HDIL-Mired In Dharavi

BSE 532873; CMP Rs 338
 
Industrialists/Businessmen/Investors must realise that charity and politics do not go hand in hand in India. Look at HDIL which is undertaking a mammoth project for the reconstruction and rehabilitation of the slums adjoining the Bombay Airport, known as Dharavi.
 
What HDIL promoters and investors do not realise is that the project will see huge arm twisting and flow of grease money to successive political parties which are and would be governing Maharashtra, the labour unions and local legislators.
 
The Dharavai slum rehab will costs huge sums and will be spread over years if not decades, and ultimately meet the same fate as Enron’s 2000 MW LNG based $ 3 bn Thermal Power Plant at Dharwad, which inspite of its re-christening as Ratnagiri Power and owners like NTPC, remains non-operational long after Enron collapsed.
 
The HDIL stock is a Sell, even though the notes given below by the management will make us feel otherwise.
 
Airport project to generate revenues from 1QFY09
 
Management expects that the company will convey ~53 acres of land for the first phase of the project (involving resettlement of 18,000 – 22,000 families) in
1QFY09 . As per estimates this move will generate Land TDR of ~3m sf. Revenues on the same could also be recognised in 1QFY09 itself.
 
The first phase of rehabilitation families is expected to take 24 months.
Recent policy changes on SRA beneficial
 
Management has welcomed the increase in size of tenement given under the slum redevelopment scheme from 225sf to 269sf of carpet area (460 sf super built up) as they believe that while increased FSI will compensate the developers for constructing a larger house, a larger unit size will also make it easier to convince the slum dwellers to move from their existing dwelling.
 
Increase in housing size also adds to the TDR receivable from the airport project, which the management now expects to be 40m sf (construction TDR).
 
Land requirement for airport project
 
The increase in applicable FSI for high density slum rehab scheme from 3x to 4x brings down land requirement for resettlement of airport project to an estimated 150 acres of land. HDIL expects to tie-up the land at an average price of Rs200m/ acre. It has acquired and paid for about 1/3rd of land requirement, which will be utilized for the first phase of the project.
 
TDR realisations
 
In the first phase of the Mumbai airport resettlement project, families will likely move to Kurla, which will be considered as the source of TDRs. Hence, these TDRs could fetch premium valuation as the point of origination will mean that these TDRs could be utilised in high value zone adjacent to Bandra Kurla Complex (BKC).
 
Increase in FSI in suburban Mumbai to 1.33x
 
The move is likely to impact the demand for TDRs adversely as developers will likely buy 0.33x of FSI from the state government.
 
No immediate need to raise additional funds
 
The company’s outstanding debt has increased by Rs18bn so far in FY08 to Rs22bn to buy land for airport resettlement project and the Vasai SEZ project. The gross debt/equity ratio is still reasonable at 0.73. The current cash balance of Rs17bn includes the recent commercial asset sale.

Modern Dairies-The IFC Washington Appraisal

Modern Dairies-Ushering White Revolution II
BSE 519287; CMP Rs 45
 
The World Bank affiliate IFC-Washington is picking up a near 20 per cent Equity stake in the company at Rs 60 per share, a 33 per cent premium to the current market price and the promoters raising their stake at Rs 84 per share. At 1.5 mn litres of Milk per day, Modern Dairies is the biggest Milk processor in Northern India, probably bigger than even Nestle’s Dairy in Moga.
 
Here is the IFC-Washington’s project appraisal:
 
Overview
 
Modern Dairies Limited (Modern Dairies or the company), a dairy company based in the state of Haryana (Northern India), is undertaking a 4-year investment program to expand its milk sourcing activity and to increase processing capacity for further processed dairy products such as Casein.
 
As part of the project, the company has already successfully commissioned plant to produce 9000 MT of Casein per annum with other by-products like WPC, Lactose and Pure Ghee. Additionally, the company has already successfully increased its milk processing capacity at its plant near Karnal, Haryana from 0.5 million to 1.5 million liters of milk per day (lpd). 
 
The company now plans to conduct the second phase of its investment program, comprising of:

- Expanding its milk supply network of farmers in the vicinity of the processing plant,
- Finalizing the implementation of its production line of nutritional products,
- Modernizing its current operations to manufacture new products and achieve higher productivity,
- Installing a 3.5 MW rice husk based power plant for captive electricity supply, and
- Financing working capital needs.
 
Project Sponsor & Ownership
 
The company is owned by the Goyal family, whose core business before starting the dairy business in 1992 was Steel. In 1973, Mr Amarjit Goyal started Modern Steels Limited, a publicly traded steel manufacturer and trader based in the Northern state of Punjab and with annual revenues of about US$62 million in FY2007. Modern Dairies was launched in 1992 by the son of Mr Amarjit Goyal, Mr Krishan Goyal, after the government liberalized the dairy industry in 1991.
 
Mr. Krishan Goyal has been actively involved with the Confederation of Indian Industry (CII), a well respected association of private companies. He was Chairman of the CII, Chandigarh Council between 2003-06 and has been an advocate for progressive policy making for the dairy industry. Mr. Krishan Goyal also served as a member of the first Governing Board of Punjab Engineering College (Deemed University), Chandigarh, from 2004 to 2008.

Modern Dairies is a publicly traded company, with 46% of the shares belonging to the general public, and the Goyal family retaining control with 54% of shareholding.
 
Project Cost
 
Total project cost amounts approximately $54 million. The project began in FY2006 and will end in FY2009.

IFC is looking to invest in a debt and equity package of up to $15 million, for IFC’s own account.
 
Location
 
The factory is located at kilometer 136 on the National Highway No 1, outside the municipal limits of Karnal, in the state of Haryana. The company is headquartered in Chandigarh, the capital city of the states of Haryana and Punjab.
 
Development Impact
 
The project will support the continuing improvement of the Indian dairy sector to achieve greater efficiencies and milk quality.
 
In addition to positive economic impact, the project will bring the following development impact:

- Expand its milk processing capacity and install manufacturing equipment of dairy products;
- Collect milk from over 60,000 rural households, in 1,800 village level centers (from the current 350),
- Benefit farmers by promoting productivity, product quality, and increase in milk supply,
- Benefit other suppliers (such as transportation companies), and clients thanks to increased local supply and expanded product range,
- Contribute development of private sector in the dairy industry, typically more efficient than cooperatives,
- Develop cogeneration capacity of 3.5MW.
 
IFC’s Contribution
 
- Providing necessary risk capital in the Indian dairy sector that has received little attention form equity investors until now;
- Providing a Stamp of Approval to a medium sized company looking at expanding into overseas markets.
- Assisting the company in enhancing its environmental, safety and social practices;
- Assisting the company in improving transparency and Corporate Governance through change of auditors to well-known firm and a formal arm’s length agreement with Modern Dairies Farms;
- Improving farmers’ production practices and installing chillers to improve the quality of milk supply;
- Supporting renewable energy through increase in cogeneration capacity.
 
Environment and Social Issues
 
This is a Category B project. IFC’s early review of this investment identified the following environmental, social, health and safety issues: environmental, health and safety management systems; labor working conditions, including occupational health and safety; emergency preparedness and response; chemical storage and handling; and pollution prevention and control, especially wastewater treatment and reuse/discharge.

While all Performance Standards are applicable to this investment, IFC’s environmental and social due diligence indicates that the investment will have impacts which must be managed in a manner consistent with the following Performance Standards:

- PS1 - Social and Environmental Assessment and Management System
- PS2 - Labor and Working Conditions
- PS3 - Pollution Prevention and Abatement
- PS4 – Community Health, Safety and Security

There are no issues related to land acquisition and involuntary resettlement, and no impact on indigenous people or cultural property under the project, nor is it expected to have any impacts on natural habitats, forests, or protected or sensitive areas.
 
One major pillar of the company’s operations is collection of milk from the farmers / families at the village level. The company has developed an extensive network of extension services in the surrounding areas. One key feature of this supply chain development effort is the establishment of a network of village level collection centers, bulk coolers and chilling centers.
 
The extension services currently focus on increasing the communities’ awareness/knowledge about the dairy related aspects, but the company has plans to expand this to other areas for the welfare of these communities.
 
As a part of its corporate social responsibility (CSR), the company has promised to plan and implement some awareness programs related to community health (e.g. HIV AIDS), general hygiene etc. leveraging this network of milk collection centers at village levels.

For all such aspects of community engagement, the company has agreed to develop to IFC’s satisfaction any further procedures needed to comply with IFC Performance Standards, including disclosure of relevant facts to community members regarding the company operations, and provision for handling and resolving queries or grievances received from community members.
 

Bio-fuel from Algae

In the context of climactic changes and of soaring prices for a barrel of petroleum, biofuels are now being presented as a renewable energy alternative. Presently, research is being done on microscopic algae which are particularly rich in oils and whose yield per hectare is considerably higher than that of sunflower or rapeseed. At the industrial level, bioreactors which use microalgae to trap CO2 and NOx are in active development in the United States.
Algae farming for oil is the next biggest opportunity for Biofuel industry. Algae  like corn, soybeans, sugar cane and other plants (like Jatropha), use photosynthesis to convert solar energy into chemical energy. They store this energy in the form of oils, carbohydrates, proteins, etc. The plant oil is converted to Biodiesel. Hence Biodiesel is a form of solar energy. The more efficient a particular plant is at converting that solar energy into chemical energy, the better it is from a biodiesel perspective. Among the most photo synthetically efficient plants on this earth are various types of algae.
The vision of Solix Biofuels is to unlock the complex secrets of one of the simplest organisms on Earth, microalgae, to create a commercially viable biofuel that will play a vital role in solving climate change and petroleum scarcity, without competing with global food supply.
 
Because algae can grow so fast, such farms are expected to yield much more energy per acre than other biofuels. “If algae are shown to be a cost-effective way” to reduce carbon footprints, notes Berzin, “the power industry will become a gorilla pushing algae forward.” That’s not likely: GreenFuel’s main research collaborators so far are electric utilities.
Existing biofuels are primarily made from food crops, such as corn and soybeans. U.S. production of corn ethanol, buoyed by federal subsidies, has soared from 1.6 billion gallons in 2000 to 6.5 billion last year. Its explosive growth has demonstrated biofuels’ gusher potential. Of course, given recent oil prices, they may well be the locus of the next bubble, and there is clearly a backlash brewing. But biofuels that are not derived from food crops, such as cellulosic ethanol made from switchgrass, could be a major new source of transportation fuel. Think, said a McKinsey analyst last year, of its reaching Saudi-oilfield proportions by 2020.
Algae-energy research
In a move that galvanized biofuels entrepreneurs, the federal Defense Advanced Research Projects Agency (DARPA) in November launched a major research program to enable the cost-competitive production of military jet fuel from both cellulosic and algal feedstocks. The director of the program, Douglas Kirkpatrick, says he thinks major questions about algal fuels’ technical feasibility will be answered in “the next three to five years.”
That sounds about right: Algae-energy research is bubbling with new ideas and talent and is beginning to get backing from venture capital. “In the past the money in this area went only to academics,” says Matt Caspari, CEO of Aurora BioFuels in Alameda, Calif. “Now it’s reaching entrepreneurs who are applying technologies that didn’t exist ten or 15 years ago.”
Two-year-old Aurora is developing biodiesel from oil-rich algae cultivated in labs at the University of California at Berkeley. Solazyme, a South San Francisco biotech, is working to develop algae that produce more gallons of biodiesel per acre. And several players, including Kent SeaTech (San Diego), A2BE Carbon Capture (Boulder), and LiveFuels (Menlo Park, Calif.), plan to combine aquaculture with algae farms.
Some species of algae are so rich in oil that it accounts for over 50% of their mass. NREL has selected approximately 300 species of algae, as varied as the diatoms (genera Amphora, Cymbella, Nitzschia, etc.) and green algae (genera Chlorella in particular). These samples are stored at the Marine Bioproducts Engineering Center (MarBEC), where they are put at the disposition of researchers from around the world. Both fresh-water and salt-water algae,
Particularly rich in oils, were selected. Molecular biology technology is used to optimize the production of algae lipids, as well as their photosynthetic yield. Other species, capable of synthesizing hydrogen, are also the object of research.

What’s cooking with coal ??

Coal prices inevitably impact the fortunes of sectors ranging from power to steel. A look at the possible effects.

Reams have been written about rising crude oil prices and its ramifications on our lives. Amidst the hullabaloo, most of us have not noticed that the price of another important fuel has gone up sharply too––coal. Those interested in commodities would know that Big Sandy Barge coal is now trading at $105 dollars per short tonne. It was just $50 dollars in September 2007!

If the doubling of crude oil prices happened in one year, it took coal prices just nine months flat to do the same. Coal’s importance lies in its role in generating power. Being a widely-used fuel in industry, coal prices inevitably impact the fortunes of sectors ranging from cement to steel. What could be the possible effects of rising coal prices?

Why the rise

 The reasons behind the price rise range from increasing demand from thermal power plants, the spiralling prices of crude oil and supply-side issues created by poor infrastructure to demand from developing economies.

Rapid economic growth, primarily in China and India, will push global demand for benchmark steam coal up to 800 million tonnes a year in 2009, from 589 million tonnes in 2007, coal information provider, McCloskey Group, has forecast.

Reports also suggest that the availability of coal will remain limited over the long-term. This is because the coal export market has seen a transition driven by China, Indonesia, and Vietnam — which are exporting less coal than in 2007. Key exporter South Africa is expected to follow suit to meet domestic demand.

Effect on earnings

 Coal is supposed to remain the backbone of global energy supply for the next quarter of a century, according to experts. Among the sectors that may be directly impacted by constraints on coal availability would be metals, power-generation and cement.

Coal is mainly available in two types, thermal and coking varieties. While thermal coal - the more expensive one - is used by power plants, the coking variety is chiefly used as one of the inputs by steel and cement companies.

Steel companies: They in particular have much to fear from the rise in coal prices. For example, Steel Authority of India Ltd (SAIL) could end up paying more for imported coal now. In the absence of long-term contracts which could have saved costs, some companies will have no other option than to pay up more.

Reports suggest that high-grade coking coal prices have gone up to about $300 a tonne, against $95 a tonne a year-and-a-half ago. Rise in input prices could escalate costs, bringing down margins, if these companies are unable to pass on the hike to consumers.

Earlier this month, the government persuaded steel makers to roll back price hikes in a desperate bid to control inflation. However, companies such as Tata Steel may be able to handle coal shortage better, since they have stakes in coal mines abroad.

Cement companies: Firming coal prices have cemented more worries in the board-rooms of cement makers. The manufacturers are in a fix due to skyrocketing coal prices, which is pushing up the production cost. Cement companies face an additional hurdle: The Government is determined to bring down cement prices. Cement companies use permits to get coal domestically. While Coal India has recently cut the quantum of coal to be allocated to an individual company, coal prices have also been increased three times last year by major suppliers.

Thus, to counter the supply shortage cement companies are trying to opt for the costlier-by-the-minute ‘imported coal’. Since power costs account for a substantial portion of cost of cement, profitability may come under pressure, in the absence of any relief on the price-front.

Power companies: The latest price spikes might also put question marks on the profitability of power generation companies. Ultra-mega thermal stations operating on imported/domestic coal could face pressure as they are not allowed flexibility on tariffs. For companies such as NTPC which plan to import several million tonnes of coal in 2008-09, costs could swell.

The silver lining seems to be an assurance from the Coal Ministry that it will not increase prices this year. The power sector accounts for 75 per cent of the total coal demand.

But if coal demand from power generation companies outstrips domestic supply, they too will be sucked into the vortex of imported coal — prices of which show no signs of calming down soon.

Oxford Analytica: Is Another Depression On The Cards?

The boom/bust cycle in asset prices typifies the present downturn, as it did the Great Depression. This has led to suggestions that the world economy could operate far below capacity (i.e., with high unemployment) for an extended period–as it did in the 1930s.
Key characteristics of the current business cycle are reminiscent of the Great Depression (1929-1933):
 
Credit flows and asset prices. Today, the centrality of credit flows and asset prices is fueling interest in the “Austrian school” approach to the business cycle, which emphasizes difficulties inherent in unwinding credit-driven asset price bubbles:
 
– Asset locus. Both the current credit crisis and Great Depression saw U.S. debt to income levels deviate significantly from long-term averages, driving up asset prices and leading to a “mean reversion” entailing significant asset-price reversals.
 
– Boom/bust. The bust followed a long period of favorable conditions for asset-price bubbles. Low inflation allowed the Fed to keep interest rates low in the 1920s. Indeed, it relaxed policy during the 1928-1929 stock market boom, drawing criticism that it was fueling stock market exuberance. (It also reduced the discount rate in an effort to ease pressure on the U.K. external account to help the Bank of England adhere to the gold standard.)
 
Financial shock. During both periods, the key disturbance was to the financial system, originating from disturbances elsewhere, that is:
–the stock market crash in the inter-war episode; and
–the subprime crisis in the current episode.
This contrasts with most post-war recessions, where inflation played the key role:
–Monetary tightening dented the real economy as higher interest rates depressed aggregate demand.
–Casualties in the banking system were secondary, and easily contained–even the 1980s savings-and-loan crisis came in the aftermath of recession, rather than preceding it.
Emergency response. A further parallel entails crisis management:
 
– Inter-war. The emergence of the Fed in 1912 confused the response to financial crisis. The private sector’s own crisis-management mechanisms (”banking holidays” organized through clearinghouses) were not triggered after the 1929 stock market collapse and subsequent bank runs, in deference to the new central bank.
 
Yet the Fed viewed crisis management–i.e., liquidity provision–as incompatible with its mandate to keep the currency convertible into gold, and failed to fulfill its role as lender of last resort to the banking system. The modern consensus is that this failure turned a downturn into the Great Depression.
 
– Today. The Fed today is under no such restraint. Yet crisis management in the financial sector is in similarly uncharted territory–in the “shadow banking” sector in particular (i.e., the non-bank financial institutions with short-term liabilities and long-term assets, such as hedge funds or structured investment vehicles).
 
Best responses to the current credit market seizure might become clear only after the fact, when more moderate responses have been proved inadequate. One example is public purchase of private assets such as subprime mortgage-backed securities. Even if this proves necessary to restore financial intermediation, it will probably not be exercised until lesser remedies fail–at considerable pain to the economy.
 
Silver lining? Overshadowed in historical recollection by the Great Depression and Second World War, the late 1930s saw a dramatic U.S. recession that had the makings of another global depression. Yet the sharp U.S. downturn, which itself was quickly reversed, did not badly affect the world economy. Parallels with today are striking:
 
“Decoupling.” The 1937 episode provides the only antecedent for the “decoupling” hypothesis of today’s emerging markets. The emerging markets of that era were net international creditors–as they are today, and have not been at any time in between. Their huge stores of foreign reserves allowed them to sustain domestic demand even as export receipts temporarily tailed off.
 
Currency pegs. That era’s emerging markets were known as the sterling bloc, a group of net exporters whose currencies were faithfully pegged to sterling. In fact, today’s East Asian exchange-rate arrangements are far more similar to the sterling bloc’s than Bretton Woods, to which they are frequently likened. In both cases, pegs were de facto, consensual and unilateral, rather than internationally obliged, as under Bretton Woods.

Commodities Prices: Speculation Exposed

That was a nice dip yesterday!

We were so well covered that we spent the day in member chat discussing World Hunger as we ho-hummed the sell-off, but we did get a little bullish towards the end of the day and started picking off some callers, looking for at least a bounce in the morning but willing to roll down or add to some of our stronger long positions.

Is India Vulnerable Or Resilient?

So far, 2008 has been an extremely challenging year. The deterioration in the global macro-environment and consequent rise in risk aversion and spreads has resulted in increasing volatility across all asset classes.
 
India too has not been immune to global developments with the equity markets down 16% from their peaks, bond yields edging closer to 8% from 7.5% levels earlier , and the currency depreciating by 3% to Rs40.5/US$ levels.
 
And, as we have explained in an earlier note
1, during times of volatility, it is countries with high twin deficits that are viewed as most susceptible to changes in global risk appetite.
 
India’s CAD to widen to near 1991 levels:
Oil prices at record highs and the fact that India imports close to 70% of its crude oil requirement, coupled with a slowdown in export growth to 14% levels from 20%+ seen earlier, will likely result in the trade deficit widening to US$115bn.
 
As a result, despite buoyant invisibles (software exports and remittances), India’s CAD would widen to US$36.7bn or 2.8% of GDP, up from 1.2% of GDP in FY08. A deceleration in capital flows in the current environment poses further risks to the external account.
 
Off balance sheet items hide the true fiscal picture:
 
India’s fiscal situation, which had been a steadily improving trend, appears to have taken a turn for the worse. While the ‘printed’ number is targeting a combined fiscal deficit of under 6% of GDP for FY09, given the various off-balance sheet items, the true deficit would trend close to 8%. India’s high deficit leaves limited fiscal space for policy maneuvers and at times is a deterrent for capital inflows.
 
India: Resilient or Vulnerable? Analyzing the Evidence
 
So, how vulnerable is India? Following the methodology adopted by our CEEMEA economics team in a series of notes
2, we assess India’s external vulnerability by measuring its dependence on capital inflows by using a ratio of the CAD and external debt amortization divided by the existing stock of FX reserves.
 
Besides the dependence on capital flows, it is also important to try and measure the speed at which money can go out. Coupling our previous analysis of key parameters to these variables, we re-visit the issue of India’s external vulnerability.
 
In terms of dependence on capital flows, India fares pretty well compared to most economies running current account deficits. Moreover, if one looks at possible outflows, cumulative portfolio flows since FY91 are US$64bn, with the current market value of FII holdings estimated at US$258bn.
 
Taking into account non-resident Indian deposits - the other element besides FII flows commonly defined as ‘hot money’, we believe the current level of forex reserves will be able to offset volatility in the interest rate and rupee markets.

The Glittering Run For Gold Is Over !

Gold has benefited from dollar strength and investor and speculator buying
due to fears of stagflation and the impact of the credit crunch. We forecast
that gold will fall over the next two years to levels better supported by
jewellery demand.
 
We forecast that gold will average $851/oz in 2008, higher than our previous forecast due to the better than expected Q1-08 outcome. Our forecast of $750/oz for 2009 is unchanged.
 
The consensus forecast is for gold to average $862.30/oz according to the LBMA forecast 2008 publication.
 
Performance
Speculative and investment buying resulted in gold trading sharply higher in January and February, breaking the previous all-time high of $850/oz in the first real trading day of 2008 and then going on to set records, culminating in a new all-time high of $1030/oz.
 
But gold could not hold onto these lofty levels and slipped back to trade down to $874/oz. After a bounce to just above $950/oz in
April, the metal has succumbed to more widespread profit taking and is trading around $880/oz at the time of writing.
 
In the absence of the unusually strong safe-haven buying of gold we believe gold would be trading near $700/oz and the metal is vulnerable to a further correction.
 
Demand environment
The first three months of 2008 saw very poor jewellery demand as gold moved sharply higher with our sales desks report jewellery demand of 5-15% of the levels we consider strong. The sell-off in gold in late March has seen some recovery but demand remains much lighter than normal for the time of the year and this leaves the metal vulnerable to further profit taking.
 
ETF investors bought only 2.0 million ounces of gold in the first quarter of 2008, disappointing considering the very strong performance of gold. Net redemptions have occurred since then and as at 24 April, total ETF positions stood only 600koz higher than on December 31
st with 1.6moz of redemptions between 22 and 24 April.
 
US futures market gold investors held large spec long positions through the first ten weeks of 2008 before liquidating some of their holdings in late March and April.
 
Supply environment
GFMS report that gold production fell by 0.4% in 2007 to 2,476t as mining companies struggle to maintain existing production and are failing to find new mines to expand. We expect gold supply will remain under pressure in 2008, not least because of the power and other production problems faced by the South African mining industry, discussed in more detail in the introduction to the precious metals section.
 
Our refinery contacts and physical sales desks in Switzerland report a surge in the sale of scrap gold coming back to the market with the gold price at such elevated levels. This is reducing the jewellery industry¡¯s net demand for gold.
 
Gold mining de-hedging continued at a rapid pace in 2007 according to GFMS, which estimates the net hedgebook declined by a record 446t. The remnant of the global hedgebook is now small to GFMS and increasingly concentrated in a only a few mining companies. We expect the rate of producer de-hedging to slow in 2008, but we have said that every year for the past few years and have been surprised by aggressive buy-backs each year.
 
Central banks remain net sellers of gold, disposing of a total of 481t in 2007, more than the 370t sold in 2006. The vast majority of the sales in both years came from the signatories of the Central Bank Gold Agreement (CBGA) with Spain and Switzerland the most interesting sellers. Spanish sales increased sharply in 2007 while Switzerland, a large seller under the first CBGA, restarted sales due to the high gold price, which had increased gold¡¯s proportion of its total reserves.
 
Some small central bank buying was noted in 2007 including
Qatar and Russia, although most large central banks that have small gold holdings remained sidelined.
 
News-flow to watch for
The quarterly results of the gold miners with hedgebooks ¨C including
AngloGoldAshanti, Barrick and Newcrest ¨C for signs of further de-hedging.
 
Weekly COTR data from the CFTC and daily open interest figures from
TOCOM are useful measures of visible speculative positioning.
 
Quarterly supply and demand reports from the World Gold Council.

Is Thermal Coal The New Oil

Given the apparent energy variance between Coal and Crude, and providing for that inefficiency, the spot price of Coal has the potential to rise upto $ 160 per tonne against 2008 supply contracts of $ 125 per tonne. A near 30 per cent upside hereon.
 
While investors live under the impression that Coal prices will drop over 2009-2012, the chances are that supplies from new mines in Australia and Indonesia will be dedicated to Indian Thermal Power Plants where close to $ 100 bn will be spent over the next 5 years.
 
Indian investors might do well to pick out the listed Coal miners in the country and build long term positions in those stocks, in anticipation of a Super-Spike in Crude prices. This is of significance because while Oil reserves globally will not stretch beyond 25 years, Coal would and most thermal plants globally would then be striving for Coal which too would be diminishing being a finite asset for Earth.
 
 
We continue to view the thermal coal market has having some of the
strongest fundamentals in the commodities space. Demand in the developing countries remains very strong and inelastic.
 
Supply on the other hand has been hobbled by infrastructure constraints, weather problems and strong domestic demand from exporter nations resulting in a significant deceleration and in some cases contraction in export levels.
 
2008 contracts were recently settled at US$125/t; we believe that there is upside risk to our 2009E contract forecast of US$125/t.
 
Spot prices for thermal coal in both the Australian and South African markets have been exceptionally volatile over the past quarter, leading many utility analysts around the global to rush back to their models.
 
Following the Chinese power crisis in February which pushed Newcastle coal prices over US$140/t, the central government moved to prioritise shipments of thermal coal from minesite to the coastal utilities. The rebuild of inventories was very rapid (more so than
what we were expecting) and this resulted in some slack entering into the market.
 
Consequently NWC prices fell back to the US$120/t level.
 
2008 contract settled at US$125/t
 
Xstrata settled 2008 contracts at US$125/t; this was pretty much in-line with our forecast of US$130/t. We also believe Rio Tinto may have settled at this level.
 
We currently forecast contract pricing for 2009 at US$125/t; however we believe that there may be upside risk to this forecast given continued supply-side problems globally, but specifically we believe that the Chinese power issues which emerged early this year was in fact a consequence of a chronic infrastructure bottleneck rather than solely a function of adverse winter weather.
 
Availability to remain poor over the long-term
In 2007 the key issue for the thermal coal market was the transition of China, from its position as a once significant exporter of thermal coal into the seaborne market to one where the country was a net import.
 
This inflection point, combined with a significant deceleration of Indonesian export growth, from an estimated 36% in 2006 to roughly 10% in 2007 in addition to a deceleration in Vietnamese export growth from 76% in 2006 to 10% in 2007 resulted in the emergence of substantial tightness in the seaborne thermal coal market.
 
Coal stocks in China falling again＃
According to InterFax coal stockpiles in China have ＆plummeted＊ from March＊s level; and some power plants are facing limited supplies. The SERC indicated at a recent press conference that total coal stockpiled in key power plants dropped to about 47mt at 20 April from 53mt at the beginning of March.
 
Small mine closure: Some coal industry analysts within China suggest that the problem is the fact that the government has forced many small-scale coal mines to close over the past year (for safety and efficiency issues)
 
Lack of cashflow: According to the head of the Shanxi Electric Power
Assoc; 70% of thermal power plants across China have suffered operational losses in Q1 08; with prices up 160% y/y. He has indicated that some power plants are not securing sufficient cash flow to source enough coal for power generation.
 
Infrastructure: We believe that the above conditions, in addition to
insufficient transport capacity, rail/road and shipping, are responsible for the squeeze in Chinese thermal coal markets.
 
There are risks of further power shortages this summer in China as the country enters into is peak power consuming period.
 
We expect that if conditions in fact worsen the Chinese government will, once again, be forced to intervene, possible steps include;
 
1) Mandate sufficient coal supplies to utilities by prioritising shipments
from mine-site to the southern, coastal utilities.
2) Restricting further export quotas
3) Re-opening smaller mines; although this doesn＊t solve the problem of getting the coal to the consumer.
 
News-flow to watch for
←
Conclusion of Japanese contract negotiations
←
China 每 end-of-month trade statistics (imports, domestic production)

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.