Coal

Markets

Far East and Australian Thermal coal markets

Demand for imported seaborne thermal coal in the Pacific Basin in 2004 exceeded initial expectations and rose by 8% compared to 2003. Sustained tightness in availability from major producing nations saw 2004 characterised by higher price levels. The term contract price for Australian thermal coal, previously referred to as the Japanese Reference Price, was unclear this year with producers settling term tonnage into Japan at varying price levels depending on the timing of the contract. For its annual contracts with most of the Japanese utilities, Xstrata Coal secured a price of $45 per tonne FOB, effective 1 April 2004. This price represents a 68% price increase on last year's unofficial reference price of $26.75 per tonne and surpassed the prices achieved by other Australian shippers who contracted earlier in the year. Annual supply to the Korean generating companies was priced later at around $51 per tonne, an increase of over 100%, reflecting the market's upward momentum as the year progressed.

The spot market experienced an unprecedented rise in prices in the early part of the year. From $39 per tonne in January, Newcastle FOB spot price jumped to approximately $63 per tonne in early July before slipping back to the mid-$50 range for most of the second half of 2004.

Non-delivery of contracted Chinese export tonnage and delays caused by Indonesian monsoon rains resulted in tight supply from the outset of the year and caused major utilities in Japan, Korea and Taiwan to enter 2004 with low stocks. The strength in demand was sustained as the year unfolded with a 7% increase across these "big 3" importing nations, despite the gradual return of suspended nuclear output in Japan. Contributors to demand for coal included growth in industrial production and GDP across the Asia-Pacific region, new coal-burning units coming on-stream in Korea and Taiwan, and a very hot summer in Japan. In addition, the high price of oil during 2004 prompted power utilities across Asia to switch to coal wherever feasible.

The supply of thermal coal in the Asia-Pacific region is dominated by Australia, China and Indonesia. Well-publicised supply constraints in Australia relating to infrastructure, together with self-imposed export quotas in China, allowed Indonesia to continue its strong export growth and claim most of the expansion of the 2004 marketplace. It is, however, estimated that half of Indonesia's growth during the year came from lower-grade sub-bituminous coal which has a limited export market. Currently, on a total tonnage basis, Australia and Indonesia are now jointly the largest thermal coal exporters in the world, with each exporting around 106 million tonnes per annum.

New South Wales thermal coal exports increased by approximately 9% period-on-period as a result of increases in throughput at the Newcastle port. In February 2004, Port Waratah Coal Services (PWCS), which manages the port at Newcastle, sought approval from the Australian Competition and Consumer Commission (ACCC) to introduce a capacity distribution system in response to a vessel queuing crisis. This system quickly reduced the vessel queue from over fifty in March to fewer than ten by July. Consequently, average demurrage exposure has reduced from over $1.80 per tonne to less than $0.40 per tonne, despite peaks in vessel queuing still occurring at the end of each quarterly allocation period. PWCS has since received approval to extend the capacity distribution system into 2005.

Unlike New South Wales, Queensland's thermal coal exports fell by 5% in 2004 after a slow start to the year due to heavy rains and a reclaimer failure at the Dalrymple Bay Coal Terminal (DBCT). Later in the year DBCT became capacity constrained which saw a queue of forty ships form by the end of 2004. In addition, the high prices of metallurgical coals meant that, where possible, mines elected to produce metallurgical coal at the expense of lower-priced thermal.

The Asian market continues to be strongly influenced by China due to its vast and rapidly growing coal production capacity. Despite the Chinese government's recent attempts to slow the rate of economic growth, China's booming economy has fuelled a rate of growth in domestic demand for coal that is outstripping increases in domestic production. Consequently, Chinese exports fell in 2004. The unpredictability of Chinese coal exports was reduced in part by the tightening of the export licence system by the Chinese government. As signalled early in the year, licences for a total 80 million tonnes of coal were issued during 2004, of which 80% were used for export of thermal coal.

The major Asian utilities appear to have modified their purchasing policies in response to tight market conditions and the reduction in Chinese exports, placing less reliance on the spot market and returning to term contracts. Xstrata Coal is directing an increasing percentage of its thermal coal sales into the Asian market as Japanese and Korean customers seek to increase their purchases from reliable Australian term suppliers to protect against Chinese volatility. Asia continues to consume the bulk of Xstrata Coal Australia's export thermal coal and represents about 90% of 2004 export sales, with the remainder going to Europe and the Americas, including a significant supply contract into Mexico priced at $70 per tonne FOB. Term/annual contracts made up 63% of Xstrata Coal Australia's export sales with the balance being sold on the spot market.

Xstrata Coal continues to maintain a stable and balanced domestic portfolio to provide geographic and currency diversification. Domestic thermal coal sales are predominantly long-term contracts with power utilities in both New South Wales and Queensland and represent about 15% of total thermal coal sales from Xstrata Coal's Australian operations.

European and South African thermal coal markets

Robust thermal coal markets at the beginning of 2004 continued to gain momentum during the first half of the year with the average price up 57% to $39 per tonne, a substantial improvement year-on-year. Reduced exports out of South Africa and China, and the flow-on effects of a tight Pacific market arising from infrastructure constraints in New South Wales, all made a positive contribution to the supply and demand balance in the Atlantic.

On the demand side, the Americas, in particular the United States, absorbed a significant share of the growth in Colombian export volumes, while Argentina and Chile both purchased additional coal to replace natural gas shortages. In Europe, import demand rose with the UK and France increasing import tonnage as domestic coal production continues to be phased out. By April 2004, these developments combined to result in a spot price of approximately $45 per tonne. By the end of June, with electricity markets showing some improvement and renewed activity in the derivative markets, spot prices surged to above $65 per tonne, albeit for limited physical volumes and a short period of time.

Coming off these mid-year highs, demand was static during the second half of the year. The advent of CO2 trading and National Allocation Plan (NAP) limits from 1 January 2005 in the European Union generated uncertainty in forecasting coal burn by power stations, which affected coal purchasing. On the pricing front, continued use of the derivatives markets to lock in generating margins contributed to price volatility as both liquidity and market drivers, such as electricity and gas prices, changed. Lower than expected reductions in Polish exports and higher than anticipated Russian export volumes both dampened the market. Spot prices decreased from approximately $59 per tonne by the end of September, to approximately $51 per tonne in the final quarter of 2004.

The South African domestic market remained strong in 2004, with tightness in supply of higher-grade product and increased demand from Eskom for low-grade coal.

New spot and annual contracts for the supply of low quality coal to Eskom saw overall Eskom sales increase 53% year-on-year. This was achieved despite lower long-term Eskom contract sales volumes from the Douglas Tavistock Joint Venture (DTJV) due to production difficulties at Middelburg mine. Xstrata Coal's received average Eskom pricing fell year on year due to lower inflation-related adjustments, together with a change in contractual quality mix year on year.

Despite stable demand in the non-Eskom domestic market, sales volumes decreased by 21% due to the diversion of some higher grade domestic product to the higher margin export market. The majority of non-Eskom domestic contracts from Xstrata Coal achieved above-inflation increases helped by a change in year-on-year reporting and the quality mix.

Coking coal markets

Demand for export coking coal was driven to record levels by the end of 2004 on the back of two consecutive years of 8% growth in global steel output. Steel production is expected to grow by an additional 9% in 2005, spurred by increasing Chinese domestic demand for both imported and locally-produced steel.

For the 2004/05 contract period, Xstrata Coal settled its hard coking coal contracts into the Asian and European markets at varying prices up to $135 per tonne. Allowing for the large volume of carry-over tonnage associated with production difficulties under MIM, which was delivered at 2003/04 prices, the average price of coal delivered in the new period was approximately $85 per tonne, an increase of 83% on the prior corresponding period. Similar prices were achieved for Collinsville semi-hard coking coal into the Asian steel market.

China's escalating infrastructure expansion fuelled an increase in its steel imports from Japan, Korea and Taiwan, resulting in a commensurate increase in demand for coking coal from these countries. Indian demand for imported coking coal was strong as Indian steelmakers supply both China and their own growing domestic steel market. Growth in the Japanese economy and in the European and North American steel market also contributed to tightness in supply and record steel prices.

The export coking coal market enjoyed the full impact of this heightened demand as China continued to import hard coking coal on long-term contracts and in increasing quantities, while simultaneously restricting its coke and coking coal exports to protect domestic steelmakers. The lack of export coke available from China prompted an increase in global demand for imported coking coal, most noticeably in India where imports increased by 15% in 2004.

The fundamental market deficit was exacerbated by Australian and Canadian supply issues during 2004, rendering these producers unable to satisfy the additional demand for coking coal in full. The supply gap was partially met by the USA's re-emergence as a high-cost swing supplier to the Asian steelmakers.

The growth in global demand for hard coking coal has had a positive effect on semi-soft coking coal demand and prices, with semi-soft coking coal used to overcome the shortfall in available hard coking coal. The semi-soft coking coal price has also been boosted by the buoyant global thermal coal market, which traditionally sets the floor price for this coal.

During 2004, the majority of Xstrata Coal's hard coking coal was sold under long term contracts, with 64% to Asia, 28% to Europe, and the balance to the Americas, Africa, Australia and the Middle East. Xstrata Coal's semi-soft coking coal production comes from its New South Wales operations, with almost all such sales going to the Asian markets. Japanese mills were the dominant buyers for 2004, accounting for over 60% of total sales, and the spot market comprising 26% of total sales of semi-soft coking coal.

Notwithstanding recent attempts by the Chinese government to rein in growth rates, the overall outlook for the export coking coal market remains positive on the back of infrastructure constraints in Australia and Canada and the buoyant global steel industry.

Operations

Australian thermal coal

Total consolidated production for 2004 was 35.6 million tonnes, 3% lower than the prior period. This decrease is attributable to the sell-down of Xstrata's interest in Queensland coal assets from 75% to 55% in November 2003. On a like-for-like basis, production increased by 3% year-on-year.

Despite the impact of the sell-down of Queensland thermal coal operations on production and sales volumes for the period, EBIT increased considerably from the prior year, up 400% from $91 million to $454 million. This substantial increase was primarily driven by the significantly higher coal prices achieved in 2004, partially offset by a stronger Australian dollar.

New South Wales production was maintained at 2003 levels. Despite the closure of Cumnock underground mine and the decision to produce higher margin export coal from Ravensworth East, which has a lower yield than domestic coal, productivity-driven increases were achieved across a number of operations, in particular at Beltana and United.

On a like-for-like basis, Queensland production rose by 18% in 2004, on the back of increased mining and production at Collinsville and the start up of the Suttor Creek and Eastern Creek operations. The increase was partially offset by reduced production at Newlands' Mains Deposit as this mine reaches the end of its useful life.

Efficiency and productivity improvements at Beltana, United, Mount Owen and Bulga Open Cut, together with reduced development costs at Newlands Southern underground mine, delivered mine-site unit cost savings. This positive result was mitigated by higher government royalty costs associated with higher coal prices and increased demurrage expenses, which increased local unit costs by 3%. After allowing for revenue-related costs and inflation, there was a 4% decrease in unit costs. The continued strengthening of the Australian dollar has seen US dollar unit cash costs increase by 17% from the prior year.

Despite total production being 3% down on 2003, export sales of thermal coal increased by 6% during the period. In New South Wales the introduction of the capacity distribution scheme at PWCS did not dampen export sales, with a 13% increase period-on-period as Xstrata Coal obtained other exporters' unused capacity and placed additional Baal Bone sales through Port Kembla. This was offset by lower export sales out of Queensland for the period due to the sell-down of assets. Adjusting for the impact of the sell-down, however, Queensland sales volume actually increased by 11% for the period as the Suttor Creek and Eastern Creek operations were ramped up.

Notable productivity improvements were made across the New South Wales mines during 2004. The performance of the Bulga Complex in 2004 set new records, with the coal preparation plant handling 13.5 million tonnes of managed ROM coal, 25% up on its previous best of 10.8 million tonnes in 2000. The Complex also produced, on a managed basis, an impressive 8.9 million tonnes of product coal, 27% higher than its previous record of just over 7 million tonnes in 2000.

Beltana's first full year of operation saw it achieve an annual production of almost 6 million ROM tonnes (managed basis), making it the highest and most cost-efficient producing longwall mine in Australia, closely followed by Newlands Southern underground mine.

In December 2004 development approval was secured to increase the life of the Mount Owen operation by ten years, giving access to all mineable reserves. This approval encompassed the upgrade of mine infrastructure, including rail, to increase capacity from 9 million to 15 million tonnes per annum. This secures the future of both Ravensworth East and Glendell, with Mount Owen now permitted to process export coal from these operations. The Ravensworth East mine was successfully reengineered as an export mine and was integrated into the Mount Owen Complex. United, which made the transition from bord and pillar mining to a longwall operation during 2003, also achieved record ROM tonnage during 2004, continuing to perform at consistently high levels of productivity with increased output of almost 500,000 tonnes using a similar size workforce.

Ulan Open Cut and Baal Bone set new performance benchmarks. Baal Bone, in particular, took advantage of the buoyant market and the availability of export capacity at Port Kembla to increase its production and productivity levels by 16% with no increase in the workforce.

In Queensland, Newlands' production of 10 million tonnes of ROM coal (on a managed basis) represented a 22% increase from 2003 production. The Southern Underground's achievement of an individual mine record, together with additional output from the open cut operation, resulted in a record number of tonnes processed by the coal preparation plant. The inclusion of Suttor Creek in NCA's production profile also contributed towards the overall strong performance of the Newlands operation. Suttor Creek contributed approximately eight months of operation and is expected to make a significant contribution to Newlands' thermal production profile as it continues to ramp up to Suttor Creek to full production of 3.6 million ROM tonnes per annum (on a managed basis) in 2006.

Following Xstrata's increased shareholding in Cook Colliery to 95% in April 2004, management focused on the consolidation and redesign of the operation. Parallel to this was a keen emphasis on improved safety management, with these efforts recognised by the Queensland government with the nomination of Cook for the "Most Improved Safety Management in Queensland Central West Region" Award.

Australian coking coal

Coking coal EBIT, boosted by the higher coal prices achieved in 2004, was up over three-fold year-on-year to $112 million. The operational performance of the former MIM coal operations in Queensland has significantly improved following the successful implementation of a comprehensive turnaround programme. Xstrata Coal's focus on the proactive management of major hazards has secured a dual benefit in the form of improved business productivity and a safer workplace.

The 17% decrease in production, period-on-period, from 6.3 million tonnes to 5.2 million tonnes was attributable to the sell-down of Queensland coal assets. Stripping out the effect of the sell-down, production increased by 13%.

Higher production levels were achieved at Oaky No. 1 as the methane gas drainage programme took effect as well as the significant increase in production at Oaky North enabled by reconfiguration of the longwall equipment. Since the acquisition of the MIM coal assets, Xstrata Coal has secured a 37% improvement in the productivity of the Oaky Creek longwalls. The increased production from the Oaky Creek underground operations was partially offset by a planned reduction in production from the higher-cost open cut operation.

During 2004, rail and port infrastructure comprising the central Queensland coal chain generally operated at maximum capacity with the three major routes through Gladstone, Dalrymple Bay Coal Terminal (DBCT) and Abbot Point unable to satisfy requests for increased capacity for the 2004/05 contract period. Although this problem was exacerbated in 2004 by the collapse of DBCT's reclaimer, it is evident that rail infrastructure and supply of rolling stock are also limiting volumes of contracted tonnage through DBCT. The Queensland ports have all sought to implement improvement initiatives to optimise the efficiency of the existing infrastructure in the short term but in the longer term major infrastructure expansions will be necessary to meet speculative demand forecasts.

Local currency unit cash costs rose by 7% period-on-period due to higher royalty payments associated with stronger coal prices. The removal of the impact of these royalties and inflation shows a marginal decrease in costs period-on-period. This is a result of cost savings on a mine FOR basis with Oaky North achieving higher production output offset by increased distribution and demurrage expenses. US dollar unit cash costs have increased by 22% year-on-year due to the strengthening of the Australian dollar.

Export sales volumes of coking coal for 2004 decreased by 21% period-on-period due to the sell-down of assets. Removing the effect of the sell-down, export sales volumes rose 7% due to increased production at Oaky No. 1 and Oaky North, despite the coal supply chain issues at DBCT.

South African thermal coal

Total production for 2004 was 19.2 million tonnes, a 14% increase on the prior year. Contributors to this rise included increased output following the revision of the operating roster at two of the mines, the expansion of operations at Tselentis, and the production and sale of low grade by-product at Phoenix to take advantage of the tightening Eskom market.

In spite of the constant strength of the South African rand throughout 2004, South African EBIT increased by 370% to $102 million, predominantly due to the high coal prices achieved during the period.

Local currency unit costs decreased marginally period-on-period and, after removing inflation, real cost savings of approximately 5% were achieved on the back of higher levels of production. However, the continued strengthening of the South African rand meant unit costs in US dollar terms increased by 11%.

Export sales of thermal coal fell by 7% on the prior period to 12.9 million tonnes. This decrease however, which was primarily the result of rail capacity constraints, was partially offset by a 9% increase in domestic sales, mainly from the Phoenix operation.

Operational highlights for the year include:

• the completion of the underground rejuvenation project at Boschmans which saw the move from cut, drill and blast operations to continuous miners as well as the commissioning of higher capacity conveying systems;
• an increase of 40% in output and record production at Tavistock Colliery following the $10 million investment upgrade of the beneficiation plant and mining equipment in 2003/4 and a revised operating roster. The plant upgrade has delivered a strong return on capital with a positive outlook for Tavistock in 2005;
• a 20% increase in output at South Witbank Colliery with the introduction of a revised operating roster; and
• an increase of 38% in output and record production at Tselentis attributable to capacity production at the contract underground, optimisation of the contract opencast, the successful removal of plant bottlenecks and utilisation of spare plant capacity at a neighbouring mine.

Developments

Australia

For 2004, Xstrata Coal Australia's capital expenditure totalled AUD325 million ($240 million). The key projects to which this capital expenditure relates include:

• further development of the Rolleston project, with the commencement of expenditure in the first half of 2004, following Board approval in February;
• continued development of the new Northern underground mine at the Newlands complex. The mine, which will replace production from the existing Southern underground mine, will be completed in late 2005 with full production scheduled for early 2006;
• the purchase and reconstruction of a dragline for overburden removal at the Eastern Creek pit at the Newlands complex. Operations are expected to commence in January 2005; and
• commencement of work to implement a $68 million state-of-the-art longwall system together with a $16 million underground drift conveyor system at the Ulan underground coal mine. The new longwall system will enable Ulan to operate as one of the lowest cost underground mines in Australia.

The commissioning of the Rolleston coal mine remains on time, following approval from the Board in February 2004 to develop the long life, open-cut, export and domestic thermal coal operation. Rolleston enjoys a rapid development profile, with first production of some one million tonnes expected in 2005, and full production on a managed basis of 6 million export tonnes per annum and 2 million tonnes domestic production expected in 2008.

Capital expenditure for Australia is expected to be higher in 2005 than 2004 due to the continued development of the Rolleston project, the ongoing development of the Northern underground mine at Newlands, and installation of the previously mentioned longwall system at Ulan. In addition, a project for the replacement of the existing Newlands coal handling preparation plant with a new Dense Medium Cyclone (DMC) plant will commence. This project will enable the production of coking coal product from the current reserves and will provide additional capacity to coincide with the commencement of the Northern Underground mine. Furthermore, the coal processing facilities at Bulga and Mt Owen will receive significant upgrades enabling increased throughput and cost savings.

South Africa

Evaluation of two major projects commenced in 2004; namely the Goedgevonden mine and the Verkeerdepan extension to the Tselentis operation, with significant work undertaken on each during the year.

A total of ZAR410m ($65 million) was directed to capital expenditure for Xstrata Coal's South African operations in 2004. This expenditure relates to a number of key projects including a $8 million project to gain access to a new mining area at WitCons scheduled for completion in the first half of 2005 and the purchase of a total of five new continuous miners at South Witbank, Tavistock and Boschmans to replace older technology units and improve productivity at a total cost of around $13 million.

Capital expenditure in South Africa is expected to increase in 2005 due to the continued development of the Goedgevonden project and the Verkeerdepan extension.

The go-ahead for the expansion of the Richards Bay Coal Terminal was again delayed. This was due to further delays by Transnet and Spoornet in both negotiating the renewal of the export coal industry rail agreement, due to expire at the end of March 2005, and approving the capital required to expand the coal rail system. The appointment of a new Transnet Board and recent changes in Spoornet's senior management should see the satisfactory progression of these issues in the first half of 2005.

In accordance with the Minerals and Petroleum Resources Development Act, which was enacted on 1 May 2004, Xstrata Coal is continuing its commitment to transformation in its South African business, having made progress in all areas addressed by the South African Government's Scorecard, including plans to address the participation of black economic empowerment groups in the ownership of assets.