08 Anglo American plc Annual Report 2015

STRATEGIC REPORT MARKETPLACE REVIEW

MARKETPLACE REVIEW

India’s economy is the exception to this weaker growth story. Following the election of Narendra Modi’s Bharatiya Janata Party, GDP growth has picked up markedly. If the new government implements more far-reaching reforms, the economy could see its growth rate running at around 7%-8% per year in the medium term.

THE TRANSITION OF EMERGING ECONOMIES

China’s slowdown is, however, also a corollary of the authorities’ determination to rebalance and restructure the economy. Over the past two decades, the country has experienced an extended investment boom. The government is now promoting a less capital-intensive growth model. Inevitably, this implies lower aggregate economic growth rates and weaker demand growth in many commodity-intensive sectors, such as steel and cement, albeit mitigated by potentially stronger demand for other metals and minerals, including diamonds, PGMs and copper.

2015 proved to be yet another challenging year for the mining industry – continued economic uncertainty, slowing economic growth and demand, and the resulting sharply lower commodity prices led to the value of many mining companies falling to historic lows and management teams having to implement a range of initiatives to reduce operating and capital costs, to conserve cash and protect their balance sheets.

THE SHIFTING GLOBAL ECONOMIC ENVIRONMENTA number of global trends have developed in recent years that have had a significant bearing on the economic performance and prospects of many countries that play a major role in the global trade of mined products:

CHINA’S SLOWDOWN

According to the IMF, global GDP increased by 3% in 2015, compared with 3½% in 2014. Since the global financial crisis in 2008/09, the world economy’s growth rate has consistently fallen short of its pre-crisis levels, raising concerns about a protracted ‘secular stagnation’ within the advanced economies, in which growth is persistently weak. In the emerging economies, average growth rates are likely to remain depressed as China’s infrastructure-fuelled boom fades.

The IMF estimates that the advanced economies grew by 2% in 2015, slightly faster than in 2014. While growth picked up modestly in the US, Europe and Japan, it remains subdued relative to the pre-crisis trend, and there are worries the crisis has had a long term detrimental effect on the future path of output.

The emerging economies experienced a further marked slowdown in 2015, with aggregate growth of 4% compared with 4½% in 2014. China’s economy has slowed significantly in recent years as it has begun to mature following a period of unprecedented national infrastructure development that absorbed ever larger volumes of raw materials, particularly iron ore and metallurgical coal for steel production. Most forecasters expect a further slowdown over the next five to 10 years, reflecting the end of the investment boom, diminishing potential for ‘catch-up’ growth, a shrinking workforce, and a significant debt overhang in the corporate sector.

The continuing slowdown in China is inevitably inflicting damage on other emerging economies, and especially among mining-commodity producers. Economists are now becoming more cautious about medium term growth prospects in these economies. Brazil and South Africa have suffered particularly from the drop in commodity prices, which has only been partly offset by their weaker currencies. Their underlying potential growth rates have fallen to around 2%-2½% a year compared with 3½%-4% at the height of the commodity boom.

%

6057422350382212453415

5

Iron ore 2014 2010 2005 2000Copper 2014 2010 2005 2000Nickel 2014 2010 2005 2000

Source: IMF

Household consumptionInvestment

20122002199219821972196219520

10

20

30

40

50

60

70

80

Source: China’s National Bureau of Statistics

09

Strategic report

Anglo American plc Annual Report 2015

SUPPLY OF COMMODITIES EXCEEDING DEMAND

The decline in investment expenditure in China has weighed particularly on prices for metals and minerals. As a result, 2015 marked a year of much weaker demand growth for most mined commodities, while supply continued to increase.

A number of supply cuts have been implemented across the mining industry. To date, however, such cuts have proved to be insufficient to stimulate a meaningful price recovery in the absence of stronger demand growth.

DiamondsEnd-consumer demand for diamonds continued to be robust in the US, which is the largest consumer market for polished diamonds, with an estimated 45% share of demand. Chinese demand growth for diamond jewellery saw a considerable slowdown after being the engine of growth for the industry in the last decade. Other emerging markets saw weaker consumer demand, exacerbated by the strength of the US dollar. The resulting demand weakness was amplified into the value chain, with jewellery retailers reducing their desired stock levels and, consequently, their purchasing from the midstream. Faced with lower polished demand and high stocks, built up during 2014 and early 2015, the midstream sector reduced its demand for rough diamonds, which caused a build-up of inventory, with downward pressure on rough diamond pricing.

Looking forward, global carat production is expected to grow followed by a period of stabilisation. Post-2020, there is potential for a production decline given the lack of recent discoveries of significant scale and depletion of the resource base. This decline in production, combined with the expected growth in consumer demand for diamond jewellery, points to strong prospects for the diamond business in the medium to long term.

Precious metalsPlatinum production recovered from strike-affected 2014 levels, with an estimated 14% increase in mined supply, to reach levels similar to 2013. Supply from autocatalyst recycling, however, is thought to have decreased as recyclers held onto scrap in the low price environment. Higher platinum offtake by the autocatalyst and industrial sectors was largely offset by lower demand from the jewellery sector. Combined with outflows from physical exchange traded funds (ETFs), the net effect was a more balanced market in comparison with the substantial market deficit in 2014. Palladium demand for autocatalyst and industrial applications was relatively stable year-on-year. In line with the platinum market, the increase in mined

supply, together with outflows from ETFs, reduced the significant market deficit recorded in 2014. The weak South African rand contributed to the steady decline in PGM prices through 2015.

Although, in the near term, the growth outlook for PGMs is unclear due to potentially reduced platinum jewellery demand in China and uncertainty surrounding the autocatalyst market, longer term demand is forecast to be robust given the expected demand for new and cleaner vehicles in maturing economies, coupled with increasingly stringent global emissions legislation.

Base metals Slowing demand growth was a key contributor to the weak copper market during 2015 – global consumption was below expectations, while forecasts for Chinese demand growth in particular have been scaled back. Although cuts or unintended disruptions to output increased during 2015, removing close to 1.2 Mt of copper from global mined production, recently commissioned mines are now ramping up and are set to add considerable tonnage to the market over the medium term. Over the long term, supply is expected to struggle to meet growing demand given limited sources of new primary copper supply, declining grades and more challenging mining conditions in the existing global portfolio of ageing copper mines.

Despite the ban on Indonesian exports of nickel ore continuing in 2015, a number of factors negatively affected the nickel market. These included an abrupt fall-off in Chinese (and global) stainless steel production, by far the largest end-using sector of nickel, as well as Chinese nickel pig iron output beating expectations. Refined production growth outside of China also remained reasonably strong in the absence of significant price-induced cutbacks, even as the declining price cut deep into the global cost curve. As a consequence, LME inventories increased throughout the year, reaching unprecedented levels by year end.

Bulk commodities Steel demand fell globally by about 3% in 2015 – the first annual decline since 2009 – largely due to Chinese demand softening by around 5%. This resulted in a decrease in the consumption of both metallurgical coal and iron ore.

Iron ore fundamentals deteriorated on the back of declining global demand and strong growth in low-cost supply, particularly from Australia. A number of new projects are ramping up, or are expected to be commissioned in the near future, delivering a total of 250 Mtpa of new supply since 2013, equivalent to 12% of 2015 global supply, compared with demand growth of only 50 Mtpa.

Indexed 2015 commodity prices

Jan 2015 Dec 2015

Pric

e In

dex,

1 Ja

nuar

y 201

5 =

1.0

0.5

0.9

0.8

0.7

0.6

1.0

1.1

Source: Anglo American Commodity Research

Iron ore (Platts 62% CFR China)

Iron ore (34)%

Thermal coal

Thermal coal (15)%

Metallurgical coal

Metallurgical coal (26)%

Nickel

Nickel (29)%

Platinum

Platinum (24)%

Copper

Copper (28)%

Diamonds

Diamonds (15)%

Anglo American basket price

Anglo American (24)%

10 Anglo American plc Annual Report 2015

STRATEGIC REPORT MARKETPLACE REVIEW

MANAGING CAPITAL ALLOCATION PRIORITIES AND REDUCING DEBT

The now lengthy period of commodity price weakness has had a significant impact on the health of mining companies’ balance sheets. Across the mining sector, companies are making efforts to preserve cash and reduce capital commitments. Capital expenditure – both future commitments and actual spend – has been cut considerably, with few new projects being approved for development and, indeed, corporate focus has now shifted to placing loss-making, excess capacity onto care and maintenance.

A MORE DIFFICULT MINING ENVIRONMENT

Grade deterioration and ore reserve depletion are important determinants of both longer term supply requirements and cost trends. A wide variety of factors is likely to continue to provide structural upward cost pressure, including: availability of both water and power; declining head grades; technical problems; increasing infrastructure costs as mines are built in more remote locations; and the shift to underground mining as easy to access near-surface ore bodies are depleted. Consequently, mining companies face a significant challenge to reduce costs and improve productivity against a background of limited investment appetite and few significant breakthroughs in technological capability. Technological innovation and a focus on operational improvements are likely to be critical to the achievement of sustainable cost and productivity improvements.

STAKEHOLDER ACTIVISM AND GOVERNMENT REGULATION

Mining companies across the world are facing greater demands and expectations from increasingly vocal stakeholder groups, with often competing interests.

Governments, which had become used to high levels of revenue from mining at the peak of the commodity cycle, are having to adjust to a much more challenging environment. They are under pressure to strike a balance between delivering more benefit and regulatory reform, while at the same time not deterring much-needed private sector investment.

TRAINING AND RETAINING SKILLED EMPLOYEES AND MAINTAINING SOUND LABOUR RELATIONS

As mining methods become more technically complex, the need to train and retain skilled staff becomes ever more important. In an environment where older, less-productive mines are being placed onto care and maintenance or sold, and technical innovation leads to more mines being mechanised, maintaining positive labour relations enables business continuity and enhanced productivity, as skilled labour shortages and industrial unrest can significantly affect production and costs.

In metallurgical coal, the slump in Chinese imports largely offset stronger demand from India and other Asian markets, with overall seaborne trade reducing slightly from 290 Mt in 2014, to around 275 Mt. While Australian supply was maintained, other less competitive sources such as the US and Canada were displaced.

The impact of China’s slowing growth profile, coupled with an increase in hydro-power generation in the country, also affected thermal coal demand there, with imports falling by c.25% year-on-year. However, the continued reliance on thermal coal for power generation, particularly in the developing world, has limited the downward price impact of slowing growth relative to other bulk commodities.

PROLONGED DOWNTURN IN COMMODITY PRICES

The combination of subdued demand and, in some instances, oversupply of commodities has placed significant downward pressure on prices. The chart on page 9 shows the percentage reduction in the prices of the metals and minerals produced by Anglo American over the course of 2015.

As the global market for commodities has deteriorated, the mining sector has been characterised by a marked reduction in costs in most regions, resulting in average industry costs falling; for example, metallurgical coal costs have declined by an estimated 15% over the year. However, the oversupply of many commodities has meant that prices have generally fallen by considerably more than costs, which has led to a significant portion of the industry becoming loss-making.

CHALLENGES FACING THE MINING INDUSTRY AND ANGLO AMERICANIn light of the global trends described above, there are a number of challenges currently facing the mining industry and Anglo American, including:

REDUCING COSTS

Significant cost reductions and efficiency efforts are being undertaken across the mining industry in a bid to improve relative positions on commodity cost curves and, hence, profitability. The measures being taken include: headcount reductions; a focus on core assets to improve productivity, with many companies taking the decision to close capacity and remove high cost production; and maintaining strong capital discipline. Lower oil prices have helped many producers lower their input costs (although higher energy costs and high inflation in both South Africa and Brazil have hampered cost reduction efforts in those commodity producing countries), while the devaluation of many local currencies is also helping miners’ costs in US dollar terms. One of the effects of weakening local currencies, however, is that marginal producers are being supported for longer, thereby prolonging the period of oversupply.

MARKETPLACE REVIEW continued

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Strategic report

Anglo American plc Annual Report 2015

FOCUS ON DE BEERS, PGMS AND COPPER

• Materially streamlined core portfolio of 16 assets

• Improved competitive profile – advantaged cost positions, world class ore bodies, and balance of geographic and end markets

• Asset quality, mineral endowment options and scale to support future opportunities

• Differentiated, premium positioning for expanding consumer-driven markets.

PORTFOLIO TRANSFORMATION UNDER WAY

• Nickel, Niobium and Phosphates, and Moranbah and Grosvenor metallurgical coal disposal processes under way

• Further progress made on other previously announced disposal processes, including certain platinum assets in South Africa, and thermal and metallurgical coal operations in South Africa and Australia.

CASH FLOW ENHANCEMENTS FURTHER STRENGTHEN BALANCE SHEET

• $1.9 billion of cost and productivity improvements in 2016, expected to continue into 2017 and beyond as the organisation is aligned with streamlined portfolio

• Step change 50% ($250 million) central and global support cost reduction in the medium term

• 25% year-on-year reduction in total capex expected, to less than $3.0 billion in 2016

• Dividend suspended and will resume with payout ratio when appropriate

• Strong liquidity maintained, with c.$15 billion of cash and undrawn facilities.

In response to the significant challenges facing the mining industry as a whole and Anglo American, including the lower commodity price environment, we have set out the details of wide-ranging measures that will sustainably improve cash flows and materially reduce net debt, while focusing the Group’s strategy and streamlining the organisation.

Anglo American will be focused on competitive, long life assets with considerable organic growth opportunities that mine the materials expected to benefit from long term, consumer-driven growth trends as the global economy evolves and developing economies mature.

ANGLO AMERICAN’S RESPONSE

FOCUSED PORTFOLIO THAT DELIVERS

SOCIO-ECONOMIC TRENDSCurrent global economic trends suggest slowing demand growth for infrastructure investment commodities, towards more consumer-driven product demand.

512 millionForecast number of middle class households in China and India combined by 2030, compared to 204 million in 2015, a 150% increase.

9 Nine of the most important jurisdictions worldwide – covering 80% of global car sales – are adopting more stringent vehicle emission and fuel economy standards.

$270 billionGlobal new investment in renewable energy in 2014, an increase of 17% on 2013.

CONSUMER TRENDSThe burgeoning middle class in emerging markets is stimulating consumer spending, while the developed world is experiencing rising demand for clean energy technologies and renewables.

2%–4.5%Global rough diamond demand in real value terms is expected to grow between 2% and 4.5% annually over the next 15 years.

20 millionThe number of electric vehicles, including plug-in hybrid and fuel cell vehicles, the Electric Vehicles Initiative seeks to help deploy by 2020.

9,000 lbsA photovoltaic solar farm plant can use approximately 9,000 lbs of copper per megawatt of peak capacity.

ANGLO AMERICAN DELIVERSOur core portfolio will focus on De Beers, PGMs and Copper, driven by consumer-driven markets.

De BeersThrough our 85% interest in De Beers, the world’s leading diamond company, we offer a differentiated and high quality position to meet growing consumer demand.

PGMsAs the world’s leading PGM producer, we are helping to develop innovative technologies in fields such as automotive, clean energy and chemicals.

CopperWith interests in two of the world’s largest copper mines, we supply copper products to a range of industries, including telecommunications, renewable energy technologies and electric vehicles.

Meeting global

consumer- driven

demands

Sources: Bain & Company, The International Council on Clean Transportation, Frankfurt School – UNEP Collaborating Centre, Copper Development Association Inc., and Clean Energy Ministerial. For more information See page 16