Demand vs Supply Resources Steve Hamblyn Wednesday 16 August 2006

Page 1 19/04/23XX_OHXXw.ppt

Demand vs Supply

Resources

Steve HamblynWednesday 16 August 2006


Resources: Global ThemesChinese demand growth:

• The world’s biggest raw materials consumer (China) is also the world’s fastest growing.

• We believe that this situation could continue for many years.

• In the longer term, this will be supplemented by Brazil, India, Russia ( the Goldman Sachs “BRIC” idea).

• Bumps in the road will occur, but in the longer term, it’s the trend rate of growth that matters.

Supply constraints:

• Reduced exploration and development spending over the past eight years.

• Too few greenfield projects available, and reduced discovery rates.

• Long lead-times from discovery to commercial production.

• Infrastructure bottlenecks (oil; bulk commodities).

• Skills shortages, and long lead-times for equipment orders.

Currency:

• Weak US dollar environment.

Global demand growth:

• We envisage moderate (trend) growth in OECD raw materials offtake.

We believe this environment will sustain strong commodities prices and improved growth opportunities. Resources company valuations should continue to rise.

We recommend an overweight resources position.

Investment Flows:

• Dominance of “long-only” investment style (Index Funds).

• Hedge funds and CTAs.


A Structural Change in Commodities Markets

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600

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1000

1200

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000

Global Steel Production; 1950 - 2004 (million tonnes)

Million tonnes

Source: I ISI ; GSJBW ResearchNote: We have used global steel production as a proxy for demand.

Post-war reparations and J apanese Industrialisation

First Oil Shock

Second Oil ShockCollapse of Soviet

Union

Asian Crisis

China-led demand growth acceleration


Chinese Industrialisation has Some Way to Run;whilst India has Barely Started

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OECD - Historical (from 1970)Korea - Historical (from 1970)J apan - Historical (from 1950)China - Historical (from 1970)India - Historical (from 1970)Brazil - Historical (from 1970)Russian Federation (from 1995)

Copper: I ntensity of Use Analysis

Per Capita Consumption (Kg)

Per Capita GDP (constant 1995 US dollars)Source: CRU International; GDDC; World Bank; GSJBW Research estimates


Supply is Struggling to Keep Pace

• Geological constraints: Enough orebodies? And of what quality (copper, nickel, zinc)?• Infrastructure bottlenecks: Rail and port capacity (bulk commodities).• Skills shortages: Geology and Mining Engineering have become unfashionable disciplines.• Equipment lead-times: Extended lead-times contribute to project delays.• Cost-push: Capital and operating costs have risen and are continuing to rise.

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1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005e60

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100

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Worldwide Expln Spend (LHS) LME Copper Price (RHS)

Worldwide Mining Exploration Expenditure, and Copper Prices

US$ billion

Source: Rio Tinto Chart Book; LME; GSJBW Research

USc/ lb

-50 -40 -30 -20 -10 0 10 20 30 40 50

Engineering Science

Mechanical

Civil

Electrical

Industrial

Chemical

Materials

Environmental

Geology

Mining/ Minerals

Cumulative Change in Canadian Undergraduate Engineering Enrolments, 1998 - 2002

PercentSource: Canadian Council of Professional Engineers; Teck-Cominco Ltd

** Positive for incumbent producers as raises barriers to entry for the industry **

“In this market the risk to production is on the downside and the risk to costs is on the upside” Chris Lynch, Group President BHP Carbon Steel Materials, June 2006.


Commodities Preference: Positive for BHP and RIO

Price risk is relative to GSJBW forecasts Source: GSJBW Research estimates

Copper

I ron Ore

Nickel

Oil

Steel

Thermal Coal

Gold

Diamonds

Zinc

Alumina

Aluminium

Coking Coal

Lead

Industrial Minerals

Commodities for which supply/demand

fundamentals appear to be improving, or exceeding

our expectations

Commodities for which fundamentals are in line with our expectations.

Tendency to Upside Price Risk

Tendency to Neutral Price Risk

Commodities for which supply/demand

fundamentals appear to be deteriorating, or under-

performing our expectations

Tendency to Downside Price Risk

BHP Billiton | Divisional EBI T Contribution Chart (2007e)

Copper 34%

Iron Ore16%

Petroleum20%

IndustrialMinerals

1%

Coking Coal10%

Energy Coal3%

Diamonds2%

Aluminium5%

Stainless Steel Materials9%

Source: GSJBW Research estimates

Aluminium7%

Copper33%

Iron Ore 40%

Energy Coal11%

Diamonds4%

Industrial Minerals

5%

Rio Tinto | Divisional EBIT Contribution Chart (2007e)

Source: GSJBW Research estimates


Project Inventory Issues: Copper Example

The world is not running out of copper, but:• Discoveries are lagging demand growth.

• Head grades are falling.

• Key projects for near-term development are smaller than those available a decade ago.

Therefore more are needed… …exacerbating the skills shortage.

• There are no more “free” SXEW options.

• There is a tendency to more remote locations. With infrastructure implications. With different country risk issues.

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1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

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1.15

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1.25

1.3

1.35

1.4

1.45

1.5

Years of Consumption in Identified Global Reserves (LHS)

Average Head Grade (% Cu; RHS)

Source: USBM; US Geological Survey; CRU International; Xstrata (CESCO Presentation)

Global Reserves of Copper, and Average Mined Head Grades

Global Reserves (years of consumption) Average Mined Head Grade (% Cu)

The World's Largest Existing Copper Mines The Largest Greenfield Projects

Mine CountryProduction

(ktpy) Project CountryProduction

(mtpy)Escondida Chile 1450 Tenke Fungurume DR Congo 400Grasberg Indonesia 750 Oyu Tolgoi Mongolia 240Chuquicamata Chile 700 Rio Blanco Peru 220Norilsk Russia 500 Mansa Mina Chile 205El Teniente Chile 470 Spence Chile 200Collahuasi Chile 460 Quellaveco Peru 200Antamina Peru 380 Salobo Brazil 200Morenci USA 370 Toromocho Peru 200Los Pelambres Chile 345 Alemao Brazil 186Batu Hijau Indonesia 300 Pebble USA 180Radomiro Tomic Chile 300 Tampakan Philippines 160OD Australia 250 Agua Rica Argentina 160Candelaria Chile 250 Lumwana Zambia 150Los Bronces Chile 240 Gaby Sur Chile 135Bingham USA 230 Safford USA 114Mt Isa Australia 200 Cristallino Brazil 100

Total (16 Mines): 7195 Total (16 Projects): 3050

Source: CRU International; Company data


Costs are Rising: Capex (1) Some Australian Examples

Project Company LocationOriginal Budget

Revised Budget

Increase

RAVENSTHORPE BHP WA US$1050m US$1340m +28%

MILLENIUM Excel WA A$95m A$160m +68%

TELFER Newcrest WA A$1400m A$1900m* +36%

DOUGLAS Iluka VIC A$140m A$270m +93%

YABULU BHP QLD US$350m US$460 +31%

+36%

Source: Company data, GSJBW Research estimate


• According to data from BHP Billiton, the cost of construction in Western Australia has risen by 50% over the last 4yrs.

• Combined with the strengthening A$ over the same period (which increased 46%), capital costs for projects in WA have more than doubled.

Q4 2001 Q4 2005

46%

Impact of Exchange Rate

USD per AUD

Source: Company Data

Construction Projects in Western Australia

Q4 2001 Q4 2005

50%

Capital Cost Escalation(AUD)



Q4 2001 Q4 2005

118%

Capital Cost Escalation and Exchange Rate(AUD)



Costs are Rising: Capex (2)


Costs are Rising: Operating Costs

• Operating costs are also on a rising trend. Contributing to this are:

General inflation. Exchange rates (weak US$). Energy costs. Consumables. Labour (at all levels). Falling ore grades (some commodities). Rising royalties.

• Some elements of the cost increase will be at least partly reversible (e.g. our long-term oil price assumption is US$40/bbl, not today’s cash price!).

• Other parts of the cost increase, we regard as essentially structural.

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Mar-02 J un-02 Sep-02 Dec-02 Mar-03 J un-03 Sep-03 Dec-03 Mar-04 J un-04 Sep-04 Dec-04 Mar-05 J un-05 Sep-05 Dec-05 Mar-06


Cash Cost (C1, net of by-product revenue; USc/ lb)

I nco: Trend in Quarterly Average Nickel Production Costs, from 1Q2002

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A$/tonne

US$/tonne

Currency Units per Tonne

Source: Company Data; GSJBW Research estimates

Hamersley: Trend in Annual I ron Ore Operating Costs (excluding depreciation)

48% increase since 2001

115% increase

since 2001


Long Term Price Trends

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1895 1905 1915 1925 1935 1945 1955 1965 1975 1985 1995 2005 2015 2025

Copper - Real

Copper Prices in Real (2002) Terms from 1905

USc/lb

GSJ BW

Source: US Geological Survey; CRU International, GSJBW Research estimates

US, European and J apanese industrialisation. Chinese industrialisation

Oil shocks / USSR supply side shock

Can China cause real prices to increase?

The Value Gap

Forecast period is very small - valuations depend on long term forecasts

Forecast Period


Commodity Index Funds: How Much Money?

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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006(* )

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Other Indices (US$bn; LHS)

GSCI and sub-indices (US$bn; LHS)

Value of GSCI, year-end (RHS)

Estimated Global Growth in Commodity I ndex I nvestments

US$ billion

Source: Goldman Sachs FICC

GSCI Year-end Value

Note: *Goldman Sachs FICC estimate of total funds invested at 28/04/2006. GSCI value at 19/06/2006.


Share Price /Valuation Relationships

-40

-20

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60

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100

AngloG

old

(US$)

Lihi

r

New

cres

t

J ubi

lee

Nicke

l

Oxi

ana

Oil

Sear

ch

Woo

dsid

e

I luka

Sant

os

BHP

Billito

n (U

S$)

Exce

l Coa

l

Rio T

into

(US$

)

Zini

fex

Portm

an

Blues

cope

Mac

arth

ur C

oal

Alum

ina

Min

ara

Cente

nnia

l Coa

l

Percent

Resources Sector: Premiums/ Discounts to DCF Valuations

Source: I RESS; GSJ BW Research estimates (Priced at 03/7/2006)


Key Commodities Price Forecasts

Summary of Key GSJ BW Commodities Price Assumptions

2004A 2005A 2006F 2007F 2008F 2009F 2010FLong Term (2011 Nominal)

Long Term (2006 Money)

Aluminium USc/ lb 78 86 107 89 85 88 97 104 94

Copper USc/ lb 130 167 289 238 200 210 220 148 134

Nickel USc/ lb 628 669 744 730 810 675 615 555 503

Zinc USc/ lb 48 63 127 119 103 88 95 77 70

Oil US$/bbl 41.42 56.48 66.32 57.00 50.00 45.00 40.00 40.00 36.00

A$ exchange rate US$/A$ 0.74 0.76 0.76 0.78 0.75 0.73 0.73 0.72 0.72

J FY 04-05 J FY 05-06F J FY 06-07F J FY 07-08F J FY 08-09F J FY 09-10F J FY 10-11FLong Term (2011 Nominal)

Long Term (2006 Money)

Thermal coal US$/t 45.00 52.00 50.00 46.00 42.00 40.00 44.00 44.00 40.00 % change (y/y) 64% 16% -4% -8% -9% -5% 10%

Coking Coal (HCC) US$/t 57.50 125.00 115.00 90.00 80.00 70.00 77.00 77.00 70.00 % change (y/y) 24% 117% -8% -22% -11% -13% 10%

I ron ore (fines) USc/dmtu 35.99 61.72 73.45 73.45 66.11 49.98 51.00 51.00 46.00 % change (y/y) 16.7% 71% 19% 0% -10% -24% 2%

Source: LME; Reuters; TEX Report; GSJBW Research estimates


All The Major Resource Stocks Against The Market

Documents

Demand vs Supply Resources Steve Hamblyn Wednesday 16 August 2006