ARM Coal

ARM Coal experienced a challenging year, with the weak pricing environment compounded by operational issues and a marked reduction in demand and prices in the second half.

Divisional structure

Mangisi Gule Chief Executive: ARM Coal

Scorecard

Operational overview – attributable to ARM

										Operational
								F09/08		target
				F2009		F2008		% change		F2010
	Attributable sales
	PCB	Mt		3.8		4.9		(22)
	Export	Mt		2.2		2.7		(18)
	Domestic	Mt		1.6		2.2		(27)
	GGV	Mt		0.5		0.7		(28)
	Export	Mt		0.1		0.1		0
	Domestic	Mt		0.4		0.6		(33)
	ARM total	Mt		4.3		5.6		(17)
	Export	Mt		2.3		2.8		(18)
	Domestic	Mt		2.0		2.8		(28)
	ARM Coal operating margin	%		38		3.7
	Headline earnings attributable to ARM	R million		135		175		(23)

ARM Coal operational statistics – PCB & GGV combined

* The F2008 on-mine saleable cost reported was R148/t, which included 1.8 mt of stockpile coal sold to Eskom.

Loading of coal at Goedgevonden Coal Mine

Review of the year

ARM Coal experienced a challenging six months to June 2009, with the weak pricing environment being compounded by a range of operational challenges. Attributable cash operating profit in the current year increased by 18% compared to the previous financial year but attributable headline earnings declined by 23%. There was a substantial increase in the normal depreciation mainly due to depreciation of the capitalised value of the Douglas Tavistock JV off-take agreement.

Saleable production for the year was 12% lower than the previous financial year, mainly due to a fire at the Tweefontein plant in November 2008, and abnormally high rainfall in the first quarter of the 2009 calendar year. This decrease was to some extent offset by an increase in saleable production from 1.6 mtpa to 2.5 mtpa at the Goedgevonden (GGV) open cast mine during the current financial year.

Total on-mine costs per tonne increased by 35% in F2009, mainly as a result of an increase in contractor and consumable costs and the reduction of 12% in saleable production.

Commissioning of the GGV plant has been delayed from the first quarter to the third quarter of calendar 2009. This was mostly attributable to the abnormally high rainfall referred to above, as well as re-work on steel fabricated for use in the coal processing plant.

From January 2009 there was a marked reduction in demand for inland- and Eskom-quality coal. Although average prices achieved during the financial year were higher than the previous financial year, the last six months of F2009 experienced a decline of 30% for Eskom sale prices compared to the first six months of F2009.

The benefit that GGV enjoyed in the previous financial year, of a significant increase in sales volumes to Eskom, did not continue during F2009. Eskom's purchases of coal on shortterm contracts decreased as the shortage of coal experienced by the utility was largely resolved in the second half of the 2008 calendar year. A long-term coal supply agreement with a oneyear ramp-up and a six-year supply was concluded with Eskom.

Export volumes were lower during F2009 due to a delay in the commissioning of the RBCT coal processing plant and logistical problems experienced with transporting coal to the port.

At GGV cash costs per sales tonne increased by 11% year-onyear to R89.66 as the long-term cost per saleable tonne (which is used to determine the amount of working costs to be capitalised) was recalculated. This first-time capitalisation of working costs was occasioned by large volumes of in-pit inventory being exposed during the development stage, which will benefit the operation in the future.

ARM attributable thermal coal sales (Mt)

Reconciliation of headline earnings to operating profit

Earnings from the Coal Division attributable to ARM were negatively impacted by a number of accounting issues:

	The IFRS accounting requirement related to imputed interest on the Xstrata debt facilitation; and
	Additional amortisation at the ARM level provided as a result of the IFRS purchase price allocation rules.

F2009 PCB revenue (attributable to ARM)		F2009 GGV revenue (attributable to ARM)

Construction of coal valve at stacker at Goedgevonden

Logistics

RBCT will commission the Phase V expansion project in the fourth quarter of 2009. Transnet Freight Rail (TFR) is currently unable to supply RBCT its existing coal export capacity of 76 mtpa and it appears that, as a result of a mismatch between TFR rail capacity and the RBCT terminal capacity, the additional capacity (15 mtpa) that was to be created by the Phase V expansion will not be utilised for some time.

ARM Coal is optimistic, however, that a solution will be found to satisfy all shareholders. The proposed ramp-up profile for GGV export coal over the next three years is expected to be achieved as GGV will be a very low-cost producer and has a modern rapid load-out terminal.

Mining rights status

The documentation supporting the application for the conversion of old order mining rights to new order rights has been submitted for all of XCSA's mining properties, and efforts continue to expedite approval.

There are 20 prospecting rights that have been granted. Of these, XCSA has applied for mining rights for some, and will be applying for the renewal of the remaining prospecting rights.

During F2008, the old order mining right over the GGV property was converted and notarially executed. The new order mining right in respect of the Zaaiwater property was also granted and notarially executed during this period. ARM Coal and XCSA will apply for a Section 11 transfer to incorporate both these licences into one licence in their respective names as partners in the GGV joint venture.

Capital expenditure

Capital expenditure during the year increased by 81% compared to the previous year, reaching R5.8 billion. Capital expenditure at GGV is progressing to plan for the commissioning of the Coal handling processing plant (CHPP) in the third quarter of 2009. At year end over 91% of the capital cost to build and equip the mine had been committed. Abnormally high rainfall during January and February 2009 resulted in a delay in the completion of the project. Current indications are that the project will be completed during the second half of the 2009 calendar year. The main capex items were:

	GGV: R1.96 billion.
	PCB:
	– Southstock Phase 2 underground development – R43 million;
	– Butterfly project – R117 million;
	– ATCOM East Project – R48 million;
	– ATCOM East-mineral rights – R1 831 million;
	– CHPP project at Tweefontein – R12 million; and
	– Two Seam Project at Tweefontein – R49 million.

Transitioning to low cost operations

Source: Xstrata Coal South Africa presentation 13 August 2009.

Prospects

The GGV long-term supply agreement concluded with Eskom during the year will improve the stability of cash flows from ARM Coal amid the current market volatility.

In the export market, coal's competitiveness relative to alternative fuels will continue to underpin its position as a base load fuel for power generation as economic growth recovers.

China's net import position, the commissioning of further generating units and higher demand from power generators in Korea, as well as India's growing requirement for imported coal to meet its domestic electricity needs, contribute to a positive outlook for seaborne thermal coal demand in the Pacific market. Despite high stocks in both the Pacific and Atlantic markets, the thermal coal market remains in contango, suggesting stronger pricing in 2010.

GGV is expected to be a lower-quartile cost producer on the global thermal coal cost curve. This will improve the overall structure of ARM Coal's mining from more expensive under - ground mining to cost competitive open cast mining.

We are continually evaluating our prospecting rights in the Witbank area for future opportunities. However, the future development of potential mining operations will be constrained by rail and road infrastructure.

Market review

Export market

Lower coal demand from most traditional importers, in response to the economic downturn, has been offset to some extent by a surge in demand from China and India, along with slower supply growth from exporters including Indonesia and Colombia. For the year to date, the market remains broadly balanced.

Xstrata Coal South Africa (XCSA) has secured contract price settlements with Japanese power utilities for the year commencing 1 April 2009, in the range of US$70 to US$72 per tonne FOB basis 6 322 GAR, and US$75 per tonne for the year commencing 1 July 2009. These settlements are generally used as benchmark prices for contracts with other customers in the Pacific markets, whereas term and annual contracts represented 65% of XCSA's thermal coal sales in the first half of 2009.

Approximately 60% of export sales from South Africa for the first half of 2009 were priced on a spot or indexed basis, with the balance priced under term or annual contracts. FOB prices, as indicated by the API4 index, have declined from US$80 per tonne in January to trade within a range of approximately US$55 to US$65 per tonne from March. Under an off-take agreement with Glencore, coal from Prodeco operations is sold at US$75 per tonne basis 11 300 Btu/Ib.

Export thermal coal market pricing trends for F2009 RCBT FOB (US$/t) spot prices

Domestic (Eskom) market

The Coal Supply Agreement (CSA) with Eskom for the 3.5 mtpa thermal local production has been agreed, on favourable dynamic pricing terms with compensation for superior quality. Salient details of the contract including the following:

	The CSA has a term of 17 years (one year ramp-up and four periods of four years each).
	Prices are determined based on a number of factors:
	– base price is linked to a base coal value of 21.5 MJ/kg on an air dried basis over the life of the CSA;
	– a penalty/reward scheme is set up around the base price;
	– the base price is adjusted according to an agreed annual escalation clause; and
	– each tranche has a different base price from the effective date.
	The CSA has two tranches.
	Tranche 1:
	– based on a fixed Rand price per tonne of saleable product;
	– total sales volumes of 48 mt over the 17-year term;
	– one-year ramp-up – sales volume range of 2.4 mt to 3.2 mt;
	– four periods of four years each – sales volumes of 2.6 mtpa; and
	– the base price is reviewed three months before expiration of each four-year period.
	Tranche 2:
	– initial base price fixed, but at a higher level than Tranche 1;
	– based on variable volumes over the 17-year term;
	– total sales volumes of 3.3 mt or 0.7 mtpa for the first four years from June 2010 to June 2014; and
	– renegotiable before the commencement of the following four-year period.

5 Seam coal floor at GGV

ARM Coal Operational Statistics

Participating Coal Business (PCB)

* Included in saleable production for comparison purposes.

Goedgevonden (GGV)

* Excludes capitalised interest.