Coal Might Become A Bigger Story Than Oil

Merrill Lynch: Metals And Mining
European Metals and Mining analysts at ML project Thermal Coal prices to rise by atleast 30 per cent, as new contracts get closed out for supplies due in 2009.
 
Time for coal to rerate vs. alternate fuels?
 
Last week Xstrata hosted a lunch with the CEO of their Coal division, Peter
Freyberg. Peter suggested that energy content equivalence may play a role in
pricing coal in the medium term.
 
While we do not hope for a return to the bad old days of the 1970s with oil companies rushing to buy coal mines to get cheap BTUs in the ground, we do consider that the world will increasingly have to  consider all their energy alternatives on a cost benefit basis.
 
On this basis, despite its challenges, we think coal looks likely to play a significant role in the future global energy mix. Consider gas at US$11/mmbtu. If typical coal is about 30 GJ/t (approx 30 MMbtu/t) but half as efficient in use as gas, coal should, in theory, trade up to US$165/t. This is a near 30 per cent upside to spot price of $ 129/t of thermal coal.
 
Coal supply demand fundamentals are compelling
 
McCloskey has recently published thermal coal supply demand forecasts based on 3.5-4% CAGR in demand which suggest a market in 100 Mtpa deficit by 2015-2017. Xstrata believes that this could understate the growth potential for seaborne thermal coal where seaborne demand growth has recently been closer to 7% per year.
 
Xstrata believes that if this continues, the 100 Mtpa deficit could be more like 400-500 Mtpa. As is known, coking coal demand is underwritten by strong growth in steel intensity in large emerging markets (India, China).
 
Upside if coal is priced vs. alternate fuels
 
Peter suggested that energy content equivalence may play a role in pricing coal in the medium term. While we do not hope for a return to the bad old days of the 1970s with oil companies rushing to buy coal mines to get cheap BTUs in the ground, we do consider that the world will increasingly have to consider all their energy alternatives on a cost benefit basis.
 
On this basis, despite its challenges, we think coal looks likely to play a significant role in the future global energy mix.
 
Consider gas at US$11/mmbtu. If typical coal is about 30 GJ/t (approx 30
MMbtu/t) but half as efficient in use as gas, coal should, in theory, trade up to
US$165/t.
 
Pricing strong: Thermal doubles, coking coal triples
 
Pacific thermal coal contracts have recently been signed at US$125/t, up from US$55/t previously. Coking coal contracts have been settled around US$305/t, up from US$98/t. Xstrata indicated that the spot market for coking coal is supporting much higher prices than this with many spot transactions being settled at >US$350/t. Xstrata group have yet to price about 60% of their coal for FY2008. In their production release Anglo American highlighted that a large portion of their 2008 Met coal volumes are also yet to be priced.
 
Xstrata’s world leading coal business
 
Xstrata has a world-leading export coal business, #1 in export thermal coal, #3 in export coking coal. Peter indicated that the group was disappointed with last year’s profit of US$1.2 billion (EBITDA) and expects this figure to triple this year to US$3.6 billion (MLe US$3.4 billion). On ML forecasts, this makes coal about 24% of 2008E EBITDA, second only to copper in contribution to group earnings.
 
Managed production is 97.4 Mtpa with potential +100 Mtpa capacity giving +8% CAGR medium term.