Coal Outlook Report

Commodities Research21 December 2012

PLEASE SEE ANALYST CERTIFICATIONS AND IMPORTANT DISCLOSURES STARTING AFTER PAGE 48

Coal and Freight Quarterly 2014: Bring it on

x The story of 2012 will be the story of supply, as coal trade is on track to expand by a

supply-led 82 mt (a 10.5% y/y increase). With every major exporter adding volume, and the US chipping in an incremental 13 mt, 2012 saw the coal market awash with supply, and prices duly tumbled. European prices were down 24% over the year, Australian prices declined 28%, and Chinese prices decreased 30%.

x The strong supply side this year has stimulated demand. We expect European takes to be up by some 15 mt (mostly in the UK and Spain), Indian imports to rise 18 mt and Chinese imports to increase by an impressive 40 mt y/y.

x Looking ahead to 2013 and 2014, the supply side continues to look buoyant with investments coming to fruition in many of the major exporting countries and thereby increasing export capacity. In total, we have identified projects that could add 136 mt of export capacity by the end of 2014 a 15% increase on 2012 trade.

x While the supply side could stay robust, the demand side is likely to be less obliging. We expect reductions in imports to come from Europe (as environmental legislation results in the closure of some older coal plant and economic growth remains stagnant) and, more importantly, China, as investments in alleviating domestic transportation constraints will come to fruition in 2014. We expect the latter to allow a reduction in Chinese coal imports of some 35 mt in 2014. While India looks like a country that will continue to grow its imports rapidly, its price sensitivity will likely keep pressure on prices.

x With India increasingly taking centre stage in the coal market, there will be sufficient demand to continue expanding the trade of sub-bituminous (low CV coal), which is facilitated by low freight rates. For the next two years, we forecast that freight rates will remain at low levels.

x Given the above, we expect that the coal markets will continue to trade at levels around the marginal cost of the higher-cost producers, with potentially more pressure to the downside. We think the levels of cost support in the market are likely to increase from 85-90 $/t (CIF ARA) currently to 90-95 $/t in 2013, as we are forecasting oil prices will be 14% higher y/y. Our 2013 average price outlook for CIF ARA is 95 $/t, 93 $/t for FOB Richards Bay and 92 $/t for FOB Newcastle. Without the cost price pressure from oil, these price forecasts would be some 6-7 $/t less given the expected pressure from supply.

Trevor Sikorski +44 (0)20 3134 0160 [email protected] Miswin Mahesh +44 (0)20 7773 4291 [email protected] Sijin Cheng +65 6308 6320 [email protected] www.barclays.com We would like to thank Afonso Campos for his contribution to this report.

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MARKET OVERVIEW

Six things to look out for in 2013 and 2014 are.

x Markets being good at creating supply, but bringing some tension as a result. With 2012 a year in which the market was led by the supply side, the next two years seem likely to be the same as most of the major exporters are targeting y/y incremental sales. We estimate that the major exporters will look to put in 32 mt more in 2013 and 7 mt more in 2014. The market is going to continue to be constrained by the demand side, and this will mean prices will have to work hard to increase demand and/or discourage supply.

x China is unlikely to see much growth in its coal imports. Total Chinese demand for coal is likely to grow, due to underlying economic growth and a return to a more normal hydro year after a wet 2012. However, that growth will likely be slower as the share of coal-fired plants in new generation falls and additional stimulus to the economy will probably be less focused on infrastructure. Furthermore, the growth of imports of coal is likely to lag that level: the disjoint between domestic and foreign coal prices is unlikely to be as big this year since domestic prices have already settled lower and domestic investment in China is focusing on moving coal demand inland, while improving the ability to move domestic coal around the country. As such, we see broad stabilisation in imports in 2013 before a fall-back in 2014 to 100 mt.

x The level of fuel switching away from gas and to coal in power generation in Europe will likely fall. In 2012, the two most sensitive markets to fuel switching have been the UK and Spain, which together have seen coal demand rise by 17 mt in the first 8 months of the year. While power demand has seen little change y/y, the increase in coal use has largely come at the expense of gas-fired generations market share. This dynamic depends on relative prices, and while the gas market has certain downside risks, we expect prices to be a little higher in the next two years, given market exposure to oil. In terms of carbon, market intervention is now unlikely before Q4 13, meaning lower carbon prices for longer. So, 2012 could be a high point for coal imports into Europe but we would not expect much loss of market share for coal until 2014.

x The US shale gas boom will remain a US phenomenon. Interest is increasing in the UK in shale gas and the December lifting of the shale gas exploration ban suggests the country is getting serious about using this resource. Having said that, we are unlikely to see the shale gas volumes necessary to bring gas price to levels that would encourage fuel switching much before 2017. The US will continue to export coal to balance its energy surplus until 2016, but we believe that exports will be lower in 2013 and 2014.

x We are bullish on oil prices, expecting around a 15% increase in those prices; this would increase the costs of delivered coal, adding some support to prices. This suggests that the 85-90 $/t support levels seen this year could translate into a higher support range, although price pressure from supply leads us to expect that prices will still trend towards the bottom of that range.

x The flight to low quality of the last two years will likely remain, as all of the high-quality benchmarks have seen reductions in prices but much demand remains price sensitive. In particular for Indian demand, which is so important without further expansion in Chinese demand, the call on low-priced coals of reduced CV will remain. Importantly, the cheap freight that we have seen over the last two years that helps facilitate the trade in low CV coals is expected to remain.

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In terms of the know unknowns, the big one is weather and this introduces risk on both the supply side (unexpected disruptions) and the demand-side (heating/cooling load, hydro availability). While there are plenty of other risks, the markets seem likely to trend down to the marginal cost of the higher-cost exporters and any upside away from this is likely to come from supply-side disruptions in the major exporters.

FIGURE 1 Global coal price development ($/t)

50

100

150

200

Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

CiF ARA M+1 $/t

FOB Richards Bay M+1 $/t

FOB Newcastle M+1 $/t

Source: McCloskeys, Barclays Research

While weather is always a random force

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BALANCES AND PRICES

FIGURE 2 Global trade balances (mt)

mt 2007 2008 2009 2010 2011 2012F 2013F 2014F

Japan 126 131 113 125 120 132 133 136 South Korea 66 74 80 89 94 94 96 99 China 16 14 58 92 102 142 145 110 India 35 36 60 75 92 110 133 162 Europe 167 165 153 137 158 173 171 169 Others 198 201 186 202 214 211 216 225

Total imports 608 621 650 720 780 862 894 901

Australia 112 125 139 141 147 170 180 186 Indonesia 195 200 233 291 323 337 355 360 South Africa 67 68 67 70 69 74 78 80 Russia 74 70 78 76 81 96 96 96

Colombia 65 69 63 69 76 80 90 94 US 24 35 19 23 34 47 35 25 Others 71 54 51 50 50 58 60 60

Total exports 608 621 650 720 780 862 894 901

Y/Y change (%) 7% 2% 5% 10% 8% 10.5% 4.0% 1.0% Note: This month sees a rebalancing of our balances which had previously included Vietnamese Anthracite exports into steam coal volumes into China. This has been removed from both export and import sides to avoid confusion. The arrows show directional change to our forecasts from the last quarterly. Source: McCloskeys, Barclays Research

FIGURE 3 Price forecasts

Annual averages Quarterly averages

Benchmarks 2010 2011 2012 2013F 2014F Q1 13 Q2 13 Q3 13 Q4 13 Q1 14 Q2 14 Q3 14 Q4 14

API 2 (US$/t) 93 122 93 95 95 93 97 95 95 96 96 94 94

API 4 (US$/t) 92 116 94 93 91 91 95 93 93 92 91 90 89

Newcastle (US$/t) 99 121 95 92 90 90 94 92 92 92 90 90 88

Note: The arrows show directional change to our forecasts from the last quarterly. Source: Ecowin, Barclays Research

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FOCUS: EXPORT COAL

Road to 2014: Making sense of coal export volumes Despite the persistence of low global coal prices, there are a large number of new projects due to come online during 2013 and 2014. The majority are announced by the major exporters, although new participants are beginning to emerge. The projects are a mix of: brown-field projects which are expansionary in nature, seeking to enhance their efficiency, takeaway capacity or overall output from existing operations; and green-field additions. Overall, the projects currently under construction can increase the total production of coal at the major exporters by some 136 mt/y by 2014, which would translate into a 16% increase on 2012 exported volumes assuming all new coal is produced and exported.

FIGURE 4 Minimum expected incremental production by 2014

Country Incremental capacity additions (mt)

Change from 2012 (mt)

Discussion

2013 2014 Total

Australia 32.7 32.7 Most of the additions to productive capacity to come online in 2014

Colombia 14 15 29 Production instability risks remain.

Indonesia 47 47 Some of these increments likely to be seen before 2014.

Mozambique 5 9 14 Infrastructure debottlenecking crucial for further production capacity expansion

Russia 8.5 4.5 13 Production sensitivity to input costs and high stocks

Total 27.5 108 136 Source: Company reports, McCloskey, Reuters, Barclays Research

The numbers we present indicate a buoyant supply side, with increases in coal prices arising due to Asian demand having encouraged significant interest in expanding capacity. We caveat the numbers shown in Figure 4 see below.

x The tracking of investments is largely confined to the major exporting countries and where company data have been used, the major producers. Developments in other countries and other producers can be important when taken in aggregate.

x The market in 2012 has suffered from over-supply and the persistence of relatively low prices (against costs to port) exist to discourage producers from putting in as much incremental volume into the market as seen this year. How the low prices influence producer behaviour, and how much supply response is seen from more mature mines, will be important in understanding future production patterns.

x Large infrastructure projects are usually subject to delays, so some delay to incremental volumes should be expected. The newer the area where the investments are being made, and the more difficulty the operating environment, the more important those delays are likely to be in any given project. Hence, the numbers are potentially biased to the upside.

x Most of the major exporting countries are seeing domestic use expand. This could compete for new production, or eventually could end up limiting the exports of low grade coals developments that are being discussed in both Indonesia and South Africa. How the market deals with this, given the sensitivity to price of the buyers, is an issue.

Ongoing investment in coal supply points to growing export capacity

although the numbers are not an expectation of future volumes

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Taking these factors into consideration and given the expansion plans, we are forecasting that coal trade:

x Will expand from most major exporters, but the expansion in volumes of 32 mt in 2013 and 7 mt in 2014 will largely be a supply-led phenomenon. The Pacific Basin exporters will be among the biggest gainers as increments in Australia and Indonesia are forecast to be among the largest, and this suggests that the biggest price pressure will be felt on their benchmarks; and

x US exports will likely decline for a variety of reasons, not least as the US is one of the highest marginal cost exporters. We expect that Colombian volumes will expand into the gaps left by the reductions in US volumes and that this will help keep a market for Russian volumes.

We now look at the projects in the individual major exporters.

Australia

Potentially the largest increments of supply through to 2014 could come out of Australia. Putting this into context, Australia has seen its total seaborne coal exports increase every year since 2001 (CAGR of 5.2%) and is on track to maintain the upward trend in 2012 again as its exports have increased 27.98 mt, or 12.3% y/y, over the first 10 months.

In terms of expanding exports in Australia, mining investments come from:

x Indias Adani Group, which currently does not produce in Australia but wants to produce 60 mt/year by 2020. The group is spending USD4.5bn on the project and is expecting first production of 2 mt to come in by 2014. The company has reported target average production costs of 60 $/t, suggesting that it will be profitable to export at Newcastle prices above 80 $/t.

x Other projects such as the:

USD$1.3bn Ulan West expansion is expecting to add an extra 6.7 mt/y of annual thermal coal capacity from 2014 over an eighteen-year lifespan.

Progress on the Ravensworth North project, which is aimed at increasing the output of both thermal and semi-soft coal by 8 mt/y, starting in 2014.

A finalisation of work at the Caval Ridge operation, which will ultimately supply the market with at least 8 mt of coking coal, with 5.5 mt of this expected to be added in 2014, despite the project having suffered significant opposition due to labour-sourcing disputes.

x Peabody and Cockatoo are both expanding production as well, and both companies are expected to add 1.5 mt over the coming couple of years.

Port capacity is expanding as well with NCG port, co-owned by six groups, planning to increase its capacity from 53 mt to 66 mt by mid-2013.

Despite the expected capacity gains, current export levels in the Basin are causing low prices with Newcastle prices having averaged 82.4 $/t over Q4 12. Given that pricing, some supply response is occurring with the more high-cost producers coming under pressure. Australian producer, Coal & Allied, has announced its redundancy plan, while Centennial Coal has announced at least 40 layoffs and will be shutting in supply temporarily as it halts some of its production in January.

Australian export capacity is leading the way

Although current prices are low

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While supply reductions are possible, there are issues around transportation and port capacity charges, with coal shippers through the Newcastle (PWCS and NCIG) terminals reported by McCloskey to have signed up for around 190 mt of export slots in 2013 and 210 mt in 2014. While this covers both steam and coking exports, the 2013 levels represent an increase of some 50 mt on annualised 2012 numbers through the port. Such an increment looks unlikely, given the potential lack of that much demand, and will result in producers/ shippers with unused volume allocations racking up port charges against no export volumes. Regardless, the message is that port and rail constraints are unlikely to be binding in the coming years, with most producers likely to undershoot against capacity commitments rather than overshoot.

As with most markets, the level of exports will be highly predicated on price levels, which will be a function of demand. As such, we see 2013 and 2014 as both having the potential for additional volumes to come into the market from Australia. We are forecasting that Australia will put an incremental volume of 10 mt in 2013 and 6 mt in 2014, but highlight that these numbers are predicated on limited demand. A higher level of Pacific demand would be met easily with additional Australian supply, and it is Australian exports that we expect will be most constrained by a pull back in Chinese demand. However, for Australian volumes to expand with capacity, they would likely need to displace Chinese domestic coal and that will be more difficult to do given the improved internal transport systems (see discussion under Chinese demand in this report).

Colombia

The country has been increasing production at an average pace of 8% per annum for the past eleven years, with mostly positive increments within that timeframe. Over 2012, Colombian production is likely to fall just short of the revised 91 mt (initial target 97 mt) level. The labour unrest seen in July and August that disrupted mining and transportation were key factors in the shortfall. Of the 2012 production, we are estimating that exports will go up by 3-4 mt to reach 79-80 mt.

Colombia has been targeting a coal production figure of 120 mt/year by 2014, with the external market being a main destination for those volumes. Reaching that target from current production levels of around 90 mt suggests 30 mt of incremental production to be realised in 2014 which would potentially take 2014 exports up significantly beyond the 100 mt/year level. With most of the thermal coal from Colombia being low in both sulphur and ash, appealing to most buyers and specifically the European utilities, Colombian coals will likely have ready markets.

New supply capacity is being invested in with a few major projects that are scheduled dominating, potentially adding almost 16 mt/year by 2014. The projects included here are outlined below.

x The significant expansion of the Cerrejon, the countrys largest mine co-owned by a consortium of three of the worlds largest producers. The hefty USD1.3bn project is around 40% complete with work on the site scheduled to be finalised by Q3 2013, and this will to help the mine produce an estimated additional 2 mt that year. Another 6 mt is expected as production ramps up through 2014, taking the mines total production up to its target of 40 mt/y.

x The Prodeco project consists of two open-pit mines and is planning to increase capacity at its collieries by 5.5 mt/y to just over 20 mt/y by the end of 2013. The project is linked with the construction of a loading port, with the capacity to initially handle 21 mt annually; which is expected to be ready by Q3 2013.

raising a question on use of future port bookings

Future volumes could be constrained by lack of demand

Colombian exports showing limited y/y growth

but they can do more

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x A number of smaller-scale projects including the Pacific Coal expansion of the La Caypa and Cerro Largo mines. The company expects its combined annual output to increase by nearly 2 mt; from 1.65 mt to 3.6 mt of mostly high specification thermal coal. In a move to boost exports, Pacific will be lowering its trucking costs by an average of 45% by changing its port of preference to the Puerto Brisa port; this is expected to be completed early next year.

The Colombian government is working to increase the countrys ability to supply coal internationally and has pledged investment in coal export infrastructure. One such project is the recently announced plan to spend in excess of $390bn to improve the navigability of one of the Magdalena River, a main transport artery for coal.

While Colombia has a good track record of expanding its production capacity, the labour unrest of this year and the ongoing civil war with Revolutionary Armed Forces of Colombia (FARC), suggests the path to expansion has some risks.

We do, however, expect an increase in coal exports in Colombia of 10 mt/y in 2013 and a further 4 mt in 2014. Much of this expansion will be in light of expected reductions in US exports.

Indonesia

Since 2000, Indonesia has continuously increased its total coal (bituminous and other specs) production, recording a CAGR of around 18% over that time. The countrys exports of bituminous coal have tripled from 53.8 mt in 2000 to around 172 mt in 2011. However, 2011 was the first year that bituminous coal exports decreased y/y, as the prevailing high prices for coal drove increasing interest in its plentiful production of lower grade, sub-bituminous (sub-bit) coal. The trend to greater exports of sub-bit has been growing for a while and since 2005 the country has increased its exports of sub-bituminous material by over 40% annually. In 2012, we estimate that total coal exports from Indonesia will grow by 17 mt, but that sub-bit volumes will now account for over 50% of the total, compared with 47% in 2011 and 38% in 2010.

Following on from a rapid period of expanding exports, planned production expansions are limited to:

x Bumi, the worlds largest exporter of thermal coal, is increasing production at a variety of its mines by 48% to 114 mt in 2014, from around 77 mt today; and

x Berau is targeting an increase of its sub-bituminous production capacity. The company is looking to increase its production by 50% from 20.13 mt in 2011 to 30 mt in 2014.

FIGURE 5 Indonesian production by selected mine (mt)

2012 (mt) 2014 (mt)

Mine Capacity Production Capacity Production

KPC 51 45 75 65

Arutmin 33 30 40 35

FBS 3 2 12 10

Pendopo 1 0 7 4

Total 88 77 134 114

Source: Company Reports, Barclays Research

With Indonesian producers benefitting from among the lowest costs in the world, the appetite, particularly for the low-graded coal, will still exist. While sub-bit prices have fallen along with the benchmark prices, some regulatory issues facing the Indonesian sub-bit

and provided civil issues are limited, they likely will

Indonesia has expanded more than most countries

and will likely continue to benefit from low average costs

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21 December 2012 9

market remain. Although the imposition of taxes on exports remains more of a question than a certainty, there is also the possibility that royalties will increase in the next two years from 3-5% to around 13.5%. As royalties increase, the costs of Indonesian exports will rise and market share could be lost to other producers, particularly South African sub-bituminous.

While the investment is there, the regulatory environment in Indonesia will likely continue to pose the major risks. In particular, any limits on sub-bituminous exports, which are now more than half of Indonesian exports, would constrain these volumes considerably.

We are forecasting that Indonesian volumes will increase by 14 mt in 2013 and 18 mt in 2014, largely driven by an expansion of sub-bit demand from India.

Russia

While Russia produces a large volume of coal, domestic consumption levels means that it exports roughly one-third of it every year. Of total coal exports, steam coal accounts for around 80% of total volumes, while the rest is coking. Even though data remain sketchy, Russia looks like it will also be adding production capacity in the coming two years. Production projects are outlined below.

x SUEK (27% of Russian coal production, 27% of total exports in 2011), which is looking to increase its exports of coal by 10-15 mt/y over the next five years, while investing some RUR100 billion. Even though increments for individual years have yet to be announced, the company states that increases will be in line with the development of rail and port infrastructure. With this likely to be a gradual process, we look for only small growth from SUEK in the next two years.

x Kuzbassrazrezugol, or KRU, (14% of Russian coal production, 22% of total exports in 2011) is stepping up its efforts in topsoil removal at its locations, although it does not disclose specifically how much incremental supply it will produce in the coming years. It expects to see incremental production in 2013, mostly from steam grades.

x Mechel (7% of Russian coal production, 4% of total exports in 2011), the countrys fourth-largest exporter, is looking to increase production by about 10.5 mt (33%) through 2014 to 41 mt. The increments in production are 8 mt in 2013 with another 2.5 mt in 2014. The company produces a mix of coal specifications, which should leave it well placed for changes in market trends; about 48% of this is coking material, 38% is steam coal and the rest is others. Mechel has cut its 2012 target by over 13%, to 30.5 mt, in response to the more moderate takes of coal in H2 12.

Two of the issues around further production is reports of high coal stock levels at mines and ports and the relatively high price of Russian coal to port. Given its relatively high cost base for exports with transportation costs to port being around 55% of the total cost of sales, Russian volumes will be among the first to be affected by coal price reductions, and will find it harder to compete for market share against some of the lower-cost producers. The challenges to expand imports given the lack of major export projects currently being advanced, and particularly against a wider environment of higher oil prices, suggests incremental volumes from Russia in the next two years will occur only if there is a surge in the global demand for traded coal.

We note other developments in Russia, including the addition of in 10 mt/y of added export capacity into the Vostochny port, but this is not forecast to come on line before 2017.

As such, we are forecasting that for the next two years, Russian export growth is likely to be modest, and to experience flat exports in 2013 and 2014.

But limits on sub-bit exports would be a problem

Russian expansion is less well defined

while port expansions seem to be a way off

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North America

For 2013 and 2014, the issue on US volumes is less about investments to increase capacity and more about whether the following factors do/do not prevail.

x An up-tick in domestic coal burn as coal recaptures market share in power. For this to occur, there needs to be a change in relative prices, with gas being made more expensive in 2013 than in 2012, thereby improving domestic demand. US gas prices have been on an increasing trend over the second half of 2012 and by the middle of December prices were back to the 3.5 $/mmbtu level. With our US gas prices forecast to be 3.25 $/mmbtu in 2013 and to reach 4 $/mmbtu in 2015, coal plant will regain some market share. We expect domestic coal burn to increase by 7% at least.

x If export prices stay high enough to encourage coal exports. In terms of the viability of exports:

API-2 prices, which have come back from lows around the 85 $/t level to trade above the 90 $/t level. With the curve staying around these levels as well, 2013 is not likely to see much in the way of the 100 $/t contracts that characterised much of Q1 and supported good volumes in the market. While coal exports should still be profitable at +90 $/t;

Domestic freight rates, which have seen more supportive developments as CSX, the main east coast rail line operator, introduced a proposal to index rail charges for coal exports onto the API-2 price in the month the coal is being shipped plus a fuel surcharge. While the exact proposal was not made public, McCloskey reported that the index value could be 15% of the API-2 price plus 2 $/t surcharge on the rates. If the API-2 price is 90 $/t, then this would lead to a 15.5 $/t charge. In context, 2012 shipment tariffs quoted earlier in the year were 39-56 $/t, although prevailing rates are now put at around 19 $/t by McCloskey. A reduction in rail charges to these levels would help keep US coal to be more competitive in the export market; and

International shipping rates remain depressed and are unlikely to see much increase in the coming two years. This is a mixed blessing for US coal, which has a shorter distance to Europes ARA ports than Colombian or South African volumes.

x Reductions in domestic coal production are likely to occur, with a number of announced reductions likely to be increasingly felt through 2013.

A shorter-term issue, but one likely to affect Q1 13, is the navigability of the Mississippi River, which has very low river levels due to a hot dry summer in the region. Given the low levels on both the river and in dams, here river authorities are scaling back the release of water on the Missouri River, which will affect downstream flow into the Mississippi. This will affect barge shipping of coal to gulf export terminals, and with river levels now unlikely to improve until Q2 when the spring run-off occurs, Q1 exports could be affected.

Last, US domestic stocks still remain high but have been decreasing, with August numbers around 17 mt above the five-year average, but some 25 mt lower than the peak of stocks seen in May of this year.

Given the above, we are forecasting that total exports from the US will be down 12 mt in 2013 and by another 10 mt in 2014.

South Africa

In South Africa, expansions are less on the production side and more focused on expanding rail capacity to allow fuller utilisation of existing mines.

US Stocks lowering as production eases

South Africa focusing on rail issues

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While rail constraints have been an important constraint in the past, we note that the main rail operator, Transnet, has the capacity to move around 6.3 mt of coal per month (or 76 mt/y), but thus far the capacity has been underutilized, with railings to the Richards Bay Coal Terminal (RBCT) averaging 5.7 mt (or 68 mt/y). So, even without further expansion South Africa could support increased sales of around 8 mt.

Rail operator Transnets capacity is set to expand:

x Through its current plans to increase export railings from around 72 mt this year to 81 mt by 2014, due to an expansion of the fleet and other infrastructure investment. It is creating a rail link to the Swaziland network which will allow it to divert other freight away from the main coal artery, thereby helping it to increase capacity by a further 5-6 mt by Q1 2016; and

x Plans to build its own coal terminal at Richards Bay, ostensibly to facilitate exports for smaller mining companies and new market entrants. At present, the existing Richards Bay Coal Terminal handles output from established mining companies. The new proposal will facilitate those miners which are currently facing difficulty in accessing export capacity and have had to otherwise restrict their production levels. Transnet has planned to build the open access terminal with export capacity of 14 mt initially, with plans to expand it to 32 mt if required. However, this is still at early stages and we would not expect it to swell capacity in the next two years.

Despite the lack of major expansion on the table in the next two years, we expect that South Africa will provide good supplies to the market next year, with an incremental increase of 5 mt in 2013 and 4 mt in 2014, taking total exports to 80 mt by the end of that year.

In terms of risks, the mining sector continues to be vulnerable to labour unrest so there is potential downside to these numbers. With India being its single largest customer, we expect that the demand for below-benchmark grade coal will grow. Also, given tensions around the export of that volume, any move to rein them in would damage South Africas ability to increase its exports.

New exporter: Mozambique

Coal projects in Mozambique have been developing, taking advantage of the countrys largely untapped coal reserves and relative proximity to markets, such as India. In Figure 6, we outline the major coal projects that are under development in the country.

FIGURE 6 Coal mining and export projects in Mozambique

Company Project Size (mtpa) Timing Discussion

Vale Moatize 2.6 5 11

2012 2013 2014

2012 numbers down due to lack of rail capacity to port. It is expected that upgrades to this route will allow the expansion of capacity. 70% of tonnage is coking coal, 30% is steam. Vale believes it could take its capacity to around 22 mt in the future, although these are not firm expansion plans.

Beacon Hill Resources

Minas Moatize 0.6 1.2 4

2012 2013 2014

The company still needs to finish its financing needs and secure rail allocation, without which, the supply would be essentially shut in.

Anglo-American Talbot

Revuboe 8 2015 (at the earliest)

The government has not yet awarded the licence and the project has been delayed until at least 2015, The project was expected to have an output of around 8 mt of, 3 mt of those to be thermal, while the rest would be high-spec coking coal for the steel industry.

Source: Barclays Research

Although it could do more with existing infrastructure

Some downside risks, including limiting sub-bit exports

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Despite the interest in Mozambique, a number of issues still need to be resolved, including a lack of existing infrastructure to facilitate exports, making projects more complicated. Also, with the mining industry in its infancy, the broad support networks of trained staff and experience with managing the logistical chain of coal exports is missing. While such barriers will be surmounted, this takes time and we continue to expect that the level of exports into the market from Mozambique will be increasing but limited.

Mozambique exports to be limited over the next two years

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COAL BENCHMARK PRICES: OVERVIEW AND OUTLOOK

Coal benchmarks: Flat lining Having fallen for most of the first four months of 2012, the global coal benchmark prices have generally traded in range for most of the second half of the year. Since May 2012, CiF ARA M+1 has traded in a 85-96 $/t range, and at around an 89 $/t mean. Tellingly, Jan 13 coal was trading around the 92 $/t, suggesting that the market sees little upside to prices this winter, while pointing to a further period of range-bound trading. Atlantic Basin prices improved moderately over H2, with the strikes in Columbia removing some volumes, while a cold Q4 helped to stimulate some more demand.

Similarly, most of the other global benchmarks have established a sideways range, although Richards Bay (South Africa) has traded in a wider range since May, with RB FOB M+1 trading with a mean of 87 $/t, but in an 80-102 $/t range. The wider range reflects some of the greater volatility that has moved the Pacific Basin coal market this year. Newcastle (Australia) FOB M+1 traded similarly to RB, with an 87 $/t mean and a 78-100 $/t range. Both of these were back-trading just above their means in December, reflecting some of the better buying for coal that was apparent in a Q4 that was colder than the previous year.

Chinese FOB prices of the Bohai Rim (Northern China) declined and saw more correction over H2, which helped to bring prices in line with imported coal. The M+1 prices traded at a 124 $/t mean and in a 115-145 $/t range, with a strong Q3 price correction pointing to a trend reduction over this period. By December, these prices were trading towards the bottom of their range at 116 $/t.

FIGURE 7 M+1 steam coal price benchmarks

14 Dec 2012

14 Jun 2012

3 Jan 2011

6 month % change

One year % change

ARA CIF (Europe) 91.3 85.9 109.2 6% -17%

Richards Bay FOB 87.1 84.8 103.9 2.7% -17%

Newcastle 6,300 Kcal/kg GAR FOB 87.9 88.9 111.4 -1.2% -21%

Bohai Rim FOB 5,500 Kcal/kg NAR 116.7 140.2 151.7 -17% -23% Source: Ecowin, Barclays Research

FIGURE 8 Evolution of steam coal benchmarks (M+1)

FIGURE 9 European forward prices (CIF ARA, $/t)

50

100

150

200

Jan-08 Jan-09 Jan-10 Jan-11 Jan-12

CiF ARA M+1 $/t

FOB Richards Bay M+1 $/t

FOB Newcastle M+1 $/t

80

86

92

98

104

110

116

122

Sep-12 Dec-12 Mar-13 Jun-13 Sep-13 Dec-13

14/12/2012 02/01/2012 14/06/2012

Source: Ecowin, Barclays Research Source: Ecowin, Barclays Research

Benchmark prices stayed low, underlying well-supplied markets

Sideways trading dominated H2

Barclays | Coal and Freight Quarterly

21 December 2012 14

European coal contango In terms of the monthly contracts, the M+1 M+2 contango levels are trading in the middle of December at around the -2 $/t levels for January coal, which is above the yearly average of around -1 $/t. The contango is reflecting some buying given the colder Q4 seen this year, although we do not really see much more mileage in that spread without another bout of cold weather coming into the market.

Of more interest, the M+1 Y+1 has come in and is now trading around the 6 $/t level, lower than the 10.5 $/t over which that spread has averaged for the year. While the very big numbers seen early in 2012 have largely been eroded, they suggest that greater producer volumes are being put into some of the longer-dated contracts. While the still-wide contango levels point to a well-supplied prompt, the remaining good value on the further ahead curves should still allow volumes from the more expensive marginal producers to continue to be sold into the market. The contango is even more interesting when the prompt prices are compared with the Q4 13 prices, with that spread being out at the 10 $/t level. That level of contango will likely come in and the structure of the curve suggests that producers hedge over a much more limited time horizon than the European utilities. As we get nearer to delivery, we would expect the producers to become more active with putting volume into those contracts and for the premium of those future-dated contracts to begin to come in.

The curve does look structurally in contango though, and the Y+1 to Y+2 spread has stayed around the -9 $/t level across the last quarter. As outlined above, we think that this reflects a lack of liquidity in the far-dated contracts, particularly as all of these are suffering from a liquidity squeeze, given recent regulatory and credit market developments. We could see some modest further widening, particularly if as we expect, utilities start to hedge more power backed by coal out in 2014, but that is a strong call given the current contango.

FIGURE 10 M+1 M+2 price differentials (Cif ARA, $/t)

FIGURE 11 M+1 Y+1 price differentials (Cif ARA, $/t)

-8

-6

-4

-2

0

2

4

6

8

Jun-10 Dec-10 Jun-11 Dec-11 Jun-12 Dec-12

M+1 - M+2 (Cif Ara, $/t)

-20

-18

-16

-14

-12

-10

-8

-6

-4

-2

0

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

M+1 - Y+1 (Cif Ara, $/t)

Source: Ecowin, Barclays Research Source: Ecowin, Barclays Research

Price differentials Europe CIF - South African FOB

After a period around May and June where South African FOB was priced at a premium to the European delivered prices, a subsequent re-pricing for FOB RB has put it back to a discount but the spread has stayed in the non-arbitrage channel where FOB RB does not price into Europe at spot.

Contango is more modest

Contango more interesting with the far-dated contracts

Further widening is a big call

FOB Richards Bay priced out of Europe

Barclays | Coal and Freight Quarterly

21 December 2012 15

Given that the differentials have been trading in the non-arbitrage channel for the better part of the last two years, the main take-away is that the two prices now bear very little real relationship to each other. With Europe tending to balance with supply from other suppliers (Colombia, Russia, and the US), while South African volumes are predominantly called on by Asian buyers such as India (30% of South African volumes this year) and China and Taiwan (together, 26%).

FIGURE 12 CIF ARA - FOB Richards Bay ($/t)

-20

-15

-10

-5

0

5

10

15

20

Mar-11 Jul-11 Oct-11 Feb-12 May-12 Sep-12

API 2 - API 4 ($/t) Arb into Europe ($/t) Arb out of Europe ($/t)

Source: Ecowin, Bloomberg, Barclays Research

The relationship between Richards Bay and Newcastle prices has been variable has traded in a fairly narrow range over the first eleven months of 2012, averaging -1.4 $/t, but trading in a 6.7 to -14.4 $/t range. The start of the year saw Newcastle trading at those strong premiums, as good Chinese demand drove high demand for the Australian coal. However, as China began to slow down and Chinese prices started adjusting to lower demand and growing inventories, Newcastle prices came under pressure. By early December, RB FOB was trading around a 2 $/t premium to Newcastle, effectively pricing RB out of the far-Eastern markets, and pushing more of those volumes into India.

The bit sub-bit spread: Australia and Indonesia

The spread between off-specification (lower CV) coal prices in Australia and Indonesia and benchmark (higher CV) coals showed considerable volatility over the year. The only clear pattern seemed to be that peak coal demand periods, such as winter and high summer, corresponded to the peaks of the premium for the benchmarks, while off-peak demand periods (spring, autumn) saw the premium reduce.

The differential between FOB Newcastle 5,500 kcal/kg NAR and FOB Newcastle 6,300 kcal/kg GAR, on an-adjusted CV basis, went from periods of strong premiums for the benchmark to discounts in the shoulder months. From the price relationships, we note the following points.

x There are periods where high CV coal is at an energy content discount to the prices paid for low CV and that points to a level of sensitivity to absolute prices by many buyers. In some countries, buyers are sensitive enough to prices that they would still rather pay for the lower-priced coal, even if they get less energy per $, than pay for the coal that is more expensive in absolute terms, as that may be all that they can afford.

x The periodic, somewhat seasonal discounting of the benchmark grades coincides with lower demand periods when benchmark volumes need to increasingly compete for market share against the low-CV coal. With low CV coal having seen demand stay buoyant, those prices fell slower as the benchmarks chased the market downwards.

With South Africa looking east for demand

RB and Newcastle trading together

Off-spec and on-spec Australian differentials have narrowed and widened

Barclays | Coal and Freight Quarterly

21 December 2012 16

x The relationship between the two sub-bit markers have been much more consistent and largely reflect the freight differentials between Indonesia and Australia.

FIGURE 13 Spreads between off-spec and on-spec coal CV adjusted ($/t)

-5

0

5

10

15

20

Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12 Oct-12

Newc (6300) - Indonesia (5000)

Newc (6300) - Newc (5500)

Source: McCloskey, Barclays Research

By December, the discounts for sub-bit coal were around the 6 $/t level (NEWC against NEWC), while the freight differentials between the two exporters was around the 5 $/t level.

Price outlook, forecasts and trade recommendations Atlantic basin

The Atlantic Basin is looking reasonably well balanced in 2013 and 2014, with the expected increases in Colombian and Russian volumes likely to be reasonably offset by reductions in US volumes. While we think there are a number of factors driving the latter, modest pricing will be needed to ensure that an incentive is not provided to bring those volumes back into the market. With European demand likely to see only modest reductions from the 2012 peak levels, the European market will rely on Colombian, Russian and US volumes for supply, but the rebalancing between the exporters will be needed given the expected pressure we see in the Pacific Basin.

The outlook is for prices to stay in range, not straying too far from the marginal costs of the higher-cost US and Russian exporters. Apart from a supply outage, the main upside price pressure will come from an underlying movement upwards of the marginal cost of the key exporters. With our crude prices forecasts for a 14% y/y average increase, we expect that this will increase the cost floor from 85-90 $/t to around the 90-95 $/t level. We note that the oil prices are not expected to climb until Q2 13 and thus impacts on the cost floor are likely to be more pronounced in the second half of the year.

Our forecasts are for:

x CIF ARA prices for 2013 at 95 $/t (up 2 $/t on our last forecast) on a combination of similar fundamentals, but reflecting the impact of oil-driven costs on price support levels. Without the increase in oil prices, our CIF ARA price forecasts for the year would be 89 $/t. With 2014 looking even more unbalanced in terms of potential supply surplus, our CIF ARA forecasts stay at 95 $/t, which points to a movement towards the bottom of the price support range, given the continued increases in oil prices expected that year.

Atlantic Basin reasonably balanced

Oil cost-driven pressures suggest only upside

Barclays | Coal and Freight Quarterly

21 December 2012 17

Pacific Basin

The Pacific Basin looks more unbalanced from a supply situation with targeted expansions out of Australia, Indonesia and South Africa coming up against flattish y/y Chinese exports and growth only in price sensitive India. In 2014, the supply story is even more pronounced while an expected reduction in Chinese needs for imported coal could cause considerable chaos in the market. Given this background, we are forecasting:

x FOB Richards Bay for 2013 price forecasts are 93 $/t (up 1 $/t from 92 $/t) for 2013 on the same logic. For 2014, we expect that prices will be 91 $/t in 2014 as the fall out from reductions in Chinese import levels falls heaviest on Pacific Basin exporters. The continued appetite for low spec coal in India is likely to keep the pressure on the South African benchmark coal prices. In the absence of the oil price pressure, our forecast prices for FOB RB would be 87 $/t. We do expect given an emerging supply imbalance in the Pacific Basin that RB prices will trade on average at a discount to CIF ARA.

x FOB Newcastle prices will be the lowest of the three, at 92 $/t in 2013 and 90 $/t in 2014. The low 2014 prices against the countervailing cost pressure points to the intense competition we expect to see between Australia and Indonesia for reducing demand out of China.

Trade recommendations

Given our expectation is fundamentally bearish, but with some oil-driven cost support resulting in prices only gradually trending upwards, we see good reasons for looking at the high levels of contango in the curve. One of our existing trades looks for a widening between contracts expiring in CIF ARA December 2013 and 2014. We recommend that this trade, which is currently delivering gains of 10%, is held. Another trade is more an outright trade, and Q4 13 trading at 100 $/t looks over-priced against our expectations. We think the structural contango in the market, given the difference between when utilities hedge and when producers put volume in the market, opens up opportunities. Here, we recommend an outright short is taken.

FIGURE 14 Coal market trade recommendations

Trade Opening price level 20 Sept 12

Price level 18 Dec 12

Rationale

Previous trade

CIF ARA: Sell Q4 12 Buy Q1 2013

Dec 12 = 89.1 Q1 13 = 92.3

Dec 12 = 90.5 Q1 13 = 93.5

The trade closed at a loss of 6% as the contango narrowed from 3.2 $/t to 3 $/t as while it was cold, it was not cold enough to drive enough of a difference between the two contracts.

Previous trade

CIF ARA: Buy Dec 13 Sell Dec 14

Dec 13 = 96.5 $/t Dec 14 =105.15

Dec 13 = 96.6 Dec 14= 104.7

The contango narrowed from 9 $/t to 8.1 $/t, providing a return of 10% on the trade. We still expect further narrowing as we go further and so still recommend that the trade is held.

New trade

CIF ARA Sell Q4 13

100 $/t An outright short as this contract seems to be over-priced and over-bid against the volumes producers are happy to put in the market at the further end.

Source: Reuters, Barclays Research

Pacific Basin seeing plenty of supply

Directional trades difficult but contango looks too wide

Barclays | Coal and Freight Quarterly

21 December 2012 18

THE GLOBAL COAL MARKET: FUNDAMENTALS

2012 will be remembered as a year that has been very good for the supply side of the coal market, with exports from all the major exporters up 14% y/y over the first seven months. The rise of global exports was seen across basins, and we estimate that the 2012 increments will come from the:

x Atlantic Basin, from Russia (15 mt, up 19% y/y), the US (13 mt, up 38%), and Colombia (4 mt, 5%); and

x Pacific Basin, from Australia (23 mt, up 16% y/y), Indonesia (17 mt, up 5%) and South Africa (5 mt, up 7%).

Demand for exports has not exactly stopped accelerating. However, the increments in supply from all of the key exporters were against a background in which additional demand for seaborne had to be stimulated by the steep reduction in benchmark prices seen in the first half of the year. With supply staying robust through H2, benchmark prices were left trading in their low ranges, at times dipping to the price levels at which supply from the higher-cost exporters was being challenged.

FIGURE 15 Incremental growth in exports (mt)

-10

-5

0

5

10

15

Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12 Jul-12

USA Colombia South AfricaRussia Indonesia Australia

Source: McCloskey, Barclays Research

While exports were robust, demand was good with 2012 seeing:

x European coal consumption now forecast to be up 12 mt y/y, with most of those gains coming out of the UK and Spain, as lower-priced coal was aided by low carbon prices to help push gas out of merit in those countries. With gas never being in merit in most of the continental markets, it was the loss of LNG to Europe, combined with the healthy coal supply, that made the difference; and

x Asian coal consumption leading the way, with:

China now forecast to see increments of 40 mt y/y (a 40% increase), as low-priced benchmarks price themselves into a Chinese domestic market that was still experiencing periodic constraints on moving domestic coal around, and a low hydro year. While the slowdown in economic growth slowed the pace, this is still a very significant movement upwards in imported volumes;

2012 has been the year of supply

Everything up in the Atlantic

Barclays | Coal and Freight Quarterly

21 December 2012 19

Indian growth now forecast at an incremental 18 mt y/y, ie, very healthy and reflecting the continued expansion of power generation capacity. While there have been issues around the Rupee depreciation, this has mostly led to Indian buyers continuing to buy sub-bit coals, with India buying 38% of Indonesias sub-bit exports;

Japan posting a 12 mt y/y gain, as the post-Fukushima energy shortage continues to draw in more thermal energy sources.

The 2013 and 2014 coal market looks likely to expand less sharply in the next two years, despite plenty of new supply capacity expected to coming online in that period (see discussion in the focus section of this report) is likely to run into a lack of demand as there are forecast reductions in coal demand in:

x Europe, given the combined impacts of little growth in industrial production and further environmental legislation; and

x China, given better hydro expected and the forecast fruition of investment to alleviate domestic transportation constraints. We forecast that around a 35 mt reduction in imports will be needed in China in 2014.

With only India looking to be an engine for growth, the market will have to rely on prices being low enough to help to lock in some production.

Export supply: Still rocking

Atlantic Basin supply Colombia: Momentary pause

In H1 12, Colombian exports were up 5.2 mt y/y (15% y/y) and looked set to continue to increase. A 25-day rail workers strike disrupted supplies, and pushed July exports down 0.6 mt m/m and 0.9 mt y/y and August exports down 1.8 mt. Since then, y/y increments have come back, but to a smaller degree than we saw in H1, meaning that over the first four months of H2 Colombian volumes are down 1.9 mt y/y. To the end of October, in terms of destination of exports:

x Europe accounts for 73% with 47.6 mt of coal coming in, which is 3.0 mt higher y/y;

x Latin America accounts for 22%, with 13.8 mt being sold, although this represents a y/y reduction of 1.9 mt to the region; and

x Asia accounting for 6%, up 2.1 mt y/y to 4.1 mt, with the largest volumes being sent to China (1.9 mt) and Korea (1.3 mt). Almost no additional coal has been exported to Asia in H2.

A key reason for the weak H2 in Colombian exports centres on social issues, ie, either labour disagreements or the periodic attacks on infrastructure as part of the long running civil insurgency in that country. In early September, the large producer Cerrejon released a statement that the railroad connecting its mine to its coal export port on the Caribbean coast had been attacked for the second time in a month. Although this had a minor disruption on exports, clearly Colombia would have added greater volumes into the market without the supply disruptions.

We are forecasting that over 2012, Colombian exports of steam coal will come in at 80 mt, up 4 mt y/y.

Normal service resumed after the July strike

Supply disruptions happened, leaving Colombian increments low

Barclays | Coal and Freight Quarterly

21 December 2012 20

US: a big change

2012 will likely be the year of the US exports, with these adding 14 mt more thermal coal into the market by the end of September a 60% increase y/y.

The growth in US exports was driven by low power demand for coal due to both:

x US thermal generation in the first 9 months of the year was down y/y by 221 TWh (16%); and

x A change in relative prices, with US gas seeing prices as low as 1.91 $/mmbtu, and averaged 2.78 $/mmbtu over the first 11 months of 2012, compared with an average of 4.1 $/mmbtu in the same period in 2011. Given this, US coal-fired generation in the first 9 months of the year was down by 220 TWh (16%) ,while natural gas-fired generation was up by 201 TWh (26%).

The result was that coal consumption in power generation was down by 107 Mst in the first nine months of 2012. In response to the pushing out of coal from the US merit order, production reductions eventually followed, with coal production being down 65 mst (6.5%) by the end of November.

The other avenue for the coal not being used in power was exports, and of the total 37 mt y/y exported by the end of September, 64% went to Europe, and 25% to Asia. Given the current rate of exports, we expect 2012 exports will reach 47 mt a 16 mt y/y increment.

FIGURE 16 Colombian exports (y/y change)

FIGURE 17 US exports (y/y change)

0

1

2

3

4

5

6

7

8

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

2010 2011 2012

0

1

2

3

4

5

6

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

2010 2011 2012

Source: McCloskey l, Barclays Research Source: McCloskey, Barclays Research

Russia: Raising the game

Over the first ten months of 2012, Russian exports of coal were reported by the Ministry of Energy as being up by 18% y/y, with incremental steam coal volumes up by around 14 mt a very good performance by Russian coal, which took advantage of the strong European demand seen this year. Exports were reasonably strong throughout the year despite periods where European delivered coal prices traded as low as 85 $/t, a challenging price level to sell in Russian volumes. However, prices along the 3-6 months out curve never fell below the 90 $/t level, allowing Russian volumes to be comfortably sold into the market throughout the year.

US volumes strong throughout

Pushing volumes in

Barclays | Coal and Freight Quarterly

21 December 2012 21

South Africa

In 2012, South African coal exports have achieved an annualized rate of 74 mt , slightly below our expectations of 76 mt. This represents a growth of 8% y/y, although this annual growth rate hides that RBCT coal exports:

x Were higher y/y by 4.6 mt (17%) in H1 2012; and

x In the first five months of H2 dropped by 0.48 mt y/y (or a 2% reduction).

The reduction is largely due to:

x A series of strikes in the mining and transportation sector during this period. Railing data to RBCT indicates that deliveries to the coal terminal were up by 15% y/y in H1, while in H2 this is falls to a 2% y/y; and

x Less enquiries for South African coal as global coal demand slowed its growth rates in 2012. Even with the slower growth in railings, the inventory data at RBCT suggest a surplus in H2 building at a faster-than-seasonal pace. Since the end of H1, coal inventories at the terminal built by 0.8 mt to 3.7 mt.

In terms of pricing in the international market, South African coal continues to face difficulty pricing into Europe at the prompt given the unattractive price differentials. With the CIF ARA FOB Richards Bay differential averaging -0.6 $/t and the freight rate from Richards Bay to Europe averaging 9 $/t through this year, there were few opportunities for prompt cargoes to price into Europe without a discount applied to the benchmark. As a result, South African exports of steam coal to Europe have fallen by 2 mt/y, down to around 10 MT for the year.

And the competition in the Pacific is heating up, with traditional sources of supply (Indonesia and Australia), as well as suppliers from the Atlantic Basin (Colombia and the US). In terms of the direction of South African coal exports, India continues to increase its markets share, within the pool of its customers. Indias share of South African bituminous exports in the year-to-date is 30% compared with the 27% averaged in the same period in 2011. China has also seen a similar basis-point increase in the share of South Africas steam coal customer base, increasing from 14% to 18% in 2012.

Looking forward we see similar trends continuing to hold for the direction of South Africas coal exports, with Europe being more reliant on Russia, Colombia and the US for its supplies.

Pacific supply Indonesia: Slowing down Of all the exporters, Indonesian data are the most lagged with a full set of data only available up until July. Across the first seven months of 2012, exports increased by 10 mt, or 7% y/y. While this is well below the growth rates seen in the previous years, the growth still is considerable given the high basis on which they were being measured and reflects the continued investment in the sector that has been made. With Australian coal exports staying firm through most of the year, we expect that this will extend to the Indonesian numbers and are forecasting that 2012 numbers will come in at 340 mt a 17 mt increase on 2011 export numbers.

One of the highlights of the Indonesian data is the expansion of the sub-bit exports (101 mt), with these exceeding the export of bituminous coal (89 mt) for the first sustained period on record. The market for sub-bit has been sustained despite periods where that material was more expensive than the benchmark coals on a CV adjusted basis. The key markets for the sub-bit material were India (38% of total sub-bit exports) and China (22%).

SA volumes up 8% y/y

Pacific Basin competition is an issue

Indonesian coal exports remained robust in 2012

With sub-bit leading exports

Barclays | Coal and Freight Quarterly

21 December 2012 22

The lack of much H2 data for Indonesia does raise some questions over exactly where the volumes are going. Issues to consider include:

x In response to the adjustment of Indonesian prices across all of H2 to an average of 60 $/t, the Indonesian Coal Mining Association had cut its 2012 forecast of production by about 50 mt, from a 395 to a 345 mt mid-point level, as companies such as Adaro and Berau adjusted production targets. While this could moderate export volumes, major producers like Bumi have announced they were maintaining coal production levels, but being careful to match grades to demand a reference to the fact the market is still there for sub-bit coals, particularly from India.

x The continued strong expansion of Australian volumes in the second half of the year is somewhat at odds with the more modest performance of South Africa (strike affected)

For the remainder of the year, we expect Indonesian coal producers to maintain exports around current levels. Given the ramp-up seen in H2 11, this means fewer additional incremental volumes will be put in but that y/y increments will stay around 14 mt for the year.

Australia

Over the first ten months of 2012, Australian exports of thermal coal were up 19.6 mt y/y (16%) to 139 mt, with incremental sales being seen in every month apart from August. Australia remains the key exporter to Asia with its exports being focused on: Japan (45% of its thermal volumes), China (19% of total), Korea (17%) and Taiwan (10%). Other locations outside these four only accounted for 9% of total Australian thermal coal sales.

The strong growth in Australian exports has been driven by large port infrastructure additions including the 30 mt of export capacity in 2012 that the Newcastle port added. With other capacity additions on the way see the focus piece we do think that demand is going to be the key constraining factor on Australian export growth over the coming two years.

Export demand: Still very competitive

Macroeconomic outlook EU

The euro area is set for another year of weak economic activity, and differences across countries are likely to remain significant. Our economists expect growth to return to positive territory in Q2 13 but to remain below-trend until the end of 2014.

Economic data released at the end of November suggest that business sentiment is bottoming in most euro area countries, while remaining well below the historical average. Overall economic activity remains driven down by the ongoing fiscal tightening, credit restraints in peripheral countries and private sector deleveraging. Despite the impressive improvement in financial markets following the ECBs announcement of the outright monetary transaction (OMT), surveys on bank lending show little transmission to the real economy. Given the absence of a clear rebound in economic sentiment, our economists have revised our 2013 growth forecast down slightly from +0.3% to +0.1% as they now envisage GDP to start growing moderately only in Q2.

The 2014 outlook depends on EU governments making significant progress in the crisis resolution framework. Even though the magnitude and simultaneity of the fiscal adjustment have played significant roles in the economic slowdown, our economists believe the double-dip recession could have been avoided if euro area governments had reacted more swiftly and more efficiently to renewed tensions in sovereign debt markets. The decision to launch an enhanced integration of the euro area at the June European Council is an important

Australian exports to grow with port expansions

But demand will be the constraining factor

European outlook remains weak

and 2014 could also see low growth

Barclays | Coal and Freight Quarterly

21 December 2012 23

milestone in the crisis resolution and should gradually restore sound financial conditions across the board. However, discussions about the architecture of EMU are likely to be chaotic, and tensions could resume temporarily in the meantime.

Assuming that significant progress is achieved in 2013 and the structural reform agenda gains momentum, our economists expect growth to resume in 2014 and GDP to expand 1.4%. However, this should not be sufficient to restart job creation, and unemployment would reach a record high in peripheral countries, it would peak at double-digit record highs.

China: More stable growth

Chinas policymakers are expected to gather in December for the annual Central Economic Work Conference (CEWC) to set the policy framework for 2013. Our economists expect the government to retain its 7.5% GDP growth target and 4% CPI inflation target for next year.

Government policies for 2013 will likely favour activity related to the following three areas: urbanisation, new strategic industries and consumption. The new party leadership, introduced in November 2012 for the next ten years, has indicated that it is interested in a more balanced, sustainable economy, rather than one marked by faster growth at the expense of other social costs such as environmental degradation. In addition, we expect consumption to account for an increasingly larger share of the growth, which is currently predominated by fixed-asset investments and net exports. The new leadership has suggested that it will try to encourage private consumption through a variety of measures including more equitable income distribution and better social welfare. While this kind of structural rebalancing will take time, it appears that the government plans to actively reduce the overwhelming importance of fixed-asset investment. While downside risks could test the will of the new leadership, so far the message has been consistent.

Overall, the central bank will likely maintain a relatively stable monetary condition. Our economists no longer expect further interest rate cuts from the PBoC. But the CNY may appreciate modestly, driven by both relatively high inflation and nominal appreciation against the USD. It is critical to monitor changes tin the composition of total social financing because some segments may contain potential financial risks.

FIGURE 18 EU real GDP (y/y change)

FIGURE 19 EU real industrial production (y/y change)

-8%

-6%

-4%

-2%

0%

2%

4%

6%

Q1-

00

Q1-

01

Q1-

02

Q1-

03

Q1-

04

Q1-

05

Q1-

06

Q1-

07

Q1-

08

Q1-

09

Q1-

10

Q1-

11

Q1-

12y/y change in real GDP

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

Jun

08Se

p 08

Dec

08

Mar

09

Jun

09Se

p 09

Dec

09

Mar

10

Jun

10Se

p 10

Dec

10

Mar

11

Jun

11Se

p 11

Dec

11

Mar

12

Jun

12Se

p 12

Y/Y change in EU industrial production (%)

Source: Eurostat, Barclays Research Source: Eurostat, Barclays Research

Government policies moving away from infrastructure

Some further CNY appreciation may help keep imports competitive

Barclays | Coal and Freight Quarterly

21 December 2012 24

India: A slower growth period

In terms of the fundamentals of the Indian economy, industrial production (IP) growth rose to 3.3% from 0.5% in September, but was still below the +4% growth seen during FY 11-12 and 6% during H1 FY 11-12. Trends in consumption are also a source of concern as the latest GDP data show that private consumption growth was at a multi-year low of 3.7% y/y in Q3 12 (4.6% in Q1-Q3 2012), which compares with recent years that have seen more than 7% y/y growth. However, there are a few positive signs emerging with a gradual uptick in intermediate goods production, which typically leads overall IP by two to four months. According to our economists, the gradual but steady uptick in this segment provides evidence that economic activity is now on an upward trend. A combination of more accommodative monetary stance and government policy initiatives is expected to aid the recovery in growth in 2013. In line with these factors, our economists expect GDP growth to reach 6.6% in FY 2013-14, from the 5.6% in FY 2012-13. These growth levels represent a move toward a more stable level of economic activity rather than a sharp turnaround in growth momentum.

Others

The economic outlook for the Pacific Basin remains better than in the Atlantic, with the main economies posting healthy growth. While 2012 saw most regions recording slower y/y growth rates, these are expected to improve with India and the remainder of emerging Asia forecast to post growth back up at around 6.5% in 2013 and to 7.1% in 2014.

FIGURE 20 Economic assumptions Atlantic Basin (% y/y)

2010 2011 2012F 2013F 2014F

Global GDP 5.0 3.8 3.0 3.2 4.0

Atlantic Basin

Real GDP UK 1.4 0.9 -0.1 1.3 2.2

Real Industrial production (IP)

UK 2.1 -0.7 -2.3 -0.2 2.0

Real GDP Eurozone 1.7 1.5 -0.4 0.1 1.4

Real IP Eurozone 7.4 3.5 -2.5 -2.8 0.0

Real GDP Latin America 6.2 4.4 2.9 3.3 3.9

Pacific Basin

GDP China 10.4 9.3 7.6 7.6 8.1

Industrial production China 15.6 13.7 9.8 11.0 12.0

GDP India 8.6 7.4 5.3 6.5 7.2

GDP Emerging Asia 9.3 7.6 6.1 6.5 7.1 Source: Barclays Research

Energy commodity pricing Oil market outlook: Brent crude started the year trading around the 105 $/bbl, finished Q1 trading around the 122 $/bbl level, and by mid-December was trading around the 110 $/bbl mark. The two key drivers of this volatility have been: on the downside, the slow-down in global macroeconomic activity and the periodic resurfacing of European sovereign debt issues; while the upside has largely been driven by the periodic emergence of geopolitical risks. In the background, the fundamentals have been mixed with lower oil-demand growth reflecting the macroeconomic situation, but the supply side remaining tight with gains in US production largely being offset by reductions in other non-OPEC regions. As a result, the spare capacity available in the market remains at low levels, meaning the market will remain sensitive to any supply side outages.

Indian growth will improve

Growth remains focused on Asia

Oil could see a break out in 2013

Barclays | Coal and Freight Quarterly

21 December 2012 25

This brings us to 2013 and while some developments, such as continued US liquids expansion holds some downside, we believe geo-political risk will dominate this year and will hold the most upside. In particular, the thorny question of the Iranian nuclear situation is poised to reach a tipping point and, with resolution of the issue unlikely to be easy, we expect that this risk will dominate from Q2 onwards and will strongly influence prices. Therefore, we are bullish on oil and our Brent price forecast is for 2013 to average 125 $/bbl and for 2014 to average 130 $/bbl.

Gas market outlook: UK NBP gas prices have traded broadly in a range with quarterly average prices coming in between 55-60 p/therm over the first three quarters of the year, while Q4 prices have tended to be a bit stronger, trading between 65-70 p/therm. The relative stability in prices hid significant shifts in the underlying fundamentals of the market. On the supply side, the UK market saw a 51% y/y reduction in LNG takes, although this was partly offset by increases in Norwegian flows (up 35% y/y). On the demand side, residential demand was up 6% y/y due to a colder year than in 2011, but this was more than offset by a reduction in gas demand from the power sector by 34% y/y. Despite these big shifts, the offsetting nature of these changes led to limited volatility in prices.

The supply picture for 2013 remains largely the same, with little forecast further LNG losses but the market does seem more poised with upside risks. The reason for this is there could be greater demand, with the introduction of a UK specific carbon tax and the potential for around 6 GW of coal plant being required to shut down by the end of that year. Given this, the market will need to find some additional supply; if there is a cold winter that adds in further residential demand prices would be poised for a move upwards. Much of the downside risk is to do with a ramping up of Russian flows, and while Russia certainly has the productive capacity and transportation infrastructure, it will need to lower prices if it is to stimulate much additional demand in markets outside the UK. We forecast gas prices to see a gradual but sustained increase y/y, with NBP prices averaging 65 p/therm next year (up 9% y/y) and 67.5 p/therm in 2014.

European carbon market outlook: Over 2012, European carbon markets saw a fair amount of volatility, predominantly trading in the 6-9 /t range, with abundant supply weighing on the market but punctuated by upside episodes with price rises driven by noise around the potential for the EC to intervene in the market. By mid-December, the much delayed auctions of phase 3 carbon had begun and prices for the front-year contracts were being pushed to the bottom of the range.

In terms of fundamentals, the market is already significantly long carbon and a recessionary outlook for European industrial production in 2013 and the continued uptake of European renewable forms of generation are squeezing thermal generation in power. Some additional demand side is being seen by the power sector switching to coal from gas, but this is unlikely to add much more than 30 mt to emissions. Therefore, the main prospect for price recovery is the proposal by the EC to take 900 mt out of the caps of 2013-2015 and sell them in 2019 and 2020. While the EC had promised to move quickly on this, the political realities have led to more recent announcements that suggest that this proposal is likely to go forward quite slowly. As a result, operationalisation of that back-ending is likely to be delayed and 2013 could still see much of the 2013 cap being auctioned until the proposal is formally adopted sometime in Q3 13. This holds out the possibility that prices will get worse before they get better, as we expect prices to see some downside towards (and possibly below) the 5 /t level. For 2013 we are forecasting prices to average 8.5 /t and to increase to 10 /t as the back-loading is felt more significantly in that year.

With gas and carbon risks biased to the upside, which of these two commodities prevails will begin to determine whether coal retains its competitive value.

2012 gas market was largely one of trading in range

While 2013 is more of the same

While things could get worse and then better for carbon

Barclays | Coal and Freight Quarterly

21 December 2012 26

FIGURE 21 Barclays Energy market price forecasts

Market Product Units 2010A 2011A 2012 2013 2014 2015

Oil WTI US$/bbl 79.6 95 96 115 124 125

Brent US$/bbl 80.3 111 113 125 130 135

Natural Gas Henry Hub US$/mmbtu 4.39 4.02 2.77 3.25 - 4.00

NBP p/therm 42.2 56.4 59.5 65 67.5

Carbon EUA /t CO2 14.5 13.4 7.25 8.5 10 12

CER /t CO2 12.4 10.2 3.5 2.5 2 1.5 Source: Barclays Research

European demand In terms of coal demand in Europe, the fuel continues to: benefit from relative prices in power that has seen it gain market share from gas; while suffering from the overall stagnation and recession seen in European economies and the continued increase in renewable generation capacity.

In terms of EU power, total gross power output across the EU over the first seven months of the year was flat y/y, with the increasing pressure of a slightly colder Q1 being offset by the reductions seen in economic activity and cooler summer. While total generation was unchanged, the call on conventional thermal generation was down 3% y/y (down 27 TWh) with the additional generation largely coming from more renewables and better nuclear availability.

Despite the reduction in overall thermal power demand, coal-fired generation has remained in the money in the power stack given the discussion of relative prices mentioned above.

In terms of European total coal demand:

x European hard coal consumption was up by 6.4 mt (3.6% y/y) over the first seven months while lignite consumption was up 7.6 mt (or 2.9% y/y) taking total steam coal consumption up by 14 mt y/y. The figures hide a stronger first quarter and a weaker summer period for hard coal consumption.

x Hard coal consumption gains were focused in: The UK, with consumption up 10.6 mt or a 30% increase y/y over the first nine

months of 2012. The UK gains have all largely come due to fuel switching, with coal pushing gas out of merit;

Iberia, with consumption up 6.7 mt, or a 56% y/y increase, in the first seven months, largely due to hydro levels being well below average levels. While hydro power output was down some 10.7 TWh y/y by the end of November, coal-fired generation in that period was up 9.5 TWh y/y. However, coal-fired generation had been up as much as 10.8 TWh in July, suggesting that total incremental coal use from Iberia across all of 2012 is unlikely to be much more than 6 mt;

Italy has seen a 0.8 mt or a 5% increase in coal use over the first eight months, reflecting the lower ability to see fuel switching in that country.

x Growth in lignite consumption has been more consistent throughout the year, coming mostly from Germany (7.6 mt first nine months), spurred by the new large lignite plant commissioned across 2011 and 2012. German hard coal use was down 1.1 mt over the first nine months, meaning total coal use was up some 6.5 mt y/y.

Outside those markets, coal consumption gains were either less pronounced or fell, with central European coal consumption down 8 mt across the first seven months.

European coal demand was good in 2012

Barclays | Coal and Freight Quarterly

21 December 2012 27

European coal imports over the first seven months were up 9.3 mt, with gains in the UK (8.2 mt) and Iberia (5.1 mt) and most other regions seeing reductions in imports. With imports exceeding consumption over that period, this points to inventory build going into the summer and helps explain the lack of demand pressure at the end of the summer period. For all of 2012, we forecast that total EU imports of coal will be up 15 mt a 3 mt reduction on our previous forecast. Looking forward, we see more of the same although some inter-country differences in outlook leads us to forecast that total coal imports could fall modestly by 2 mt in each of the next two years.

Germany

While renewables continue to be important as a source of increasing power generation in a market that is seeing little underlying growth, the notable development was the substitution of lignite (up 7.6 mt, or 5.8% y/y over the first seven months) for hard coal (down 1.1 mt, 2.9% y/y). On a net basis, coal consumption was up by 6.5 mt although the call on imports was only slightly down into the country (-0.5 mt).

Looking ahead, German coal burn is likely to remain at similar levels to what we have seen so far with coal in merit against gas and lignite in merit against steam. In the next two years, a key development to watch is the 7.5 GW of new coal-fired stations that are scheduled to come online in 2013 and 2014 that will have much higher efficiencies than many of the existing plant. The main addition in 2012 has been the 2.2 GW of lignite capacity added by RWE at Neurath, which has already helped displace some hard coal as seen above. While gas plant remains most at risk from seeing its load factors reduced further, older, less efficient coal plant will also see its position in the merit order deteriorate. With renewable capacity also being added and the next nuclear plant only coming offline in 2015, additional demand for coal here in the absence of underlying power demand growth is likely to be limited, given that gas remains marginal in the German power market.

For 2012, we are forecasting German coal burn to be up by 8.5 mt, although hard coal use will be down by 1.5 mt, with most of the need for the added lignite being met by domestic production. For 2013, we estimate that new plant will add some 4 mt to demand for hard coal as 4.2 GW of new plants are expected to come on line, albeit most of them in H2, while 2014 will see 3.3 GW added and incremental coal use up by 5 mt.

FIGURE 22 European dark spreads favour coal on the merit order

FIGURE 23 European weather a mild winter, a brief cold spell and a late start to the summer

-20

-10

0

10

20

30

40

Dec-11 Mar-12 Jun-12 Sep-12 Dec-12

54% v 30% 48% v 36%

Gas SRMC - coal SRMC /MWh

-50%-40%-30%-20%-10%

0%10%20%30%40%50%

Sep

Oct

Nov Dec Jan

Feb

Mar

Apr

May Sep

Oct

Nov Dec Jan

Feb

Mar

Apr

May Sep

Oct

Nov Dec Jan

Feb

Mar

Apr

May Sep

Oct

Nov Dec Jan

Feb

Mar

Apr

May Sep

Oct

2008 2009 2010 2011 2012

Source: Barclays Research Source: FGE, Barclays Research

Coal imports to fall in Germany this year

Key developments is new plant

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21 December 2012 28

FIGURE 24 EU renewable capacity additions (GW)

FIGURE 25 German thermal capacity additions (GW)

0

5

10

15

20

25

30

35

2000 2002 2004 2006 2008 2010 2012 2014

Wind Solar Other renewables

-3000

-2000

-1000

0

1000

2000

3000

4000

5000

2011 2012 2013 2014

Additions (MW) Closures (MW)

Source: EWEA, EPIA, Barclays Research Source: BNA, Platts, Barclays Research

UK

One of the most active of the fuel switching markets is the UK, and coal consumption in the first 9 months of 2012 was up 10.5 mt (29% y/y). Domestic coal production over the same period saw a decline of 1.4 mt (down 10% y/y), leading to a greater call on imports and on inventories. Over the first nine months, total imports have been up by 10.3 mt while inventories have averaged 1.9 mt less y/y, finishing September at 15.8 mt which is 2.5 mt less than the same period last year.

With all of the dynamics driving higher coal use seen to September persisting into Q4 12, the broad trend will persist of coal use and imports up. With the cold Q4 seen to date, this is likely to lead to further increments, even if these are likely to slow down as Q4 11 had already started to see coal fully in the money against gas. Given this, we expect coal use in the UK will be some 13 mt higher y/y (25% up y/y) in 2012.

Healthy coal burn in the UK continues

FIGURE 26 UK power generation market share (%)

FIGURE 27 Healthy coal consumption in the UK (mt)

0%10%20%30%40%50%60%70%80%90%

100%

Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12

Nat gas Coal Nuclear Renewables

0

1

2

3

4

5

6

7

8

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

2009 2010 2011 2012

Source: DECC, Barclays Research Source: DECC, Barclays Research

Barclays | Coal and Freight Quarterly

21 December 2012 29

As we outlined in the last issue, we believe 2012 is shaping up to be a peak year for coal consumption in the UK as in 2013:

x The derogations taken by a number of coal plant under the large combustion plant directive (LCPD) will result in up to 6.3 GW of installed coal capacity coming off the grid as they use up their limited life-time hours. Of this, around half could be off-the grid by the end of Q1 13, while the remainder would likely see hours used up in Q4 12. In terms of annualised generation, this could remove as much as 26 TWh of coal fired generation, or 10.6 mt coal demand. We estimate the impact on coal consumption in 2013 will be half of that, or a 5 mt reduction, before the full impact is felt in 2014.

x The competitive position of coal will see some erosion as the UK implements a carbon floor tax that will add to the costs of generating with fossil fuels. The carbon tax rates are 4.94 /t CO2 (April 2013-March 2014), before climbing to 9.55 /t CO2 (April 2014-15). With coal more carbon intensive than gas, the tax will fall harder on coal-fired generation. While current forward prices suggest that coal will largely retain its market share in 2013 despite the tax imposition, the tax means that the fuel is much more exposed to any changes in the relative fuel prices, with potential strengthening in EU ETS CO2 prices from potential policy intervention (see Quarterly Carbon Standard, 11 October 2012) a particular risk. By 2014, we do expect that gas could well be more competitive given the +10 /t adder to the carbon price, particularly if adding to carbon prices that have risen on intervention.

Given both of these, we are forecasting that UK coal consumption will be down 5 mt in 2013 and a further 7 mt in 2014.

FIGURE 28 Effect of UK carbon tax on competitiveness of generation costs

20

25

30

35

40

45

50

55

SUM 2012 WIN 2012 SUM 2013 WIN 2013 SUM 2014 WIN 2014 SUM 2015 WIN 2015

Gas - NBP /MWh Gas - NBP: w/o CO2 tax /MWh

Coal /MWh Coal: w/o CO2 tax /MWh

Note: Uses 3 December prevailing forward curves for all commodities. Source: Ecowin, Barclays Research

Iberia

Spanish coal use has been strong this year, as the common themes of increased competitiveness of coal, but pressure from renewables has played out. While Spanish total power generation to the end of November was down 1.1% y/y, its generation profile has seen: hydro generation down some 10.7 TWh (-39% y/y); gas generation down by 11.8 TWh (-26%); while coal generation was up 9.5 TWh (27%); renewables up 6.8 TWh (14%) and nuclear generation up 2.6 TWh (6%). A key interplay here has been between gas and coal, with much of the increase in coal-generation driven by fuel switching, while much of the drop in hydro was made up by the increases in renewables and nuclear.

Power demand down but coal taking market share

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21 December 2012 30

The big question for Spanish coal use is how much hydro comes back and does this push some coal plant out of base-load and back into mid-merit. By November, hydro reservoir levels still remained 20% below average five-year levels,