This is from Macquarie research on Met coal. RIV is the gorilla...

This is from Macquarie research on Met coal. RIV is the gorilla in the room, so its probably only a matter of time before someone works its out. dyor.

Rains and logistical problems remove any met coal slack and reinvoke

memories of 2008

 An abundance of recent news stories on Australian infrastructure problems have drawn attention

back to the metallurgical coal market, which crept under the radar during the second half of 2009.

We believe the market is extremely tight, however not to the extent which saw $400/t spot prices

in 2008. With China‟s move to a significant importer structurally changing seaborne trade and

limited supply response available, met coal remains our favoured bulk commodity.

 Demand growth for met coal has been extremely strong in recent times, with HoH rises in crude

steel production during 2H09 in the key importing regions Japan (+39%), Latin America (+41%)

and Western Europe (+22%). We expect further rises particularly in Japan, Korea and Brazil

during the current quarter. This is likely to push the pig iron production dependent on seaborne

met coal above the 340mt annualised mark during 2010. Furthermore, we estimate that met coal

stockpiles at European and Japanese coal plants fell by 12mt during 2009. While some of these

were converted into coke stocks, a return to higher production levels is likely to see the majority of

this material replenished, boosting apparent demand.

 With each tonne of pig iron production requiring 0.650.7t of met coal, the implications for

seaborne trade are positive. We expect a further 5% rise in seaborne trade during 1Q10 to 65mt

with the low production levels in 1Q09 this represents substantial YoY growth of 78%.

The big market unknown continues to be Chinese domestic production. While official figures have

risen (most likely due to capturing a greater proportion of the smaller mines in the statistics), on an

apparent basis output is still below 2008 peaks. We expect the Shanxi consolidation process to

yield 3035mt of results this year, with a further 52mt growth in Chinese pig iron production

necessitating this. Whatever Chinese production may be, we expect imports into China to continue

at a level comparable to 2H09, as the larger blast furnaces built in recent times require higher

quality coke, entailing use of premium hard coking coal. With premium grades in short supply in

China and coke blends using increasing volumes of hard coal, imported material will continue to

find a market.

In terms of a supply response, recent months have seen positive growth out of Australia and the

US. The Goonyella system has hit record export levels, resulting in 1% YoY growth in hard coking

coal exports during 2009. Further growth out of Australia during the first half of 2010 is crucial to

bringing the market toward balance. While every US company with potential met coal tonnes has

reacted and announced expansion, these will take time to come to fruition. Given that December

showed extremely strong exports at 4.03mt, we think short-term capacity has been reached, thus

incremental growth is limited. Therefore, over 2mt of export growth out of Australia will be required

in 1H10 to meet demand needs.

The current situation should not force the Japanese steel mills to push the panic button, as the

circumstances are not as damaging as they were in 2008. However, the last remaining slack has

now come out of the supply chain, such that any further disruption will have a significant price

effect. We believe there is still potential upside for the current spot price prior to contract

negotiations being settled, particularly with the ongoing debate over the contract pricing period.

Given BHP‟s insistence and the absence of other viable options, it seems highly probable that

quarterly contracts will become, if not the norm (yet), an established market price. We believe

some annual contract agreements will be reached, however at an inflated price to the initial

quarterly deals. This would also reflect the bullish market fundamentals for met coal through the

short and medium term.