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Market Analysis Report, Group E1

MARKET ANALYSIS REPORT OF THE ASIAN HCC COAL MARKET

1. Market Definition
The purpose of this report is to analyze the seaborne Hard Coking Coal
market in the Asian Pacific Region.

The coal market can be segmented into two: coal for steel production
‘coking coal’ and coal for power generation ‘steaming coal’. Coking coal is
classified into three types, Hard Coking Coal (HCC), Semi-Soft Coking Coal
(SS), and Pulverized Coal Injection (PCI). Each type has an independent
market because each type has different characteristics (for example, only
HCC swells when heated). This report focuses on HCC. The HCC coal market
satisfies the ‘SSNIP’ test as due to the specific characteristics of HCC coal,
even a significant price change would not cause end-users to switch to other
types of coal.

In countries such as the U.S., China and Russia, most of the coal produced is
consumed domestically. However, the seaborne market is important for
resource poor countries such as Japan, South Korea and India. This report
focuses on the biggest seaborne coal market, the Asian Pacific market:

Seaborne Coal Demand 2009-2025 (Source: Wood Mackenzie – Metallurgical Trade June 2009)
Market Analysis Report, Group E1

Suppliers
Although the market is fragmented into five major suppliers, in essence the
structure appears monopolistic as BHP controls a market share double that
of its biggest competitor (see below) and more importantly has access to the
largest and best quality resources. As such BHP is essentially a price maker
for HCC.

Market suppliers:

Source : Xstrata Annual Report 2008 and Wood Makenzie

Buyers
As HCC is used for steel production, buyers of HCC are the major steel mills:
2008 Main Operations
Rank Million Company
tonnes
1 103.3 ArcelorMittal Global

2 37.5 Nippon Steel1 Japan

3 35.4 Baosteel Group China


4 34.7 POSCO Korea
5 33.3 Hebei Steel Group China

6 33 JFE Japan
7 27.7 Wuhan Steel Group China

8 24.4 Tata Steel2 India

9 23.3 Jiangsu Shagang China


Group
10 23.2 U.S. Steel U.S
Market Analysis Report, Group E1

Source : World Steel Association

Prices and Demand


HCC prices had been near cost until early 2003 due to plentiful supply.
However, with the growth of India and China, demand for HCC has expanded
faster than supply, increasing prices:

Source: Sumitomo Corp.

Cost Curve of Hard Coking Coal in 2009


Market Analysis Report, Group E1

2. Industry Cost Structure


A typical cost structure for a HCC mine is given below:
  Oaky Creek No. 1
Underground Operation

  US$milli Fixed/Variable
on
Labor 23 Fixed
Repair 9.6 Variable
Consumables 6.1 Variable
Energy 2.5 Variable
Processing Cost 3.6 Variable
Sales and Distribution 34.4 Fixed
Depreciation 8.4 Fixed
Sum 87.6
Fixed Ratio 75%

Source: Oaky Creek JV Report – Sept. 09

Fixed Cost and Variable Cost


Fixed costs are extremely high. Costs which are normally variable such as
fuel, labor and transport are also fixed costs for many mines. Firstly, for
underground coal mines, once mining has started, it cannot be stopped due
to technical reasons regardless of the price of coal or the cost1. Thus, costs
such as fuel become fixed in the medium term. Secondly, labor unions tend
to be strong at coal mines, thus restricting head count reductions 2. Thirdly,
transport costs are fixed costs at most coal mines due to take-or-pay
contracts with rail and port companies.

Sunk Costs
In coal mines, sunk costs comprise; mine feasibility analysis costs,
construction costs such as box cutting and construction of accommodation
for the miners.

Entry Costs
Entry costs to the HCC market are high mainly due to lack of HCC reserves
and of access to existing infrastructures. For example, the current estimated
cost of developing the Wandoan Site in Australia is estimated to exceed

1
Sumitomo Coal Australia Pty Ltd.
2
Oaky Creek Monthly Management Report December 2008, published by Xstrata
plc.
Market Analysis Report, Group E1

US$4billion, which mainly composed of rail and port construction cost. 3

Scale Economies
Due to the significant level of fixed costs in a coal mine, an increase in
production significantly decreases fixed costs per unit. However, scale
economies are limited by the size of each mine. If a mine is expanded to
mine poorer quality deposits or mine conditions, which require more work to
produce or mine HCC, diseconomies of scale can occur.

Learning Economies
Productivity increases as the geological characteristics of the mine become
clearer. By learning more about the geology of the mine, mining companies
can mine more effectively.

Influence of cost structure on firm’s opportunities and threats


Opportunities
As entry costs are extremely high, barriers to entry in the market are high.
Barriers to entry are reinforced by the limited amount of physical HCC
resources globally. Thus the threat of new entrants is low and BHP can
retain the monopoly structure.

Threats
The very high fixed cost base for the industry makes the main players
vulnerable to a sharp fall in demand. In the event of a fall in demand, firms
may find that their marginal revenue is greater than marginal variable cost
but significantly less than marginal total cost. This would make firms loss-
making in the short to medium term until enough industry wide capacity was
closed to restore the industry to profitability. However, given strong growth
in demand currently, this scenario does not look likely to occur.

3. Demand

3
Wandoan Coal Mine Development Project Conceptual Study, 2008.
Market Analysis Report, Group E1

Demand Drivers
The demand for HCC coal is significantly influenced by the demand for high
quality steel as HCC is currently essential to the production of high quality
steel. The underlying drivers are demand for cars and skyscrapers, which
require high quality steel.

Another driver of demand for HCC is the demand for steel in general,
including high and low quality steel. Increasing the proportion of HCC used
to make low quality steel increases the unit cost but also increase
productivity. When the demand of steel is high, steel makers usually try to
achieve higher productivity despite the increase in variable costs4.

The specification of coal mined from a particular mine differs from that of
others. Each buyer has his own recipe for cokes, using more than 10
different types of coking coal. Because of this, buyers cannot buy on the
spot market and must enter into annual supply contracts with suppliers in
order to ensure they receive the correct recipe coking coal. This reduces the
price sensitivity of buyers5.

Influence of demand drivers on firm’s opportunities and threats


Opportunities
As there are no substitutes for HCC coal in the high quality steel
manufacturing process at present, this gives the firms in the market
significant market power.

Threats
The underlying demand drivers are mainly in highly cyclical industries such
as construction and the automotive industry. Thus demand for steel is
highly exposed to any economic downturn.

4
Interview with Nippon Steel on 12th November 2009.
5
Interview with Nippon Steel on 12th November 2009.
Market Analysis Report, Group E1

4. Competitive Situation
Key elements of costs
As we have discussed above, the huge upfront costs required to build a coal
mine constitute significant barriers to entry and make the entry of new
players unlikely. This allows the market to remain profitable.

The role of pricing rivalry


Due to the monopoly structure of the market, pricing rivalry is not a feature
of this market.

The attractiveness of market and threat of entrants


As the barriers to entry are high and the use of HCC is the only way to
produce high-quality steel, the HCC market is very profitable for exiting
players. In addition, the demand of HCC is increasing with the growth of
emerging markets, which should ensure future profitability for this market.

5. Prospect of profitability
The prospects for the profitability of the HCC market are bright as long as the
reserves of HCC last. First, supply is limited. Reserves are finite and the
entrance barriers to the market are very high. Second, demand is growing.
As long as high quality steel is in demand, steel producers need to keep on
buying HCC and with the growth of developing countries, the demand for
high quality steel is on an upward trajectory.
Market Analysis Report, Group E1

Appendix I
Reference List of all sources

Due to the lack of published information on this very specialized market, the
seaborne Asian Pacific HCC coal market, we had to rely on a variety of
information sources:

Interviews:
Interview with Nippon Steel on 12th of November
Interview with Sumitomo Coal Australia on 11th of November
Interview with Sumitomo Corporation on 11th of November

Published Information:
Oaky Creek Coal Monthly Management Report December 2008
Oaky Creek JV Report – Sept 09
Wandoan Coal Mine Development Project Conceptual Study, 2008.
Wood Mackenzie – Metallurgical Trade, June 2009
Xstrata Annual Report 2008
Sumitomo Annual Report 2008
World Steel Association (URL : http://www.worldsteel.org)
Morgan Stanley - Iron Ore and Coal Industries Update, March 2008
Japan Coal Development Co. Ltd – The basic knowledge of
Coal(Japanese Book), Oct, 2008
Committee of Overseas Iron and Steel Raw Materials – The Companion
of Mineral Resources (Japanese Book), December 1994

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