China is by some margin the largest stainless steel producing country, with stainless melt production of approximately 5.6 million tonnes in 2006, and also remains the most important driver of global demand growth. In response to strong growth in demand for stainless steel, demand for ferrochrome increased by an estimated 10% in 2006, bringing global demand to 6.3 million tonnes. The lower growth rate in ferrochrome demand compared to stainless steel is due in part to increased production of high carbon ferrochrome, which has a higher chrome content, and the use of chrome-bearing nickel pig iron by Chinese producers, to cushion the impact of high nickel prices. Despite sustained higher nickel prices, the ratio of stainless steel scrap used in Austenitic stainless melt declined by 1% in 2006 to 42% due to lack of scrap availability, further supporting demand for ferrochrome.

China has emerged as a significant producer of ferrochrome and has almost doubled ferrochrome output from 494,000 tonnes in 2004 to 925,000 tonnes in 2006, meeting the bulk of increased demand from China and globally. However, as Chinese stainless melt and ferrochrome demand continue to increase, it is expected that environmental pressure, limited availability of electric power and reliance on imported ore will combine to restrict further expansions in Chinese ferrochrome production, resulting in increased alloy imports. The Chinese government recently halved the import duty on ferrochrome to 1%. Firm capacity expansion projects have also been announced for South Africa, India and Russia over the next four years.

Ferrochrome base prices continued to come under pressure in the first quarter following a 5¢ price decrease to 68¢ per pound at the end of 2005, falling to 63¢ per pound. The strong recovery in demand seen from the second quarter resulted in prices rapidly rebounding to 70.25¢ per pound, with further increases in the two subsequent quarters to 75¢ per pound and 78¢ per pound respectively.

Strong stainless melt production is expected to continue, with China anticipated to increase production further to approximately 6.5 million tonnes in 2007. As a result, the momentum gained during the year in ferrochrome demand is set to continue into the first half of 2007. Longer term, stainless steel demand is forecast to grow at approximately 6% per annum, which should result in similar growth in global ferrochrome demand.

Strong demand for crude steel has been underpinned by relatively strong economic growth in Europe, CIS, North America and especially China, which together account for nearly 70% of global vanadium demand. Vanadium supply increased in response to strong demand and has resulted in a continued strong vanadium market in relative equilibrium.

Ferrovanadium prices have declined from the record high prices seen in 2005, with the average price declining to $38.50 per kilogram in 2006, down from $70.50 per kilogram in 2005. Prices appear to have stabilized at around $30 per kilogram throughout the fourth quarter of 2006 and into 2007, well above long term average prices. Prices are expected to remain above historical levels for 2007.

New supply is likely to emerge from the two major Chinese producers, where additional capacity is planned, and potentially from Western Australia by the end of 2007. However, with further growth anticipated in crude steel production, demand for vanadium units should remain firm during 2007.

The extended period of elevated vanadium prices is, however, resulting in predominantly temporary substitution in certain applications such as commodity grade rebar. Worldwide ferro-niobium consumption has increased significantly, with the majority of ferro-niobium consumption growth coming from China. It is anticipated that lower vanadium prices will result in reverse substitution. This is, in turn, expected to support prices and limit volatility in 2007.

Platinum Group Metals

The second half of 2006 was marked by a strong rally in the platinum market, propelling prices to a 25-year high of $1,415 per ounce in November 2006. High rhodium prices also further enhanced the profitability of platinum group metals (PGM) producers mining the UG2 reef within the Bushveld Igneous Complex, which has a higher rhodium content. The rhodium price continued its three-year climb reaching a high of $6,275 per ounce in May 2006. The positive outlook for PGM prices is supported by improved supply-demand fundamentals and is expected to continue in the short term. Growth in demand is expected to continue due to the growing European market for auto catalysts, with good potential for this market to grow further in the US in the near future.

Healthy market fundamentals in aluminium pushed the LME aluminium cash price to a multi-year high of $3,275 per tonne on 11 May 2006. The average LME cash price in 2006 was $2,570 per tonne, 35% higher than the 2005 average of $1,898 per tonne. At the end of 2006, the LME price closed at $2,850 per tonne, well above the annual average and prices have remained robust into the first quarter of 2007.

Globally, consumption of aluminium is estimated to have increased by 7% over the previous year. Demand grew strongly in China, up by approximately 20% over 2005 levels to represent nearly a quarter of total global demand, consolidating China’s position as the world’s largest consumer of primary aluminium. Demand growth from North America and Western Europe was more modest, with a slight decline in consumption in Japan year-on-year.

Global aluminium production increased by approximately 6% in 2006, with China again the largest producing nation, reporting a 19% increase in primary aluminium production over the previous year. Other regions experiencing production growth included the Middle East, South America and Australia, while production from the US and Western Europe declined slightly year-on-year.

In 2007, demand and production from China will continue to be the dominant factors in determining the global supply/demand balance in the aluminium market. Recent analyst forecasts have moved from projecting a small deficit in 2007 to a modest surplus, on the back of more rapid production growth from China. With global demand growth forecast to be at, or near, the levels seen in 2006 and inventory levels already low, any shortfall in this projected production growth should be very supportive of the aluminium price during 2007.

Alumina prices were volatile during 2006, peaking at over $600 per tonne in May before falling to around $200 per tonne by year end. However, spot prices rebounded quickly in the early part of 2007. Analysts had been forecasting a significant surplus in the global alumina market for 2007, but delays to planned expansions and curtailment of marginal capacity should be supportive to spot prices during the coming year. Power costs continue to be a concern for some smelters with operations in Western Europe, the US, and more recently South Africa, experiencing difficulties. Regional power grids in developing countries may continue to come under severe strain, resulting in periods of disruption to supply and loss of aluminium production.

Despite strong demand throughout most of 2006, weak US housing starts and industrial customer de-stocking resulted in a smaller than expected demand growth of only 1.5% for aluminium foil products in the US and Canada. North American imports of Chinese aluminium foil products increased by approximately 20% in 2006. If US trade representative complaints against China’s subsidised 13% VAT rebate on exports of aluminium foil and other semi-fabricated aluminium products are successful, this would severely limit the economic viability of these products into the North American market.

As a result of this demand growth and the market’s recognition that export volumes from the Hunter Valley were stabilising at levels significantly below initial expectations, the first half of 2006 saw a swift recovery in Newcastle spot prices, increasing from around $40 per tonne in early January and stabilising within the range of $51 to $54 per tonne. Xstrata Coal secured annual contracts prices with the majority of Japanese utilities at around $52.50 per tonne free on board (FOB). The prices were effective for the year commencing 1 April 2006, slightly down on average prices in 2005.

In the second half of 2006, an apparent oversupply in the Pacific induced by de-stocking caused spot prices to slide to around $41 per tonne in late November. However, the continued decline in Chinese export volumes brought buyers into the market to cover Chinese shortfalls and this, combined with the onset of winter buying, led to a rapid recovery in prices. The FOB Newcastle spot price was over $50 per tonne at the close of 2006. Average received prices for Xstrata’s Australian thermal coal declined from $51.20 per tonne in 2005 to $46.40 in 2006.

The Asian market accounted for over 75% of Xstrata’s managed export thermal coal sales from Australia in 2006 with Japan, Korea and Taiwan remaining dominant. Term and annual contracts comprised 60% of Xstrata Coal‘s Australian managed export thermal sales in 2006, with the balance sold on the spot market.

Market supply was characterised by surging Indonesian export growth, of which a significant proportion went into Europe, flat exports from Australia and a substantial decline in Chinese exports. Despite the progress made in improving the export coal chain, Australia’s export growth in 2006 continued to be constrained by supply-side issues, including production problems at several large New South Wales mines, labour and equipment shortages and ongoing infrastructure constraints. The Hunter Valley coal chain’s ‘Capacity Balancing Scheme’, approved by the Australian Competition and Consumer Commission (ACCC), proved successful in ensuring minimal queuing at the Newcastle port throughout most of 2006. This scheme was annulled in September and subsequently the shipping queue at Newcastle has grown. Following producer and Port Waratah Coal Services agreement, it is anticipated that the ACCC will ratify the reintroduction of a Capacity Balancing Scheme towards the end of the first quarter of 2007.

Xstrata Coal continues to maintain a stable and balanced domestic portfolio to provide geographic and currency diversification. Domestic thermal coal sales remain predominantly long-term contracts with power utilities in both New South Wales and Queensland and represent about 20% of total managed thermal coal sales from Xstrata Coal’s Australian operations.

Atlantic thermal coal markets

Atlantic export coal prices strengthened during the first half of 2006 from spot prices of $43 per tonne in January to a peak of above $55 per tonne in March, thereafter stabilising at between $47 and $53 per tonne. Average received prices declined slightly from $48.50 per tonnes in 2005 to $45.80 per tonne in 2006. The European and Mediterranean import market grew by around 8% with imports from the Americas up by around 14% year-on-year. The strong European market largely reflected the robust but volatile energy market in Europe during the year as oil, gas and electricity prices reached record levels.

Although South African export tonnages were constrained during the first half of the year by a combination of rail bottlenecks and mine production disruptions, this was largely offset by improved volumes during the second half, due to a stable performance from the rail network and the recovery of export production. In 2006 total South African export volumes of approximately 67 million tonnes were slightly lower than the 69 million tonnes exported in 2005. Export sales from Xstrata Coal’s South African operations were 1% lower than in 2005, and account for about two-thirds of the Group’s total South African sales tonnage.

Export volumes from Colombia increased overall by about 7%, despite some production disruptions caused by industrial action and minor impacts from weather and equipment availability. The major portion of this growth went into the Americas with the balance into Europe. Export thermal coal demand in North and South America grew by approximately 14% year-on-year, and this trend is expected to continue. On a pro forma basis, average received prices declined slightly from $51.72 per tonne in 2005 to $49.30 per tonne in 2006.

The price of carbon credits, allocated and traded under the EU emissions trading scheme, was volatile throughout 2006, fluctuating from a high of ?30 per tonne to a low of ?6 per tonne. On average, carbon credit prices in 2006 exceeded the prior year average. Nonetheless, seaborne coal exports to Europe in 2006 are estimated to have increased by approximately 8% over the prior year. For the majority of 2006, imported coal remained the least expensive fossil fuel for electricity generation.

The South African domestic market, which accounted for around a third of Xstrata Coal’s South African sales volumes, also remained robust during 2006. Supply of higher-grade industrial products remained tight and, together with increasing demand for lower-grade coals from Eskom, supported domestic coal prices. Both new and extended annual contracts for the supply of low quality coal to Eskom contributed to an overall increase in Xstrata’s sales to the Eskom market of 15% over 2005 levels. Average received prices from Eskom increased by 4% in 2006 due to inflation-related adjustments coupled with changes in quality mix and delivery bases.

Non-Eskom domestic sales volumes decreased by 20% in 2006, as coal was diverted to meet higher margin export demand. The majority of non-Eskom domestic contracts from Xstrata South African coal operations achieved above-inflation increases, but this was also coupled with a change in quality mix resulting in an average price increase of 22% year-on-year.

Coking coal markets

Term prices for premium quality hard coking coal were established by the BHP Billiton Mitsubishi Alliance (BMA) and the Japanese Steel Mills (JSM) in January 2006 at about $115 per tonne, some 8% lower year-on-year. Prices for lower quality hard coking coals were discounted by a greater percentage, reflecting the increasing supply of these lesser grade coals. Despite a further drop from the record prices achieved in 2004, demand for hard coking coal remains robust and continues to command a high premium over historical prices.

Xstrata Coal’s hard coking coal prices for the 2006-07 contract year were agreed with term customers in Europe and Asia at an average level of $114 FOB per tonne. During 2006, the vast majority of Xstrata Coal’s hard coking coal was sold under long term contracts, with 60% of output going to Asian markets, 24% to Europe, and the balance to the Americas, Africa, Australia and the Middle East. The high premium for hard coking coal during 2006 has resulted in increased interest by non-traditional European markets for Xstrata’s high volatile semi-soft coking coal to reduce costs. Prices for Xstrata’s semi soft coking coals were settled at an average level above $59 FOB per tonne. Average received prices for Xstrata’s hard coking coal remained at a similar level to the previous year, at slightly over $111 per tonne. Japanese steel mills were once again the dominant buyers of coking coal in 2006, accounting for over 60% of Xstrata’s total sales including semi soft. Coking coal was predominantly sold under long-term contracts with spot market sales comprising less than 30% of total sales. Steel companies are showing considerable interest in the prime low volatile coking coal produced from Xstrata’s new Wollombi mine. Shipments from this operation commenced in the fourth quarter.

Demand for seaborne metallurgical coal remained constant over the course of 2006. Global steel prices strengthened in most regions from the second quarter and despite falling slightly in the second half, remain well above historical levels. Pig iron production increased by 24% in China in 2006, compared to 2.5% annual growth in the rest of the world and just 1% growth in coking coal importing countries excluding China. Lower quality domestic coking coals, rather than imports, have largely fuelled increased Chinese pig iron production, and, as a result of significantly higher export prices, China imported 39% less coking coal in 2006 than in the previous year.

Australian coking coal exports declined marginally during the first half of 2006, principally attributable to production difficulties, skills shortages and a series of planned longwall moves, rather than any market impact. During the second half of the year, production recovered resulting in total Australian coking coal export growth of more than 3 million tonnes for 2006 compared to 2005. Canadian exports remained in line with 2005 levels and lower US coking coal exports were offset by small increases from Poland, New Zealand and Indonesia.

Global steel production forecasts continue to show growth in Brazil, Russia, India and China. Construction of new integrated blast furnaces in Brazil and India in particular, will continue to drive demand growth for imported coking coal whilst further growth is also forecast in Japan, Korea and Taiwan as new coke-making capacity comes on line.

In contrast to 2005, copper demand from the major Western consuming regions was stronger than expected, while apparent Chinese consumption growth has been limited by inventory de-stocking. Global copper exchange inventories increased by more than 96,000 tonnes over the year to 252,533 tonnes at the end of 2006. Much of this increase occurred during the fourth quarter, due to slowing economic conditions in the US as well as inventory de-stocking ahead of the financial year-end. Despite this increase, exchange stocks remained at a critically low level and at the end of 2006 represented five days of global consumption.

The oversupply of copper concentrate that accumulated in 2005 was progressively eroded during 2006 through a combination of increased global smelting capacity and a series of mine production problems in the industry. This tightening concentrate situation drove spot concentrate treatment and refining charges down from $135 per dry metric tonne and 13.5¢ per pound at the beginning of 2006 to around $50 per dry metric tonne and 5¢ per pound by year-end. Further growth in smelting capacity should continue to outstrip mine supply and maintain the downward trend in treatment and refining charges in 2007.

Although slowing economic growth is likely to generate weaker demand conditions in the US during the year, this is likely to be offset by continuing refined copper demand growth in China and Europe, together with an expected end to Chinese inventory de-stocking. These factors, together with the potential for further supply-side disruptions, should help to support another year of strong copper prices.

Significant de-stocking of the stainless steel market in the latter part of 2005, together with strong global economic growth in 2006, drove increased demand for stainless steel during the year. Global stainless steel production reached record volumes in the first half, boosted by the commissioning of an estimated nearly 2 million tonnes of new stainless steel production capacity in China. Seasonal summer shutdowns at European and North American mills temporarily offset some of the demand pressure for nickel, leading to a more balanced physical market. However, with order books at the mills booked into the first quarter of 2007, previous production rates were quickly resumed and continued to the end of the year. As a result, stainless steel production for 2006 is estimated at 28 million tonnes, an increase of some 14% from the previous year.

Demand was also very strong from non-stainless steel sectors, such as foundry and nickel alloys, and especially from the aerospace, oil and gas, and power generation industries.

On the supply side, more than 40,000 tonnes of nickel production losses were announced during the course of 2006, contributing to tightness in the market. With many nickel producers operating at high capacity utilization rates and postponing or forgoing maintenance shutdowns, there is a greater risk of future potential disruptions to operations in 2007 and beyond. Elevated nickel prices in 2006, together with a 45% increase in stainless steel production by Chinese mills, also led to the emergence of a new source of primary nickel. Chinese ferronickel and pig iron plants began importing significant quantities of low-grade laterite nickel ores from the Philippines, for conversion in blast furnaces into low grade nickel pig-iron, producing between 20,000 and 40,000 tonnes of contained nickel. Break-even costs for this high cost, marginal supply are estimated by market analysts to be in the range of $8 to $11 per pound. While Chinese stainless steel producers are likely to increase imports of laterite nickel ores in 2007, this additional supply, together with imported and domestically produced refined nickel, will be absorbed by planned expansions in stainless steel production. As a result, the net impact on the global nickel market is likely to be neutral.

The nickel market is estimated to have recorded a deficit of 34,000 tonnes in 2006, with most of the deficit occurring during the first seven months, as evidenced by the run-down of LME stocks during the period. Strong physical demand for nickel and tight nickel supply, together with investment fund interest in commodities, helped to fuel an unprecedented rise in the LME nickel cash price from $6.25 per pound ($13,786 per tonne) at the start of the year to around $15.74 per pound ($34,700 per tonne) in late August and later peaking at $16.16 per pound ($35,635 per tonne) in December. For the latter part of the year, the market remained in equilibrium, as LME stock levels remained within a narrow range, finishing the year at 6,600 tonnes, representing 1.5 days of global consumption, and with prices trading in the range of $13 to $16 per pound ($28,000 to $35,000 per tonne). The average LME nickel cash price more than doubled compared to the previous year, reaching $10.96 per pound ($24,155 per tonne), up from $6.68 per pound in 2005 ($14,732 per tonne).

Demand is expected to remain strong from the non-stainless steel sector and particularly from super alloys producers in 2007. However, overall demand growth for nickel is expected to moderate somewhat during the year. In addition, with a number of major producers sold out and LME inventories at critically low levels, the nickel market will not be able to accommodate a deficit, and cannot sustain global nickel demand growth in excess of 4% year-on-year. Importantly, while nickel supply is forecast to increase by 7% or around 95,000 tonnes in 2007, this additional supply will not be enough to satisfy anticipated demand, even when factoring in a decelerating economic cycle.

Under such conditions, the short and mid-term price outlook remains favourable with prices expected to remain well above long-term averages. The tightness of the market and further potential supply shocks are also likely to lead to price volatility in 2007.

Domestic demand in China continued to grow strongly, reflecting robust economic growth and a surge in new galvanizing capacity in response to booming demand from the automotive and home appliance sectors, as well as from extensive construction and infrastructure investment.

In 2006, global zinc metal production rose in response to increased demand, continued higher prices and improved concentrate availability. Metal output increased by 6%, the highest annual growth since 2000.

The largest increase in refined production was in China, where metal output increased by 14% to three million tonnes. Increased refined production from China, India and Kazakhstan, combined with incremental improvements at many western smelters, enabled metal supply to reach 10.7 million tonnes in 2006.

Strong market fundamentals combined with investment fund buying drove prices up strongly in the first half of the year, and, after a weaker third quarter, again in the fourth quarter peaking at $4,619 per tonne in November. The average LME zinc price increased by 137% in 2006 to $3,264 per tonne, up from an average of $1,382 per tonne in 2005.

Global zinc concentrate production responded to higher prices in 2006, increasing by 6.7% to 10.7 million tonnes. China, India and Kazakhstan accounted for the majority of global mine supply growth, principally from existing mine operations. The concentrates market remained tight during the year, resulting in a further drop in negotiated treatment charges. Benchmark treatment charges fell from $126 per tonne basis $1,000 zinc in 2005 to $128 per tonne basis $1,400 zinc in 2006, equivalent to $80 per tonne at a $1,000 zinc price basis. The tightness in the supply of zinc concentrate is anticipated to ease in 2007 as new mines come into production during the year.

With the majority of zinc stocks depleted, zinc supply is expected to experience a small deficit in 2007, as new mine supply becomes available to increase refined metal production levels and almost meet forecast global demand requirements. Demand in China, India, South East Asia and Eastern Europe will continue to support steady consumption growth. Stocks are expected to remain low supporting a continued strong price environment in 2007.

Lead

Global consumption of refined lead rose by over 4.5% to 7.95 million tonnes in 2006. China continues to exert a significant and growing influence on the global lead market, where lead usage has risen strongly in recent years, driven by surging battery production due to the country’s rapidly expanding automobile and communications sectors.

Global production of refined lead increased by 5% to 7.9 million tonnes in 2006. Around half of this amount came from secondary production, mainly from battery recycling. In China, primary lead production increased by 12% while secondary production increased by 21%.

As a result, the refined lead market was in supply deficit in 2006 with lead stocks at LME warehouses remaining at very low levels during the period. At the end of 2006, LME stocks of 41,125 tonnes represented less than one week of global consumption.

During the year, the cash price for lead traded between $914 and $1,809 per tonne, to finish the year at $1,775 per tonne. The average price in 2006 was $1,287 per tonne, 31% higher than the previous year. Backwardation was again a key feature of trading throughout the year, reflecting the tight physical market.

The lead market is expected to be largely balanced in 2007 with global lead consumption anticipated to continue to grow, but at a comparable rate to 2006. China will continue to be a dominant force in both consumption and production. Despite strongly increasing domestic demand, exports of refined lead from China are expected to remain at similar levels to 2006 as domestic lead mine production responds to high price levels. Lead stocks should continue to remain at low levels and consequently the market is expected to remain fairly tight throughout 2007, supporting lead prices.