13/01/2012

1

Managing in a Commodity WorldUniversity of Alberta

Michael O'Shaughnessy, Teck Resources LimitedJim Popowich, Mining Guy at Large

January 2011

Teck Coal Safety Culture Growth and Safety

2

Growing the business and improving safety

1.25 0.95 0.62 0.57 0.41 0.28

2.50 3.33

1.96 1.61 1.97 1.82

0

1

2

3

4

5

2005 2006 2007 2008 2009 2010

LTI/M

As

per

200,

000

Hou

rs W

orke

d

LTI Freq MA Freq

-100

0

100

200

300

400

500

600

2005 2006 2007 2008 2009 2010ytd

Peo

ple

Employee Replacements Employee Additions Vacation Coverage

Source: Teck

13/01/2012

2

Outline

3

• 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

4

A look back and a look forward…

13/01/2012

3

Challenges Facing the Resource Sector

5

• 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?

With Challenges Come Opportunities

6

• 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.

13/01/2012

4

Economics 101 – The Supply and Demand Relationship

7

Price ($/unit)

Units Available

Panic Buying

Cost Driven Floor Price

Price

Units

Supply Demand

Supply, Demand and the Commodity Cycle

8

Price ($/U

nit of Production)

Time

Super Cycle

Floor Price

Based on Usual Demand and Supply Response

Units of Production or Consumption

Time

Supply Demand

Excess Supply

Supply Shortfall

13/01/2012

5

The Balancing Act: What to Do

9

• 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

10

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

198

0

198

1

198

2

198

3

198

4

198

5

198

6

198

7

198

8

198

9

199

0

199

1

199

2

199

3

199

4

199

5

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9

201

0

201

1

201

2

201

3

201

4

201

5

Re

al G

DP

(%

Ch

an

ge

Ye

ar

ove

r Y

ea

r)

Long Term Real GDP Forecast (YoY)

Global OECD Developing

Source: IMF Oct/10

13/01/2012

6

How Increase in the Standard of Living Affects Commodity Demand

11Source: Rio Tinto

Commodity Super-cycle Commodity Price Increases CPI Adjusted - US$ (Base Year 1960 = 100%)

12

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

24%

26%

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%

220%

240%

260%

196

0

196

2

196

4

196

6

196

8

197

0

197

2

197

4

197

6

197

8

198

0

198

2

198

4

198

6

198

8

199

0

199

2

199

4

199

6

199

8

200

0

200

2

200

4

200

6

200

8

201

0

CPI (YoY) Zinc Nickel Copper Aluminum IronPotash Oil Coking Coal Uranium Gold Average

Source: USGS Mineral Information, LME, Bloomberg

13/01/2012

7

2008 Company Share Value Follows Commodity Prices

13 Source: finance.yahoo.com

0%

20%

40%

60%

80%

100%

120%

140%

160%

180%

200%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

Teck BHP Vale Rio Freeport

Barrick Potash Exxon Dow

Have Commodity Prices Recovered?

14 Source: CRU steel, LME, EIA

$0

$200

$400

$600

$800

$1,000

$1,200

$1,400

Jan‐07

Apr‐07

Jul‐07

Oct‐07

Jan‐08

Apr‐08

Jul‐08

Oct‐08

Jan‐09

Apr‐09

Jul‐09

Oct‐09

Jan‐10

Apr‐10

Jul‐10

Oct‐10

Jan‐11

(US$/tonne)

HRC Steel Price

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

Jan‐07

May‐07

Sep‐07

Jan‐08

May‐08

Sep‐08

Jan‐09

May‐09

Sep‐09

Jan‐10

May‐10

Sep‐10

Jan‐11

(US$/bbl)

WTI Oil Price

$0.00$0.20$0.40$0.60$0.80$1.00$1.20$1.40$1.60$1.80$2.00

Jan‐07

May‐07

Sep‐07

Jan‐08

May‐08

Sep‐08

Jan‐09

May‐09

Sep‐09

Jan‐10

May‐10

Sep‐10

Jan‐11

(US$/lb)

Zinc Price

$0.00

$0.50

$1.00

$1.50

$2.00

$2.50

$3.00

$3.50

$4.00

$4.50

Jan‐07

May‐07

Sep‐07

Jan‐08

May‐08

Sep‐08

Jan‐09

May‐09

Sep‐09

Jan‐10

May‐10

Sep‐10

Jan‐11

(US$/lb)

Copper Price

13/01/2012

8

An Industry under Transformation

15

Historical Industry Characteristics

• Fragmented, local

• Engineering focused with limited shareholder return orientation

− Poor capital discipline

− Misallocation of capital

• “Acquisitions destroy value”

• Volume increase to reduce costs

− Exacerbated cycles

“Boom and bust” cycles, volatile earnings, poor returns

Today’s Industry Characteristics

• Consolidated, global

− Dominance of “Global Diversified” model

• Greater capital discipline

− Access to mainstream capital markets

− Shareholder return focused

− Rational capacity addition

• Acquisitions a valuable component of growth strategy

• Negotiating power with suppliers, labour and government

More stable cash flows, higher returns

Source: Mick Davies, Xstrata

Market Share – Four Firm Ratio

16

0%

10%

20%

30%

40%

50%

60%

0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

10 Year Average ROCE

Top 4 Companies Share of the Market

Petroleum

Nickel

Zinc/Lead

Copper

Industrial Minerals

Gold

Alumina

Aluminum

Iron

Coking Coal

Thermal Coal

Steel

Source: Citigroup, Xstrata

13/01/2012

9

Impact on an Industry Long Term

17 Source: Credit Suisse

An industry undersupplied going forward

Where Will the Skilled People Come From?

18

900

1,100

1,300

1,500

1,700

1,900

2,100

2,300

2,500

2,700

2,900

20 -24

25 -29

30 -34

35 -39

40 -44

45 -49

50 -54

55 -59

60 -64

Peo

ple

(00

0)

1980 2011

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

New

Hir

es

Oil Sands Teck Coal

The demand for people in the Western Canada resource sector

A changing demographic pool in Canada

Source: Estimates based on announced growth plans

13/01/2012

10

Supply Side Challenges of Strong Demand

19

18

16

12

16

9

17

7

23

12

12

3

4

6

29

9

11

19

14

6

14

9

14

22

22

20

18

0 10 20 30 40 50

Grinding mills

Crushers

Power Generators

Draglines

Rope Shovels

Reclaimers

Shiploaders

Barges

Locomotives

Wagons

Large Haul Trucks

Tyres

Drills

Months

Normal Delivery Time Summer 2008 Additional Delays

Source: Suppliers, Rio Tinto

20

The Met Coal Market: A Case Study

13/01/2012

11

Seaborne Metallurgical Coal Market

21

Other Canada, 1%Teck, 9%

BMA, 21%

Anglo, 9%

Xstrata, 6%Rio Tinto, 4%

Other Australia, 17%

Other USA, 14%

Other World, 19%

Source: AME

Strong Global Demand Leading to Record Coking Coal Prices…

22

$0

$50

$100

$150

$200

$250

$300

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

Har

d C

oki

ng

Co

al P

rice

s (U

S$/

ton

ne)

13/01/2012

12

...But Inflation and FX Impact Revenue…

23

$0

$50

$100

$150

$200

$250

$300

$350

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

Har

d C

oki

ng

Co

al P

rice

s ($

/to

nn

e)

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

Cost Increases Also Tend to Mitigate Higher Commodity Prices (Teck Coal)

24

$0

$50

$100

$150

$200

$250

$300

$350

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

Har

d C

oki

ng

Co

al P

rice

s an

d C

ost

s ($

/to

nn

e)

Costs (FOB) RealCoal Price CDN$/tonne (Real)Oil ($/bbl) Real

13/01/2012

13

The Customer and Their Ability to Pay

25

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

$1,000

$0

$50

$100

$150

$200

$250

$300

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

Ste

el P

rice

(U

S$/

ton

ne)

Oil,

Co

al a

nd

Iro

n P

rice

s (U

S$/

ton

ne)

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

Steel Intensity: Economic Growth and Steel Consumption

26Source: 2004 – 2009 OECD & WSA, Steel Producers

13/01/2012

14

Global Car Sales

27

16.419.8 19.4 19.6 19.3 18.8

15.912.7 13.9

14.3

17.1 16.7 17.0 17.3 18.3

17.6

16.6 16.2

0.3

0.6 1.32.7 4.2 5.2

5.07.3

9.30.3

0.6 0.6 0.81.0

1.2

1.31.5

1.8

6.3

6.6 6.77.6

7.88.1

8.78.9

11.4

1.6

1.9 1.72.2

2.73.3

3.73.9

4.3

0

10

20

30

40

50

60

1990‐99 2000 2001‐03 2004‐05 2006 2007 2008 2009 2010F

Sal

es (

mil

lio

ns

of

cars

)

South America Other Asia India China Europe North America

Source: Scotiabank Global Auto Report

Note: Europe includes Russia

Teck Coal Sales (GHO 80%)

28

-

150,000

300,000

450,000

600,000

750,000

900,000

0

5,000

10,000

15,000

20,000

25,000

30,000

198

3

198

4

198

5

198

6

198

7

198

8

198

9

199

0

199

1

199

2

199

3

199

4

199

5

199

6

199

7

199

8

199

9

200

0

200

1

200

2

200

3

200

4

200

5

200

6

200

7

200

8

200

9F

201

0F

Glo

bal

Ste

el E

x C

hin

a (0

00 t

on

nes

)

Teck

Co

al S

ales

(00

0 to

nn

es) Teck Coal Global Steel Ex China

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

Fording Coal, Teck Cominco, Luscar and others EVCP Teck

13/01/2012

15

Impact of Global Slowdown on the Steel Sector

29

-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

50%

Q1/08 Q2/08 Q3/08 Q4/08 Q1/09 Q2/09 Q3/09 Q4/09 Q1/10 Q2/10 Q3/10

Global Auto Global Steel Global Steel Ex China Teck Coal

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

Hard Coking Coal Cost Curve Position

30Source: WoodMac

13/01/2012

16

31

The Fertilizer Industry: A Case Study

Nominal Produce Prices

32

0

2

4

6

8

10

12

14

16

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

$ BU Soybean PricesMonthly Average of Daily Close of Nearby Futures Contract

Source: CBOT

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

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

$ BU Corn PricesMonthly Average of Daily Close of Nearby Futures Contract

Source: CBOT

1

2

3

4

5

6

7

8

9

10

11

12

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

$ BUWheat Prices

Monthly Average of Daily Close of Nearby Futures Contract

Source: CBOT

Source: Mosaic

13/01/2012

17

Real Produce Prices (Inflation Adjusted)

33

0

10

20

30

40

50

60

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

$ BU Soybean Prices - Inflation Adjusted in 2007 $Monthly Average of Daily Close of Nearby Futures Contract

Source: CBOT and US DOL

0

2

4

6

8

10

12

14

16

18

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

$ BU Corn Prices - Inflation Adjusted in 2007 $Monthly Average of Daily Close of Nearby Futures Contract

Source: CBOT and US DOL

0

5

10

15

20

25

30

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

$ BU Wheat Prices - Inflation Adjusted in 2007 $Monthly Average of Daily Close of Nearby Futures Contract

Source: CBOT and US DOL

Source: Mosaic

A Linkage between Oil and Corn Prices?

34

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

13/01/2012

18

The Link to Oil: The Case of Corn

35Source: Mosaic

More People, More Food, More Consumption

36

• 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

13/01/2012

19

Fertilizer Prices

37

0

100

200

300

400

500

600

700

800

900

1000

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

$ STMOP Prices

Blend Grade fob U.S. Midwest Warehouse

Source: Green Markets

100200300400500600700800900

1000110012001300

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

$ MTDAP Prices

fob Tampa Vessel

Source: Fertecon

50

150

250

350

450

550

650

750

850

950

00 01 02 03 04 05 06 07 08 09 10

$ MTAmmonia Prices

c&f Tampa

Source: Fertecon

100

200

300

400

500

600

700

800

900

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

$ STGranular Urea Prices

fob U.S. Midwest Warehouse

Source: Green Markets

Source: Mosaic

38

Discounted Cash Flow

13/01/2012

20

The importance of the DCF

39

• 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

Simple DCF Model

40Discount rate of 10%

New Coal S1 Year

Year 0 1 2 3 4 5 6 7 8 9 10

Capital ($millions) ($100) ($100)

Production (mtonnes) 1.0  1.0  1.0  1.0  1.0  1.0  1.0  1.0  1.0  1.0 

Commodity Price ($/t) $250  $250  $250  $250  $250  $250  $250  $250  $250  $250  $250 

Site Costs Fixed ($millions)

Site Costs Variable ($/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 

Operating Margin ($/t) $0  $170  $170  $170  $170  $170  $170  $170  $170  $170  $170 

Profit ‐ pre tax ($millions) $100  $270  $170  $170  $170  $170  $170  $170  $170  $170  $170 

Tax ($millions) $30  $81  $51  $51  $51  $51  $51  $51  $51  $51  $51 

Profit ‐ post tax ($millions) $70  $189  $119  $119  $119  $119  $119  $119  $119  $119  $119 

Discounted Cash Flow ($millions) $70  $172  $98  $89  $81  $74  $67  $61  $56  $50  $46 

Cash Flow ($millions) $1,330 

NPV ($millions) $865 

13/01/2012

21

DCF Scenarios

41

Summary Comparison

S1 S2 S3 S4 S5 S6

production/year 1 2 1 2 1 2

mine life 10 5 10 5 10 5

capital ($millions) 200 400 200 400 200 400

commodity price US 250 250 250 250 150 150

discount rate 10% 10% 8% 8% 10% 10%

DCF Scenarios

42

Summary Comparison

S1 S2 S3 S4 S5 S6

production/year 1 2 1 2 1 2

mine life 10 5 10 5 10 5

capital ($millions) 200 400 200 400 200 400

commodity price US 250 250 250 250 150 150

discount rate 10% 10% 8% 8% 10% 10%

Cash Flow $1,330  $1,470  $1,330  $1,470  $685  $825 

NPV $865  $1,169  $933  $1,220  $469  $681 

13/01/2012

22

Dangers of the DCF

43

• 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

Summary - How Stable is Your Revenue Stream Today and Going Forward?

44

• 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?