13/01/2012

Managing in a Commodity World

University of Alberta
Michael O'Shaughnessy, Teck Resources Limited
Jim Popowich, Mining Guy at Large
January 2011

LTI/MAs per 200,000

Hours Worked

Teck Coal Safety Culture

Growth and Safety
5

LTI Freq

4
3
2
1
0

2.50
1.25
2005

600

MA Freq

3.33
1.96

1.61

1.97

0.95

0.62

0.57

0.41

0.28

2006

2007

2008

2009

2010

Employee Replacements

Employee Additions

1.82

Vacation Coverage

500

People

400
300
200
100
0
-100

2005

2006

2007

2008

2009

2010ytd

Growing the business and improving safety

2

Source: Teck

13/01/2012

Outline
The supply/demand fundamentals and the global picture
The fertilizer industry a case study on leading indicators
and underlying fundamentals
The met coal industry a case study on price increases
and cost pressures
DCF Examples

A look back and a look forward

13/01/2012

Challenges Facing the Resource

Sector
Global financial crisis
Has the economy recovered? Is another correction coming?
Availability of future projects
Large easy projects already found and developed
Lead time to project start, political risks, regional risks
Challenges at current operations
Resource depletion, higher strip ratios, falling head grade, longer hauls,
deeper mines
Sustainability
Water, biodiversity, energy, community, people, product stewardship,
cumulative effects, air and environment
Cost escalation and scarce raw materials
Energy, labour, equipment, tires, supply chain
Protectionism Potash Corp
What do Inco, Falconbridge, Alcan, Placer Dome, Petro Canada,
Aur Resources and Fording Trust have in common?
5

With Challenges Come Opportunities

Urbanization of 1.4 billion people expected between
2005 2025
Industrialization of emerging economies
The move to middle class, replacement vs. additional demand
Population growth
BRICS (Brazil, Russia, India, China, South East Asia)
expected to sustain high economic growth
Longer and longer and longer project lead times exasperating
supply reaction
Expansion delays brought about by the global recession in
2008 will support prices longer term

World commodity demand expected to double over

the next 15 to 20 years.
6

13/01/2012

Economics 101 The Supply

and Demand Relationship
Demand

Price

Supply

PanicBuying

Price($/unit)

Units

CostDriven
FloorPrice

UnitsAvailable
7

UnitsofProductionorConsumption

Supply, Demand and the

Commodity Cycle
Supply

Demand

Excess Supply

Supply Shortfall

Price($/UnitofProduction)

SuperCycle
Time

FloorPrice

BasedonUsualDemand
andSupplyResponse
Time

13/01/2012

The Balancing Act: What to Do

2006 the super cycle might
be real
2007 review of mines for
profitability due to CDN dollar
appreciation
2008 ramping up on record
prices
2009 how do we keep our
people employed and stay in
business
2010 back on the growth path
What do you do when it is
constantly teetering? For
volatility build flexibility

Under
supply

Over
supply

The Driving Force Global GDP

Long Term Real GDP Forecast (YoY)
9.0%
8.0%
7.0%

5.0%
4.0%
3.0%
2.0%
1.0%
0.0%
-1.0%

1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015

Real GDP (% Change Year over Year)

6.0%

-2.0%
-3.0%
-4.0%
Global

10

OECD

Developing

Source: IMF Oct/10

13/01/2012

How Increase in the Standard of

Living Affects Commodity Demand

11

Source: Rio Tinto

Commodity Super-cycle

Commodity Price Increases CPI Adjusted - US$

(Base Year 1960 = 100%)

CPI (YoY)
Potash
12

Zinc
Oil

Nickel
Coking Coal

Copper
Uranium

Aluminum
Gold

2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990

0%

1988

2%

0%

1986

4%

20%

1984

6%

40%

1982

8%

60%

1978
1980

10%

80%

1976

12%

100%

1974

14%

120%

1972

16%

140%

1970

18%

160%

1968

20%

180%

1966

22%

200%

1964

24%

220%

1962

26%

240%

1960

260%

Iron
Average

Source: USGS Mineral Information, LME, Bloomberg

14

Jul07

Jul08

Jul09

Jan11

Oct10

Jul10

Apr10

Jan10

Oct09

Jan08

Jan11

Sep10

May10

Jan10

Sep09

May09

Jan09

Sep08

Rio
Dow

Apr09

Jan09

$1,200

Oct08

$1,400

May08

$160
$140
$120
$100
$80
$60
$40
$20
$0

Apr08

Sep07

(US$/bbl)

Vale
Exxon

Jan08

Oct07

CopperPrice
May07

Jan07

Jan11

Sep10

ZincPrice

Apr07

(US$/tonne)

Jan10
May10

BHP
Potash

Jan07

Jan11

Sep10

May10

Sep09

May09

Jan09

Sep08

Teck
Barrick

Jan10

Sep09

May09

Jan09

May08

Jan08

Sep07

May07

1/2/08
1/22/08
2/11/08
3/2/08
3/22/08
4/11/08
5/1/08
5/21/08
6/10/08
6/30/08
7/20/08
8/9/08
8/29/08
9/18/08
10/8/08
10/28/08
11/17/08
12/7/08
12/27/08
1/16/09
2/5/09
2/25/09
3/17/09
4/6/09
4/26/09
5/16/09
6/5/09
6/25/09
7/15/09
8/4/09
8/24/09
9/13/09
10/3/09
10/23/09
11/12/09
12/2/09
12/22/09
1/11/10
1/31/10
2/20/10
3/12/10
4/1/10
4/21/10
5/11/10
5/31/10
6/20/10
7/10/10
7/30/10
8/19/10
9/8/10
9/28/10
10/18/10
11/7/10
11/27/10
12/17/10
1/6/11

180%

Sep08

May08

Jan08

Sep07

$4.50
$4.00
$3.50
$3.00
$2.50
$2.00
$1.50
$1.00
$0.50
$0.00
Jan07

13

May07

Jan07

(US$/lb)
$2.00
$1.80
$1.60
$1.40
$1.20
$1.00
$0.80
$0.60
$0.40
$0.20
$0.00

(US$/lb)

13/01/2012

2008 Company Share Value

Follows Commodity Prices

200%

Freeport

160%

140%

120%

100%

80%

60%

40%

20%

0%

Source: finance.yahoo.com

Have Commodity Prices Recovered?

WTIOilPrice

HRCSteelPrice

$1,000

$800

$600

$400

$200

$0

Source: CRU steel, LME, EIA

13/01/2012

An Industry under Transformation

Historical Industry Characteristics

Todays Industry Characteristics

Fragmented, local

Consolidated, global

Engineering focused with limited

shareholder return orientation

Greater capital discipline

Dominance of Global Diversified model

Poor capital discipline

Access to mainstream capital markets

Misallocation of capital

Shareholder return focused

Acquisitions destroy value

Rational capacity addition

Acquisitions a valuable component of growth
strategy

Volume increase to reduce costs

Exacerbated cycles

Negotiating power with suppliers, labour and

government

Boom and bust cycles, volatile

earnings, poor returns

15

More stable cash flows, higher returns

Source: Mick Davies, Xstrata

Market Share Four Firm Ratio

60%

50%

10YearAverageROCE

Iron

40%
Alumina
Industrial
Minerals

30%
Coking Coal

20%
Thermal Coal
Copper
Aluminum
Steel

10%

Zinc/Lead

Nickel
Petroleum

Gold

0%
0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Top4CompaniesShareoftheMarket
16

Source: Citigroup, Xstrata

13/01/2012

Impact on an Industry Long Term

An industry undersupplied going forward

17

Source: Credit Suisse

Where Will the Skilled People

Come From?
The demand for people in the
Western Canada resource sector
4,500

Oil Sands

A changing demographic pool

in Canada
2,900

Teck Coal

3,500

2,500

3,000

2,300

2,500
2,000
1,500
1,000
500
0

People (000)

2,700

New Hires

4,000

1980

2011

2,100
1,900
1,700
1,500
1,300
1,100
900
20 - 25 - 30 - 35 - 40 - 45 - 50 - 55 - 60 24 29 34 39 44 49 54 59 64

18

Source: Estimates based on announced growth plans

13/01/2012

Supply Side Challenges of

Strong Demand
NormalDeliveryTime
Drills

Tyres

20

LargeHaulTrucks

22

Wagons

12

Locomotives

12

22
14

Barges

23

Shiploaders

9
14

Reclaimers

17

RopeShovels

6
14

Draglines

16

PowerGenerators

19

12

Crushers

11
16

Grindingmills

18
0

19

Summer2008AdditionalDelays
18

10

29
20

Months

30

40

50

Source: Suppliers, Rio Tinto

The Met Coal Market: A Case Study

20

10

13/01/2012

Seaborne Metallurgical Coal Market

Other World, 19%

Other Canada, 1%Teck, 9%

Other USA, 14%

BMA, 21%

Anglo, 9%
Other Australia,
17%

21

Xstrata, 6%
Rio Tinto, 4%

Source: AME

Strong Global Demand Leading

to Record Coking Coal Prices
Hard Coking Coal Prices
(US$/tonne)

$300
$250
$200
$150
$100
$50

1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010

$0

22

11

13/01/2012

...But Inflation and FX Impact

Revenue
Hard Coking Coal Prices ($/tonne)

$350
$300

Coal Price US$/tonne (Nominal)

Coal Price US$/tonne (Real)
Coal Price CDN$/tonne (Real)

$250
$200
$150
$100
$50

1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010

$0

23

Cost Increases Also Tend to Mitigate

Higher Commodity Prices (Teck Coal)
Hard Coking Coal Prices and Costs
($/tonne)

$350
$300

Costs (FOB) Real

Coal Price CDN$/tonne (Real)
Oil ($/bbl) Real

$250
$200
$150
$100
$50
1960
1962
1964
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010

$0

24

12

13/01/2012

The Customer and Their Ability to Pay

$1,000

Steel HRC (US$/tonne)

Thermal (US$/tonne)
Coal HCC (US$/tonne)
Iron Ore (US$/tonne)
WTI Oil (US$/bbl)

$900
$800
$700

$200

$600
$500

$150

$400
$100

$300
$200

$50

Steel Price (US$/tonne)

$250

$100
$0
2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

$0
1984

Oil, Coal and Iron Prices (US$/tonne)

$300

25

Steel Intensity: Economic Growth

and Steel Consumption

26

Source: 2004 2009 OECD & WSA, Steel Producers

13

13/01/2012

Global Car Sales

60

50

2.2

Sales (millions of cars)

1.9
40

6.6
0.6
0.6

1.6
6.3
0.3
0.3

30

1.7
6.7
0.6
1.3

3.7
8.7

1.2
5.2

1.0
4.2

0.8
2.7

3.9

8.1

7.8

7.6

4.3

3.3

2.7

1.3
5.0

1.8

1.5

9.3

7.3
17.1

17.0

16.7

18.3

17.3

17.6

14.3
20

10

11.4

8.9

19.8

16.4

19.6

19.4

19.3

18.8

15.9

16.6

16.2

12.7

13.9

0
199099
2000
South America

200103
200405
2006
Other Asia
India

2007
China

2008
Europe

2009
2010F
North America

EVCP

Teck

Note: Europe includes Russia

27

Source: Scotiabank Global Auto Report

Teck Coal Sales (GHO 80%)

Fording Coal, Teck Cominco, Luscar and others

25,000

Teck Coal

750,000

Global Steel Ex China

2010F

2008

2009F

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

1995

1994

1993

1992

1991

150,000

1990

5,000

1989

300,000

1988

10,000

1987

450,000

1986

15,000

1985

600,000

1984

20,000

Global Steel Ex China (000 tonnes)

900,000

1983

Teck Coal Sales (000 tonnes)

30,000

Note: 2010F Teck Coal represents midrange of current public guidance.

28

14

13/01/2012

Impact of Global Slowdown on

the Steel Sector
50%
40%
30%
20%
10%
0%
Q1/08

Q2/08

Q3/08

Q4/08

Q1/09

Q2/09

Q3/09

Q4/09

Q1/10

Q2/10

Q3/10

-10%
-20%
-30%
-40%
Global Auto
29

Global Steel

Global Steel Ex China

Teck Coal

Source: Volkswagon, Global Insight, CRU steel, World Steel Association, IMF

Hard Coking Coal Cost Curve

Position

30

Source: WoodMac

15

13/01/2012

The Fertilizer Industry: A Case Study

31

Nominal Produce Prices

Soybean Prices

$ BU

Corn Prices

$ BU

Monthly Average of Daily Close of Nearby Futures Contract

Monthly Average of Daily Close of Nearby Futures Contract

8.0

16

Source: CBOT

Source: CBOT

14

7.0

12

6.0

10

5.0
8

4.0
6

3.0

2.0

1.0

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
Wheat Prices

$ BU

Monthly Average of Daily Close of Nearby Futures Contract

12
11

Source: CBOT

10
9
8
7
6
5
4
3
2
1
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

32

Source: Mosaic

16

13/01/2012

Real Produce Prices

(Inflation Adjusted)
Soybean Prices - Inflation Adjusted in 2007 $

$ BU

Corn Prices - Inflation Adjusted in 2007 $

$ BU

Monthly Average of Daily Close of Nearby Futures Contract

Monthly Average of Daily Close of Nearby Futures Contract

18

60
Source: CBOT and US DOL

Source: CBOT and US DOL

16
50
14
12

40

10
30
8
6

20

4
10
2
0

0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

Wheat Prices - Inflation Adjusted in 2007 $

$ BU

Monthly Average of Daily Close of Nearby Futures Contract

30
Source: CBOT and US DOL

25
20
15
10
5
0
70 72 74 76 78 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10

33

Source: Mosaic

A Linkage between Oil and

Corn Prices?
The linkage to oil: the case of corn
Corn demand for U.S. ethanol production sets market price
Key drivers of corn prices are the price of oil and exchange rates
Strong economic growth or weak dollar cause oil prices to increase (and vice-versa)
Higher oil prices and tax benefits boost U.S. ethanol economics/production
(and vice-versa)
Higher ethanol production increases corn demand (and vice versa)
Higher corn demand increases crop nutrient demand (and vice versa)
Impact of speculators/hedge funds on commodities (15%)
Traditional drivers may not matter as much on a short term basis
Weather
Population growth
Per capital income growth
Assessment
All drivers matter
Agricultural fundamentals continue to look rock solid
34

17

13/01/2012

The Link to Oil: The Case of Corn

35

Source: Mosaic

More People, More Food,

More Consumption
Large sections of farm being converted into corn for fuel
A growing population with an appetite for meats as opposed to
rice (a larger middle class)
Same area to grow food and an increasing population means
we need ways to become more productive with the resources
we have

36

18

13/01/2012

Fertilizer Prices
MOP Prices
$ ST

1300
1200
1100
1000
900
800
700
600
500
400
300
200
100

Source: Green Markets

900
800
700
600
500
400
300
200
100
0

fob Tampa Vessel

Source: Fertecon

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Ammonia Prices

$ MT

Granular Urea Prices

c&f Tampa

$ ST

950

fob U.S. Midwest Warehouse

900

Source: Fertecon

Source: Green Markets

850

800

750

700

650

600

550

500

450
350

400

250

300
200

150
50

100
00

37

DAP Prices

$ MT

Blend Grade fob U.S. Midwest Warehouse

1000

01

02

03

04

05

06

07

08

09

10

90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

Source: Mosaic

Discounted Cash Flow

38

19

13/01/2012

The importance of the DCF

Provides an opportunity to assign value to future cash flows and
todays terms and compare projects with different time horizons

DCF=

++

DCF = discounted value of cash flow

CF = cash flow in each year
r = discount rate, puts a risk or value of money today vs in a future
period as investor could put their money elsewhere

rd = return on debt (loan/bond rate) , Wd = amount of debt,
re = return expected by shareholders, We = market capitalization
Ever increasing project lead time creating focus on DCF
39

Simple DCF Model

NewCoalS1
Year

Year
0

($100)

($100)
1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

1.0

$250

$250

$250

$250

$250

$250

$250

$250

$250

$250

$250

SiteCostsVariable($/t)

$45

$45

$45

$45

$45

$45

$45

$45

$45

$45

$45

Transportation($/t)

$35

$35

$35

$35

$35

$35

$35

$35

$35

$35

$35

$0

$170

$170

$170

$170

$170

$170

$170

$170

$170

$170
$170

Capital($millions)
Production(mtonnes)
CommodityPrice($/t)

10

SiteCostsFixed($millions)

OperatingMargin($/t)
Profit pretax($millions)

$100

$270

$170

$170

$170

$170

$170

$170

$170

$170

Tax($millions)

$30

$81

$51

$51

$51

$51

$51

$51

$51

$51

$51

Profit posttax($millions)

$70

$189

$119

$119

$119

$119

$119

$119

$119

$119

$119

$70

$172

$98

$89

$81

$74

$67

$61

$56

$50

$46

DiscountedCashFlow($millions)
CashFlow($millions)
NPV($millions)

40

$1,330
$865

Discount rate of 10%

20

13/01/2012

DCF Scenarios

SummaryComparison
S1

S2

S3

S4

S5

S6

production/year

minelife

10

10

10

capital($millions)

200

400

200

400

200

400

commoditypriceUS

250

250

250

250

150

150

discountrate

10%

10%

8%

8%

10%

10%

41

DCF Scenarios

SummaryComparison
S1

S2

S3

S4

S5

S6

production/year

minelife

10

10

10

capital($millions)

200

400

200

400

200

400

commoditypriceUS

250

250

250

250

150

150

discountrate

10%

10%

8%

8%

10%

10%

$1,330

$1,470

$1,330

$1,470

$685

$825

$865

$1,169

$933

$1,220

$469

$681

CashFlow
NPV
42

21

13/01/2012

Dangers of the DCF

What if the project is in too early a phase for a dcf? Multiples
and industry comparables are useful
Heavily dependent on the discount rate and your price
assumptions, do you have it right?
What if your project misses the cycle?
Value of management and their ability to move with the cycle
(increase or decrease capacity depending on market
conditions)
Always need to keep an eye on the balance sheet to make
sure you can pay your bills
43

Summary - How Stable is Your Revenue

Stream Today and Going Forward?
Supply/demand balances
Substitution
Diversification (regional, sector, commodity)
Position on cost curve
Brownfield vs. Greenfield time to market
Level of consolidation 4 firm ratio
Competitors changes to the market
Going beyond the discounted cash flow to the option analysis
Stakeholders and risks associated
How many of you are dart players?
44

22