Market Analysis Report, Group E1

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 Rank 1 2 3 4 5 6 7 8 9 10 Million tonnes 103.3 37.5 35.4 34.7 33.3 33 27.7 24.4 23.3 23.2 Company ArcelorMittal Nippon Steel1 Baosteel Group POSCO Hebei Steel Group JFE Wuhan Steel Group Tata Steel2 Jiangsu Shagang Group U.S. Steel Global Japan China Korea China Japan China India China U.S Main Operations

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 on 23 9.6 6.1 2.5 3.6 34.4 8.4 87.6 75% Fixed/Variable Fixed Variable Variable Variable Variable Fixed Fixed

  Labor Repair Consumables Energy Processing Cost Sales and Distribution Depreciation Sum Fixed Ratio

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 2

Sumitomo Coal Australia Pty Ltd. 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. 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 lossmaking 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

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. highly exposed to any economic downturn. Thus demand for steel is

4 5

Interview with Nippon Steel on 12th November 2009. 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 : 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