1. Coal | C H I N AB AS I C M AT E R I AL S / M E T AL S & M I N I N G NOMURA INTERNATIONAL (HK) LIMITEDIvan Lee, CFA+852 2252 6213 ivan.lee@nomura.comMatty Zhao +852 2252 1397 matty.zhao@nomura.com BULLISHR E P O R TA N C H O RAlways room for dessertStocks for actionWe think the China coal sector remains a sweet investment even after a satisfyingWe prefer coal players with strongcourse of price performance since the lows of 4Q10. We are bullish despite near-term reserves, sustainable output growth andgovernment intervention (cap on key contract prices) and escalating input costs, higher exposure to spot rather thangiven (a) solid demand growth (6.5% in 2011F) backed by strong GDP growth and thecontract prices. We highlight Shenhuasprice competiveness of coal; (b) tight supply (4.2% in 2011F) given accelerating integrated model and third-party trades,industry consolidation, safety concerns, depleting coal resources in the east andand Yanzhous highest leverage to thetransportation bottlenecks; and (c) strong pricing power, the sellers market and lowspot market and internationalgearing, allowing coal firms to pass on additional costs like resources tax to buyerstransformation.and to sail safely against the macro headwinds. We expect spot prices to rise by 8% in2011F and 5% in 2012F with seasonal adjustments, and contract prices to gain 3% Price Stock TickerRating Pricetargetand 7%, respectively. We think the market is concerned about the price cap, andShenhua 1088 HKBUY 34.4041.0missing the point that it applies only to key contracts (40% of total contract sales), China Coal1898 HK NEUTRAL* 12.9013.90and we see ASP upside from potential upward revision of non-key contract pricesYanzhou Coal1171 HK BUY* 24.45 30.4 * Initiating coverage, Cutting PTwhen inflation cools. To mitigate the impact, coal players can also cut their contract Note: local currency, share prices as of 12 January 2011sales portion, reduce fulfilment rates or provide lower-quality coal. Overall, we seeclosingdouble-digit EPS growth for the top players; BUY calls on China Shenhua (integratedbusiness model and third-party trades) and Yanzhou Coal (spot market and globalAnalystsexposure). China Coal, NEUTRAL, is the biggest victim of the price cap.Ivan Lee, CFA +852 2252 6213 Tight supply/demand outlook with strong pricing powerivan.lee@nomura.com Coal price to remain strong in 2011-12F Matty Zhao Government intervention not a serious headwind +852 2252 1397 matty.zhao@nomura.com Top pick Shenhua; initiate on China Coal (Neutral) and Yanzhou (Buy)Nomura Anchor Reports examine the key themes and value drivers that underpin oursector views and stock recommendations for the next 6 to 12 months.Any authors named on this report are research analysts unless otherwise indicated. See the important disclosures and analyst certifications on pages 113 to 116.Nomura 18 January 2011

2. Coal | C H I N AB AS I C M AT E R I AL S / M E T AL S & M I N I N G NOMURA INTERNATIONAL (HK) LIMITEDIvan Lee, CFA+852 2252 6213 ivan.lee@nomura.comMatty Zhao +852 2252 1397 matty.zhao@nomura.comBULLISH Action Stocks for actionWe are Bullish on China coal despite the strong performance, due to tight supply We prefer coal players with strong(+4.2% pa) and resilient demand (+6.5% pa) in 2011F. We see the spot (contract)reserves, sustainable output growthprice rising 8% (3%) in 2011 and 5% (7%) in 2012 with seasonal adjustment. and higher spot portion. We highlightDespite a contract price cap, ASP upside should come from non-key contract price Shenhuas integrated model andrevision. Shenhua: BUY. Initiate on China Coal (NEUTRAL) and Yanzhou (BUY).third-party trades, and YanzhousStrong pricing power and low gearing allow them to sail against macro headwinds. highest leverage to the spot market and international transformation. CatalystsGDP; seasonal price movement; seaborne price; asset injection; consolidation.Price Stock TickerRatingPricetargetAnchor themesShenhua 1088 HK BUY 34.4041.0 China Coal1898 HK NEUTRAL*12.9013.90Despite government intervention, we are Bullish, driven by solid demand backed byYanzhou Coal1171 HK BUY*24.4530.4GDP growth and coals price competiveness; tight supply given safety concerns, * Initiating coverage, Cutting PT Note: local currency, share prices as of 12 January 2011industry consolidation, depleting resources in east and transportation bottlenecks.closingAlways room for dessertAnalystsIvan Lee, CFA Tight supply/demand outlook with strong pricing power+852 2252 6213China is heavily reliant on coal and will likely continue to be so until it finds anivan.lee@nomura.cominexpensive substitute. We are positive on the coal sector despite near-termgovernment intervention (key contract price cap) and escalating input costs, given: Matty Zhao1) solid demand growth backed by strong GDP growth and coals price +852 2252 1397matty.zhao@nomura.comcompetiveness; 2) ongoing tight supply given increasing safety concerns,accelerating industry consolidation, transport bottlenecks and depleting coalresources in the east; 3) the strong pricing power, the sellers market and the lowgearing, allowing coal firms to pass on additional costs (like a resources tax) tobuyers and sail safely against macro headwinds. Industry consolidation with moredisciplined supply favours big players with government support for resources,allowing them to grow faster than the industry. Coal price to remain strong in 2011-12FDespite the spot coal price already rising 25% y-y in 2010, given the tight supplyand rising commodity prices, we expect the spot price to rise 8% and 5% and thecontract price to rise 3% and 7% in 2011-12F. Yet the spot price, at RMB775, islikely to be RMB735-RMB865 over the rest of the year with seasonal adjustment. Government intervention not a serious headwindPrice cap only applies to key contracts, accounting for 40% of total contract volumesales. To mitigate the impact, coal players can cut contract sales portion, cutfulfilment rate or provide lower quality coal. ASP upside may arise from a potential7% non-key contract price revision later this year when potentially inflation cools. Top pick Shenhua; China Coal (NEUTRAL ) and Yanzhou (BUY)Shenhuas unique integrated business model, with captive logistics network andsufficient reserves, helps it facilitate third-party trade and sustain double-digitgrowth and above-average ROE. Yanzhous expansion into Australia and highexposure to the local spot market lets it benefit from strong regional prices and beimmune to the 2011 local contract price cap. While we like China Coals long-termoutlook, due to its recent resources gained through industry consolidation andacquisitions, near-term performance could be hit by the 2011 contract price cap.Nomura 1 18 January 2011 3. Coal | China Ivan Lee, CFA / Matty ZhaoContentsAlways room for dessert4Robust coal price in 2011-12F due to tight supply/demand 4Potential winners are5Sensitivity Analysis 6Investment risk6P/E comparison7P/B comparison8Operation metrics comparison 9Valuation comparison12Coal price to remain strong in 2011-12F 152011 contract price cap 15No price control on non-key contracts 162012F contract price to increase by 7% y-y17Strong spot price with seasonality fluctuation17Solid coal demand growth20driven by power, steel and cement20 th12 FYP: coal drops to 63% of total energy consumption 23 but absolute coal demand will continue to outpace supply24 and it is difficult to replace coal in the near term24Tight supply remains26Expect coal supply to see 4.2% CAGR for 2010-15F26Government restriction on capacity expansion26Geographically imbalanced supply27Small mines consolidations cause short term tightness 28Transportation bottlenecks to persist until 2014F 30Limited capacity expansion from the two backbone lines31Trucks too expensive and less efficient 31Regional lines link Inner Mongolia but cannot solve the problem 32New railways to ease the bottleneck in 2014F/ 2015F 32Increasing imports to fill the supply gap 34China becomes a net coal importer in 2009 34Supply gap to be filled by imports in 10F-12F 34Indonesia and Australia as main suppliers 35Rising costs ahead36Fees and levies edging up production cost 36Transportation costs is a big part37Nomura 2 18 January 2011 4. Coal | ChinaIvan Lee, CFA / Matty ZhaoAppendix I: Policy development on coal 38Development on the price intervention policy 38Coal and energy consumption reduction initiatives38Development on resources tax and other surcharges39Small mine consolidation 39Appendix II: Industry knowhow40Sector valuation 42Valuation methodology and key risks45Latest company viewsChina Shenhua Energy 48China Coal Energy67Yanzhou Coal 88Also see our Anchor Report: IndonesiaAnd our global mining teams report:Coal mining: Perfectly placedChinese supply shortage and Indian(18 January, 2011) electricity take-off set stage for strong coal decade (9 January, 2011)Nomura318 January 2011 5. Coal | ChinaIvan Lee, CFA / Matty ZhaoExecutive summaryAlways room for dessertChina is reliant on coal as its major primary energy source, with around 70% of its China is reliant on coal as itsprimary energy needs met by coal in the past 10 years higher than the world major primary energy source, withaverage of 29% in 2009 (source: CEIC). On the back of the strong GDP growth,around 70% of its primary energyneeds met by coal in the past 10Chinas abundant coal resources and coals price competiveness, we believe Chinasyearscoal-powered industry expansion model will continue in the next decade until it findsan inexpensive substitute. Although NDRC (National Development and ReformCommission) plans to reduce coals contribution to the countrys primary energy mix to63% by 2015, coal will likely remain the key energy source for many years.Despite robust share price performances for stocks in the coal sector, we stay positiveand expect domestic thermal coal prices to stay strong in FY11F-FY12F. This isdespite the announced near-term government intervention (key contract price cap) andescalating input costs given: Solid demand growth backed by strong GDP growth and price competiveness ofcoal; Ongoing tight supply given increasing safety concerns, accelerating industryconsolidation, transport bottlenecks and depleting coal resources in the east; The strong pricing power of coal companies in the sellers market. Coal firms canpass on additional costs (like a resources tax) to its users, in our view; and Despite rising inflation and interest rates in China, we believe the strong pricingpower and the low gearing should allow coal companies to sail safely against themacro headwinds.Robust coal price in 2011-12F due to tight supply/demand 2011F: We expect key contract price to be frozen; non-key contract to rise 7% from2Q11F; blended contract price to rise 3% y-y; spot price to rise 8% y-y; keycontract-to-spot price discount of 29% 2012F: We expect key contract and non-key contract prices to rise 7%; spot priceto rise 5%; key contract-to-spot price discount of 28%Although we expect the average spot coal price to rise 8% y-y to RMB804/ tonne for2011, given the current coal price at RMB775/tonne (10 January 2011), we expect theprice to move between RMB735-RMB865/tonne for the rest of the year, with seasonalweakness (strength) in February to May (June to August) and September to October(November to January).Exhibit 1. Projected price trend in 2011-12F FY12F avg. spot RMB844/t (+5% y-y)FY11F avg. spot RMB804/t(+8% y-y)spot price non-key contract7% rise in 2012F key contract7% rise from Q211RMB610/t (+7% y-y)RMB570/t (unchanged)May-11 May-12 Mar-11Nov-11Mar-12 Nov-12Jan-11Jul-11 Sep-11 Jan-12Jul-12Sep-12 Spot Key contract Non-key contractSource: Nomura est.Nomura418 January 2011 6. Coal | ChinaIvan Lee, CFA / Matty ZhaoExhibit 2. China: coal industry supply / demand forecast(mnt) 2005 200620072008 2009 2010F2011F2012FCoal production (a)2,3502,529 2,692 2,8023,050 3,261 3,3973,539% chg7.6 6.4 4.18.9 6.9 4.24.2Net increase179 163 110248 211 136142Coal consumption (b) 2,3192,551 2,727 2,8113,020 3,299 3,515 3,707% chg10.0 6.9 3.17.4 9.2 6.5 5.5Net increase232 17784209 279 216 193Change in inventory and others* (c) (15) (47)(38) (14) 133105 5549As % of total production (0.6)(1.9) (1.4)(0.5) 4.43.21.6 1.4As % of total consumption(0.6)(1.9) (1.4)(0.5) 4.43.21.6 1.3Net exports/(imports) (d) 4625 25 (103) (142)(172) (217)% chg (44.8)(91.4) 134.6n/a38.220.926.2As % of total production 1.9 1.0 0.10.2(3.4) (4.4)(5.1) (6.1)As % of total consumption2.0 1.0 0.10.2(3.4) (4.3)(4.9) (5.9)Export726353 452320 2020% chg(11.8)(15.9) (14.6) (49.7)(12.4) - -Import (26)(38)(51) (40)(126) (162)(192) (237)% chg 45.633.9(20.9) 211.929.0 18.423.5Source: CEIC / NBS, Nomura est.Potential winners areWe reiterate our BUY call on Shenhua and initiate coverage on China Coal with aNEUTRAL call and Yanzhou Coal with a BUY.Shenhua (1088 HK, BUY): unique integrated coal giant; third partytrade to sustain double digit growth and above-average ROEShenhuas distinctive integrated business model, with a captive logistics network andsufficient reserves, helps facilitate third-party trade and sustain double-digit growth andabove-average ROE despite slowing self-production in our view. We think the potentialnon-key contract price revision and whole group listing are near-term catalysts. Thestock is at 12x FY11F P/E, in line with the industry average 12.2x FY11F P/E; ROE ishigher than sector average.China Coal (1898 HK, NEUTRAL): attractive long-term picture butlacks short-term catalystWhile we like China Coals long-term output growth story, backed by resources gainedthrough recent acquisitions and industry consolidation, we are concerned about itsnear-term performance as it is the biggest victim of the 2011 contract price cap andgiven a lack of near-term catalysts, in our view. At 11.8x FY11F P/E, in line with theindustry average, we believe it is fairly valued. Initiate with NEUTRAL and PT ofHK$13.90.Yanzhou Coal (1171 HK, BUY): best-positioned to benefit from pricingtrends, transforming into an international play; well-deserved re-ratingWe like Yanzhou Coal as a pure play on our Bullish view on coal prices given itsexpansion into Australia and high exposure to the local spot/seaborne market. TheFelix acquisition and the announced planned stake increase in Ashton mine underpinproduction and our 23% EPS growth projection for 2011F. Its 10.9x FY11F P/E looksundemanding compared with Asian players at 15.6x FY11F P/E. Although seasonalcoal price weakness may prompt some volatility, we call a BUY.Although we like Yanzhous expansion into Australia and its high leverage to the spotmarket, Shenhua is our top pick in the sector, as we are concerned about potentialweakness in spot prices in the coming months (from February-May due to seasonalNomura 5 18 January 2011 7. Coal | China Ivan Lee, CFA / Matty Zhaoadjustments), which may suppress Yanzhous share price performance in the nearterm.Sensitivity AnalysisWe have conducted an earnings sensitivity analysis on spot price, contract price, unitproduction cost and sales volume. It shows that Yanzhou Coal has the highest positiveleverage to spot coal prices upside, while China Coal is the most vulnerable to theincrease in unit production cost.Exhibit 3. Sensitivity analysis to 2011F net profit(%) Shenhua China CoalYanzhou*% chg in net profit on 1% chg in spot price 1.03 1.10 3.1% chg in net profit on 1% chg in contract price 0.97 1.60 1% chg in net profit on 1% chg in unit cost(1.02)(2.03)(0.76)% chg in net profit on 1% chg in sale vol 0.90 0.801.05* Yanzhou - ASP for self-produced coalSource: Nomura ResearchInvestment riskUpside risks: Higher than expected coal price and volume sales: Coal prices are the mostsensitive factor to earnings. Our sensitive analysis shows that for every 1% rise incoal price, coal companies average earnings are expected to increase by 1.5%. Higher coal import boosted by a strengthening Renminbi. Our economics teamexpects the Renminbi to appreciate 6% and 5% against the dollar in 2011F and2012F, respectively. If the appreciation is faster than our expectation, we believecoastal import volumes will rise, putting upward pressure on domestic coal prices.Downside risks: Weaker-than-expected recovery in Chinas economy. If Chinas economyrecovers more slowly than we expect, we believe coal demand from the four keysectors will deteriorate and exert pressure on coal prices. Higher unit production cost: Higher cost hikes could be mainly from policy-related cost increases. For FY11F, the Chinese government is highly likely toimplement a new resources tax based on coal prices, rather than on currentproduction volume, which could raise costs for all Chinese coal producers. Wehave already factored in 5% of the ex-mine coal price resources tax in 2011F. Oursensitivity analysis shows that every 1% change in unit production coal, coalcompanies earnings are affected by an average of 1.27%. High CPI inflation: High CPI inflation not only increases input costs but also putspressure on a likely coal price cap. The strong pricing power and the sellers markethave allowed coal firms to pass on additional costs to buyers. The coal price cap isunlikely to be long-lived and effective, in our view. Higher interest rate: The expected 3 interest rate hikes (25bps each) in 2011F isnot an issue for Shenhua and China Coal as they are under-geared with net cash,and at 21.9% gearings (net debt to equity) respectively, with strong positive freecash flow. However, this may be a bigger concern to Yanzhou given its 51%gearing level as of 2011F.Nomura 6 18 January 2011 8. Coal | ChinaIvan Lee, CFA / Matty ZhaoP/E, P/B comparisonP/E comparisonExhibit 4. Shenhua forward P/E Price (HK$)100.090.0 Avg: 16.5x 30x80.070.0 25x60.0 20x50.040.0 15x30.0 10x20.0 5x10.0 0.0 Jan-07Feb-08 Mar-09Apr-10Source: Bloomberg, Nomura estimatesExhibit 5. China Coal forward P/E Price (HK$)35.0Avg: 16.4x30x30.025x25.020x20.015.015x10.010x5.0 5x0.0Jan-07Feb-08Mar-09 Apr-10Source: Bloomberg, Nomura estimatesExhibit 6. Yanzhou Coal forward P/E Price (HK$)50.0 20x45.040.0Avg: 8.8x35.0 15x30.025.0 10x20.015.0 5x10.05.00.0Jan-07Feb-08Mar-09 Apr-10Source: Bloomberg, Nomura estimatesNomura7 18 January 2011 9. Coal | ChinaIvan Lee, CFA / Matty ZhaoP/B comparisonExhibit 7. Shenhua forward P/B Price (HK$)80.070.05xAvg: 3.0x60.04x50.03x40.030.02x20.010.00.0Jan-07Feb-08 Mar-09 Apr-10Source: Bloomberg, Nomura estimatesExhibit 8. China Coal forward P/B Price (HK$)45.040.0 Avg: 2.3x 5x35.030.0 4x25.0 3x20.015.0 2x10.0 1x5.00.0Jan-07Feb-08 Mar-09 Apr-10Source: Bloomberg, Nomura estimatesExhibit 9. Yanzhou Coal forward P/B Price (HK$)35.03x30.0Avg: 1.8x25.020.02x15.010.01x5.00.0Jan-07Feb-08 Mar-09 Apr-10Source: Bloomberg, Nomura estimatesNomura818 January 2011 10. Coal | ChinaIvan Lee, CFA / Matty ZhaoOperation metricsOperation metrics comparisonExhibit 10. Operation metrics comparison (1/3) 2009A2010F 2011F 2012FProductionCommercial coal production volume -self (mnt)China Shenhua210226 257285China Coal79 94 101111China Coal (Raw coal)101120 130142Yanzhou Coal36 4548 50(y-y%)China Shenhua 714 11China Coal 19 89China Coal (Raw coal)19 89Yanzhou Coal 26 64Sales volume (mnt)China Shenhua254294 327360China Coal97117 124134Yanzhou Coal38 5154 56Contract sales volume contribution to domestic sales(%)China Shenhua715855 55China Coal 737165 62Yanzhou Coal 232825 25Coking coal sales volume contribution (%)China Shenhua 0 0 00China Coal2 2 35Yanzhou Coal 283232 33PricingASP of self-produced coal (RMB/t)China Shenhua388431 457479China Coal 416472 505547Yanzhou Coal 506648 748800(y-y%)China Shenhua11 6 5China Coal 13 7 8Yanzhou Coal 2816 7CostUnit production cost - self produced (RMB/t)China Shenhua101109 119128China Coal 199213 230246Yanzhou Coal 245286 299315(y-y%)China Shenhua 8 98China Coal7 87Yanzhou Coal 17 56Source: Company, Nomura estimatesNomura918 January 2011 11. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 11. Operation metrics comparison (2/3) 2009A2010F2011F2012FCost (Cont)Unit transportation cost - self produced (RMB/t)China Shenhua106109113116China Coal84 90 94 97Yanzhou Coal11 11 12 12Total unit cost - self produced (RMB/t)China Shenhua207219231244China Coal 283303324343Yanzhou Coal 256297311328(y-y%)China Shenhua 566China Coal776Yanzhou Coal 1655Effective tax rate (%)China Shenhua 21 21 21 21China Coal23 23 23 23Yanzhou Coal27 27 27 27Effective interest rate (%)China Shenhua 6 666China Coal4 666Yanzhou Coal0.4 456ProfitabilityRevenue (RMB mn)China Shenhua121,312155,638 187,715 213,719China Coal53,187 71,28081,90995,170Yanzhou Coal20,253 35,09542,56646,959(y-y %)China Shenhua28 21 14China Coal 34 15 16Yanzhou Coal 73 21 10Reported EPS (RMB)China Shenhua1.591.912.29 2.67China Coal 0.590.790.87 1.10Yanzhou Coal 0.841.521.87 2.05(y-y %)China Shenhua20 20 17China Coal 34 10 26Yanzhou Coal 81 23 10Source: Company, Nomura estimatesNomura1018 January 2011 12. Coal | ChinaIvan Lee, CFA / Matty ZhaoExhibit 12. Operation metrics (3/3)2009A2010F 2011F2012FProfitability (Cont)Overall EBITDA margin (%)China Shenhua48 454445China Coal 25 262628Yanzhou Coal 35 384040Overall EBIT margin (%)China Shenhua39 373637China Coal 21 222123Yanzhou Coal 26 313333NPM (%)China Shenhua26 242425China Coal 15 151415Yanzhou Coal 20 212222Key RatiosROE (%)China Shenhua20 212222China Coal 13 151517Yanzhou Coal 15 232423ROCE (%)China Shenhua15 161718China Coal 11 111112Yanzhou Coal 10 141516Net gearing (%)China Shenhua6 1 net cash net cashChina Coalnet cash14 22 24Yanzhou Coal4854 51 33EBITDA interest coverage (%)China Shenhua29 202332China Coal 30 171719Yanzhou Coal158 1210 9Current ratioChina Shenhua1.7 1.71.6 1.7China Coal 3.3 2.62.1 1.9Yanzhou Coal 1.9 2.12.2 2.3Source: Company, Nomura estimatesNomura 11 18 January 2011 13. Coal | China Ivan Lee, CFA / Matty ZhaoValuationValuation comparisonExhibit 13. Valuation comparison (1/3) Price Market FreeNet profitNet earningstarget Price cap float Reptg Fiscal(Local $ m)growth (%)Company Ticker Rating L. Curr.L. Curr. (US$mn) (%) curr. Y/E10F11F12F10F11F 12FCoalAsiaHong Kong - Thermal CoalShenhua Energy-H1088 HK BUY41.00 34.4087,94627CNYDec37,99945,58553,17420 20 17China Coal-H1898 HK NEUTRAL13.90 12.9021,98444CNYDec10,51611,59514,62734 10 26Yanzhou Coal-H1171 HK BUY30.40 25.4516,08940CNYDec 7,459 9,19010,10581 23 10Average 45 18 18Hong Kong - Coking CoalFushan 639 HK Not rated n.a. 6.114,22969HKDDec1,8972,218 2,44368 17 10Hidili1393 HK Not rated n.a. 7.471,97946CNYDec7191,064 1,32378 48 24Average 73 32 17Hong Kong Average 56 24 17ChinaDatong Coal601001 CH Not ratedn.a. 20.59 5,21238CNYDec 1,157 1,409 1,562 (22)22 11Pingdingshan Tianan Coal Mining Co 601666 CH Not ratedn.a. 21.31 5,85338CNYDec 2,467 2,762 3,05775 12 11Shanxi Guoyang 600348 CH Not ratedn.a. 28.1010,22042CNYDec 2,607 2,947 3,34740 13 14Shanghai Energy600642 CH Not ratedn.a.7.70 3,67149CNYDec 1,528 1,658 1,798(5) 88Hengyuan Coal600971 CH Not ratedn.a. 50.01 3,31627CNYDec 1,078 1,223 1,270 107 134Luan Environmental Energy 601699 CH Not ratedn.a. 58.5510,18731CNYDec 3,011 3,484 4,18443 16 20SDIC Xinji 601918 CH Not ratedn.a. 14.08 3,94020CNYDec 1,320 1,745 2,29958 32 32China Average 42 17 14S.E. AsiaBanpuBANPU TB Not ratedn.a. 846.00 7,56563THBDec18,39519,78122,077298 12BumiBUMI IJBUY4,300 3,075.00 7,09891USDDec 147 246 984 (23)67300ITMGITMG IJBUY 73,000 54,600.006,85535USDDec 305 517 934(9)70 81Bukit Asam PTBA IJ BUY 30,000 23,100.005,87335IDRDec1,851,924 3,000,869 5,247,881(32)62 75Indika Energy INDY IJ Not ratedn.a. 4,975.00 2,85837IDRDec1,161,037 1,981,082 2,316,451 60 71 17AdaroADRO IJ BUY3,700 2,625.00 9,26440IDRDec2,879,949 6,033,456 11,255,203 (34) 109 87S.E. Asia Average (2)64 95Asia Average32 35 42AustraliaWhitehaven CoalWHC AUNot ratedn.a.6.80 3,39433AUDJun 5891196 (76)57115New Hope CorpNHC AUNot ratedn.a.4.90 4,11388AUDJul189 190233 (90)122Gloucester CoalGCL AUNot ratedn.a. 12.87 1,82735AUDJun 4467109 (46)53 62Stanmore CoalSMR AUNot ratedn.a.1.35 16966AUDJun n.a.n.a. n.a. n.a. n.a. n.a.Macarthur Coal MCC AUNot ratedn.a. 13.55 4,10251AUDJun123 231306 (27)88 32Australia Average(60)50 58North AmericaArch CoalACI US Not rated n.a. 35.53 5,773100 USDDec178453 627 323154 38Consol Energy Inc.CNX US Not ratedn.a. 53.0411,979100 USDDec458716 1,056 (15)56 47Peabody Energy Corp.BTU US Not ratedn.a. 63.3417,079100 USDDec8101,281 1,54981 58 21N. America Average 129 90 36Note: pricing as of 12 Jan 2011 closing / Indonesia Coal report published on the same day uses 11 Jan, 2011 closing price for pricing.Source: Company, Bloomberg, Nomura estimatesNomura12 18 January 2011 14. Coal | ChinaIvan Lee, CFA / Matty ZhaoExhibit 14. Valuation comparison (2/3) EPS (Local $)EPS growth (%)P/E (x) PEGP/B (x) Yield (%)Company 10F 11F 12F 10F 11F12F 10F11F12F 10-12F 10F11F 12F10F 11F12FCoalAsiaHong Kong - Thermal CoalShenhua Energy-H1.91 2.292.67202017 15.3 12.09.81.0 3.02.4 2.02.22.8 3.4China Coal-H0.79 0.871.10341026 13.8 11.88.91.0 2.01.7 1.41.92.2 2.9Yanzhou Coal-H1.52 1.872.05812310 14.3 10.99.41.0 3.12.5 2.02.12.7 3.2Average451818 14.5 11.69.31.0 2.72.2 1.82.02.6 3.2Hong Kong - Coking CoalFushan0.35 0.400.45491512 17.4 15.2 13.61.8 1.91.7 1.62.63.2 3.6Hidili0.35 0.540.67765624 17.3 11.19.00.5 2.01.7 1.51.32.0 2.7Average633518 17.4 13.2 11.31.0 2.42.0 1.72.02.6 3.2Hong Kong Average522518 15.6 12.2 10.11.1 2.42.0 1.72.02.6 3.2ChinaDatong Coal 0.86 0.991.18(4) 1520 24.1 20.9 17.41.8 4.03.7 3.52.02.4 2.7Pingdingshan Tianan Coal Mining Co1.31 1.511.69691612 16.3 14.1 12.61.6 3.52.9 2.62.93.1 3.1Shanxi Guoyang1.15 1.341.464917 9 24.5 21.0 19.32.5 8.36.6 4.91.92.2 2.4Shanghai Energy 0.52 0.560.60(7)8 7 15.0 13.8 12.92.7 1.31.2 1.22.02.5 2.7Hengyuan Coal 2.50 2.762.887711 4 20.0 18.1 17.33.7 4.43.7 2.9n.a. n.a.n.a.Luan Environmental Energy2.62 3.093.58431816 22.3 19.0 16.41.7 6.25.1 3.82.03.1 3.5SDIC Xinji0.75 0.961.20672825 18.7 14.7 11.80.9 3.83.1 2.5n.a. 2.1 2.9China Average421613 20.1 17.4 15.42.1 4.53.8 3.02.22.6 2.9S.E. AsiaBanpu68.95 72.87 80.94 32 611 12.3 11.6 10.52.1 3.42.9 2.42.22.6 3.0Bumi0.01 0.01 0.05(23) 67 300 48.3 28.97.20.3 3.73.3 2.30.80.4 0.7ITMG0.27 0.46 0.83 (9) 7081 22.5 13.37.30.3 7.45.4 3.62.42.7 4.5Bukit Asam 803.74 1,302.39 2,277.60 (32) 6275 28.7 17.7 10.10.4 8.66.4 4.42.61.7 2.8Indika Energy228.25 385.51 447.35646916 21.8 12.9 11.10.5 4.23.4 2.81.32.1 3.1Adaro95.43 188.63 351.88(30) 9887 27.5 13.97.50.3 4.23.3 2.40.90.6 0.7S.E. Asia Average 06295 26.9 16.49.00.7 5.34.1 3.01.71.7 2.5Asia Average 313442 21.1 15.6 11.81.3 4.23.4 2.71.92.3 2.8AustraliaWhitehaven Coal 0.11 0.190.40 (82) 70 115 62.4 36.8 17.10.7 3.13.1 2.80.81.3 2.6New Hope Corp 0.23 0.230.28 (90)(2)26 21.3 21.7 17.33.0 1.71.7 1.62.73.6 3.3Gloucester Coal 0.51 0.470.72 (44)(7)52 25.3 27.2 17.92.2 5.62.7 2.40.40.5 0.9Stanmore Coaln.a. n.a.n.a.n.a. n.a.n.a.n.a. n.a. n.a. n.a n.a. n.a.n.a. n.a. n.a.n.a.Macarthur Coal0.49 0.771.03 (39) 5933 27.9 17.5 13.20.6 3.02.3 2.11.52.6 3.4Australia Average (64) 3056 34.2 25.8 16.41.6 3.42.5 2.21.42.0 2.5North AmericaArch Coal 1.17 2.853.78 317144 33 30.4 12.59.40.3 2.62.2 1.81.11.1 1.1Consol Energy Inc.2.25 3.044.46 (25)35 47 23.6 17.4 11.90.7 3.73.1 2.50.80.8 0.8Peabody Energy Corp.3.03 4.805.8081 58 21 20.9 13.2 10.90.5 3.73.0 2.30.50.5 0.6N. America Average124 79 33 25.0 14.4 10.70.5 3.32.8 2.20.80.8 0.8Note: pricing as of 12 Jan 2011 closing / Indonesia Coal report published on the same day uses 11 Jan, 2011 closing price for pricing.Source: Company, Bloomberg, Nomura estimatesNomura 1318 January 2011 15. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 15. Valuation comparison (3/3) Net debt/equity (%)RoE (%) RoA (%)EV/EBITDA (x)Company 10F11F 12F 10F 11F 12F10F11F12F 10F11F 12FCoalAsiaHong Kong - Thermal CoalShenhua Energy-H 1 net cash net cash20.721.6 21.814.515.1 15.48.36.6 5.3China Coal-H1422 24 15.415.2 17.010.1 9.2 10.08.37.2 5.7Yanzhou Coal-H5451 33 23.524.4 22.812.312.6 12.79.27.1 5.9Average 2336 29 19.920.4 20.512.312.3 12.78.67.0 5.6Hong Kong - Coking CoalFushan net cash net cash net cash 11.612.4 12.7 8.2 8.79.08.77.2 6.6Hidili41 41 3511.514.5 16.6 6.0 7.49.1 12.59.2 7.2Average 26 37 3017.118.1 18.610.610.9 11.59.37.4 6.0Hong Kong Average 27383116.517.6 18.210.210.6 11.39.47.5 6.1ChinaDatong Coaln.a. n.a. n.a. 13.215.1 15.712.212.3 12.6n.a. n.a.n.a.Pingdingshan Tianan Coal Mining Co n.a. n.a. n.a. 25.624.6 22.614.815.2 14.1n.a. n.a.n.a.Shanxi Guoyang n.a. n.a. n.a. 33.829.8 26.614.613.8 13.6n.a. n.a.n.a.Shanghai Energyn.a. n.a. n.a.9.3 8.79.3 6.8 6.16.4n.a. n.a.n.a.Hengyuan Coaln.a. n.a. n.a. 19.718.9 17.0 n.a.n.a. n.a. n.a. n.a.n.a.Luan Environmental Energy n.a. n.a. n.a. 31.129.8 27.513.715.1 15.3n.a. n.a.n.a.SDIC Xinji n.a. n.a. n.a. 18.920.4 21.5 n.a.n.a. n.a. n.a. n.a.n.a.China Averagen.a. n.a. n.a. 21.621.1 20.012.412.5 12.4n.a. n.a.n.a.S.E. AsiaBanpu 58 39 1334.627.0 25.416.012.8 12.5 13.68.1 6.8Bumi 195166 80 8.712.1 37.8 1.9 2.9 11.49.16.4 3.0ITMG net cash net cash net cash 35.547.1 59.237.257.7 97.6 13.58.1 4.2Bukit Asam net cash net cash net cash 31.141.5 51.854.574.8 97.7 21.0 12.1 6.5Indika Energy9 net cash net cash20.227.1 26.9 9.814.1 16.3 63.9 48.441.2Adaro 216 net cash15.526.8 37.2 8.917.0 28.9 10.66.4 3.4S.E. Asia Average 71 71 4724.330.3 39.721.429.9 44.1 22.0 14.910.8Asia Average49543721.123.2 26.115.118.4 23.9 16.2 11.5 8.7AustraliaWhitehaven Coalnet cashnet cashnet cash5.9 8.7 17.5 7.1 9.7 18.8 30.8 19.410.1New Hope Corpnet cashnet cashnet cash7.1 8.59.5 9.2 9.7 12.7 12.89.3 9.5Gloucester Coalnet cashnet cashnet cash 25.616.4 18.423.018.9 22.6 25.0 16.510.7Stanmore Coal n.a.n.a.n.a. n.a.n.a. n.a.n.a.n.a. n.a. n.a. n.a.n.a.Macarthur Coal net cashnet cashnet cash 11.515.0 17.311.214.5 17.6 17.6 11.2 8.3Australia Average n.a.n.a.n.a.12.512.1 15.612.613.2 17.9 21.6 14.1 9.6North AmericaArch Coal 714222 8.819.0 22.5 5.9 9.8 12.89.96.6 5.5Consol Energy Inc. 106855615.618.3 23.0 8.2 9.2 12.9 11.18.4 6.4Peabody Energy Corp.2711 net cash 19.324.6 23.6 9.513.0 13.89.87.3 6.3N. America Average68463914.620.6 23.0 7.910.7 13.2 10.37.4 6.0Note: pricing as of 12 Jan 2011 closing / Indonesia Coal report published on the same day uses 11 Jan, 2011 closing price for pricingSource: Company, Bloomberg, Nomura estimatesExhibit 16. Diversified mining with sizable coal assetsMkt Cap CurrentTarget Potential Base Growth TotalPrice/P/E EV/EBITDAFCF YieldCompany Ticker Rating Price Price Upside NPV Options NPV Total NPV10E11E12E 10E 11E 12E 11EXstrata XTA LN $70,814Buy15.3522.00 43%17.1 4.8 21.90.70 14.27.15.8 8.54.3 3.315.5%Rio TintoRio LN $140,265Buy45.4361.00 34%48.013.1 61.10.74 10.37.06.4 6.24.2 3.413.6%BHP Billiton BLT LN $224,780Reduce 25.5024.00 -6%18.8 5.5 24.41.05 12.27.96.7 6.94.2 3.214.0%Anglo AmericanAAL LN $66,045Buy33.9744.00 30%34.3 9.3 43.60.78 13.36.25.4 8.74.2 3.415.1%Average Diversified Mining Sector 12.57.06.1 7.64.2 3.314.5%Global Average* 22.1 15.7 11.5Note: As of closing price on 12 Jan, 2011 (Pricing day), Global average computed using companies shown in Ex. 15 and 16. Indonesia Coal report published on thesame day uses 11 Jan, 2011 closing price for pricing.Source: Bloomberg, Datastream, Nomura estimatesNomura1418 January 2011 16. Coal | ChinaIvan Lee, CFA / Matty ZhaoCoal pricingCoal price to remain strong in 2011-12FDespite investor concern that NDRC policy intervention may weigh on near-term coalprices, we expect domestic thermal coal prices to stay strong in FY11F-FY12F, giventhe structurally tight supply and demand outlook, lingering transportation bottleneckand rising production costs. 2011F: We expect the key contract price to be frozen; non-key contract price to rise7% from 2Q11F onwards (implying 5% weighed average growth in FY11F);blended contract price to rise 3%; spot price to rise 8%; key contract-to-spot pricediscount of 29%. 2012F: We expect the key contract and non-key contract price to rise 7%; spotprice to rise 5%; key contract-to-spot price discount of 28%.Exhibit 17. QHD spot price vs. contract price(RMB/t) Spot price refers to Shanxi blend Peaked at RMB995/t after(5,500kcal/kg) at Qinghuangdao portgovernment announced spot1,200price cap on July 23 Spot PriceContract Price1,000 Spot price down 22.1% from the800peak in July 2008, at RMB775/tonne on 10 Jan 2011600gap: RMB20~30/t570540400458200Mar-02Mar-03Mar-04Mar-05Mar-06Mar-07Mar-08Mar-09Mar-10Jun-02Sep-02Dec-02Jun-03Sep-03Dec-03Jun-04Sep-04Dec-04Jun-05Sep-05Dec-05Jun-06Sep-06Dec-06Jun-07Sep-07Dec-07Jun-08Sep-08Dec-08Jun-09Sep-09Dec-09Jun-10Sep-10Dec-10Source: China Coal Transport and Distribution Association (CCTD), Nomura researchExhibit 18. Nomuras China coal price projectionRMB/tonne 20092010F 2011F2012FKey contract price (FOB) -40% of total contract sales540 570 570 610y-y (%)6 0 7Non-key contract price (FOB) -60% of total contract sales Price is in between spot and contract price; different on eachcompany; moving with spot coal price trendy-y (%)6 5 7Blended contract price (FOB) increase (%)6 3 7Spot price600744804844y-y (%) (17)25 8 5Note: coal price refer to Shanxi blend (5,500 kcal/kg) FOB priceSource: Nomura estimates2011 contract price capGiven inflationary pressure, the frozen power tariff since 2009 and strong appeals frompower companies, the NDRC froze the 2011 KEY contract coal price for powercompanies. Contract prices, production volume and railway capacity for coaltransportation were discussed at the 2011 national coal production and transportationvolume meeting (the annual meeting) held in late December 2010 and it was agreedto keep the key contract price for power companies unchanged from the 2010 level(RMB570/tonne), according to the China Coal Transport and Distribution Association(CCTD).Nomura 1518 January 2011 17. Coal | China Ivan Lee, CFA / Matty ZhaoPrice cap only applies to key contracts (40% of contracts)The price cap only applies to KEY contract sales to power companies rather than to allcontract sales. Although the NDRC has not defined key contracts, we believe keycontracts include annual contract quotas allocated to coal companies in thegovernment-controlled part of the economy, to be signed at the annual meeting, andwhich have secured railway capacity.According to the 2011 railway capacity allocation framework issued on 6 December2010, the NDRC has assured railway capacity for 769mn tonnes of coal to be sold tothe power industry. Based on our communications with CCTD and several big coalcompanies, we estimate key contract volume accounts for only 40% of total contractsales in China in 2011, taking into account contracts signed at and outside the annualmeeting.Ways to mitigate contract price risksWe believe coal companies could adopt various steps to offset the contract price risks: Cut exposure to contract sales in 2011 Shenhua has been doing so since 2010,with contract sales dropping from 71% in FY09 to 58% in FY10F. Reducing contract fulfilment rates or providing lower quality coal to key contractcustomers. Adjusting the customer base for contract sales, shifting from power companies tocompanies in other industries.Potential upside the price cap may be short-lived?While we assume a 2011 key contract price of RMB570/ tonne (5,500 Kcal/kg), in lightof the NDRCs intervention, there may be potential upside to our projection given: SOE coal companies only account for 50% of the annual coal production (source:CCTD ; period 2009). This, in addition to the strong pricing (bargaining) power ofcoal companies over independent power producers (IPPs) and the prevailing 26%discount of key contract price to spot (Shanxi 5,500Kal/kg QHD FOB price atRMB775/tonne as at 10 January 2011), it is impossible for the central governmentto control the implementation at the working level in our view. In 2008, the NDRC implemented the price cap policy twice for spot prices. However,only three months after the second price cap did the Qinhuangdao (QHD) price fallto the level desired by the government (see policy development section in thisreport). Although the price cap for 2011 applies to key contracts rather than spot, itseffectiveness arguably hinges on implementation. We think many of these contractswill be renegotiated or fulfilment rates will fall substantially in 2H11F.No price control on non-key contractsDespite the key contract price being unchanged, China has not intervened on non-key contracts this year, though railway capacity is not guaranteed and was notallocated during the annual meeting.Non-key contract price to stay flat in 1Q11In 1Q11, we expect the non-key contract price to be unchanged from the 2010 level,given: Coal companies hope to secure railway capacity through signing key and non-keycontracts (in the 2011 railway capacity allocation framework some of the railwaycapacity has not been specifically allocated to certain coal producers). The government might watch non-key contract prices during the expected peak ininflation around end-2010 and early 2011.Nomura1618 January 2011 18. Coal | China Ivan Lee, CFA / Matty Zhaobut to rise 7% in 2Q-4Q11However, in light of the high correlation with the spot price and with the spot priceprojected by us to climb by 8% in 2011, we believe the price of non-key contracts many of which are signed on a quarterly or monthly basis will rise in 2Q-4Q11,narrowing the differential with the spot price.Given the prevailing 26% contract-spot-price spread, contract fulfilment rates shouldfall substantially from 2Q onwards and many non-key contracts are likely to berenegotiated when CPI inflation retreats. We expect non-key contract prices to rise by7% y-y in 2Q11. In our eyes, with no change in 1Q11 and a 7% y-y increase in 2Q-4Q11, the yearly weighted average change in the non-key contract price is 5% y-y.This implies the blended contract price will rise by 3% in FY11F.2012F contract price to increase by 7% y-yOn the assumption of no government intervention in the 2012 contract price, webelieve contract price will catch up and increase by a bigger 7% y-y or RMB40/tonnegiven: Coal companies will pass on the new resources tax, if implemented, to customersgiven it is a sellers market and their strong pricing power over IPPs. We havefactored in RMB15/tonne (3%-5% on the ex-mine price) resources tax for the 2012contract price (see the cost section in this report for details). Based on the current spot price of RMB775/ tonne (10 January 2011), the spot-to-contract price spread is RMB205/tonne 95% higher than the historical (from Jan2003) average of RMB105/tonne. With the spot price further strengthening in4Q11F while the key contract price was unchanged from the FY10F level, the gapwill widen at end 2011, leaving enough room for contracts to be hiked in 2012, inour opinion.Strong spot price with seasonality fluctuationBig price jump in FY10Due to the two price caps imposed by the government in 2008 and the global financialcrisis, the spot coal price at Qinhuangdao port for 5,500kcal/kg bottomed atRMB451/tonne in December 2008 (source: CCTD). With the economic recoveryspurring strong coal demand growth, the spot coal price has rebounded.In 2010, the average spot coal price rose to RMB744/tonne (up 25% y-y). Demand forwinter warming, intensified by truck transport bottlenecks due to snow blocking roadsin the north, further pushed up the price in 4Q10 and 1Q11, culminating in a QHD spotprice (10 January 2011) of RMB775/tonne.Exhibit 19. QHD FOB spot thermal coal price(RMB/tonne) Shanxi 5,500 kal/kg1,200Datong 5,800kal/kg1,000General 4,500kal/kg800600400200 0 Mar-03 Jun-03 Dec-03 Mar-04 Jun-04 Dec-04 Mar-05 Jun-05 Dec-05 Mar-06 Jun-06 Dec-06 Mar-07 Jun-07 Dec-07 Mar-08 Jun-08 Dec-08 Mar-09 Jun-09 Dec-09 Mar-10 Jun-10 Dec-10 Sep-03 Sep-04 Sep-05 Sep-06 Sep-07 Sep-08 Sep-09 Sep-10Source: CCTD, Nomura researchNomura17 18 January 2011 19. Coal | China Ivan Lee, CFA / Matty ZhaoContinued upside trends in 2011-12FAfter a robust run in FY10, we expect the spot price to stay strong with growth of 8% inFY11F to RMB804/tonne and 5% in FY12F to RMB844/tonne, given: Tight supply outlook for the next two years. On the back of fast growingdemand and limited supply growth due to small mines consolidation and transportbottlenecks, we see upside for the spot price in the next two years. Strong international coal price in the next two years. Our international metaland mining team forecasts that the Australian thermal coal price will rise 43% toUS$140/tonne (around RMB930/tonne) in 2011.Exhibit 20. Nomura Australia coal price forecast20082009 2010F 2011F2012FThermal coal (US$/tonne) 12570 98140170y-y (%) - (44) 404321Source: Nomura research... but weaker spot price in 2Q- 3Q due to seasonal effectAlthough we expect the average spot coal price to rise 8% y-y to RMB804/ tonne for2011, given the current coal price at RMB775/tonne (10 January 2011), the price isexpected to move between RMB735-865 for the rest of the year, with seasonalweakness (strength) in February to May (June to August) and September to October(November to January), in our view.Exhibit 21. Projected price trend in 2011 12 FY12F avg. spot RMB844/t (+5% y-y)FY11F avg. spot RMB804/t(+8% y-y)spot price non-key contract7% rise in 2012F key contract7% rise from Q211RMB610/t (+7% y-y)RMB570/t (unchanged)May-11May-12 Mar-11Nov-11 Mar-12Nov-12Jan-11Jul-11 Sep-11 Jan-12Jul-12Sep-12 Spot Key contractNon-key contractSource: Nomura est.We do not expect the spot price to be significantly stronger during the year, oranywhere close to RMB900-1,000 level, given the prevailing high coal inventory days(17 days as of 27 December 2010, source: sxcoal) at direct-supply power plants. Thiscompares with an average of 15 days since July 2007 and 10 days on 23 July 2008when the spot coal price peaked at RMB995/tonne (source: CCTD).Nomura 18 18 January 2011 20. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 22. National coal inventoryExhibit 23. Coal inventory at direct supply power plant(mn tonne) National coal inventory (LHS) (%)Inventory Days2501530 Days of coal inventory (RHS) Inventory MoM growth rate (RHS) 10 25200 520150 015100Average: 15.4 days (5)10 50(10)5 0 (15) 0 May-06 May-07 May-08 May-09 May-10 Mar-06 Nov-06 Mar-07 Nov-07 Mar-08 Nov-08 Mar-09 Nov-09 Mar-10 Jan-06Jul-06 Sep-06 Jan-07Jul-07 Sep-07 Jan-08Jul-08 Sep-08 Jan-09Jul-09 Sep-09 Jan-10Jul-10 Sep-10 Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Feb-09 Jun-08 Aug-08 Oct-08 Dec-08 Apr-09 Jun-09 Aug-09 Oct-09 Dec-09 Feb-10 Apr-10 Jun-10 Aug-10 Oct-10 Dec-10Source: Nomura estimates Source: CCTD, sxcoal, Nomura ResearchMinimal impact from flooding in AustraliaWe think the recent Queensland, Australia, flooding will have limited impact on Chinasthermal coal market, given 1) Queensland mainly produces coking coal as opposed tothermal coal, 2) China is almost self-sufficient on coal supply, with over 96% of coalsupply come from the domestic market, while net imports are only 4% (source CEIC,sxcoal). Therefore, even though the international coal price has been pushed up,Chinas QHD spot coal price has remained soft. 3) In 2010, Indonesia overtookAustralia to be the biggest coal exporter to China; Chinas 9M10 imports from Australiawere less than 1% of coal supply. According to our Indonesia coal analyst IsnaputraIskandar, Indonesia is more competitive in coal exports to China given: 1) its closerproximity to southern China, with lower transport costs to China (US$7/tonne versusUS$11/tonne for Australia and US$19/tonne for South Africa, according to AustralianMineral Economics); 2) growing production capacity; and 3) Indonesian coal producerstypically do not prioritise domestic demand over exports. We think China will lift importsfrom Indonesia, while paring the significance of Australian coal to China givenAustralias capacity constraints and higher transport costs to China.Nomura 19 18 January 2011 21. Coal | ChinaIvan Lee, CFA / Matty ZhaoDemandSolid coal demand growthdriven by power, steel and cementCoal consumption in China increased from 2,319mnt in 2005 to 3,020mnt in 2009,indicating a CAGR of 6.8%. According to BP statistical review of world energy June2010, although China only accounts for 13.9% of total coal reserves in the world,China consumed 46.9% of the worlds total coal in 2009 in terms of energy output. Thepower industry accounted for most coal consumption in 2009 (48%), followed by steel(17%), cement (12%) and chemicals (3%).Exhibit 24. China coal consumption (FY05-09)Exhibit 25. China coal consumption by industries (mnt) (%)Power SteelCementChemicalsOthersCAGR(05-09F) : 6.8%3,210 100 90 24%20% 20%19%3,02028%2,568 2,81180 3%3% 3%2,727 2,551 70 3%3% 11% 11%12% 2,31911% 11%1,9266017% 16%17% 15%16% 501,28440 30 43%45%49% 49%48%64220 100 0 20052006 200720082009 2005 2006 20072008 2009Source: CEIC, Nomura Research Source: CEIC, Nomura ResearchWe forecast 2010F coal consumption to reach 3.3bn tonnes, up 9.2% y-y, based on abottom-up approach driven by projected growth in thermal power generation, steel,cement and chemical production. In 2011F and 2012F, we forecast 6.5% and 5.5%growth based on a similar approach.Exhibit 26. Coal consumption projection breakdown by downstream industries(mnt) 2006200720082009 2010F 2011F 2012FPower 1,159 1,326 1,3651,463 1,616 1,754 1,862y-y growth (%)143 7 10 96Steel 408462461 525591 620660y-y growth (%)13014 13 56Cement272299319 377430 471508y-y growth (%)10718 14108Chemicals 8792 90 92 92 9292y-y growth (%) 6 (2)20 00Others625549575 563570 578585y-y growth (%) (12) 5 (2)1 11Total coal consumption2,551 2,727 2,8113,020 3,299 3,515 3,707y-y growth (%) 10 6.9 3.1 7.49.26.5 5.5Source: CEIC, CCTD, Nomura ResearchRobust thermal power output growthChina heavily relied on thermal power for its power generation. At 2009, thermal power We estimate coal used in theaccounted for 82% of the total generation, followed by hydro (16%) (per CEIC). thermal power industry will riseThermal power generation experienced a 10.1% CAGR during FY05-09. For 11M10, by 9% in FY11F and 6% in FY12Fthermal generation was up 13.2% y-y (source: CEC) and we forecast 13.5% y-y growthfor FY10.Nomura20 18 January 2011 22. Coal | ChinaIvan Lee, CFA / Matty ZhaoFor 2011F and 2012F, we forecast thermal power output growth to reach 9.8% and7.6%, respectively, on the back of robust GDP growth of 9.8% for 2011F and 9.5% for2012F, as per our China economist. This assumes a power/GDP growth beta of 1 and0.9 for 2011F and 2012F, respectively, down from 1.3x in 2010, mainly due to thegovernments effort to reduce energy intensity. Beijing aims to reduce carbon intensityby 40-45% in 2020, from 2005 levels. According to the China Daily (November 2010),in reference to Xie Zhenhua, Vice-Chairman of NDRC, energy intensity should fall by20% as of end-2010 from 2005 level, on track with targets.Exhibit 27. China: power generation forecast(bn kwh) 20092010F2011F2012F2013F2014F2015F 2016F 2017F2018F 2019F2020FThermal/Coal3011.7 3,3593,6643,9294,1834,4374,688 4,864 5,0465,199 5,3565,517Growth rate (%) 11.5 9.17.36.56.15.7 3.8 3.73.0 3.03.0Hydro571.7 662716763805847888 933 9811,025 1,0711,118Growth rate (%) 15.8 8.26.45.65.24.8 5.1 5.14.4 4.44.4Nuclear 70.185125169218272331 376 424473 525581Growth rate (%) 21.3 47.0 35.3 28.9 24.8 21.713.512.9 11.511.1 10.6Others (Solar/Wind, etc)27.871 8293 104116128 157 189223 258297Growth rate (%)155.7 15.3 13.1 12.0 11.4 10.822.920.3 17.516.0 14.8Total 3681.2 4,1774,5874,9545,3105,6726,034 6,330 6,6406,919 7,2107,513Growth rate (%) 13.5 9.88.07.26.86.4 4.9 4.94.2 4.24.2Contribution (%)Thermal/Coal81.8%80.4%79.9% 79.3% 78.8%78.2% 77.7%76.8% 76.0%75.1% 74.3% 73.4%Hydro 15.5%15.8%15.6% 15.4% 15.2%14.9% 14.7%14.7% 14.8%14.8% 14.8% 14.9%Nuclear1.9% 2.0% 2.7%3.4%4.1% 4.8%5.5% 5.9%6.4% 6.8%7.3%7.7%Others (Solar/Wind, etc) 0.8% 1.7% 1.8%1.9%2.0% 2.0%2.1% 2.5%2.9% 3.2%3.6%3.9% Total 100.0% 100.0% 100.0%100.0%100.0% 100.0%100.0% 100.0%100.0% 100.0%100.0%100.0%Source: CEIC, Nomura estiamtesExhibit 28. Thermal power output forecast (08-12F) Exhibit 29. Power and industrial output growth (bn kwh)(%) GDP growth (LHS) (x) Power output growth - 3 month running (LHS)5,000 Industrial output growth - 3 month average (LHS)3,92930 34,2003,664 Beta - "power output growth/GDP growth" (RHS) 25 3,3593,4003,012 20 2 2,790 152,600 1 101,800 501,000 0(5) (1)200 (10) (600) (15) (2) 200820092010F 2011F2012F 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009Source: CEIC, Nomura estiamtes Source: CEIC, Nomura estimatesConsistent with the governments target of reducing energy intensity and improvingefficiency, small and inefficient power plants have been replaced by bigger sized units(critical and super critical with 600MW or above). Coupled with technologyadvancement, unit coal consumption for power generation has been reduced by 2-3gram/kwh (1%) pa (source china power statistics year book). Thus, we believe coalconsumption by thermal power generation will increase by a slower 10%, 9% and 6%in FY10F, FY11F and FY12F respectively.Nomura21 18 January 2011 23. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 30. China power generation forecastChina: Power supply and demandSupply2009 2010F 2011F 2012F 2013F 2014F2015F 2016F 2017F 2018F 2019F 2020FInstalled capacity (GW) 874 9541,039 1,124 1,209 1,2941,377 1,465 1,553 1,638 1,723 1,808Capacity launched (GW) 818085858585 838888858585Capacity growth10.2%9.2%8.9%8.2%7.2%6.7% 6.3%6.0%5.0%5.0%5.0%5.0%Capacity breakdownThermal74.4% 74.9% 75.5% 74.8% 72.9% 71.0%69.1% 67.9% 66.7% 65.6% 64.4% 63.2%Hydro22.5% 21.0% 19.7% 19.6% 20.2% 20.9%21.5% 21.4% 21.3% 21.2% 21.1% 21.0%Nuclear 1.0%1.4%1.3%1.3%2.0%2.6% 3.2%3.5%3.7%4.0%4.2%4.4%Winds 1.8%2.6%3.4%4.1%4.8%5.4% 6.1%6.5%7.0%7.4%7.9%8.3%Others0.2%0.2%0.2%0.2%0.2%0.1% 0.1%0.7%1.3%1.9%2.5%3.0% 100%100%100%100%100%100% 100%100%100%100%100%100%Electricity supply - fuel mixThermal 82% 80% 80% 79% 79% 78%78% 77% 76% 75% 74% 73%Hydro 16% 16% 16% 15% 15% 15%15% 15% 15% 15% 15% 15%Nuclear2%2%3%3%4%5% 5%6%6%7%7%8%Winds1%2%2%2%2%2% 2%2%3%3%4%4%Others 0%0%0%0%0%0% 0%0%0%0%0%0%DemandElectricity generation (bn KWh)3,681 4,177 4,587 4,954 5,310 5,6726,034 6,330 6,640 6,919 7,210 7,513Generation growth 6.2% 13.5%9.8%8.0%7.2%6.8% 6.4%4.9%4.9%4.2%4.2%4.2%Real GDP growth 8.5% 10.2%9.8%9.5%9.0%8.5% 8.0%7.0%7.0%6.0%6.0%6.0%Demand growth/ Real GDP growth (i.e. beta) 0.7 1.3 1.0 0.9 0.8 0.80.8 0.7 0.7 0.7 0.7 0.7UtilisationPlant utilisationNational average 51.7% 53.5% 53.8% 53.5% 53.0% 52.7%52.5% 51.7% 51.1% 50.3% 49.7% 49.2%Thermal55.2% 57.7% 57.3% 56.3% 56.2% 56.9%57.8% 57.8% 57.4% 56.8% 56.5% 56.4%Hydro37.3% 38.3% 40.7% 41.8% 40.8% 38.7%36.8% 35.5% 35.3% 35.0% 34.8% 34.7%Equivalent utilisation hoursNational average 4,527 4,685 4,715 4,683 4,647 4,6194,598 4,533 4,473 4,402 4,352 4,313Thermal4,839 5,055 5,020 4,932 4,922 4,9885,065 5,064 5,027 4,977 4,952 4,940Hydro3,264 3,352 3,563 3,661 3,574 3,3893,221 3,113 3,093 3,064 3,050 3,044OthersPeak demand (GW)828 9401,032 1,115 1,195 1,2761,358 1,424 1,494 1,557 1,622 1,690Shortage (pent-up demand, GW)4614 7101418 19415981 101 118Reserve margins (%)5%1%1%1%1%1% 1%3%4%5%6%7%Market equilibrium Balance Balance Balance Balance Balance Balance BalanceBalance Balance Balance Balance BalanceSource: CEIC, Nomura est.Steady increase in steel productionDue to power rationing since August 2010, Chinas total crude steel output dropped to50.3mt in October. However, steel prices recovered, backed by supply cuts, by 2.2-6.3% q-q in 4Q10. Our steel analyst forecasts Chinas total crude steel output to reach646mnt in 2010F, up 13.7% y-y.Given Chinas enhanced control over steel oversupply, we are looking for steadyproduction growth for 2011-12F at 6.0% and 8.0% y-y to 685mt and 739mt,respectively. By applying a 1% decrease in unit coal consumption (million tonnes ofcoal used per million tonnes steel production), coal demand from the steel industry willlikely rise by 5% in 2011F and 6% in 2012F.Strong cement output growth expectedChinas cement output has increased dramatically since 2Q10. Our cement analystforecasts total cement output to hit 1.8bn tonnes for FY10F (up 15.2% y-y), and 2.0bntonnes for FY11F (up 10.7% y-y) owing to rapid demand growth. We expect a muchtighter market in FY10F-11F with surplus supply at 1mt and 4mt respectively versus38mt in 2009. Our cement analyst is now working on her 2012F output forecast. Weassume 2012F cement output growth to be in line with 9.5% GDP growth. Assumingunit coal consumption decreases by 1% per year, the cement industry will use 10%more coal in 2011F and 8% more in 2012F.Nomura 2218 January 2011 24. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 31. Steel output forecast (08-12F) Exhibit 32. Cement output forecast (08-12F)(mnt) (mnt)1,000 2,5002,1621,974 7392,000 1,784750 685646 1,548568 1,388 5021,5005001,000250 500 00 200820092010F 2011F 2012F200820092010F2011F2012FSource: CEIC, Nomura estimates Source: CEIC, Nomura estimatesThe CAGRs for coal consumption by the chemical industry and others between 2007and 2009 were -0.1% and 1.3% respectively (source CEIC, CCTD). For FY10F-FY12F,we assume the same growth rate in projecting their respective coal demand.so coal demand will rise by 6.5 % in 11F and 5.5% in 12FTherefore, based on our analysis, we expect coal demand to rise to 3.3bn tonnes inFY10F, up 9% y-y. Demand will grow to 3.5bn tonnes in 2011F (up 6.5% y-y) and to3.7bn tonnes in 2012F (up 5.5% y-y), backed by strong demand from power, steel andcement, in our eyes.12th FYP: coal drops to 63% of total energy consumptionIn 2009, coal represented 70% of Chinas primary energy consumption, significantlyhigher than the world average of 29% and the OECD average of 20% (source BPStatistical Review of World Energy June 2010). Chinas reliance on coal is muchhigher than the second most coal dependent country, India (52% of primary energycomes from coal) (source BP Statistical Review of World Energy June 2010). In 2009,China accounted for 47% of the worlds total coal consumption, three times more thanthe second largest coal consumer, the US, according to BP Statistical Review of WorldEnergy June 2010.In order to realize a low carbon economy, China has two targets for energy and theenvironment. They are to increase the use of non-fossil energy to 15% of primaryenergy consumption in 2020, and to reduce carbon intensity by 40-45% by 2020, from2005 levels. Energy intensity should have fallen by 20% as of end-2010 (according toChina Daily), on track with targets, thanks to the power rationing introduced to 19 highenergy intensive and restricted industries in 2H10 to curb energy usage.In the 12th Five Year Plan (FYP) (2011-2015), we expect a significant part of energypolicy will be on how to achieve the two targets. According to Xinhua, the NDRC mightimplement a policy about reducing coal from 70% of primary energy used in 2009 to63% by the end of the 12th FYP in 2015 (see policy section for details).Other than policies to reduce energy consumption and CO2 generation, we believenew energy will be highlighted in the 12th FYP and emphasis will be on, in sequence,nuclear, natural gas, small hydro, wind, solar and biomass energy. The EnergyResearch Institute (ERI) of the NDRC forecasts non-fossil fuel to represent 11-13% ofprimary energy consumption in 2015 (from currently ~9%). Also, ERI expects the 2020target for nuclear is likely to increase to 70-80GW, from 40GW. Other issues expectedto be discussed in the plan should include tariff reform (power pooling), smart-gridsand imbalanced power supply between regions.Nomura 23 18 January 2011 25. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 33. China: primary energy consumptionExhibit 34. The world, OECD and India primary(FY05-09)energy consumption (2009)(%)CoalCrude Oil Natural Gas Hydro Power(%)Oil Natural gas Coal Nuclear Hydro 7%7%7% 8%8%5.1%5.7% 6.6%1001003%3%3%4%0.8% 90 4% 909.7%5.5% 8020% 19% 19% 18% 18% 8019.9%29.4% 7070 52.4% 6060 5050 25.0% 23.8% 4040 71% 71% 71% 70% 70%10.0% 3030 2020 39.7%34.8%31.7% 1010 00 20052006200720082009 India OECDTotal WorldSource: CEIC, Nomura ResearchSource: BP Statistical Review of World Energy June 2010, Nomura research but absolute coal demand will continue to outpace supplyEven with the conservative assumption of China achieving the goal of 1) reduction onreliance on coal of the primary energy consumption to 63% by 2015 and 2) energyintensity to fall by 16% from 2010 level by 2015, coal demand growth would be 4.6%and 4.4% for 2011F and 2012F from this top-down approach (versus supply growth of4.2% for 2011F and 2012F). This suggests that the coal market will remain tight overnext two years. We see upside for these numbers as well, given 1) the projectedstrong GDP growth, 2) the majority of economic activity continue to be represented bysecondary industry (industrial production) and 3) coal-fired power generation remainsthe cheapest and is Chinas main energy source.Exhibit 35. Top down coal consumption projection 2009 2010 2011 2012Assuming a 16% energyGDP growth 10.2% 9.8% 9.5%intensity reduction targetby 2015 from 2010 level,Energy Intensity reduction -3% -3%representing ~3% CAGRTotal energy consumption (Index to 100 for base year)100.0106.5 113.1Coal as primary energy consumption70.0%68.8%67.6% 66.4%CAGR-1.7%Coal consumption (Index to 68.8 for the base year: 2010) 68.872.075.1Projected Growth4.6%4.4%Source: Nomura est.Assuming China reduces coalreliance from 70% (2009) to 63%(2015), representing a ~1.7%CAGR reduction in reliance peryear and it is difficult to replace coal in the near termWe believe coal will continue to account for majority of Chinas energy consumption atleast for the next two decades. We dont think coal can be easily replaced by othertype of energy in the near term given "structural issues" including: Abundant coal reserves in China, while it is only sufficient on gas and is short of oil(source BP Statistical Review of World Energy June 2010). China has the thirdlargest coal reserves in the world with 114.5bn tons of coal reserves (source: BPStatistical Review of World Energy 1H10), after Russia and the US. This equals toNomura 24 18 January 2011 26. Coal | China Ivan Lee, CFA / Matty Zhao38 years of production based on the 2009 run rate, compared with oil at 11 yearsand gas at 29 years. Regulated power tariff without fuel cost pass through and coal remains thecheapest source of energy. Therefore, the majority of power generation willcontinue to rely on coal in the next 5-10 years in our view. Compared with othermajor energy sources, such as gas, LPG and diesel (which are more closelycorrelated with crude oil prices in our view), coal enjoys a 100%-340% costadvantage. Even though we forecast coal prices to increase, it will still maintain itspricing competitiveness in China over other major energy sources in our view. It takes more time to build other base-load and low cost fuel type power plants, likenuclear. Renewable energy (wind, solar, biomass) are not base-load power. They are lessscalable and affordable in China in our view.Exhibit 36. China: fossil fuel lifetime(yrs) 4037.5 35 28.8 30 25 20 1510.7 1050 CoalOil GasNote: Lifetime defined as reserves / productionSource: BP Statistical Review of World Energy 2010Exhibit 37. China: Energy price comparison (Sep 2010) Electricity 144206 Diesel169 188 LPG 106 134 Coal 1864Natural Gas7287 050 100150 200 250 Price per heat content (RMB per gigajoule)Source: CEIC, China coal associationNomura2518 January 2011 27. Coal | China Ivan Lee, CFA / Matty ZhaoSupplyTight supply remainsIn the past 10 years, China witnessed a rapid growth in coal output, with a CAGR ofIn the next two years, demand9%. In 2009, total production in China reached 3.05bn tonnes, more than double growth outpacing supply growthproduction in 2000. According to the BP statistical review of world energy June 2010,could lead to tight supplyChina produced nearly 46% of total world coal output. In the next two years, demandgrowth outpacing supply growth could lead to tight supply, in our view.Exhibit 38. China: coal supply forecasts(mnt)20052006 20072008 20092010F 2011F 2012FCoal production2,3502,5292,692 2,802 3,0503,2613,397 3,539% chg7.66.4 4.18.9 6.94.2 4.2Net increase179163 110248 211136 142Source: CEIC/NBS, Nomura estimateExpect coal supply to see 4.2% CAGR for 2010-15FFor 2010F, we project coal production to rise to 3,261mn tonnes, +6.9% y-y, based on9M10s actual output of 2,446mn tonnes (source: CCTD). We forecast productiongrowth to slow to 4.2% y-y for both 2011F and 2012F, yielding 3,397mn and 3,539mntonnes of coal output in the respective year based on our industry checks and analysisof the current market environment: Government intervention on capacity expansion Geographically imbalanced supply Depletion of eastern coal mines Small mines consolidating causing short term tightnessGovernment restriction on capacity expansionAccording to Reuters King coal report in Jan 2011, China accounts for 46% of the China accounts for 46% of theworlds total coal supply but is responsible for about 80% of global mining fatalities.worlds total coal supply but is responsible for about 80% ofTherefore, in light of the governments efforts to reduce energy consumption per unit of global mining fatalitiesGDP in 12th FYP and reducing coalmining casualties, Beijing has introduced morerigorous requirements for safety and approval of new coal capacity.According to Global Times (3 November, 2010), China Coal Research Institutesdirector He Youguo said that China may limit annual coal production to 3.6-3.8bntonnes in the 12-FYP (by 2015F). Although we agree that output growth will slowunder governments stringent control measures, we think that Mr Hes outputprojection (implying a CAGR of 3.7% in 09-15F) is too conservative, compared with aproduction CAGR of 6.7% from FY05-09. Our industry check with CCTD and Shenhuaconfirms our projection of around 4bn tonnes in 2015F, a CAGR of 4.2%.We believe production growth disruption would not be a major concern for leading coalplayers such as Shenhua and China Coal. We believe their output growth should runfaster than the national growth of 4.2% CAGR given their existing sufficient reserves,recent acquisitions of resources, potential pipelines from asset injections and beingbeneficiaries of small mines consolidation. In particular, Shenhuas captive logisticsnetwork could facilitate third-party trade, which supports double-digit volume salesgrowth over our forecast horizon. However, the said restriction, coupled with depletingcoal resources in Shandong, prompted Yanzhou Coal to move away from its hometown, like investing in Australia, in our view.Nomura26 18 January 2011 28. Coal | ChinaIvan Lee, CFA / Matty ZhaoGeographically imbalanced supplyChina is rich in coal resources but most of the resources are located in the Northwestpart of China, and top 10 coal production provinces are all in North or Northwest partof China (source: CEIC).Exhibit 39. China: Top 10 provinces by raw coal production(mnt) 2009 2008700601594600645500 502400 296300 230200144 137128242 21310487 85100 137 113 11695 98810ShanxiShaanxiMongoliaGuizhou HenanShandongSichuanHeilongjiang Anhui Hebei InnerSource: CEIC, Nomura ResearchGrowing reliance on Shanxi and Inner MongoliaShanxi and Inner Mongolia are critical to domestic coal supply. Contribution from theShanxi and Inner Mongolia aretwo provinces has risen from 34.5% (FY05) to 46.0% (FY10F basing on 1H10 actual).critical to domestic coal supplyPrior to 2009, Shanxi was the biggest producing province, with a CAGR of 5% inFY05-08. Although supply in Shanxi dropped to 594mn tonnes in 2009 (down 8% y-y)due to the closure of small mines policy, we expect FY10 raw coal output to recoverback to 720mn tonnes based on 11M10 output of 660mn tonnes.Inner Mongolia has the largest thermal coal resources in China according to WoodMackenzie. In the past few years, due to the upgrade of railway regional lines, whichfeed into the Daqin or Shenhuang lines (see transportation sector for details),production grew very fast and overtook Shanxi in 2009 as the largest coal producingprovince. According to Inner Mongolia Economic and Information TechnologyCommission (source: hncost.com), Inner Mongolias coal output may reach 880mntonnes in FY11; while Shanxis coal output is expected to be 780-800mn tonnes(source: CCTD and Shanxi Coal Industry Office). We expect contribution from thesetwo provinces to grow due to their rich coal resources and slowing growth (or decline)at other production bases due to depleting resources. Henan had a production decline(source: cctd) while Shandong saw slow growth (source: steelinfo) in 2010.Assuming Shanxi and Inner Mongolia contribute some 50% of national coal output inFY11 (46% in FY10F), and total output of 1.66bn tonnes, total coal output in Chinashould reach around 3.32bn tonnes in FY11, in line with our top-down projections of3.4bn in FY11 and 4bn in 2015F representing a CAGR of 4.2% for 2010-15F.Nomura 2718 January 2011 29. Coal | ChinaIvan Lee, CFA / Matty ZhaoExhibit 40. Shanxi vs. Inner Mongolia productionExhibit 41. Shanxi / IMs total % of China Production(mn t)(%)ShanxiInner Mongolia(%)700 63064550 24 23 5942523 23554581600 4060119500 3020 50220400 201815300 354 10 298 13200 256 0 10 1211100 (10) 0(20) 5 20052006 20072008 2009 Shanxi (LHS)Inner Mongolia (LHS)0 y-y (Shanxi) (RHS)y-y (Inner Mongolia) (RHS) 2005200620072008 2009Source: CEIC, Nomura Research Source: CEIC, Nomura ResearchSmall mines consolidations cause short term tightnessConsolidation limit supply.Compared with the overseas market, Chinas coal market remains fragmented. In 2009,the large stated-owned mines accounted for 50% of China total coal output; local SOEproduced 12%, while the township mines produced the remaining 38% (source CCTD).Exhibit 42. Production breakdown by miners (%) 100 Key SOE Local SOECity & Town owned 90 37% 31% 80 38% 38%38% 70 6015%14% 13%13% 12% 50 40 3054%48% 49%51% 50% 20 1002006 200720082009 20101HSource: CCTD, Nomura ResearchUnder the 11th FYP and the coming 12th FYP, the Chinese government is pushingmines to consolidate, aiming to create major mining firms with working capital to installand run safety equipment and to enhance more efficient use of resources (to improveproduction yield).Over 9,000 small mines have been closed by the end of 2010. By 2015, thegovernment plans to shutdown a further 7,000-plus mines, resulting in only 4,000mines remaining (see policy development section for details). The consolidation, in ourview, will limit supply in the near term given: Following the closure of small mines for consolidation and safety checks, coalproduction in Shanxi fell 8% to 594mn tonnes in 2009 (source CEIC). Given thesuccess in Shanxi, similar policies on closures of small mines (below 300,000tonnes of capacity) have been announced in Inner Mongolia and Henan provinces.We expect such policies to be rolled out to other major coal production provinces.Nomura 2818 January 2011 30. Coal | ChinaIvan Lee, CFA / Matty Zhao Wu Yin, Vice-Minister of the National Energy Administration, disclosed that 7,466small mines have been closed during 2006-09 nationwide. Another 1,539 areexpected to be closed by FY10, totalling more than 9,000 small mines closureduring the 11-FYP period and statistics on accidents & fatalities have beenimproved. (Source: cnstock). Even though the mines are consolidated into bigger coal players portfolio, it takes1-2 years for them to ramp-up production. but favour big playersAccording to Zhang Pings (NDRC chairman) speech at the national coal conference inNovember 2010, China targets to form 10 super large-scale coal enterprises of 100mntonnes annual capacity, and another 10 large coal companies with annual capacity of50mn tons by 2015. The12th FYP will increase annual production criteria for coalmines to: 1) at least 300,000 tonnes in all parts of China, 2) at least 0.6mn tonnes innational key planned mining areas, 3) over 1.2mn tonnes in major coal-producingprovinces, including Shanxi, Inner Mongolia, Shaanxi, Xinjiang and Ningxia.Although the consolidation is causing short-term tightness, the subsequent large scaleenterprises formation favours big SOE players, like Shenhua and China Coal. Ourview: 1) they are better-positioned in getting reserves across the nation, than non-SOEcoal players; 2) the policies bode well for enhancing market share for large scaleminers and, thereby, it would result in stronger pricing power for leading producers.Therefore, we expect the key companies to enjoy a double-digit production CAGRduring FY09-12F, more than double of Chinas coal industry production growthaverage.Exhibit 43. Market share projection Exhibit 44. Production CAGR growth (09-12F) (%) FY09FY12F(%)914 8.1 12.181211.3 6.9 10.77 1065 84.043.36 5.13421.2 1.1210 0 ShenhuaChina Coal Yanzhou CoalShenhuaChina Coal Yanzhou Coal TotalNote: measured by raw coal production Note: Yanzhou figure includes Australia productionSource: Company, Nomura est.Source: CEIC, Nomura est.Nomura29 18 January 2011 31. Coal | ChinaIvan Lee, CFA / Matty ZhaoTransportationTransportation bottlenecks to persist until2014FThe geographical disparity in supply and demand regions, with most suppliers in thenorthwest and consumers in costal areas, means that coal transportation is a keyelement of Chinas coal industry. This is intensified by the depleting resources in theold and eastern coal bases. Coal is transported by rail or truck from the Three Westregions to the main ports and then to downstream customers in the Yangtze RiverDelta and Pearl River Delta. According to the Ministry of Railways (MoR), coalaccounted for 53% of total freight goods carried by railway in 2009 in tonnage terms.Exhibit 45. Major production and consumption provincesSource: CEIC, Nomura ResearchWith railway capacity growth lagging production growth, transportation bottleneckshave become a major roadblock for Chinas coal industry in the past few years. Andwe believe this problem will persist for some years given: Limited railway capacity expansion in the two backbone railway lines (Daqin andShenhuang lines); Regional lines cannot solve the bottleneck issue; Trucking is too expensive and inefficient; and New major railway lines, dedicated to coal transportation, will not be completeduntil 2014-15F.Nomura 30 18 January 2011 32. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 46. Major railway capacity increase in Shanxi and Inner Mongolia(mn tonnes)2010F 2011F2012F 2013F2014F2015FErdos Caofeidian100 100Lvliang- Rizhao50 100Chisui line206080Total20 210 280y-y change 20 19070y-y chg from Daqin and8030 302020 0Shenhuang lineTotal capacity rise y-y 8030 3040 21070Note: Only major railways includedSource: Ministry of Railway, Inner Mongolia Science Technology & Economy magazineLimited capacity expansion from the two backbone linesThe Daqin line and Shenhuang line are the two backbones of the West-to-East railwaysystem in China, connecting key coal production provinces to the two main coalloading ports (Qinhuangdao and Huanghua ports). We expect limited expansion forthese two lines in short to medium term. Daqin line (Line 1 in Exhibit 48): Stretching 653km, linking Datong of Shanxiprovince and Qinhuangdao port, Daqin line is the most important railway linededicated to coal transportation. Its freight volume more than tripled from 100mntonnes in 2002 to 330mn tonnes in 2009 (source sxcoal). After freight volumegrowth in 2010F to 400mn tonnes due to growing demand for coal transportation,future growth should be limited. Subject to the Ministry of Railways approval, weexpect freight volume to increase by 20mn tonnes in 2011F and by 30mn tonnes toreach full capacity of 450mn tonnes in 2013F. Shenhuang line (Line 2 in Exhibit 48): Stretching 815km, Shenhuang line is thesecond largest line in terms of coal freight volume. The Shenhuang (Shenshuo-Shuohuang lines) line, which runs from Shenmu of Shaanxi through Shuozhou toHuanghua port, is owned by China Shenhua Energy. It is primarily designed tocarry coal produced by Shenhua, and will only serve third-party coal players when ithas spare capacity. In the short to medium term, we expect freight volume togradually increase to 200mn tonnes in 2014F from 140mn tonnes in 2009. However,the extra capacity could be absorbed by Shenhuas own output growth as weexpect self production to rise by 120-150mn tonnes from 2009 to 2014F.Exhibit 47. Key existing lines capacity expansion(mn tonnes) 2009 2010F 2011F 2012F 2013F 2014F2015FDaqin lines330 400 420 440 450450 450Shuohuang lines140 150 160 170 180200 200Increase by 80 30 3020 20 0Source: sxcoal, Nomura estimatesTrucks too expensive and less efficientTrucking is another way to transport coal. However, we dont think it will replacerailway as it is too expensive and less efficient. Also, in an effort to reduce dust, coaltrucks have been barred from travelling within 1km of the citys boundaries andoverloading is penalised. The higher charges are due to the lack of scale and toll roadcharges. Trucking is also much slower, especially during peak season. The local pressreported that coal trucks were stuck in the Tibet-Beijing highway for over 14 days inSeptember and pointed to coal trucks being slowed down due to severe a traffic jamthis summer from Shanxi to other provinces. Also, snowing can block roads and affectcoal truck transportation during the winter peak demand season.Nomura3118 January 2011 33. Coal | China Ivan Lee, CFA / Matty ZhaoRegional lines link Inner Mongolia but cannot solve the problemCoal from Inner Mongolia is mainly transported through regional lines that feed into thetwo backbone lines: Dazhun line (Line 3 next Exhibit): Stretching 264km, linking Inner Mongolia toDaqin line, Dazhun line is owned by China Shenhua Energy. It carried 60mn tonnesin 2009. Dabao line (Line 4 next Exhibit): Stretching 452km, from Baotou to Datong, Dabaoline is another linkage between Inner Mongolia and Daqing line. The line upgradedits capacity to 120mnt in 2009. Baoshen line (Line 5, next Exhibit): Stretching 170km, from Baotou to Shenmu ofShanxi, Baoshen line is also owned by Shenhua Energy. It connects coal fromInner Mongolia to Shenhuang line. The freight volume exceeds 22mn tonnes.These regional lines cannot solve the bottleneck issue as they still feed into the Daqinand Shenhuang lines, increasing their burden. With completion of new major linespending, transportation bottlenecks may continue to be a serious constraint for InnerMongolia coal producers as it is land locked and trucking distance to major ports (QHDport and Huanghua port) is even longer than Shanxi.New railways to ease the bottleneck in 2014F/ 2015FTo ease the transportation bottleneck, we understand that the MoR is working on threemajor lines to ease the transportation bottleneck, adding over 500mn tonnes oftransportation capacity from Inner Mongolia and Shanxi to the ports. The Third line for West-to-East system, from Erdos to Caofeidian port, wouldadd additional capacity of 200mn tonnes when it is completed. China would investRMB40bn into phase 1, the Zhangtang line, 542km, from Zhangjiakou of Hebeiprovince to Caofeidian. Phase 1 started in November 2010, and estimatedconstruction time is 4.5 years. The construction work for phase 2, from Zhungeerto Zhangjiakou, has not been officially started yet. Due to the long construction time,we expect it will only help to ease the transportation burden of 100mn tonnes in2014F (as it should start operation in mid-2014) and 200mn tonnes in 2016F. Central-southern line, running from Lvliang (Watang town) of Shanxi province toRizhao port in Shandong province, is designed for a capacity of 200mn tonnes peryear. The over 1000km line is estimated to be completed in late 2013. We expect itto be operational in 2014F, with initial capacity of 50mn tonnes, and to reach200mn tonnes of capacity by 2016F. Chisui line, stretching 357km and with designed capacity of 114mn tonnes, buildsa link between Chifeng of Inner Mongolia and Suizhong port near Hulu Island.Construction started in October 2010 and should be finished in September 2013.We expect the line to come into full operation in 2016F/2017F.Nomura3218 January 2011 34. Coal | China Ivan Lee, CFA / Matty ZhaoExhibit 48. Major railway lines to transport coalChisui line(2013)No.3 line Phase IINo.3 line Phase I(2014)(2015) Dabao line Zhangjiakou4 13Daqin lineBaoshenline5 2 Shenhuang lineCentral-southern line(2014)New lineExisting lineNote: Route is estimated basing on information from the Ministry of RailwaySource: Ministry of Railway, ditu.baidu.comNomura33 18 January 2011 35. Coal | China Ivan Lee, CFA / Matty ZhaoImportsIncreasing imports to fill the supply gapChina becomes a net coal importer in 2009China is rich in coal resources. According to BP statistical review of world energy, inJune 2010, China ranked third in proven coal reserves as of end-2009, having 13.9%of the worlds total proven reserves, following the US with 28.9% and the RussianFederation at 19.0%. The reserves-to-production ratio of China is 38 years. However,in recent years, Chinas coal supply growth has lagged its soaring coal demand andthe country has become a net coal importer since 2009, with imports of 126mn tonnesand exports of 23mn tonnes for the year, according to CCTD.Exhibit 49. Chinas total coal imports and exports Exhibit 50. Chinas net imports of coal (mn t) Import VolumeExport Volume(mn t) Net Import Net Import 1820 1615 1410 12 5 100 8 (5) 6(10) 4(15) 2 0 Jul-03Jan-04 Jul-04Jan-05 Jul-05Jan-06 Jul-06Jan-07 Jul-07Jan-08 Jul-08Jan-09 Jul-09 Jan-10Jul-10 Jul-03Jan-04 Jul-04Jan-05 Jul-05Jan-06Jul-06 Jan-07Jul-07 Jan-08Jul-08 Jan-09Jul-09 Jan-10Jul-10Source: CCTD, Nomura researchSource: CCTD, Nomura researchSupply gap to be filled by imports in 10F-12FRapid economic growth, depleting resources, transportation bottlenecks and restrictedsupply (Beijing, Guangzhou, Jiangsu and Shanghai have shut down their own minesaccording to Reuters King coal report in Jan 2011) have forced the developed eastand southern coasts to rely more on coal imports. In FY10-12F, we expect China toremain a net importer of coal, owing to the tight supply-demand situation. Fast growingdemand in China drove up coal imports significantly in 2010. Based on 9M10 netimports of 106mn tonnes (up 51% y-y), we expect full-year imports for 2010 to be142mn tonnes.Rising local demand and tight supply constraints imply that Chinas coal exportsshould remain weak at 20mn tons/year in FY11F and 12F, on our estimates, whileimports should remain strong with projected net imports at 172mn tonnes in FY11Fand 217mn tonnes in FY12F. Nevertheless, this only represents 5% and 6% of totalcoal consumption in China respectively during the same period. The 17% import valueadded tax remains one of the major hindrances (source: PRC Ministry of Finance).Exhibit 51. Net imports/export forecasts(mnt) 2005 2006 2007200820092010F2011F2012FConsumption 2,3192,5512,727 2,8113,0203,2993,515 3,707y-y chg (%) 10.06.93.17.4 9.2 6.55.5Production (2,350) (2,529)(2,692) (2,802)(3,050) (3,261) (3,397)(3,539)y-y chg (%) 7.6 6.44.18.96.9%4.2% 4.2%Changes in inventory and others (15)(47) (38) (14) 133105 55 49Net Import / (export) (46)(25)(2) (5)103142172 217Source: CEIC and NBS unless otherwise stated (2009 production data from CCTD) Nomura estimatesNomura34 18 January 2011 36. Coal | ChinaIvan Lee, CFA / Matty ZhaoIndonesia and Australia as main suppliersIn 2009, the four biggest coal exporters to China were Australia, Indonesia, Russia andMongolia. For 9M10, China imported most of its coal from Indonesia, Australia, Russiaand South Africa (source:sxcoal).According to Australian Mineral Economics (AME), China ranked No. 3 in seabornethermal coal imports in Asia in 2009. With growing requirements of coal imports to fillthe supply gap, Chinas seaborne thermal coal imports ranked second (122mn tonnes)in Asia in 2010F, between Japan (128mn tonnes) and Korea (81mn tonnes) accordingto our global metal and mining team. Although coal imports to China only account forsingle digit percentage of Chinas total annual consumption, this represents over 1/4 ofseaborne coal market imports in Asia. Therefore, the expected 20mnt-30mnt (10% oftotal seaborne market in Asia) increase in thermal coal imports should edge upseaborne coal prices further, in our view. Our estimate is based on Australiasproduction of 409mnt and exports of 142mnt in 2009, followed by Indonesia (252mnt,202mt), Russia (298mnt, 81mt) and South Africa (250mnt, 62mt).Exhibit 52. China thermal coal imports (9M10)Exhibit 53. China thermal coal imports (FY09) Others, 5% Mongolia,Others, 15%5%Indonesia, Russia, South 42%16% Australia,Africa, 11% 41%Russia, 11%Australia,Indonesia,22%34%Source: SXCOAL, Nomura researchSource: SXCOAL, Nomura ResearchExhibit 54. Coal production and imports of major countries(mnt) 2007 20082009Australia393 398409Export (seaborne thermal coal) 115 124142Indonesia217 229252Export (seaborne thermal coal) 191 197202Russia 314 329298Export (seaborne thermal coal) 88 8681South Africa 248 253250Export (seaborne thermal coal) 65 6162Note: Production account for solid fuels (incl. bituminous coal and anthracite (hard coal), and lignite and brown (sub-bituminous) coalSource: AME, BP Statistical Review of World Energy 2010Nomura 35 18 January 2011 37. Coal | China Ivan Lee, CFA / Matty ZhaoCostRising costs aheadFees and levies edging up production costCoal production costs in China have increased from RMB156/tonne in January 2007 toRMB294/tonne in July 2009, according to CCTD. Although part of the cost increasecan be attributed to higher wages and material costs under inflation pressure, we think,the main cost driver is growing levies and fees.While such cost increases do not provide a positive backdrop, the strong pricing powerof coal companies and a sellers market nowadays would allow coal firms to pass oncost increases to its users, thus extending the strength in spot coal prices, in our view.Exhibit 55. China Coal: Unit production cost(RMB/t)400350300250200150100 50 0 May-07 May-08 May-09 May-10Mar-07Nov-07Mar-08Nov-08Mar-09Nov-09Mar-10 Jan-07Jul-07 Sep-07 Jan-08Jul-08 Sep-08 Jan-09Jul-09 Sep-09 Jan-10Jul-10Note: From 2009, CCTD only announce production cost data periodically.Source: CCTD, Nomura ResearchCoal price adjustment fund and coal sustainable development fundMajor coal production provinces such as Inner Mongolia, Shaanxi, Hunan, Guizhouand Sichuan have introduced a coal price adjustment fund (CPAD). For raw coal, theCPAD ranges from RMB8/tonne to RMB40/tonne, while the charge is betweenRMB25/tonne and RMB60/tonne for clean coal.Exhibit 56. China: Coal price adjustment fund (current)Raw coal Clean coal CokeProvince Year effective(RMB/tonne) (RMB/tonne)(RMB/tonne)Inner Mongolia20098 or 15 * 20 n/aSichuan 20084060 70Chongqing 20084060 70Hunan 20083535 35Shaanxi 20051525 25Guizhou 200420** 20** 20*** RMB8/ tonne in Inner Mongolia apply to Lignite and RMB15/tonne apply to other type of raw coal. **Guizhou reduced CPAD from RMB50/t to RMB20/t in 2008Source: Xinhuanet, ccoalnew, fert.cn, chongqing government website, shaanxi government website, Nomura ResearchAlthough Shanxi is not charging the CPAD, it started to charge a levy in March 2007,after passing the proposal in 2006 and the ordinance in 2007; the proceeds flow to asustainable development fund (SDF). As of 2010, an RMB13-20/ tonne SDF chargeis applied to a regular coal mine and RMB40/tonne for unqualified coal mines. In 2009,Inner Mongolia received approval from the State Council for SDF, which might beintroduced soon. The CPAD and SFD charges for Three West areas add up RMB20-40/tonne to production costs.Nomura 36 18 January 2011 38. Coal | ChinaIvan Lee, CFA / Matty ZhaoResources tax reformsCurrently, the local governments charge RMB3-5/tonne as resources tax, representingless than 1% of the spot price. According to our industry checks in early November2010, the coal resources tax reform, if imposed, would probably change from thecurrent volume-based format to a price-based and from 3% to 5% on the sales price.Currently, there is less clarity on the implementation timetable or which price the taxwill be based on. Ex-mine price approach: by applying 5% to the FY10 average ex-mine price(Shanxi Shuozhou gas coal 4,800kcal/kg) of RMB309/tonne, the new resource taxis RMB15/tonne in FY11F for domestic coal production. Thus, the incremental costto a coal producer would be around RMB10-12/tonne. In our company analysis, wehave taken the ex-mine price approach to calculate the cost. QHD spot price approach: the new resources tax is estimated to be RMB37/tonneby applying 5% to the FY10 average QHD spot price (Shanxi 5,500 Kcal/tonne),leading to an incremental cost of RMB32-34/tonne. However, we believe, the net effects to coal companies might not be verysubstantial as the costs are likely to be passed on to customers, such as IPPs,given that it is a sellers market these days. Given the prevailing high inflation and recent coal price hike, we believe theresources tax changes will only be released after 2011 contract price negotiations.Transportation costs is a big partAs discussed in the previous sections, given the demand- supply imparity, coal needsto be transported from Northwest to Southeast China by rail and sea. Given the longdistances, transportation costs are a major cost head for coal players: Railway cost from Shanxi to Qinghuangdao port is around RMB85-98/tonne (byapplying RMB0.13-0.15 per ton per km for the Daqin line of 653km). Railway costfrom Inner Mongolia is even higher due to the longer distance of around 300-500kmto Datong. However, the higher transportation cost in Inner Mongolia is offset bylower production costs. Shipping costs vary from RMB50/ton to RMB100/ton in 2010, and peaked in Nov10 due to winter stocking. Other fees: according to David Fang of China Coal Transport and DistributionAssociation, coal producers (especially small miners) need to pay RMB50-100/tonne wagon fees to get railway capacity at the major coal producing provinces. Wealso estimate a loading fee and port handling fee of RMB50 per ton.Exhibit 57. Nomuras estimate of total unit costCost ItemRMB/tonneCash production cost (including tax & fees) 260Depreciation 40Railway cost 90Shipping 50Others (wagon fees and loading fees)100Total cost540Note: The cost estimates are based on 5,500 Kcal/ tonne thermal coal and FOB spot sales. Cost for ex-mines salesand key contract sales would be lower.Source: Nomura researchNomura 37 18 January 2011 39. Coal | China Ivan Lee, CFA / Matty ZhaoGovernment policyAppendix I: Policy development on coalDevelopment on the price intervention policyExhibit 58. Price intervention policy and news flow2008 price interventionTimeframeParticulars19 Jun, 2008 China announced a cap on thermal coal prices through the end of the year at the 19 June 2008 level (RMB830/tonne for 5,500Kcal/kg), while hiking diesel, gasoline and jet fuel prices immediately and raising retail electricity tariffs beginning 1 July 2008. However, the policy did not have an immediate impact on the spot price and coal price kept rising to RMB995/tonne as of 21 July 2008.24 Jul, 2008 NDRC issued another price cap policy. It required that the 5,500Kcal/kg thermal coal FOB price in QHD port and Tianjin port should not exceed RMB860/tonne and RMB840/tonne from the policy date to 31 Dec 2008. The spot price started to come down after the policy announcement. However, only until 27 Oct 2008, three months after this second price cap, did the QHD price come down to RMB860/tonne.Mid-2010 price interventionTimeframeParticulars25 Jun, 2010 In view of the large spread between contract and spot prices, some coal companies increased the contract price by RMB40-50/tonne in early 2010. In June, NDRC issued a document that required coal companies to honour the contract signed at the beginning of 2010 without increasing the price. Coal companies that raised prices, needed to return the extra amount back to customers.End 2010 key contract price interventionTimeframeParticularsMid-NovThe Bureau of Economic Operations Adjustment of NDRC urged coal producing provinces and enterprises to help stabilise the supply chain this winter and self-regulate coal prices. In order to contain the impact of a spot price increase on downstream industries, it also urged coal enterprises to honour coal contracts.1 Dec, 2010According to news on Xinhua, Cao Changhing, head of the Department of Price of NDRC, said during an internal conference that 2011 thermal contract price of key contract sales should be unchanged from the 2010 levels and any form of price increase is not allowed.6 Dec, 2010NDRC issued the 2011 National coal production transportation-demand notice, reiterating its effort and intent to control prices of key coal contracts. As coal transportation bottlenecks are yet to be resolved in China, NDRC uses railway transportation capacity allocation as a tool to ensure that coal companies fulfil their key contracts. In the notice, NDRC said it would favour those corporations which have mid-long term contracts for 2011 and those which possess a history of high contract fulfilment rate when allocating railway transportation capacity. For FY11F, NDRC projects railway transportation capacity of 932mn tons, of which, 769 mn tons of capacity has been allocated for thermal coal transportation to IPPs, 94.53mn tons for non-ferrous metal production, 34.84mn tons for the chemical industry (fertilizers) and 33.63mn tons for residential use. The notice further mentioned that all key coal contracts above 300,000 tons in 2010 should be carried forward into 2011. (Source: CCTD)Source: NomuraCoal and energy consumption reduction initiativesExhibit 59. Recent news flow on coal/energy reduction initiativesTimeframeParticularsMid-2010 According to Xinhua news, during its 12th FYP, the government is determined to drive its low-car