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Preference for base metals over steelmaking materials

We forecast falling prices for coal, iron ore and manganese over the medium term, given that they are trading above the 90th percentile of cost curves.

We are constructive on base metals, some of which are trading well below the 90th percentile, rendering significant parts of the respective industries cash burning.

Thematically, from a demand perspective, we also prefer base metals over steelmaking materials (iron ore, metallurgical coal and manganese).

Figure 35: Spot commodity price premium (discount) to 90th percentile

60%
	47%
50%
40%
30%
		23%	20%	19%
20%
					6%
10%						4%
0%
							-2%
-10%
-20%
								-15%	-16%
-30%
	Met. Coal, $222/t		Gold**, $1281/t	Iron ore, $74/t	Thermal coal, $98/t		Copper, $5904/t	Zinc*, $2575/t	Aluminium, $1866/t	-25%
		Manganese ore, $7/t				PGM***, $1107/t				Nickel, $11081/t

*Used commodity/company data for 2017. **Used commodity data for 3Q17.

***PGM basket price calculated using 57% Pt, 36% Pd, 7% Rh. Note: Priced as at 8 January 2019.

Source: Bloomberg, Company data, Renaissance Capital estimates

Renaissance Capital

14 January 2019

Metals & Mining

Some commodities trading above cost support

Many of our commodity price forecasts are below spot. Our long-term commodity price forecasts are supported by industry costs and we calculate these prices would result in poor industry average returns on new projects (below 9%), which we do not think would incentivise over-supply.

Management focus remains on cash-flow returns and perceived investment risk remains high for lenders.

We calculate incentive prices in the following charts as the commodity price required for a Incentive prices to achieve a 10% IRR project with industry average cash costs and industry average capital intensity to achieve

a 10% IRR.

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Steel

Renaissance Capital

14 January 2019

Metals & Mining

Steel margins have fallen below mid-cycle levels due to the recent decline in steel prices and elevated prices for inputs such as coking coal, manganese and iron ore prices.

Figure 36: Real steel replacement cost margins and near-term forecasts, $/t

350

300

302

300

241

258

250

Forecasts

200

$/t

Average, 158

150

148

100

105

50

75

49

0

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Spot

Mar 06

Sep 06

Mar 07

Sep 07

Mar 08

Sep 08

Mar 09

Sep 09

Mar 10

Sep 10

Mar 11

Sep 11

Mar 12

Sep 12

Mar 13

Sep 13

Mar 14

Sep 14

Mar 15

Sep 15

Mar 16

Sep 16

Mar 17

Sep 17

Mar 18

Sep 18

Sep 19

Mar 20

Sep 20

Mar 21

Sep 21

Source: Bloomberg, Renaissance Capital estimates

However, we maintain our cautious view on steel prices due to: 1) spare installed capacity, which could result in potential oversupply if utilisation rates increase; 2) demand headwinds as China rebalances its economy from fixed asset investment-heavy to consumer-led; and 3) rising sector capex levels, which could result in sector capacity growth ahead of demand.

Steel cost curve (global supply of 458mnt)

Figure 37: 2017 steel cash costs net of by-product credits plus capex, $/t

800

	700	Incentive price: $700/t
	600
$/t	500	Spot price: $480/t*
		Average cash cost: $428/t
	400	Severstal,344			MMK, 401
	300		Evraz,363	NLMK,388
	200

90th percentile: $494/t 70th percentile: $448/t

50th percentile: $429/t

AMSA, 533

Note: Priced as at 8 January 2018.

Source: Bloomberg, Company data, Renaissance Capital estimates

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Metallurgical coal

We believe metallurgical coal spot prices of $221/t are unsustainable given our view that prices above $180/t incentivise new supply (10% IRR for average metallurgical coal projects). Lower steel prices could reduce demand for steelmaking materials or result in capacity cuts, which could weigh on metallurgical coal prices.

Renaissance Capital

14 January 2019

Metals & Mining

Lower steel margins could put pressure on steelmaking material prices

Metallurgical coal cost curve (632mnt)

Figure 38: 2018E metallurgical coal cash costs plus sustaining capex, $/t

240

Spot price: $221/t*

200

Incentive price: $180/t

160

$/t

120	Average cash cost: $117/t				Resources,Teck 117	AngloAmerican, 121
80	73Evraz,	84BHP,	88Mechel,	Glencore, 115
40

90th percentile: $151/t

70th percentile: $125/t

50th percentile: $117/t

	170 Vale, 183
South32, 159	Severstal,

*Priced as at 8 January 2019.

Source: Bloomberg, CRU, Renaissance Capital estimates

We believe spot metallurgical coal prices make the entire industry cash-flow positive. We see no risk of capacity cuts.

Figure 39: Percentage of metallurgical coal cost curve that is cash burning over time

350					% Cash burning							330	Hard coking coal - spot, $/t										84.0%	Average LT cash burn							100%
							305																	81.0%							90%
300
																										266
					66.0%																										80%
250																							58.5%		55.5%					222	70%
200																						51.0%									60%
																													188		50%
150
																															40%
$/t																					34.5% 34.0%	29.0%
100				14.5% 14.5% 14.5%		98			12.5%													17.5%									30%
	5.5% 6.0% 6.0% 6.0%		7.5%					8.5% 8.5% 8.5%										8.5%	6.0%					81	Average LT cash burn, 12.6%						20%
50						0.0% 0.0% 0.0% 0.0%				1.5% 1.0% 1.5% 1.0%		0.0% 0.0% 0.0% 0.5% 1.0% 1.0%				4.5%	2.0% 1.5%			4.5%					4.5%	0.0% 0.5% 0.5% 0.5% 0.5% 0.5% 1.0% 1.0%				0.0% 0.0%
																															10%
0	Mar 06	Sep 06	Mar 07	Sep 07	Mar 08	Sep 08	Mar 09	Sep 09	Mar 10	Sep 10	Mar 11	Sep 11		Mar 12	Sep 12		Mar 13	Sep 13		Mar 14	Sep 14	Mar 15	Sep 15	Mar 16	Sep 16	Mar 17	Sep 17	Mar 18	Sep 18	Spot	0%

Source: Bloomberg, CRU, Renaissance Capital estimates

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Renaissance Capital

14 January 2019

Metals & Mining

From a longer-term perspective, we are cautious on coking coal demand and prices:

1.Given our cautious outlook for Chinese steel demand growth; and

2.Over the medium term, we expect Chinese steel production to shift from blast furnace to electric arc furnace, which would likely add pressure on coking coal demand and prices.

Our long-term metallurgical coal price forecast of $150/t is based on cost support of the 90th percentile of the cost curve.

Figure 40: Met coal price vs cash costs at the 90th percentile		Figure 41: Met coal price premium (discount) to the 90th percentile
Cash costs, $/t	Met coal average price. $/t

290																		110%			84%			79%
														Forecasts				90%
													206
240												188											44%							49%
	101	112	138	125	132	162	158	143	135	118	126			185	164	157	150	30%	17%			38%			34%	11%			15%		36%	19%
																		70%
190																		50%
																		10%									Historical average, 28%
140
												126						-10%		9%-							-7%	20%-
90																		-30%
40																		-50%
	2006	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017	2018E	2019E	2020E	2021E	LT (real)	-70%
																			2006	2007	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017	2018E	2019E

2%
		-5%
2020E		2021E

*Cash costs net of by-product credits plus sustaining capex.

Source: Bloomberg, CRU, Renaissance Capital estimates

Source: Bloomberg, CRU, Renaissance Capital estimates

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