Australian floods

IMPACT ANALYSIS
Australian floods to impact steel industry;
marginal impact on shipping, power

Summary Contents

The flooding in Australia has severely hit mining Sections

operations constraining the supply of coal, key raw
material in steel and power sectors.
Consequently, CRISIL Research expects a temporary
spike in coal prices hitting the profitability of non-
integrated steel players by 400-500 bps during the April-
June 2011 quarter.
CRISIL Research believes that the impact on power and
shipping sectors will be marginal due to limited
dependence of domestic utilities on imported coal and
limited exposure of the Indian shipping players to the dry
bulk market, respectively.
Floods in Australia to escalate spot coking
coal prices in first quarter 2011 2
No impact on iron ore supply 3
Margins of non-integrated steel players to
decline in first quarter 2011-12 (q-o-q) 3
Pressure in dry bulk market aggravated due to
floods in Australia 3
Non-coking coal price spike to be short-lived; negligible
impact on domestic power utilities 4

Figures

Baltic Dry Index (Jan 2006 - Jan 7, 2011) 4

Baltic Dry Index (Dec 2010 - Jan 7, 2011) 4

January 2011
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Supply disruption will impact coal, steel, shipping and power

Sector Impact of Australian floods

Coking Coal Yes

Iron ore No

Steel Yes

Power Marginal

Shipping Marginal

• The flooding in Australia has severely hit mining operations, particularly in Queensland, which accounts
for about 50 per cent of the world’s coking coal trade. CRISIL Research estimates an output loss of 10-12
million metric tonnes (mt) over the December 2010 to March 2011 period leading to a spike in spot prices. We
expect prices to increase by 19 per cent from the fourth quarter of 2010 levels averaging at $280-290/mt in the
first quarter (January-March) of 2011. However, we expect prices to moderate thereafter averaging at $250-
260/mt in 2011.

• The rise in spot prices is likely to result in higher contract prices of $260-270/mt for the April-June 2011
quarter, which will affect the profitability of steel players during the April-June 2011 quarter. We expect the
profitability of non-integrated steel players to decline by 400-500 bps q-o-q during April-June 2011.

• The supply of Australian iron ore reserves are not likely to be affected as major mines are located away
from the flood impacted area.

• For the shipping and power sectors, the impact will be relatively lower;
o The Baltic Dry Index (BDI) has seen a steep 27 per cent decline in the last 1 month due to the
Australian flooding. CRISIL Research believes that the current fall in BDI would have a marginally
negative impact on the profitability of Indian shipping players in the fourth quarter of 2010-11 due to
higher exposure to the tanker segment.

o CRISIL Research expects the price rise in non-coking coal to be a short-lived phenomenon and
estimates the temporary surge in prices to have a negligible impact on domestic power tariffs due to
limited dependence of domestic utilities on imported coal in general, and spot purchases in particular.

• Our outlook factors in a return to normal weather conditions after the January-March period. Prolonged bad
weather thereafter could result in further upside to our forecast prices.

CRISIL RESEARCH AUSTRALIAN FLOODS IMPACT ANALYSIS, JANUARY 2011 1

Australia: Flood affected regions

Source: CRISIL Research

Floods in Australia to escalate spot coking coal prices in first quarter 2011
The ongoing floods in Australia caused by La Nina weather events has severely hit mining operations in eastern
Australia forcing most major mining companies, including Peabody, Macarthur Coal, and Xstrata, to invoke force
majeure clauses. Queensland, which accounts for about 80 per cent of Australia’s coking coal exports, has been
the worst affected state while New South Wales has been affected to a lesser extent. With over 60 vessels
estimated to be waiting to load coal off the Dalrymple Bay, delivery backlogs are expected to take several weeks
to clear. The impact on Queensland is particularly significant as the state leads the production of coking coal, a
commodity in which Australian exports comprise about 60-65 per cent of world trade and about 85 per cent of
Indian imports.

The Australian Bureau of Meteorology has forecast the La Nina weather events to persist in the January to March
period. During this period, the agency predicts a 60-70 per cent chance of above median rainfall across the eastern
half of New South Wales and southeastern Queensland. With supply bottlenecks expected to persist through the
first quarter of 2011, we expect total output loss in the range of 10-12 mt (equivalent to 2 weeks of world coking
coal trade). This will cause a spike in spot prices averaging at $280-290/mt in the first quarter of 2011 – an
increase of about 27 per cent from the fourth quarter of 2010 levels. We expect production to gradually pick up
through the subsequent quarters, which will, to an extent, compensate for the first quarter output losses. Prices are
expected to moderate over the subsequent three quarters as supply firms up, resulting in a full year average price

2 CRISIL RESEARCH AUSTRALIAN FLOODS IMPACT ANALYSIS, JANUARY 2011

of $250-260/mt for 2011 compared to $221/mt in 2010.
Our outlook factors in a return to normal weather conditions after the January-March period. Prolonged bad
weather thereafter could result in further upside to our forecast prices.

No impact on iron ore supply

Iron ore supplies from Australia are not expected to be impacted, as a majority of the Australian iron ore mines
are located in the Pilbara region in West Australia, which is not affected by the floods.

Margins of non-integrated steel players to decline by 400-500 bps in first quarter

2011-12 (q-o-q)
CRISIL Research expects the likely spike in coking coal prices in the spot market to escalate contract prices for
the April-June 2011 quarter. Contract prices are expected to rise to $260-270 per tonne for the April-June 2011
quarter, which will affect steel player profitability during April-June 2011.

Coking coal accounts for 40-45 per cent of the raw material cost of a non-integrated Indian steel player. Around
60 per cent of India’s coking coal requirement is imported. During the January-March 2011 quarter, owing to the
force majeure declared by many Australian miners, some of the players might not receive the shipments at pre-
agreed contract prices of $225 (January-March 2011). These players would have to source their coking coal
requirements at spot rates, which are expected to be significantly higher than the prevailing contract prices, thus
exerting pressure on their profitability. In the event of a prolonged delay in the recovery of Queensland’s coal
export infrastructure, the impact could worsen in the subsequent quarters.

While the steel prices are expected to rise through January to June 2011, the impact of rising coking coal prices
will be lower in the current quarter and will be largely felt between April to June 2011. This will result in
improved profitability of steel players during the January-March 2011 quarter over the October-December 2010
quarter followed by a fall in margins during the April-June 2011 quarter. Accordingly, CRISIL Research expects
the profitability of non-integrated steel players to improve by 200-300 bps q-o-q for January-March 2011 and
decline thereafter by 400-500 bps q-o-q during April-June 2011. Integrated steel players would benefit from
higher steel prices and their profitability is expected to improve by 350-450 bps q-o-q for January-March 2011
and remain stable during April-June 2011 due to relatively lower dependence on coking coal imports.

Pressure in dry bulk market aggravated due to floods in Australia

The BDI has seen a steep decline in the last 1 month with the index falling from 2,096 on December 1, 2010 to
1,519 on January 7, 2011 due to bad weather conditions and flooding in Queensland, Australia, which has
impacted the coal cargo movement. As a result over 60 ships are awaiting cargo near ports in Queensland – the
primary coal exporting region of Australia. Consequently, there is a short-term pressure on global dry bulk freight
rates. In 2009, Australia exported 139 mt of thermal coal (19 per cent of world thermal coal trade) and 135 mt of
coking coal (60-65 per cent of world coking coal trade).

CRISIL Research believes the BDI will bounce back from the prevailing lows once the situation in Australia
normalises and coal shipping resumes from Australian ports. The current fall in BDI would have a marginally
negative impact on profitability in the fourth quarter of 2010-11 for Indian shipping players like GE Shipping,
Shipping Corporation of India and Mercator Shipping, who have exposure to the spot market in dry bulk segment.
However, the persistent weakness in the dry bulk market is expected to continue independent of the impact of
Australian floods due to continuous fleet addition in this segment. In 2010, about 67 million dwt (close to 13 per

CRISIL RESEARCH AUSTRALIAN FLOODS IMPACT ANALYSIS, JANUARY 2011 3

cent) was added to the existing fleet.

Baltic Dry Index (Jan 2006 - Jan 7, 2011) Baltic Dry Index (Dec 2010 - Jan 7, 2011)
14000 2300
Record capacity
11793 ut ilization levels 2200
12000 10853 2173

2100 2076
10000 2096
Huge addit ion of
new f leet 2000
8000
6395 1900 1886
6000
4643 1800
5948 4106 3822
4000 1773
2438 1700
Global economic 1974
2000 slowdown 1600
2534 1519
1700 1519
663 1500
0

1-Dec

8-Dec

15-Dec

22-Dec

29-Dec

5-Jan
Source: CRISIL Research Source: CRISIL Research

Non-coking coal price spike to be short-lived; negligible impact on domestic power

utilities
The flood situation in Australia, particularly in New South Wales, coupled with severe wet weather in Indonesia
has impacted non-coking coal supplies leading to a massive spike in prices. Newcastle (Australia) coal price
witnessed an 18 per cent spike from $107/mt in November 2010 to $126/mt in December, while South African
(RBCT) prices have increased by 26 per cent rise to reach $130/mt in December, 2010.

CRISIL Research expects the sharp rise in non-coking coal prices to last only for the next 2 months (January-
February). We believe that the current rally is driven not only by supply constraints but also by increased
purchases by Japanese and Korean utilities securing fuel supply to meet peak winter demand. We expect prices to
peak in January at around $130/mt and then retreat in the second quarter as buying subsides while supply firms-
up. We expect prices to average around $114-116/mt for the full year 2011.

CRISIL Research expects the spike in prices to have a negligible impact on domestic power utilities. Import
dependence in case of non-coking coal is only about 8 per cent of India’s total consumption. Domestic reliance on
imported coal is restricted to demand from imported coal based plants and domestic coal based plants, which use
imported coal for blending to combat domestic shortfall.

The boiler design of domestic power plants typically does not support blending higher than 10-15 per cent of the
plant’s coal requirement, thereby capping their requirement. Given their limited requirement, we expect the cost
of generation of these power plants to increase only by 3-4 paise per KWh due to the current supply constraints.

Imported coal based power plants such as Adani Power’s Mundra and Tata Power’s Trombay plants comprise less
than 5 per cent of the country’s installed generation capacity. Even in case of such power plants, most players
either own coal mines in countries such as Indonesia and South Africa or hold long-term coal supply contracts,
thereby limiting the impact of any price rise on them.

4 CRISIL RESEARCH AUSTRALIAN FLOODS IMPACT ANALYSIS, JANUARY 2011

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