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HiValue Strategies
ACCA Client Briefing No 2

Opportunity and Risk Analysis in Strategic Project Evaluation for the Australian Coal Industry
Part A Opportunities and Risks for the Australian Coal Industry Part B Strategic Project Evaluation getting it right

Bede Boyle Member of the AustCoal Consulting Alliance

Opportunity and Risk Analysis in Strategic Project Evaluation for the Australian Coal Industry
This briefing clarifies the opportunities and risks and highlights the critical success factors in Strategic Project Evaluation and is presented in two parts: Page Part A Opportunities and Risks for the Australian Coal Industry Part B Strategic Project Evaluation getting it right 3 5

About AustCoal Consulting Alliance Overview


Major mineral and energy projects have the potential to: a) Grow Value, or b) Destroy Value Strategic Project Evaluation is designed to achieve a) and avoid b).

Strong demand for thermal and metallurgical coal, particularly in Asia, and tight international supplies are expected to support growth in Australian coal exports beyond 2025. However, this growth potential can only be realised by containing FOB costs and timely provision of export infrastructure. The Australian export coal industry has strong market opportunities but also increasing exposure to significant risks associated with: Continuing strong demand abet at lower prices Infrastructure constraints compounded by rising transport costs Skilled labour shortage increasing cost of labour and services

Rising cost of materials and consumables becoming embedded costs Increased cost of capital works project delays resulting in lost revenue The greenhouse issue impacting on development consent

The cumulative impact of the above risks increase FOB costs and threaten the economic viability of major resource development projects. Unless these risks are mitigated they will ultimately impact on the economic viability of the Australian export coal industry and erode Australias competitive advantage.

Bede Boyle Convenor - AustCoal Consulting Alliance Principal - HiValue Strategies Director - Synergy Management Consulting Group Director - Pacrim Environmental Consultants

www.austcoalconsulting.com www.hivaluestrategies.com www.synergymcg.com www.pacrimenviro.com.au

3 Part A Opportunities and Risks for the Australian Coal Industry


Peter Coates, Chief Executive of Xstrata Coal (1) identified three challenges for Australian Coal: 1. Climate change 2. Cost increases 3. Infrastructure He stated that future success of Australias coal mining industry depends on: 1. Sharing responsibility for development of clean coal technology 2. Containing costs 3. Getting the infrastructure model right (1) Opportunities and Experiences from the view of an expanding multinational Peter Coates, Chief Executive Xstrata Coal McCloskey 2006 Coal Forecast Conference A.1 Continuing Strong Demand abet at Lower Prices?

Strong demand for thermal and metallurgical coal, particularly in Asia, and tight international supplies are expected to support growth in Australian coal exports to 2025 and beyond. A recent report by ABARE (2) projected that Australian coal exports would reach 394 million tonnes by 2025 representing a rise of 161 million tonnes from 2005 levels. 2005 Mt Thermal Metallurgical Total 108 125 233 Low Mt 146 210 353 2025 Reference Mt 184 210 394

High Mt 225 210 435

Having regard to thermal coal ABARE notes that While Australia is well placed to expand its market share, it could also face increasing competitive pressures in the global thermal coal market, particularly from Indonesia and China. Despite systemic problems which impede investment Indonesia has experienced dramatic export growth and overtook Australia as the worlds largest thermal coal exporter in 2005, with exports estimated at 123 million tonnes. (2) Australian Coal Exports - Outlook to 2025 and the role of infrastructure ABARE research report 06.15 October 2006 A.2 Infrastructure Constraints compounded by rising Transport Costs

ABARE (2) contends that Constraints in coal transport and handling infrastructure in New South Wales and Queensland in recent years have limited Australias capacity to respond to the largely unforseen strong growth in world coal consumption. In the longer term, the ability of Australian coal producers to maintain Australias position as a leading coal exporter and respond to the growth in global consumption is contingent on a number of factors. These include the timely and responsive development of new mines and supporting rail and port infrastructure, access to water resources and the availability of skilled resources. Demurrage has become a significant cost impost of nearly A$5/t for export companies.

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A.3 Cost Increases present a Major Risk for the Coal Industry Peter Coates (1) identified increases of 100% in diesel, 95% in royalties, 60% in explosives, 25% in contractors, 20% in roof bolts, 10% in distribution, 8% tyres and 4% in both electricity and labour impacting mining costs over a three year period. Dr Don Barnett (3) showed FOB cash costs of five listed Australian coal companies increased between 12.4% and 52.7% over three years from June 2003 to June 2006. (3) Australias Rising Costs June 2003 to June 2006 - A Case Study of Five Coal Companies Dr Don Barnett, Managing Director MINEC Pty Ltd Presented at the McCloskey 2006 Coal Forecast Conference The core risk is that these cost increases become embedded costs. A.4 Increased Cost of Capital Works and project delays resulting in lost revenue

ABARE (2) warns of the impact of increased cost of capital works. Of concern for the future competitiveness of Australias coal exports is the unanticipated rise in capital costs of coal export infrastructure projects that are currently under construction. For example, cost estimates of the port expansions at Gladstone and Dalrymple Bay have together risen by over $500 million in the past twelve months. The skills shortage has contributed somewhat to this cost inflation, resulting in increases in contractor margins, engineering fees and project management costs. A.5 Greenhouse Issue impacting on Development Consent

Peter Coates (1) stated that Emissions reductions are required and achievable CO2 capture and storage is the key technological requirement In a test case run by Greenpeace for a court order to oblige the state-planning department to consider greenhouse emissions from coal burning when it evaluates coal mining proposals, the NSW Land and Environment Court has ruled against the Director General of the NSW Department of Planning for his declaration that his Environmental Assessment for Centennials Anvil Hill mine was adequate.

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The Cumulative Effect of Above Issues impacting on Economic Viability

The cumulative effect of the above cost impacts is evidenced by the average cost increase of the five companies studied by Dr Barnett (3) being 20% over the last twelve months of his three year study. Peter Coates (1) clearly states that future success of Australias coal mining industry depends on containing costs. Unless these risks are mitigated they will ultimately impact on the economic viability of the Australian export coal industry and erode Australias competitive advantage.

5 Part B Strategic Project Evaluation Getting it Right

Major mineral and energy projects have the potential to: b) Grow Value, or b) Destroy Value Project evaluation methodologies are designed to achieve a) and avoid b) by getting it right. B.1 Strategic Project Evaluation Methodologies

Strategic project evaluation methodologies drive investment decisions, value creation and optimisation. The Feasibility Study is at the heart of strategic project evaluation methodologies. The primary purpose of the Feasibility Study is to identify the optimum project strategy from resource development to market. The Feasibility Study also provides a decision making framework for CAPEX investment, sequence and timing of development, marketing and sales. NPV analysis is used as a financial control gate for project approval and project pipeline management. However, the cumulative impact of wrong and biased assumptions can corrupt the NPV analysis and destroy value as targeted NPV values cannot be achieved in operation. Accordingly, the Feasibility Study needs to identify, evaluate and minimise technical and commercial risks as a flawed project evaluation that underestimates costs and overestimates revenue will result in value destruction. B.2 Critical Success Factors in effective Project Evaluation

The author contends that critical success factors in effective project evaluation include: 1. Adoption of a Business Risk and Opportunity Management framework to proactively engage with stakeholders to minimise the risks and maximise opportunities associated with critical project decisions. A Risk Management Maturity Tool developed by Professor Martin Loosemore is a valuable aid in helping to clarify risk and peoples attitudes to it. 2. Need for early identification of environmental and community issues at the Pre-feasibility stage as they will have significant impact on project viability. Major mining developments are increasingly attracting significant levels of social adversity which translate into cumulative cost impacts of development consent conditions and delays in project commencement. There is also the possibility of failure to secure development consent. 3. Validating and Stress Testing all assumptions which underpin the Feasibility Study: The mine plan - need for conservative estimates of production capability

CAPEX estimates - need to understand causes of cost blowouts Project development timeline - impact of resources boom on contractors OPEX estimates - need to fully understand factors that impact on mining costs - need for both short term and long term market view - timing and charges for rail and export infrastructure.

Project revenue stream Infrastructure capacity

4. Producing a Bankable Feasibility Study capable of securing equity and debt funding requires the rigorous identification, evaluation and minimisation of technical and commercial risks. The Feasibility Study will be subjected to independent due diligence analysis.

AustCoal Consulting Alliance


Strategic coal development, marketing and management consultants who add value through nine initiatives spanning the coal chain: Coal Resource evaluation and acquisition > Coal Mine development strategies > Rail > Export > Market transport infrastructure analysis and strategies developments competitiveness

1. Analysis of coal markets - demand trends and strategic sourcing issues 2. Productivity analysis and cost competitive rankings of existing and proposed mines 3. Impact of rail and port charges and coal chain throughput constraints 4. Market based profitability forecasts for coal producers, domestic and international customers 5. Mine and Infrastructure Strategic Planning and Development 6. Identification of structural and operational cost reductions and productivity improvements 7. Improving Enterprise Performance Six Sigma - Business Risk and Opportunity Management 8. Workforce recruitment, learning and development, organisational development and Enterprise Agreements 9. Strategy Deployment to the coal face

Bede Boyle BEng (NSW). AFAIM Principal - HiValue Strategies Bede is a company director, strategic consultant and mentor with over 13 years experience assisting executives in minerals and related industries including BHP, Bayswater No 2 Colliery, Cumnock No 1 Colliery, Fluor Australia, FreightCorp, General Motors - Holden Engine Operations, Leighton Constructions, Newcastle Port Corporation, NSW Coal Compensation Board, NSW DPI Mineral Resources, Port Waratah Coal Services, Powercoal, South Blackwater Collieries, State Rail and Xstrata Coal. Prior to establishing his minerals industry consulting practice in 1993 Bede was Manager Technical Services with Coal and Allied. He fulfilled leadership roles as Project Leader for Liddell Colliery Longwall Project and Project Coordinator for the planning and development of Hunter Valley No 1 Mine, Strategic Planning and Feasibility Studies.

Bede Boyle is convenor of AustCoal Consulting Alliance and Principal, HiValue Strategies with thirty years experience in acquisition of coal resources, strategic planning and development of coal mines, coal handling facilities, rail and port operations, aligned with high level government resource development policies. Dr Don Barnett, Managing Director MINEC Pty Ltd is internationally recognised as the leading analyst of the Australian Coal Industry. He provides Mine Competitive Analysis, Economic Evaluation and Strategic Advice on International and Domestic markets.

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Bob Hurley has thirty years direct experience in thermal and coking coal marketing in Asia for major Australian companies. He provides Strategic Advice on Coal Marketing and Procurement to Australian and International clients. Harry Bowman, former Chief Executive Officer of the NSW Coal Compensation Board has a unique understanding of coal geology of NSW and the economics of the NSW export and domestic coal industry. Wayne Perry, Managing Director of Pacrim Environmental Pty Ltd manages EIS and development consent processes, Environmental Management Systems, Environmental Audits and Due Diligence Studies for major coal companies. Bob Purser established Purser Corporate Communication Pty Ltd in 1984 as a public relations consultancy, which has worked on Project Advocacy and strategic communication campaigns for major coal mining and related projects. Greg Clarke, Director ABM Systems focuses on improving enterprise performance using global leading technologies such as proDacapo, QlikView and Cartesis to support - Balanced Scorecard - Activity Based Costing Business Intelligence Web Based Budgeting Financial Consolidation Process Improvement. Jim Laird is Managing Director of Synergy Management Consulting Group which focuses on Strategy Deployment, Business Excellence Six Sigma, Business Risk and Opportunity Management to realise business benefits. Michael McLean, Regional Director (Asia) WD Scott specialises in Strategy Development and Implementation, Cost Reduction and Operational Performance Improvement to optimise Return on Invested Capital. Michael Minns established his Human Resources consultancy in 1983 and specialises in recruitment, Enterprise Agreements, organisational development, learning and development to develop a productive workplace culture. Greg Mattila is a professional mining engineer and former BHP mine manager with over thirty five years pragmatic experience in coal mine and infrastructure planning and development, operational and project management, feasibility studies and business analysis, and due diligence studies. Ross Broadbent is an Engineering Design and Project Management Consultant with an unequalled depth of experience in design, construction and engineering management for mine, rail and port infrastructure developments. Ross was Engineering and Project Manager with Port Waratah Coal Services.

Bede Boyle +61 (0) 419 213 010 boyle.bede@bigpond.com www.austcoalconsulting.com

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