Salmon Farming Industry Handbook 2012

The Marine Harvest Salmon Industry Handbook The purpose of this document is to give financial analysts and

investors a better insight into the salmon farming industry, and what Marine Harvest considers to be the most important value drivers

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Contents 1. Introduction 3

2. Definition of segment 4

2.1 Seafood as part of the larger protein space 4

2.2 Stagnating wild catch growing aquaculture 5

2.3 Salmonids only contribute 2.5% of global seafood supply6

2.4 Supply of wild and farmed salmonids 7

2.5 Salmonids harvest 2011 8

3. The attributes of salmon 9

3.1 A healthy product 9

3.2 Resource efficient production 10

4. World market of farmed Atlantic salmon 12

4.1 Estimates of the market for farmed Atlantic salmon 12

4.2 Historic total harvest of Atlantic salmon 13

4.3 Trade and product flow - Atlantic salmon 14

4.4 Projecting future harvest volumes 15

4.5 Yield per smolt 16

4.6 Development in standing biomass 17

4.7 Supply and demand historic prices for Atlantic salmon 18

4.8 Historic price development by local reference prices 19

4.9 Different sizes different prices (Norway) 20

4.10 Price indexes vs. FOB packing plant 21

4.11 Price neutral demand growth - historically 6-7% 22

4.12 Price of Atlantic salmon relative to other proteins sources23

5. Industry structure 24

5.1 Top 5-10 players in main producing regions 24

5.2 Number of players producing 80% of Atlantic salmon 25

6. Production of salmon 26

6.1 Establishing a salmon farm 27

6.2 Access to licenses Norway 29 6.3 Access to licenses Scotland 32 6.4 Access to licenses Chile 33 6.5 Access to licenses Canada 34 6.6 The Atlantic salmon life/production cycle 35

6.7 Production inputs 37

6.8 Factor influencing the pace of production 39

7. Cost dynamics 40

7.1 Economy in salmon farming 40

7.2 Production costs 41

7.3 Cost component mortality and disease 42

7.4 Feed and feed ingredients 43

7.5 Salmon feed producers 44

7.6 Raw material market 45

7.7 Price, cost and EBIT development Norway 46

7.8 Salmon farming is a capital intensive industry 47

7.9 Capital needs when building biomass 48

7.10 Accounting principles for biological assets 49

7.11 Investments and payback time for new entries 50

8. Salmon diseases, mitigation, and R&D 52

8.1 Salmon disease prevention and treatment 52

8.2 Most important disease risks 53

8.3 Fish health and vaccination (Norway) 54

8.4 Research and Development 55

9. Secondary Processing (VAP) 56

9.1 European value-added processing (VAP) industry 57

9.2 Market segment (2009) 58

9.3 The European market for smoked salmon 59

Appendix 60

Weight conversion ratios and key words 61

Some historic acquisitions and divestments 62

Marine raw materials in salmon feed 64

Sustainability of fish feed 65

Atlantic salmon production cycle 66

Marine Harvest history 67

Marine Harvest worldwide 68

Marine Harvest downstream (VAP) 69

Marine Harvest sales channels (2011) 70

Sources for industry and market information 71

Updated as of July 17th 2012 Disclaimer While every reasonable precaution has been taken in the preparation of this document, Marine Harvest assumes no responsibility for errors or omissions, or for damages resulting from the use of the information contained herein. The information contained in this document is believed to be accurate. However, no guarantee is provided. Use this information at your own risk.

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1. Introduction

Salmon Salmon is the common name for several species of fish of the family Salmonidae (e.g. Atlantic salmon, Pacific salmon), while other species in the family are called trout (e.g. brown trout, seawater trout). Although several of these species are available from both wild and farmed sources, all commercially available Atlantic salmon is farmed. Salmon live in the Atlantic and Pacific Oceans, as well as the Great Lakes and other land locked lakes. Typically, salmon are anadromous: they are born in fresh water, migrate to the ocean, then return to fresh water to reproduce. Atlantic salmon farming started on an experimental level in the 1960s but became an industry in Norway in the 1980s and in Chile in the 1990s. About 60% of the worlds salmon production is farmed. Farming takes place in large nets in sheltered quiet waters such as fjords or bays, or in tanks on land. Most of the cultured salmon come from Norway, Chile, Scotland and Canada. Salmon is a popular food. Salmon consumption is considered to be healthy because of the fish's high content of protein and Omega-3 fatty acids. The volume figures in this industry handbook are mainly expressed in HOG (head on gutted). For a weight conversion table, see appendix.

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2. Definition of segment 2.1 Seafood as part of the larger protein space

Source: FAO, Population Division of the Department of Economic and Social Affairs of the United Nations Secretariat, World Population Prospects: The 2010 Revision

Although 70% of the Earths surface is covered by water, only 6% of the protein sources for human consumption is produced in this element today. The global population is expected to grow by 2 billion, to more than 9 billion, by 2050. Assuming consumption per capita stays constant, this implies a 40% increase in demand for protein. The estimates for population growth, however, assume that the growth will mainly occur in Asia and Africa, which has the lowest protein consumption per capita today. When factoring in a trend of increased consumption per capita in these areas, the demand may double by 2050. Knowing that resources for increased land-based protein production will be scarce, a key question is how protein production in sea can be expanded.

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2.2 Stagnating wild catch growing aquaculture

Atlantic salmon

Source: Kontali Analyse, FAO, OECD

There has been a considerable increase in total and per capita fish supplies over the past few decades. Aquaculture is the fastest growing animal food producing sector, and in 2011 the aquaculture industry contributed 42% of the fishery output for human consumption. On average, fish provides about 30 kilocalories per person per day globally. The dietary contribution of fish is more significant in terms of proteins - it provides the worlds population with 6% of their intake of protein. While global human population is growing at 1.7% annually, aquaculture outpaces this rate by 1.4% - growing at 3.1% annually. Annual per capita fish consumption rose from 9.9kg in the 1960s to 18.4kg in 2009. A total of 126 million tonnes (live weight equivalent) fish was available for human consumption in 2009, where Asia consumed almost two thirds. To maintain current consumption level in 2030 taking population growth into account, an additional 23 million tonnes of fish production is needed. With the stagnating wild catch, the growth in fish production (and protein supply) is expected to come from the fast growing aquaculture industry. FAO estimates that in 2030, aquaculture will have increased from 45 million tonnes to 85 million tonnes.

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2.3 Salmonids only contribute 2.5% of global seafood supply

Source: Kontali Analyse

Even with an increase in production of Atlantic salmon of more than 600% since 1980, total global supply of salmonids is still marginal compared to most other seafood categories. Whitefish is about ten times larger and consists of a much larger number of species.

Fish species - harvest/catch volumes 2010

Note: live weight is used because different species have different conversion ratios

The graph compares selected species and their respective harvest/catch volumes in 2010. Harvest of Atlantic salmon was more significant than Atlantic cod and pangasidae. But, compared to two the largest whitefish species, tilapia and Alaska pollock, Atlantic salmon was only about half the volume harvested.

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2.4 Supply of farmed and wild salmonids

Historical supply of farmed and wild salmon

Note: Small and large trout are not included in farmed volumes Source: Kontali Analyse

The general supply of seafood in the world is shifting more towards aquaculture as the supply from wild catch is stagnating in several regions, and for many important species. Wild catch of salmonids is varying between 700 000 and 1 000 000 tonnes HOG, whereas farmed salmonids are increasing. The first year when the total supply of farmed salmonids was dominated by farmed, was in 1999. Since then, the share of farmed salmonids has increased and has become the dominant source. The total supply of all farmed salmonids was over 1.6 million tonnes (HOG) in 2011. The same year, the total catch quantity of wild salmonids was about 930 000 tonnes, with pink, chum and sockeye being most common species. Origin and markets for wild salmonids

Source: Kontali Analyse The diagram shows competition of wild salmon in different markets for Atlantic salmon. About 25% of total wild catch of salmon has been imported frozen to China (from the US, Russia and Japan), and later been re-exported as frozen fillets. Once re-exported from China, one cannot distinct between the different regions.

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2.5 Salmonids harvest 2011 Farmed Atlantic salmon dominates

Source: Kontali Analyse

Atlantic salmon: By volume, the largest species of salmonids. It is a versatile product, which can be used for a variety of categories such as smoked, fresh, grilled, sushi as well as ready-made meals. The product is present in most geographies and segments on a global scale. Due to biological constraints, seawater temperature requirements and other natural constraints, farmed salmon is only being produced in Norway, Chile, UK, North America and New Zealand/Tasmania. In 2011, the total supply of Atlantic salmon was 1.46 million tonnes HOG. Pink: Caught in USA and Russia and used for canning, pet food and roe production. Quality is lower than the other species as all catch happens in a very short time period and is therefore less a valued salmonid. The fish is small in size (1.5-1.7 kg). Large trout: Produced in Norway, Chile and the Faeroes and the main markets are Japan and Russia. Trout is mainly sold fresh, but is also used for smoked production. Small trout: Produced in many countries and most often consumed locally as a traditional dish as hot smoked or portion fish. Small trout is not in direct competition with Atlantic salmon. Chum: Caught in Japan and Alaska. Most is consumed in Japan and China. In Japan, it is available as fresh, while in China it is processed for local consumption and re-exported. Little chum is found in the EU market. Varied quality and part of the catch is not for human consumption. Coho: Produced in Chile and is mostly used for salted products. It is in competition with trout and sockeye in the red fish market. Russia has increased its import of this specie the last years but Japan remains the largest market. Sockeye: Caught in Russia and Alaska. It is mostly exported frozen to Japan, but some is consumed locally in Russia and some is canned in Alaska. Sockeye is seen as a high quality salmonid and is used as salted products, sashimi and some smoked in EU. Chinook/King: Low volume species, but highly valued. Alaska, Canada and New Zealand are the main supply countries. Most volume is consumed locally. Chinook is more in direct competition to Atlantic salmon than the other species and is available most of the year.

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3. The Attributes of Salmon 3.1 A healthy product

Farmed salmon is a good source for the marine omega-3 polyunsaturated fatty acids eicosapentaenoic acid (EPA) and docosahexaenoic acid (DHA) that reduce the risk for cardiovascular disease. Data also indicates the EPA and DHA reduce the risk for a large number of other health issues. Salmon is view upon as a very versatile product, which can be used in a numerous dishes. It is popular with retailers as it is produced in a controlled environment and is stable in supply throughout the year (not subject to seasons).

Source: FAO, Marine Harvest

Salmon is nutritious, rich in micronutrients, minerals, marine omega-3 fatty acids, very high quality protein and several vitamins, and represents an important part of a varied and healthy diet. FAO highlights Fish is a food of excellent nutritional value, providing high quality protein and a wide variety of vitamins and minerals, including vitamins A and D, phosphorus, magnesium, selenium and iodine in marine fish. The substantial library of evidence from multiple studies on nutrients present in seafood indicates that including salmon in your diet will improve your overall nutritional status, and may even yield significant health benefits. In the face of increasing obesity and decreasing health standards, governments and food and health advisory bodies in Europe and the USA are actively encouraging their populations to consume more fish as part of their diet.

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3.2 Resource efficient production

Source: Marine Harvest, article in Fiskaren March 20 2009, British PIG BPEXX Yearbook 2007, www.pork.org

Protein production efficiency The main sources of animal protein are cattle, poultry, pork and seafood. The first three are farmed, while more and more of the available seafood is also farmed. One method to measure how productive the different protein productions are is the representative feed conversion ratio (FCR). In short, this tells us the kilograms of feed needed to increase the animals bodyweight by 1kg. If we compare farmed salmon with the other three species, we find a variation in the FCR between 1.2 and 8.0, where salmon is the most efficient in production and cattle are the least. The main reason why salmon convert feed to body weight so efficiently is that by being cold blooded they do not have to use energy to heat their bodies. Wild salmon has a FCR of approximately 10.0. 68 % of Atlantic salmon is edible meat

Source: Bjrkl, J., Norwegian University and Life Sciences, Norway (2002).

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3.2 Resource efficient production

Most of the fish is edible meat, while other sources of meat have a higher level of waste or non edible meat. The combination of the FCR ratio and edible yield, gives salmon a favourably high volume of edible meat per kg of feed fed, as the graph below shows. Source: FHL Comparing the amount of protein in edible parts to amount of protein fed to the animal, salmon retains the most protein relative to other animal protein sources as pork, chicken and lamb. Source: Bjrkl, J., Norwegian University of Life Sciences, Norway (2002).

Freshwater consumption in production Freshwater is a renewable but limited natural resource, which can only be renewed through the process of the water cycle. If more freshwater is consumed through human activities than is restored by nature, the result is that the quantity of freshwater available in lakes, rivers, dams and underground waters, is reduced. This can cause serious damage to the surrounding environment. Farmed Atlantic salmon requires only 1,500 litres per kg of fresh water in production whereas producing 1 kg beef requires 14,000 litres of fresh water consumption!

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4. World Production and Market of Farmed Atlantic Salmon 4.1 Estimates of the market for farmed Atlantic salmon

Source: Kontali Analyse

Supply of Atlantic salmon has more than doubled since 2000 (annual growth of 7%). Due to various constraints, Kontali Analyse expects annual supply growth of Atlantic salmon to drop to 4% in the period 2013-2020. The EU and the US are by far the largest markets for Atlantic salmon. Emerging markets, however, are growing at significantly higher rates than these traditional markets. As all harvested fish is sold and consumed in the market, the demand beyond 2013 is assumed equal to supply (estimated from Kontali Analyse). As can be seen from the below graph, salmon is one of the food categories that grows at a significantly higher rate than the worlds human population.

Source: Kontali Analyse, Population Division of the Department of Economic and Social Affairs of the United Nations Secretariat, World Population Prospects: The 2010 Revision

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4.2 Historic total harvest of Atlantic salmon

Farming of Atlantic salmon has always been dominated by a few producing countries as there are several natural conditions that have to be in place for optimal production, like seawater temperature range (see chapter 6), a sheltered coast line and certain biological conditions. In the beginning of the 2000s, Chile started to increase production sharply. However, in 2007 there was an outbreak of the ISA virus, which resulted in a serious production setback (2009-2011). Since 2010, Chilean industry has been subject to an aggressive rebuild. The production in Canada and the UK has been stable the last 5 years, and has limited potential for future growth. Other regions have generally been growing, but from rather marginal volumes.

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4.3 Trade and product flow Atlantic salmon Historically, the main market for each origin has been:

Norway EU, Russia and Asia Chile USA, South America and Asia Canada USA (west coast) Scotland mainly domestic (limited export)

The logistic and perishability of the product has led to this supply trend. A new trend since the beginning of this millennium has been that Norwegian fresh salmon meet more competition from Chilean frozen salmon in the European market. This, together with strong competition between mainly Norwegian and Chilean salmon in the Japanese market, and the increase in export from Scotland and Norway to USA during the period of reduced supply from Chile, shows that the market is becoming more globalised. Nevertheless, there will still be regional markets for the different production countries due to cost of logistics for fresh salmon. It is only frozen salmon that can be made available in large volumes for distant markets at low costs. It is generally expected that the market will continue to have a preference for fresh salmon, going forward. Global trade flows of farmed Atlantic salmon - 2011 (HOG)

Source: Kontali Analyse

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4.4 Projecting future harvest volumes

The three most important indicators on future harvest volumes are standing biomass, feed sales and smolt release. These three are good indicators on medium term and long term harvest, while the best short term indicator is standing biomass categorized by size. As most fish is harvested at a size of 4kg+, it is only the amount of large fish in the sea that can be used to estimate short term harvest. If no actual numbers on smolt releases are available, vaccine sales could be a good indicator of number of smolt releases and when the smolt is put to sea. This is a good indicator on long term harvest as it takes up to 2 years before the fish is harvested after smolt release. Variation in seawater temperature can materially impact the length of the production cycle. A warmer winter can for example increase harvest volumes for the relevant year, partly at the expense of the subsequent year. Disease outbreaks can also impact harvest volume due to mortality and slowdown of growth.

Standing Biomass Source: Kontali

Feed Sales Source: feed companies

Seawater Temperature

Source: Meteorological institutes

Disease Outbreaks Source: Media

Smolt Release

Source: Producing companies

Vaccine Sales

Source: e.g. ScanVacc

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4.5 Yield per smolt

Source: Kontali Analyse, Marine Harvest Yield per smolt is an important indicator of production efficiency. Due to the falling cost curve and the discounted price of small fish, the economic optimal harvest weight is in the area of 4-5kg (HOG). The number of harvested kg yielded from each smolt is impacted by diseases, mortality, temperatures, growth attributes and commercial decisions. The average yield per smolt in Norway was 3.79 kg (HOG) in 2010.

Since 2010, the Chilean salmon industry has been rebuilding its biomass after the depletion caused by the ISA crisis commencing in 2007. In 2010/2011, the Chilean salmon industry showed a very good performance on fish harvested due to the low density of production (improved yield per smolt). With the increased density it is possible the performance is deteriorating in 2012. Average yield in the UK and Faroe Islands in 2010 was 3.05kg and 4.49kg, respectively.

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4.6 Development in standing biomass

Source: Kontali Analyse

Because of the variation in sea water temperatures over the year, the total standing biomass in Europe has a S-curve, which is at its lowest in May and at its peak in October. The Norwegian industry is focused on minimizing the natural fluctuations as license constraints put a limit to how much biomass can be in sea at the peak of the year. In Chile the situation is different due to more stable seawater temperatures and opposite seasons (being in the Southern hemisphere). A more steady water temperature gives the possibility to release smolt during the whole year and a more uniform utilization of the facilities. The reduction of standing biomass in Chile in 2008 and 2009 is due to the impact of the ISA disease.

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4.7 Supply and demand historic prices for Atlantic salmon Source: Kontali Analyse

Due to the long production cycle and the short shelf life of the fresh product (maximum 3 weeks), the spot price clears on the basis of the overall price/volume preference of customers. As most of the farmed salmon is perishable and therefore marketed fresh, all salmon produced in one period has to be consumed in that same period. In the short term, the production level is difficult and expensive to adjust as the planning/production cycle is three year long. Therefore, the supplied volume is very inelastic in short term, while also demand is shifting with the season. This has a large effect on the price volatility in the market. Factors affecting market price for Atlantic salmon are:

Supply (absolute and seasonal variations) Demand (absolute and seasonal variations) Globalisation of the market (arbitrage opportunities between regional markets) Presence of sales contracts reducing volume availability for the spot market Flexibility of market channels Quality

Comparing FCA Oslo, FOB Miami and FOB Seattle, there are clear indications of a global market as the prices correlate to a high degree.

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4.7 Historic price development by local reference prices

Source: Kontali Analyse

The three graphs above shows quarterly average prices of salmon from 2000 to Q2 2012. As in most commodity industries, the producers of Atlantic salmon are experiencing much volatility in the price achieved for the product. The average price for Norwegian whole salmon the last decade has been about NOK 27/kg (HOG), for Chilean salmon fillet (2-3lb) USD 3.1/lb, and for Canadian salmon (10-12lb), USD 2.24/lb (HOG).

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4.8 Different sizes different prices (Norway)

The most normal market size for a salmon is 4/5kg HOG. The reason for the different sized fish is mainly because salmon farming is a biological production process, where the fish has different growth cycles and the biomass represents a normal distributed size variation. The markets for the different sizes vary, as can be seen in the above graph. The processing industry in Europe mainly uses 3-6kg HOG but there are niche markets for the small and large fish. As these markets are minor compared to the main market, they are easily disrupted if volumes become too high. Generally, small fish sizes are discounted and large sized fish are sold at premium.

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4.10 Price indexes vs. FOB packing plant

* Average difference between SSB and return to packing plant Source: Fishpool, NOS/FHL, SSB, Norwegian Seafood Council, UrnerBarry, Kontali Analyse

Several price indices for salmon are publicly available. The two most important providers of such statistics for Norwegian salmon are NOS/Fish Pool and Statistics Norway (SSB). Urner Barry in the US provides a reference price for Chilean salmon in Miami and Canadian salmon in Seattle. In Norway this is fairly simple by deducting freight cost from the farm to Oslo and the terminal cost from the NOS/FHL price (~0.70 NOK). If using the SSB custom statistics, you need to adjust for freight to border, duty and taxes, and also to adjust for quality and contract sales to get the achieved spot price back to producer. Average difference between SSB price and FCA Oslo is ~1 NOK, which gives the average difference between SSB price and back to plant at NOK 1.50**. Calculating Urner Barry Chilean fillets, back to HOG plant is more extensive. It is necessary to use UB prices for both 2/3lb and 3/4 lb and adjust for volume share, market handling (4 cent), market commission (4.5%), premium fish share (92%), reduced price on downgraded fish (30%), airfreight (USD 1.50/kg) and HOG to fillet yield (70%). **Historically this difference fluctuates from week to week and will normally be observed in the range of [-2 to +4]

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4.11 Price neutral demand growth - historically 6-7%

r= -0.866

Source: Kontali Analyse

The price correlation across regional markets is generally strong for Atlantic salmon. The Norwegian FHL price represents about two thirds of the global volumes for Atlantic salmon. Growth in global supply of Atlantic salmon is estimated to 119% in the period 2000-2012 (annual CAGR 7%), varying between -2% and 13% annually. Variation in growth rates has been the main determinant for the variation in prices. Annual average prices have varied between NOK 19.50 (2003) and NOK 37.45 (2010). Combining the data gives a linear correlation between change in global supply and change in the Norwegian FHL price. This relation has an explanatory power of almost 87% of the annual price development between 2000 and 2011.

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4.12 Price of Atlantic salmon relative to other proteins sources

Source: International Monetary Fund, Marine Harvest, Norwegian Seafood Council

Compared to other food sources containing animal protein, salmon has become relatively much cheaper during the last decades. Relative price of salmon in terms of other protein sources in selected major markets (snap-shot of consumer prices in selected retail stores, June 2012) Salmon/Beef Salmon/Chicken Salmon/Pork UK 0.8 1.4 1.8 US 1.3 2.4 1.9 Belgium 1.2 1.9 1.6 Japan 1.0 2.2 2.0 Despite salmon having become relatively cheaper over time, it is still a rather expensive product in the shelves.

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5. Industry Structure 5.1 Top 5-10 players in main producing regions of farmed Atlantic salmon (2011)

Source: Kontali Analyse

The Marine Harvest Group represents the largest total production and holds about one quarter of the volume in Norway, and about one third of the volume in North America and UK. In North America and the UK, production is more consolidated (see next page). In Norway and Chile there are several more companies with a significant production volume of Atlantic salmon. In Chile, several of the companies also produce other salmonids, such as coho and large trout.

tonnes HOG

Top 10 Norway H.Q. Top 10 UK H.Q. Top 10 North America H.Q. Top 10 Chile H.Q.

1 Marine Harvest 217 500 Marine Harvest 50 100 Cooke Aquaculture 34 200 Marine Harvest 26 800

2 Lery Seafood 117 000 The Scottish Salmon Company 23 000 Marine Harvest 33 900 Salmones Multiexport 25 200

3 Salmar 93 000 Scottish Seafarms 21 800 Cermaq 21 300 Pesquera Los Fiordos 22 500

4 Cermaq 37 900 Morpol (Meridian Seafood) 20 800 Grieg Seafood 12 200 Australis Seafood 18 000

5 Grieg Seafood 31 500 Grieg Seafood 14 800 Northern Harvest 9 000 Cermaq 15 400

6 Nordlaks 26 100 * * Salmones Cupquelan (Cooke) 13 500

7 Nova Sea 25 200 Empresas Aquachile 12 900

8 Alsaker Fjordbruk 24 800 Invertec 11 200

9 Bremnes Seashore 21 000 Aquinova (Pesca Chile) 8 100

10 Norway Royal Salmon 18 800 Salmones Friosur 7 200

Top 10 612 800 Top 10 130 400 Top 10 110 600 Top 10 160 700

Others 292 200 Others 8 800 Others 4 900 Others 38 200

Total 905 000 Total 139 200 Total 115 500 Total 198 900

* UK and North American industry are best described by top 5 producers.

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5.2 Number of players producing 80% of Atlantic salmon volume per region

Source: Kontali Analyse

Historically, the salmon industry has been made up by many, small firms. This has been the case in Norway, and to some degree in Scotland and in Chile. The higher level of fragmentation in Norway compared to Chile is the result of the Norwegian governments priority to decentralised structures and local ownership. In Chile the government put fewer demands on ownership structures in order to grow the new industry faster. During the last decade the salmon farming industry has been through a period of consolidation in all regions. The consolidation trend is expected to continue. The recent increasing number of players making up 80% of the volume in Chile is explained by the major reduction in output in connection with the ISA crisis. Given the current rebuild, the situation is expected to gradually revert to fewer players. See appendix for some historic acquisitions and divestments.

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6. Production of salmon

In all salmon producing regions, the relevant authorities have a licensing regime in place. In order to operate salmon farming, a license is the key prerequisite. The licenses constrain the maximum production for each company and the industry as a whole. The license regime varies across jurisdictions. The salmon farming production cycle is about 3 years. During the first year of production the eggs are fertilised and the fish is grown into approx. 100 grams in controlled freshwater environment. Subsequently, the fish is transported into seawater cages where it is grown out to approx. 4-5kg during a period of 14-24 months. The growth of the fish is heavily dependent on the seawater temperatures, which varies by time of year and across regions. Having reached harvestable size, the fish is transported to primary processing plants where it is slaughtered and gutted. Most salmon is sold gutted on ice in a box.

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6.1 Establishing a salmon farm

License and location (Norway) Since 1973, a license has been required to operate a salmon farm in Norway. A license gives the right to farm salmon either in freshwater or in the sea. In addition, a site where the license can be used must be granted. One license can be associated with up to four sites, and one site may use several licenses at the same time. These licenses are awarded by the Ministry of Fisheries and are administered by the Directorate of Fisheries. It is also possible to apply to the Directorate of Fisheries to change the size of a site and licenses can be traded between companies in the industry. Since 1982, new licenses have been awarded only in limited numbers the years 1985, 1988, 1999, 2001, 2002 and 2009. At the end of 2011, there were 990 seawater licenses in Norway. One license is set to a MAB of 780 tonnes (900 tonnes in Troms and Finnmark). Most Norwegian fish farming sites have between 2,340 and 3,120 tonnes allowed maximum standing biomass. License and location (Scotland) In Scotland, the licensing system is very different. Instead of a license, there are several institutions that that have to give permission before one is allowed to make use of an area. Individual site biomass is governed by environmental concerns, namely the assimilative capacity of the local marine environment. As a consequence, individual site biomass is not uniform but varies between 100 tonnes to 2,500 tonnes depending on site characteristics.

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6.1 Establishing a salmon farm

License and location (Chile) In Chile the licensing is based on two authorizations. The first is the authorization to operate an aquaculture facility, which is issued by Fishery Sub Secretary (Economy Ministry). The authorization is for unlimited time and can be traded. The second authorization is for the physical area to operate (or permission to use national sea areas for aquaculture production). This is issued by the Sub secretary of the Navy, which belongs to the Defence Ministry. The use of the license is restricted to a specific geographic area, to defined species, and to a specified limit of production or stocking density. The production and stocking density limit is specified in the Environmental and Sanitary Resolution involved for any issued license. License and location (Canada) Marine sites are located on Crown land. The Provincial Government needs to grant a so-called tenure license to occupy a certain area of the ocean bottom. These tenures are issued for periods varying from 5 to 15 years. An annual tenure rental fee is charged depending on the size of the tenure. Fees are increased annually with inflation. In 2012 the annual fee for a typical tenure of 25 ha is CAD 9,800. Tenure licenses can be renewed upon request. In addition, the Federal Government needs to grant a license of operation. This Federal License states all the conditions which the farm has to observe and regulates production parameters, such as the Maximum Allowable Biomass, the use of equipment, etc. A typical site license will range in size from 2,000 MT to 4,500 MT of Maximum Allowable Biomass. The Federal License is presently issued for one year at the time and is renewable. It is expected that as of 2013 a fee will be charged for this license based upon the amount of production on the farm, however, the exact details are not known at this point of time.

The Provincial and Federal licenses are specific for one location only. Licenses may be lost for non-compliance issues and non-payment of fees. Equipment To equip a grow-out facility you need cages (steel or plastic), mooring, nets, cameras, feed barge/automats and boats. For a normal facility in Norway (850,000 smolt release) the investment costs would be in the range of 25-30 million NOK.

29

6.2 Access to licenses - Norway It is legal to trade licenses in Norway, however there are some restrictions. If the buyer, through trade, gets control of more than 15% of the total licensed biomass in the country, he/she has to apply for an approval from the Ministry of Fisheries and Coastal Affairs. The Ministry cannot give the approval if it implies that the buyer gets control of more than 25% of the total biomass in the country. No owner can control more than 50% of the total biomass in any of the regions. In 1993, a salmon farming license was traded for NOK 200 000, while the price today is normally about MNOK 20-70. In the last round of new licenses from the government, the price was however heavily discounted (cost of MNOK 8 per license) and awarded to small players operating in rural areas. Many of these licenses have since been sold at large gains. When assignment for a license is given, it has to be used within two years with a minimum of one third of the allowed biomass. A license can be withdrawn if the owner has not been approved for a site no later than 6 months after he was granted the license. A license can be pledged. A license cannot be leased out. Example The figure below depicts an example of the regulatory framework in Norway.

1 company

Number of licenses for a defined area: 5 o Biomass threshold per license: 780 tonnes live weight (LW) o Maximum biomass at any time: 3,900 tonnes (LW)

Number of sites allocated is 3 (each with a specific biomass cap)

In order to optimise the production and harvest volumes over the generations, the license holder can play within the threshold of the three sites as long as the total biomass in sea never exceeds 3,900 tonnes (LW).

30

6.2 Access to licenses Norway

2012 utilisation per license for the industry and the largest companies

Source: Marine Harvest, Kontali Analyse, Fiskeridirektoratet, Quarterly reports

The graph is organized by highest harvest volume.

Number of sea water licenses for salmon and trout in commercial use o 2007: 929 o 2008: 916 o 2009: 988 o 2010: 991 o 2011: 990 o 2012: 990

Because of the regulation of standing biomass (maximum allowed biomass - MAB) per licence (780 tonnes LW) the production capacity per licence is limited. Annual harvest volume per license in Norway can be as much as 1,200 tonnes HOG. Larger players typically have better flexibility to maximise output per license. The average utilisation for the industry is hence lower than the utilisation for the largest companies.

0

200

400

600

800

1000

1200

1400

AverageNorway

MarineHarvestNorway

CompanyA

CompanyB

CompanyC

CompanyD

'00

0 t

on

ne

s H

OG

Average harvest per license 2012

31

6.2 Access to licenses - Norway Industry production is approaching its limit (Norway)

Estimated MAB-utilisation in Norway 2009-2012E

Source: Kontali Analyse

Due to the fact that the two counties Troms and Finnmark, in Northern Norway, have a higher MAB per license, the total MAB capacity is slightly higher than 780 tonnes LW per license. Total biomass of salmon and trout in Norway is increasing each year and is approaching the limit in terms of MAB, particularly in the second half of each year due to the seasonality of farming operations.

32

6.3 Access to licenses - Scotland

In Scotland it is legal to trade licenses and although no restriction on number is given, there is a limit on production volume ascribed to any one company. This limit is determined by the Competition Commission Authorities. Licensing aquaculture operations in the UK is currently in a transitory state; all new applications require planning application for permission to operate, as well as an environmental and Crown estate license. The granting of the planning permission is aligned to the Crown estate lease for a 25 year period. All existing fish farm leases in Scotland are currently undergoing a review process which transfers them from the Crown estate to local regional councils. These grants are automatically given a 25 year lease. The environmental license can be revoked in some cases for significant and long-term non-compliance. Most existing licenses are automatically renewed at the expiration of the relevant lease period. New license applications take around 6-12 months for the planning permission and around 4-6 months for the environmental discharge license. Expansion of existing facilities is the most efficient route in terms of cost and time, whilst brand new sites will take longer and will probably have to go through an EIA (Environmental Impact Assessment) process. The environmental license is charged annually at 5,000, whilst the standing rent is levied to the crown estate on production basis (15-17 / tonne). The applications are also charged at 145 per 0.1 hectare of farm area, while the environmental license costs 2,600 for a new site.

33

6.4 Access to licenses - Chile The trading of licenses in Chile is regulated by the General Law on Fisheries and Aquaculture (LGPA), in charge of Ministry of Economy and Defense. Licenses granted before March 2010 are issued for an indefinite period of time. However, for companies that require loans from the state, license period is cut from indefinite to 25 years (extension may be granted). According to the new regulation, licenses issued subsequent to March 2010 and licenses that have been subject to modification, have a defined horizon of 25 years. This time horizon may also be extended under certain circumstances. Licenses can be lost in case of specified violations to regulation, operation under the minimum limit during certain period, or voluntary resignation. It can be lost if e.g. the license is used for a different purpose than the one for which this was granted or environmental/sanitary violations among others. Main issues in the new legislation are:

General Law on Fisheries and Aquaculture (LGPA), modified April 2012.

Specific regulations released from LGPA, like: o RAMA: Associated to environmental aspects, monitoring and correct practices to

operate in environmental terms. o RESA: Associated to sanitary aspects, fallow period, diseases, mortalities

treatment, among others. o Minimum operation: Establishes the minimum productive of licenses and the fallow

period. o REPLA: Establishes a protection area in case of plagues appearance, such as

Alexandrium catenella

No impact on duration of current licenses.

Future production capacity will be impacted by the new law, and specifically by the following:

o Gradual opening of regions XII, XI and X after 12 months, on the first case, and after five years on the second and third cases.

o Regulations of zones, availability of areas suitable for aquaculture and fallow periods will limit production capacity and growth rate until new licenses can be approved and/or new areas opened.

o As from 2014, dormant operations may cause loss of license. o Environmental conditions given by high density in some zones may

cause decreases of production limits. o New specific regulations about maximum production density are

announced to be enacted in 2012.

34

6.5 Access to licenses - Canada

In Canada, the Provincial and Federal licenses can be assigned to a different operator through a Government Assignment Process. The provision enables a company to transfer the licenses to another company for reasons such as: moved processing to new area, distance is too great and not feasible to operate, change in species etc. The process involves First Nations consultation, and depending on the relationships between the parties this can be a lengthy procedure.

Timelines vary from one year to several years to acquire licenses for a new farm. An estimate of cost to acquire a new license/site can range from CAD 300,000 - 500,000. No licenses for new farms have been issued since 2007.

35

6.6 The Atlantic salmon life/production cycle

Source: Marine Harvest

The total production cycle takes approximately 10-16 months in freshwater plus 14-24 months in sea water in total 24-40 months. In Chile, the cycle is slightly shorter as the sea water temperatures are more optimal. See the appendix for a more detailed illustration of the production cycle.

Spawn Brood - Parr - Smolt

Transfer to sea

Growth phase in sea

Secondary processing Primary processing (to HOG)

14

-24

mon

ths

10

-16

mon

ths

36

6.6 The Atlantic salmon life/production cycle Norway (3 generations)

Source: Marine Harvest

In the autumn, the broodfish are stripped for eggs and the ova inlay happens between November and March. The producer has the possibility to speed up the growth of the juveniles with light manipulation to accelerate the smoltification process by up to 6 months. The light manipulated juveniles are called S0s and the normal grown juveniles are called S1s. In Norway, smolt is mainly released into seawater twice a year. S0s are released in autumn/spring within 12 months after ova inlay, and S1s in the autumn about 18 months after ova inlay. A very small part of the production is produced as S1, which are only put to sea 2 years after the ova inlay. The harvest is spread all around the year. In Norway, typical harvest is the beginning of the year for S0s and second half of the year for S1s. During summer, the supply to the market is significantly different to the rest of the year as harvest go from S0s to S1s, and the large S0s and the small S1s dominate the supply. After a site is harvested, the location is fallowed between 2 and 6 months before the next generation is put to sea at the same location. Smolt may be released in the same location with a two year cycle. In the example above, Generation 1 (G1) is put to Location 1 (L1), G2 put to L2, and then G3 is put in L1 again as the fish from G1 have been harvested and the location has been fallowed. Harvest volume is largest in the last quarter of the year as this is the period of best growth, and because most of the S1s are harvested in this period. Some of the last S0s and some early S1 could also be harvested in this period.

G1

G2

G3

L1

L2

L1

37

6.7 Production inputs

Eggs There are several suppliers of eggs to the industry. Aquagen AS, Fanad Fisheries Ltd, Lakeland and Salmobreed AS are some of the most significant by volume. Egg suppliers can tailor their production to demand by obtaining more or less fish for breeding during the preceding season. Production can easily be scaled. The egg market is international.

Smolt The majority of smolt are produced in-house by vertically integrated salmon farmers. This production is generally captive, although a proportion may also be sold to third parties. A smolt is produced over a 6-12 months period from the eggs are fertilised to a mature smolt with weight of 60-100 grams.

38

6.7 Production inputs

Source: Marine Harvest, Kontali Analyse, SSPO

Labour In 2011, around 5 800 people in Norway were directly employed in aquaculture, of which more than half was employed in salmon and trout production. According to Scotland Salmon Producers Organisation (SSPO), over 2 100 people are employed in salmon production in Scotland. The Scottish Government estimates that 6,200 jobs are reliant on the aquaculture industry. Estimates on Canadian employment say that around 2 500 people are directly employed in salmon farming industry. In Chile, employment has been significantly reduced as a consequence of the ISA situation that developed throughout 2008. Direct employment in Chilean aquaculture (incl. processing) is estimated to around 18 000 people in 2011. In Norway, both salaries and levels of automation are highest, while the opposite is the case in Chile. Salaries in UK and Canada are somewhat lower than in Norway. Electricity Electricity is mainly used in the earliest and latest stage in the salmons life cycle. To produce a good quality smolt, production normally takes place in tanks on land where the water is temperature regulated and/or recirculated which requires energy (8-10% of smolt cost in Norway). When the salmon is processed energy is consumed. However, this depends on the level of automation (3-5% of harvest cost in Norway).

39

6.8 Factor influencing the pace of production Sea Water Temperature

Source: Marine Harvest, racerocks.com

The sea water temperatures vary much throughout the year in all production regions. While the production countries on the Northern hemisphere see low temperatures during the beginning of the year and high temperatures in autumn varying with as much as 100C, the temperature in Chile is more stable varying between 100C and 140C. Chile has the highest average temperature of 120C, while Ireland has 110C and the three other regions have an average temperature of about 100C. As the salmon is a cold-blooded animal (ectotherm), the temperature plays an important role for its growth rate. The optimal temperature range for Atlantic salmon is 8-140C, illustrated by the shaded area on the graph. Temperature is one of the most important natural competitive advantages that Chile has compared to the other production regions as the production time historically has been shorter by a few months. With high seawater temperatures, disease risk increases, and with temperatures below 00C causes mass mortality. Both of which causes growth rate to fall.

40

7. Cost Dynamics 7.1 Economics of salmon farming The salmon farming industry is capital intensive and volatile. This is a result of a long production cycle, a fragmented industry, market conditions and a biological production process, which is affected by many external factors. Over time, production costs have been reduced and productivity has increased as new technology and new competence has been achieved. This is believed to continue in the future as commercial aquaculture still is a young industry. Revenues Reported revenues Revenues are a gross figure; they can include invoiced freight from reference place (e.g. FCA Oslo) to customer, and have discounts, commissions and credits deducted. Reported revenues can also include revenues from trading activity, sales of by-products, insurance compensation, gain/loss on sale of assets etc. Price Reported prices are normally stated in the terms of a specific reference price e.g. the NOS/FHL price for Norway (FCA Oslo) and UB price for Chile (FCA Miami). Reference prices are not reflecting freight, and other sales reducing items mentioned above. Reference prices are for one specific product (FHL = per kg head on gutted fish packed fresh in a standard box). Sales of other products (frozen products, fresh fillets and portions) will cause deviation in the achieved prices vs. reference price. Reference prices are for superior quality fish, while achieved prices are for a mix of qualities, including downgrades. Reference prices are spot prices, while most companies will have a mix of spot and contract sales in their portfolio. Volume Reported volume can take many forms. Volume harvested = Fish harvested in a specific period in a standardized term e.g. head on gutted (HOG) or whole fish equivalent (WFE) the difference being gutting loss. Volume sold can be reported using different weight scales:

Kg sold in product weight

Kg sold converted to standard weight unit (HOG or WFE) Volume sold could also include traded volume.

41

7.2 Production costs The figures below illustrate the main cost components and their relative importance in the farming of salmon in the three biggest regions. The cost level is chosen for illustration purposes.

Norway (NOK) Canada (CAD) Scotland (GBP) Chile (USD)

Feed 11,24 2,16 1,39 2.00

Primary processing 2,30 0,52 0,25 0.06

Smolt 2,08 0,56 0,25 0.46

Salary 1,31 0,52 0,14 0.10

Maintenance 0,70 0,17 0,07 0.25

Well boat 0,92 0,20 0,16 0.25

Depreciation 0,62 0,25 0,10 0.12

Sales & Marketing 0,44 0,03 0,05 0.16

Mortality 0,47 0,12 0,01 0.04

Other 2,56 0,94 1,29 1.04

Total* 22,64 5,47 3,70 4.50

*HOG cost in box delivered at the processing plant including mortality

Cost elements Feed: As in all protein production, feed makes up the largest share of the total cost. The variation in costs between the countries is based on somewhat different inputs to the feed, logistics and the feed conversion ratio. Smolt: Smolt production is done in two different ways; either in lakes or in closed/re-circulated systems in tanks on land. The smolt is produced in fresh water up to about 100g when the salmon through its smoltification phase gets ready to be put in sea water. UK has the highest costs as there has been low scale production in both land based systems and tanks. Chile has used lakes for this production and has had cheap labour, while in Norway there has been a transfer from production in lakes to large scale production in land-based systems. Salary: Salary level differs among the production regions but in general the salary cost is low because labour cost is a minor part of the total cost as much of the production is automated (e.g. feed blowers). Well boat/processing: The cost of transportation of live fish, slaughtering, processing and packing are all heavily dependent on volume, logistics and automation. Other operational costs: Other costs include direct and indirect costs, administration, insurance, etc.

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7.3 Cost component mortality and disease

EBIT costs per kg decline with increasing harvest weight. If fish is harvested at a lower weight than optimal caused by among other factors diseases, EBIT costs per kg will be higher. During the production cycle, some mortality will be observed. Under normal circumstances, the highest mortality rate will be observed during the first 1-2 months after the smolt is put into seawater, while subsequent stages of the production cycle normally has a lower mortality rate. Elevated mortality in later months of the cycle is normally related to outbreaks of disease or predator attacks. There is no strict standard for how to account for mortality in the books, and there is no unified industry standard. Three alternative approaches are:

Charge all mortality to expense when it is observed

Capitalise all mortality (letting the surviving individuals carry the cost of dead individuals in the balance sheet when harvested)

Only charge exceptional mortality to expense (mortality, which is higher than what is expected under normal circumstances)

It is not possible to perform biological production without any mortality. By capitalizing the mortality cost, the cost of harvested fish will therefore reflect the total cost for the biomass that can be harvested from one production cycle.

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7.4 Feed and feed ingredients

Source: Marine Harvest

Growth intervals 0.1 0.2 kg 0.2 1 kg 1 2 kg 2 3 kg 3 4 kg 4 5 kg Feed consume* 0.08 kg 0.75 kg 1.00 kg 1.05 kg 1.10 kg 1.20 kg

Time, months 2 4 4 3 2 2

*Estimates for Norway only typical S1 smolt

Historically the two most important ingredients in fish feed have been fish meal and fish oil. The use of these two marine raw materials in feed production has been reduced and replaced by agricultural commodities such as soy, sunflower, wheat, corn, beans, peas, poultry by-products (Chile and Canada) and rape seed oil replacing fish oil. This substitution is mainly done because of heavy constraints on availability of fish meal and fish oil. Fish meal and other raw materials of animal origin have a more complete amino acid profile compared to protein of vegetable origin and have generally a higher protein concentration. It is therefore a big challenge to produce the knowledge required to replace fish meal 100%. During the industrys early phases, salmon feed was moist (high water content) with high levels of marine protein (60%) and low levels of fat/oil (10%). The industry then went through a development of pellet feeds with focus on protein and fat content. A typical recipe in the early nineties consisted of 45% protein, whereof most of it was marine protein, i.e. fish meal. Today, the marine protein level is lower due to cost optimization and fish meal availability. However, the most interesting development has been the increasingly higher inclusion of fat. This has been possible through technological development and extruded feeds. Due to market demands, legislation and different availability of raw materials, the ingredients used in fish feed today are different from country to country, giving higher raw material flexibility in certain regions as e.g. Chile and Canada. This will have an impact on the feed price. Feed and feeding strategies aim at growing a healthy fish fast at the lowest possible cost. Standard feeds are designed to give the lowest possible production cost. Premium diets are available in most countries and are being used in certain situations where extra growth rate is profitable. Feeding control systems shall prevent feed waste and assure that the fish get enough feed to grow to its potential. Normally the fastest growing fish show the lowest feed conversion rate.

29 %

15 % 15 %

26 %

15 % 19 %

15 %

10 % 30 %

14 % 12 %

59 % 24 %

17 %

Development in use of ingredients in salmon feed receipts

Global 1990 Norway 2008 Chile 2008

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7.5 Salmon feed producers

Source: Skretting annual report, EWOS annual report, BioMar

During the last decade, the salmonid feed industry has become very consolidated, and from 2008 there has essentially been three producers, which are all subsidiaries of listed companies, controlling the majority of the output. These companies, BioMar (Schouw), Ewos (Cermaq) and Skretting (Nutreco) are operating globally. Additionally, there are some producers who are only present in their regional market. One major issue in the salmon feed industry is the future supplies of the raw materials going into feed (see next page). The major cost elements when producing salmonid feed are the raw materials required and production costs. The feed producers have historically operated on cost-plus contracts, leaving the exposure of raw material prices with the aquaculture companies.

Feed producers' market share 1998

Skretting (44%)

EWOS (22%)

BioMar (12%)

NorAqua (9%)

Biomaster (4%)

Other (9%)

Feed producers' market share 2008

Skretting (35%)

EWOS (34%)

BioMar 25%)

Other (6%)

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7.6 Raw material market

Source: Marine Harvest, Holtermann

Fish oil: Price in 2012 is about 1400 USD. Since 2009 fish oil prices has steadily increased and we expect fish oil prices to become uncorrelated with vegetable oil prices in the future. Rape seed oil: Rape seed oil prices have very much the same price trend as fish oil. As there is an increasing demand for bio diesel, there will be continued pressure on price, including other types of vegetable oil. Fish meal: In the last year there has been a decreasing trend in the price, but this is not expected to continue. Soy: After having seen the soy prices climb to the highest level in 34 years in mid-2008, the prices fell slightly and has remained stable the last couple of years. The main reason for 2008s price increase was because less soy was planted due to a shift from soy to corn in many regions, and a high demand for vegetable oil in general. Corn is planted in higher volume due to increased demand for ethanol produced from corn, i.e. former soy areas are used for corn production. Vegetable protein: Soy and corn have traditionally been very important vegetable protein sources in fish feed. As a consequence of less planting of soy and more corn for energy purposes, the price for these raw materials increases. Parallel to this there has been an increase in genetic modified (GM) production of soy and corn. To be able to get non-GM production, a premium has been put on price, i.e. non -GM products are more expensive than GM products. Wheat: Wheat has been rather stable since late 2010.

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/to

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es

Fish meal

Soy meal

Wheat

Rapeseed oil

Fish oil

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7.7 Price, cost and EBIT development (Norway)

Source: Kontali Analyse

Due to supply growth being higher than the structural growth in demand in the period 1993-2007 there was a falling trend of the price of salmon. In recent years, this trend has been broken due to the collapse of the Chilean industry, combined with effects of consolidation in the industry. As a result of cost benefits of industrialisation, consolidation and economies of scale, combined with improvements in the regulatory framework and fish health mitigation, the cost curve has also had a falling trend. The average EBIT per kg for the Norwegian industry has hence been positive with the exception of a few shorter periods, and NOK 4.12 per kg in nominal terms.

-10,00

-5,00

0,00

5,00

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20,00

25,00

30,00

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40,00

19

93

19

94

19

95

19

96

19

97

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98

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99

20

00

20

01

20

02

20

03

20

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11

EBIT/kg Price/kg Cost/kg

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7.8 Salmon farming is a capital intensive industry Cost of building biomass

Source: Marine Harvest

For illustration purposes, the farming process has been divided into three stages of 12 months. The first 12 months is production from egg to finished smolt. After this, 24 months of on-growing in sea follows. After the on-growing phase is over, harvest takes place immediately thereafter (illustrated as Month 37). In a steady state there will at all times be three different generations at different stages in their life cycle. At the point of harvest there have been incurred costs to produce the fish for up to 36 months, where some costs were incurred to produce the smolt two years ago, further costs incurred to grow the fish in seawater and some costs incurred related to harvest (Month 37). Sales price should cover the costs and provide a profit margin (represented by the green rectangle). Cash cost in the period when the fish is harvested is not large compared to sales income, creating a high net cash flow. If production going forward (next generations) follows the same pattern, most of the cash flow will be reinvested into salmon at various growth stages. If the company wishes to grow its future output, the following generations need to be larger requiring even more of the cash flow to be reinvested in working capital. This is a rolling process and requires substantial amounts of working capital to be tied up, both in a steady state and especially when increasing production.

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7.9 Capital needs when building biomass

Source: Marine Harvest

The illustration above shows how capital needs develop when one is building production/biomass from scratch. In phase 1, there is only one generation (G) of fish produced and the capital needs is the production cost of the fish. In phase 2, the next generation is also put into production, while the on-growing of G1 continues, rapidly increasing the capital invested. In phase 3, G1 has come to its last stage, G2 is in its on-growing phase and G3 has begun to increase its cost base. At the end of phase 3 the harvest starts for G1, reducing the capital bound but the next generations are building up their cost base. If each generation is equally large and everything else is in a steady state, the capital needed would have peaked at the end of phase 3. With a growing production, the capital needed will also increase after phase 3 as long as the next generation is larger than the previous (if not, capital base is reduced). We see that salmon farming is a capital intensive industry

49

7.10 Accounting principles for biological assets

Biological assets are measured at fair value less cost to sell, unless the fair value cannot be measured reliably. Effective markets for sale of live fish do not exist so the valuation of live fish implies establishment of an estimated fair value of the fish in a hypothetical market. The calculation of the estimated fair value is based on market prices for harvested fish and adjusted for estimated differences. The prices are reduced for harvesting costs and freight costs to market, to arrive at a net value back to farm. The valuation reflects the expected quality grading and size distribution. The change in estimated fair value is recognised in profit or loss on a continuous basis, and is classified separately (not included in the cost of the harvested biomass). On harvest, the fair value adjustment is reversed on the same line. The biomass valuation includes the full estimated fair value of fish at and above harvest size (4 kg LW). For fish between 1 kg and 4 kg LW a relative share of future value is included. The best fair value estimate for fish below 1 kg, smolt and broodstock is considered to be accumulated cost. The valuation is completed for each business unit and is based on biomass in sea for each sea water site. The fair value reflects the expected market price. The market price is derived from a variety of sources. Normally a combination of achieved prices last month and the most recent contract entered into. For Marine Harvest Norway, quoted forward prices (Fish Pool) are also included in the calculation. Operational EBIT Operational EBIT and other operational results are reported based on the realised costs of harvested salmon and do not include the fair value adjustments on biomass.

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7.11 Investments and payback time for new entries (Norway) Assumptions Normal site consisting of 4 licenses: Equipment investment NOK 30-35m Number of licenses 4 Licence cost (second hand market) NOK 120-200m (~NOK 30-50m per licence) Output per generation: ~4000 tonnes HOG Number of smolt released: 1m Smolt cost per unit: NOK 8 Feed price per kg: NOK 8.40 Economic feed conversion ratio (FCR): 1.17 (to live weight) Conversion rate from Live Weight to HOG: 0.83 Harvest and processing incl. well boat cost per kg (HOG): NOK 3 Average harvest weight (HOG): 4.5kg Mortality in sea: 10% Sales price: NOK 27 Source: Marine Harvest, Kontali Analyse

For new volume capacity to be established there are many regulations to fulfil. In this model, we have used only one site for simplification purpose and because we are looking at a new company entering the industry. Most companies use several sites at the same time, which enables economies of scale and makes the production more flexible and often less costly. To simplify, smolt is bought externally. Smolt is usually less costly to produce internally, but this depends on production volume. The performance of the fish is affected by numerous factors as feeding regime, sea water temperature, diseases, oxygen level in water, smolt quality etc. Sales price chosen is the average sales price from Norway the last decade.

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7.11 Investments and payback time for new entries (Norway) Results

Source: Marine Harvest

Because of the simplifications in the model and low, non-optimal production regime, production cost is higher than industry average. Due to high entry barriers in terms of capital needs and falling production costs with volume, new companies in salmon production will experience higher average production costs. During the production of each harvest the working capital needed at this farm, given the assumptions, would be peaking at MNOK 75 (given that the whole harvest is harvested at the same time). With a sales price at the historic average level, payback time for the original investments would be 12-13 years. This result is very sensitive to sales price and economic feed conversion ratio (FCR), as the figure above shows. Sales price of NOK 27 is chosen as this is close to the historical average price in Norway. FCR at 1.17 is achievable on average, while lower economic FCR is possible for parts of production and a target for the industry.

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8. Salmon diseases, mitigation and R&D 8.1 Salmon disease prevention and treatment Minimising disease risk and maintaining healthy fish stocks is primarily achieved through good husbandry and health management practices and policies. Such practices, in addition, reduce exposure to pathogens, control the potential spread of infectious disease and decrease stress. The success of health management practices has been demonstrated on many occasions and have contributed to an overall improvement in the health of farmed salmonids. Fish health management plans, veterinary health plans, bio security plans, disease mitigation plans, contingency plans, disinfection procedures, surveillance schemes as well as coordinated and synchronised zone/area management approaches all support healthy stocks with emphasis on disease prevention. For the majority of salmonid diseases, prevention is achieved through vaccination at an early stage in production. Vaccines are now widely used commercially to combat the majority of salmonid pathogens. With the introduction of vaccines a considerable number of bacterial diseases have been effectively controlled, with the additional benefit that the quantity of antibiotic prescribed in the industry has been minimised. Despite such disease prevention approaches, many diseases are recognised as conditions that can exert an impact on production if they are not controlled through the application of good husbandry and management. In some situations medicinal treatment is still required to maintain control and even the best managed farms require using medicines from time to time. For several of the viral diseases, no effective vaccines are available and no effective cure exists.

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8.2 Most important disease risks Infectious Pancreatic Necrosis (IPN) IPN is caused by the IPN virus and is widely reported. It is a highly contagious disease that can cause significant mortality. IPN can affect Atlantic salmon fry, smolts and larger fish post-transfer. Available vaccines reduce IPN-losses to some extent, but good results can also be obtained by optimizing husbandry and biosecurity measures. In addition, promising results are now seen by use of genetic selection of families less susceptible for the disease (QTL-based genetic selection). Pancreas Disease (PD) PD is caused by the Salmonid Alphavirus and is present in Europe. It is a contagious disease that causes reduced appetite, muscle and pancreas lesions, lethargy and elevated mortality. PD affects Atlantic salmon in seawater and control is achieved mainly by management and mitigation practices. Vaccination is currently in use in areas where PD is representing a risk and gives some degree of protection. Heart and Skeletal Muscle Inflammation (HSMI) HSMI, associated with Piscine reovirus (PRV), is currently reported in Norway, and PRV is found in other salmon producing countries. Symptoms of HSMI are reduced appetite, abnormal behaviour and in most cases low to moderate mortality. HSMI generally affects fish the first year in seawater and control is achieved mainly by good husbandry and management practices. Infectious Salmon Anaemia (ISA) ISA is caused by the ISA virus and is widely reported. It is a highly contagious disease that causes lethargy, anaemia and may lead to significant mortality in seawater. Control is achieved through culling / harvesting of affected fish in addition to other biosecurity and mitigation measures. Vaccines are available and in use where ISA is regarded to represent a significant risk. Salmonid Rickettsial Septicaemia (SRS) SRS is caused by an intracellular bacterium. It occurs mainly in Chile but is also observed, to a lesser extent, in Norway and the UK. It is a contagious seawater disease that causes lethargy, anorexia and elevated mortality. SRS has been controlled mainly by medicinal intervention (antibiotics), however commercial vaccines are available and in use in the Chilean industry. Gill Disease (GD) GD is a general term used to describe gill pathology occurring in seawater. The changes may be caused by different infectious agents; amoeba, virus or bacteria, as well as environmental factors including algae or jelly-fish blooms. Little is known about the cause of many of the gill conditions and to what extent infectious or environmental factors are primary or secondary causes of disease. Gill damage can lead to respiratory distress and significant mortality can occur. Currently there is no effective cure. Sea lice Sea lice, of which there are several species, are natural occurring seawater parasites. They infect the salmon skin and if not controlled they can cause lesions, secondary infection and mortality. Sea lice are controlled through good husbandry and management practices and the use of pharmaceutical products, cleaner fish (different wrasse species, eating parasites off the salmon skin), and hydrogen peroxide baths (well boats or enclosed cages).

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8.3 Fish health and vaccination (Norway)

Vaccination and use of Antibiotics (Norway)

Source: Kontali Analyse, Norsk medisinaldepot, Folkehelseinstituttet

Associated with the increase in production of Atlantic salmon in Norway in the 1980s was an increase in mortality and the incidence of disease outbreaks. In the absence of effective vaccines the use of antibiotics increased and reached a maximum of almost 50 tonnes in 1987. With the introduction of effective vaccines against the bacterial diseases Vibriosis, Cold Water Vibriosis and Furunculosis, the quantities of antibiotic used in the industry declined significantly to less than 1.4 tonnes by 1994 and has since then continued to be very low. These developments, along with the introduction of biosecurity and mitigation measures against ISA allowed for further expansion of the industry and respective production volumes. During the last two decades there has been a general stabilisation of mortality in Norway, Scotland and Canada, which has been achieved principally through good husbandry, management practices and vaccination. However, losses during seawater are still too high in Norway and Ireland, and this area has gained increased focus the last years. A positive development has been observed in Chile after rebuilding the industry after the ISA-epidemic.

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100

200

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1 000

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OG

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tive

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Antibiotics use HQ - Atlantic Salmon

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8.4 Research and development areas Disease

Developing better tools for prevention and control of listed diseases Vaccine developments/ improvements Develop new and optimize use of current pharmaceuticals for lice control

Non-pharmaceutical technologies for sea lice control, including farming of cleaner fish

Environment Environmental impact of aquaculture Capacity of coastal environment to assimilate discharges from aquaculture Interactions between cultivated and wild species Production of sterile salmon

Genetics and immunology

Tools for health and performance monitoring of Atlantic salmon Breeding and selection for disease resistant stock

Welfare

Optimise slaughter methods Physiological & behavioural measures of the welfare of farmed fish in relation to

stocking densities, environmental & husbandry factors

Feed & nutrition Fish oil and fish meal substitution in salmon diets maintaining fish health, performance

and quality. Functional diets for improved fish health Bone health and role of nutrition

Product quality

Measures to reduce prevalence of melanin (black spots) in the fish flesh Identify disposing factors and measures to reduce risk of soft flesh and gaping

Technology Most of the technology used in aquaculture is global and Norway has been a leader in the development of new technology in modern aquaculture. However, the technology and knowledge has spread fast. For instance floating cages, which are still used, was developed in Norway and exported to Chile by Norwegian players. Another example is Aquagroup supplying aquaculture equipment and software all over the world. According to Zacco (Norwegian patenting office), the patenting intensity in the salmon farming industry has grown rapidly the last two decades. R&D is done in several areas, but the most important development has been in feed and vaccines, done by large global players. In this industry the majority of producers are small and have neither had the capital nor the competence to undertake and supervise major R&D activities. This is expected to change as the consolidation in the industry continues. Smolt/ Ongrowing production and processing The technology used in these stages can be bought off the shelf. Very few patents are granted. Technology is becoming increasingly advanced to operate.

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9. Secondary processing (VAP) In salmon processing we divide between primary and secondary processing. Primary processing is slaughtering and gutting. This is the point in the value chain standard price indexes for farmed salmon are related to. Secondary processing is filleting, fillet trimming, portioning, different cuttings like choplets, smoking or making ready meal or packing with Modified Atmosphere (MAP). The products that are secondary processed are called value-added products (VAP).

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Others 19%

Shellfish and

mussels 15%

Fish 66%

9.1 European value-added processing (VAP) industry

A total value of > EUR 25 billion

Employees > 135,000

Extremely fragmented more than 4,000 companies

About 50% of all companies have less than 20 employees

Traditionally the EBIT-margins have been between 2% and 5%

The average company employs 33 people and has a turnover of EUR 4.2 million

Source: Marine Harvest, Intrafish, EU

The seafood industry in Europe is extremely fragmented with more than 4,000 players. Most of the companies are fairly small, but there are also several companies of significant size involved in the secondary processing industry: Marine Harvest, Icelandic Group, The Seafood Company, Deutche See, Royal Greenland, Labeyrie, Lery Seafood, and Morpol. Most of the largest players are basing their processing on Atlantic salmon, producing smoked salmon, portions or ready meals with different packing as vacuum or modified atmosphere (MAP). Consumers are willing to pay for quality and value-added. This means that we are expecting to see an increase in demand for products such as ready meals and ready-to-cook, together with a packing trend towards MAP as this maintain the freshness of the product longer.

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9.2 Market segment in the EU (2009)

Source: Kontali Analyse

In the EU in 2009 more than half of the Atlantic salmon went to retailers, while 45% went to hotels, restaurants and catering (HORECA). Of whole salmon and salmon fillets almost two thirds were sold as fresh fish and about one third as frozen. In the EU, salmon fillets and smoked salmon have an equal market share of 32% each, while whole fish has about 19%. In this graph, other VAP consists of all value added processed products, except smoked salmon which is represented separately.

55% 45%

Retail vs. Horeca

Retail Horeca

61% 39%

Fresh vs. frozen

Fresh Frozen

19%

32% 32%

16%

Different products

Whole Fillet Smoked Other VAP

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9.3 The European market for smoked salmon (2011) Market by country

Source: Kontali Analyse The most common secondary processed product based on Atlantic salmon, is smoked salmon. The European market for this product was 150,000 tonnes product weight (PW) in 2011, where France and Germany were the largest markets. The amount of raw material needed for this production was around 250,000 tonnes HOG, up 8% since 2009. European smoked salmon producers

Estimated Annual Raw Material - Tonnes HOG

60 - 80 000 20 - 40 000 10 - 20 000 5 - 10 000

Morpol (PL) Labeyrie (FR-UK) Norvelita (LT) Xantelar (ES)

Youngs (UK) Marine Harvest (FR) Friedrichs (DE)

Mer Alliance (FR) Ahumados Domingues (ES)

Suempol (PL) KB Rgeri (DK)

Voppen (NL) Neptune Intnl. (DE)

Lery (NL-SE-NO) Source: Kontali Analyse The ten largest producers of smoked salmon in Europe have a joint market share of about 55-60%. The production is mainly done in Poland, France, UK, Baltic states, Germany and the Netherlands. After the acquisition of the German company Laschinger, Morpol is the largest producer of smoked salmon in Europe. Morpol is based in Poland and is selling most of its production to the German market. Labeyrie is the second largest and sells most of its products to France, but are also found in UK, Spain, Italy and Belgium. Marine Harvest has its smoked salmon production in France (Kritsen) and in Belgium (La Couronne). Marine Harvest sells its smoked salmon in France, Italy and Belgium.

0% 5% 10% 15% 20% 25%

Other

Scandinavia

Spain

Be/Ne/Lux

Italy

Germany

UK

France

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Appendix

In the appendix there is an explanation of key words, and you will find key information about the Marine Harvest group such as key financial numbers, the companys history together with information about our operations upstream and downstream.

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Appendix: Weight conversion ratios and key words

Atlantic salmon Trout Coho

Live fish 119 %

Loss of blood/starving 8 %

Harvest weight 111 % 114 % 111 %

Round bled fish (wfe)

Offal 11 % 14 % 11 %

Gutted fish, approx. (HOG) 100 % 100 % 100 %

Head, approx. 9 % 9 % 14 %

Head off, gutted 91 % 91 % 86 %

Fillet skin on 67 - 77 % (C-trim approx. 70%)

Fillet skin off 56 - 68 %

Source: Kontali Analyse

Net weight: Weight of a product at any stage (HOG, fillet, portions). Only the weight of the fish part of the product (excl. ice or packaging), but incl. other ingredients in VAP

Primary processing: Whole fish HOG/GW Secondary processing: Any value added processing beyond HOG/HG Biomass: The total weight of living fish, where number of fish is multiplied

with an average weight

Ensilage: Salmon waste from processing added acid FCR = IB feed stock + feed purchase UB feed stock Kg produced weight on smolt release

Price FOB Seattle (whole fish from Canada) Notifications FOB Miami (fillets from Chile)

FCA Oslo

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Appendix: Some historic acquisitions and divestments

Year Norway

1999 Hydro Seafoods - Sold from Norsk Hydro to Nutreco Aquaculture

2001 Gjlaks - Sold to PanFish

2001 Vest Laks - Sold to Austevoll Havfiske

2001 Torris Products - Sold from Torris to Seafarm Invest

2001 Gjlanger Havbruk - Sold to Aqua Farms

2001 Alf Lone - Sold to Sjtroll

2001 Sandvoll Havbruk - Sold to Nutreco Aquaculture

2001 Fosen Edelfisk - Sold to Salmar

2001 Langsteinfisk - Sold to Salmar

2001 Tveit Grd - Sold to Alsaker Fjordbruk

2001 Petter Laks - Sold to Senja Sjfarm

2001 Krkyfisk - Sold to Salmar

2002 Amulaks - Sold to Follalaks

2002 Kvamsdal Fiskeoppdrett - Sold to Rong Laks

2002 Matland Fisk - Sold to Bolaks

2002 Sanden Fiskeoppdrett - Sold to Aqua Farms

2002 rsnes Fiskeoppdrett - Sold to Aqua Farms

2002 Toftysund Laks - Sold to Alsaker Fjordbruk

2003 Ny