage of its total capex, as well as the companys own statements, we believe Vale will

continue to take delivery of rest of the Chinamaxes on its orderbook creating further

pressure for Capesizes. However, given that these huge ships can only dock in ten ports, we

see deployment of Capesizes on shorter routes and possibly even routes of redistribution of

iron ore from the portable transhipment stations or from the Malaysian distribution centreto Asia and from the Oman distribution centre to the Middle East and Africa. This is where

we also expect good demand for smaller ships, but the conclusion is that long routes for

capes carrying iron ore from Brazil are likely to be less lucrative.

Figure 10: Capesize age profile of current fleet Figure 11: Capesize orderbook: 525 ships and when they willarrive

(26+)

5%

(16 to 25

years)

25%

(upto 5

years)

44%(6 to 15

years)

26%

(2012)

26%

(2011)

44%

(2013)

25%

2014

1%

Source: SSY, Clarksons, Lloyds List Intelligence, Barclays Capital Source: SSY, Clarksons, Lloyds List Intelligence, Barclays Capital

More Capes on the way

The future for cape routes


13/21


19 July 2011 13

Panamaxes

As of June 2011, close to 1900 Panamax ships with a total volume close to 143 million dwt

are in operation. Panamaxes have so far this year managed to perform better than capes on

the rates front, with the operating cost well covered so far. Panamaxes benefit from the

potential of better exports out of Russia during this summers grain season. It already

received a fair degree of support in May during the South American grain season. In 2011,

already close to 80 Panamaxes have been delivered from the orderbook, and for the rest ofthe year, a further 280 Panamaxes are expected to be added to the fleet. Panamaxes have

fared better than Capesizes so far this year because in 2010 fewer Panamaxes as a

proportion of the total fleet were added than the Capesize. We expect Panamaxes to fare

better than capes. However, looking at the orderbook until early 2014, more than 700

Panamaxes are expected to join the fleet, which essentially means an additional 50% of the

current fleet is going to be added over the next three years. Though Panamaxes are well

supported now, pressure could build by mid-2012 as the bulk of these new ships come

online. However, from a demand perspective, we expect more cargo to be available for

Panamaxes than for Capes. Panamaxes have the advantage of size when it comes to

delivering resources whether it be coal, iron ore or grains to new destinations with

smaller ports. Given that we are positive on Indian seaborne demand for resources, in

particular coal, we expect Panamaxes to charter through healthy routes with India as adestination. Also, given the huge Chinamaxes from Vale setting up distribution centres in

Oman and Malaysia, we expect demand for smaller ships to carry iron ore from these

centres to various destinations with smaller ports.

Figure 12: Panamax age profile of current fleet Figure 13: Panamax orderbook: 789 ships and when theywill arrive

(26+)

14%

(16 to 25

years)

25%

(upto 5years)

44%

(6 to 15

years)

26%

(2012)

26%

(2011)

44%

(2013)

25%

2014

1%

Source: SSY, Clarksons, Lloyds List Intelligence, Barclays Capital Source: SSY, Clarksons, Lloyds List Intelligence, Barclays Capital

Port congestion

Port congestion increased by the end of June across the major ports, with a total of 40 ships

queuing, which were carrying iron ore, and an average waiting period of 5.6 days. Once

Chinese ports drew stocks in the first week of July, most of the congestion cleared, with

levels now reducing to 28 and the average waiting period reducing to 4.3 days. Coal ports in

Australia were affected by unfavourable weather in Hay Point, which increased berth delays.

Congestion at the Newcastle port has increased due to coal availability issues. The last week

of June also saw increased congestion at Indian ports, with 13 ships waiting at Goa,

compared with six ships by the beginning of July, as the monsoon sets in and affected

Indian west coast exports. The average waiting period on the Indian west coast has

increased as a result of the monsoons and the loadings.

Panamaxes to

outperform Capesizes

Congestion levels increased

in June


14/21


19 July 2011 14

Short-term outlook

In the coming months, we expect freight rates to fall further, albeit slowly. We expect the

BDI to average 1250 in H2 11. In 2012, as the fleet size continues to build, we expect a more

balanced distribution of the fleet across both the basins and rates to be stable, albeit at low

levels. The sudden spikes in rates, when seasonal demand picks up, will be short lived

because, given the balance of vessels in both basins, marginal charter requirements will be

absorbed easily by the market.

Figure 14: The Baltic Indices: A drift lower and then range

bound for the rest of the year

Figure 15: Net bulker additions, more ships added to the fleet

1,000

1,200

1,400

1,600

1,800

2,000

2,200

2,400

Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11

BPI BDI BCI

-60

-40

-20

020

40

60

80

100

120

140

Jun-09 Dec-09 Jun-10 Dec-10 Jun-11

Deletions

Additions

Net Change

Net change in the bulk fleet (no. of ships)

Source: Reuters, Barclays Capital Source: SSY, Barclays Capital

Short-lived sudden spikes


15/21


19 July 2011 15

Coal prices and indicators

Figure 16: Exchange coal prices, $/t Figure 17: FOB coal prices, $/t

30

60

90

120

150

180

210

240

Jul -06 Jul -07 Jul-08 Jul -09 Jul -10 Jul -11

API 2

API 4

$/t

0

40

80

120

160

200

Jul-02 Jul-05 Jul-08 Jul-11

FOB Richards Bay prices

FOB Newcastle prices

$/t

Source: EcoWin, Barclays Capital Source: McCloskeys, Barclays Capital

Figure 18: Coal forward curve Figure 19: Coal price volatility

84

86

88

90

92

94

Aug-11 Nov-11 Feb-12 May-12 Aug-12 Nov-12

This Week Last Week 3 Months ago

/t

0

10

20

30

40

50

60

Jan-11 Feb-11 Mar-11 Apr-11 May-11 Jun-11 Jul-11

10 day close-to-close coal price volatility

Source: EcoWin, Barclays Capital Source: Reuters, Barclays Capital

Figure 20: Global steel production Figure 21: Chinese IP

Global steel production, y/y change

-30%

-20%

-10%

0%

10%

20%

30%

40%

May-09 Nov-09 May-10 Nov-10 May-11

4

6

8

10

12

14

16

18

20

22

Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11

Chinese IP growth, % y/y

Source: EcoWin, Barclays Capital Source: EcoWin, Barclays Capital


16/21


19 July 2011 16

Atlantic Basin fundamentals

Figure 22: UK steam coal imports Figure 23: Fuel switching in UK power generation

0.5

1

1.5

2

2.5

3

3.5

4

4.5

Apr-08 Apr-09 Apr-10 Apr-11

mt

4

6

8

10

12

14

16

Jun 06 Jun 07 Jun 08 Jun 09 Jun 10 Jun 11

UK Natural Gas (TWh)

UK Coal (TWh)

Source: McCloskeys, Barclays Capital Source: DECC, NETA, Barclays Capital

Figure 24: German imports by region Figure 25: US exports to the European union

Colombia

30%

USA

3%

Poland

16%

Russia

42%

South Africa

4%

Other

5%

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8


mt

Source: McCloskeys, Barclays Capital Source: McCloskeys, Barclays Capital

Figure 26: Share of South African exports to key countries Figure 27: South African exports by basin

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%


India

Netherlands

0

1

2

3

4

5

6

May-08 May-09 May-10 May-11

Total Atlantic

Total Pacific

mt



17/21


19 July 2011 17

Pacific Basin fundamentals

Figure 28: Power generation by source Figure 29: Japan power consumption by sector

0 20 40 60 80 100

China

India

South Korea

Japan

Coal Oil Natural Gas

Nuclear Hydro Others

-30

-20

-10

0

10

20

30

Sep-07 Aug-08 Jul-09 Jun-10 May-11

HouseholdOtherTotalIndustrial

Japan power demand by sectors (% y/y)

Source: FEPC, Barclays Capital Source: FEPC, Barclays Capital

Figure 30: India power generation Figure 31: Indonesian coal exports by Asian country (YTD)

-5%

0%

5%

10%

15%

20%

Sep-08 Aug-09 Jul-10 Jun-11

ThermalTotal

y/y

Japan, 13%

Others,

27%

India, 25%

China, 14%

Taiwan, 8%

South

Korea, 13%

Source: CEA, Barclays Capital Source: McCloskeys, Barclays Capital

Figure 32: Australian coal exports by Asian country (YTD) Figure 33: Monthly thermal coal imports by country

Korea

22%

China

5%

Japan

50%

Taiwan

14%

Others

9%

-

5

10

15

20

25

30

35

40

May-08 Nov-08 May-09 Nov-09 May-10 Nov-10 May-11

Japan South Korea Taiwan China

Mt



18/21


19 July 2011 18

China charts

Figure 34: China monthly power generation Figure 35: China electricity installed capacity

-20%

-10%

0%

10%

20%

30%

40%

50%

Jan-08 Nov-08 Sep-09 Jul-10 May-11

Total generation y/y

Thermal generation y/y

0

200

400

600

800

1000

1200

2000 2002 2004 2006 2008 2010

Overall

Coal-fired

GW

Source: EcoWin, Barclays Capital Source: China electricity council, Barclays Capital

Figure 36: Chinas domestic coal prices Figure 37: Chinas coal railings and port handlings (mt)

640

690

740

790

840

890

940

Jan-10 Aug-10 Nov-10 Jun-11

Shanxi (5500NAR) Datong (5800NAR)

RMB/t

80

90

100

110

120

130

140

150

160


30

35

40

45

50

55

60

65Total railings (LHS)

Port handling (RHS)

80

90

100

110

120

130

140

150

160


30

35

40

45

50

55

60

65Total railings (LHS)

Port handling (RHS)

Source: CCTD, Barclays Capital Source: CCTD, Barclays Capital

Figure 38: China monthly coal net trade Figure 39: Chinas inventory trends

-8

-6

-4

-2

0

2

4

6

8

10

12

May-04 Sep-06 Jan-09 May-11

Mt

Net importer

Net exporter

0

10

20

30

40

50

60

70

Nov-07 Jun-08 Jan-09 Aug-09 Mar-10 Oct-10 May-11

Port stocksGenerator stocks

mt

Source: CCTD, Barclays Capital Source: CCTD Barclays Capital


19/21


19 July 2011 19

COMMODITIES RESEARCH ANALYSTS

Barclays Capital5 The North ColonnadeLondon E14 4BB

Gayle BerryCommodities Research+44 (0)20 3134 [email protected]

Xin Yi ChenCommodities Research+65 6308 [email protected]

Suki CooperCommodities Research+1 212 526 [email protected]

Helima CroftCommodities Research+1 212 526 [email protected]

Paul HorsnellCommodities Research+44 (0)20 7773 [email protected]

Costanza JacazioCommodities Research+1 212 526 [email protected]

Kerri MaddockCommodities Research+44 (0)20 3134 [email protected]

Miswin MaheshCommodities Research+44 (0)20 [email protected]

Roxana Mohammadian-MolinaCommodities Research+44 (0)20 7773 [email protected]

Kevin NorrishCommodities Research+44 (0)20 7773 [email protected]

Biliana PehlivanovaCommodities Research+1 212 526 [email protected]

Amrita SenCommodities Research+44 (0)20 3134 [email protected]

Trevor SikorskiCommodities Research+44 (0)20 3134 [email protected]

Nicholas SnowdonCommodities Research+1 212 526 [email protected]

Sudakshina UnnikrishnanCommodities Research+44 (0)20 7773 [email protected]

Shiyang WangCommodities Research+1 212 526 [email protected]

Michael ZenkerCommodities Research

+1 415 765 [email protected]

Commodities Sales

Craig ShapiroHead of Commodities Sales+1 212 412 [email protected]

Martin WoodhamsCommodity Structuring+44 (0)20 7773 [email protected]

Peter RozenauersCommodities Sales, Non Japan Asia+65 9114 [email protected]


20/21

Analyst Certification(s)We, Miswin Mahesh, Amrita Sen and Trevor Sikorski, hereby certify (1) that the views expressed in this research report accurately reflect our personalviews about any or all of the subject securities or issuers referred to in this research report and (2) no part of our compensation was, is or will be directly orindirectly related to the specific recommendations or views expressed in this research report.

Important DisclosuresFor current important disclosures regarding companies that are the subject of this research report, please send a written request to: Barclays CapitalResearch Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer to https://ecommerce.barcap.com/research/cgi-bin/all/disclosuresSearch.pl or call 212-526-1072.Barclays Capital does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that Barclays Capitalmay have a conflict of interest that could affect the objectivity of this report. Any reference to Barclays Capital includes its affiliates. Barclays Capital and/oran affiliate thereof (the "firm") regularly trades, generally deals as principal and generally provides liquidity (as market maker or otherwise) in the debtsecurities that are the subject of this research report (and related derivatives thereof). The firm's proprietary trading accounts may have either a long and /or short position in such securities and / or derivative instruments, which may pose a conflict with the interests of investing customers. Where permittedand subject to appropriate information barrier restrictions, the firm's fixed income research analysts regularly interact with its trading desk personnel todetermine current prices of fixed income securities. The firm's fixed income research analyst(s) receive compensation based on various factors including,but not limited to, the quality of their work, the overall performance of the firm (including the profitability of the investment banking department), theprofitability and revenues of the Fixed Income Division and the outstanding principal amount and trading value of, the profitability of, and the potentialinterest of the firms investing clients in research with respect to, the asset class covered by the analyst. To the extent that any historical pricing informationwas obtained from Barclays Capital trading desks, the firm makes no representation that it is accurate or complete. All levels, prices and spreads arehistorical and do not represent current market levels, prices or spreads, some or all of which may have changed since the publication of this document.Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitative analysis,and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in other types of researchproducts, whether as a result of differing time horizons, methodologies, or otherwise.


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