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Annual Report and Accounts 2011 / Strategy / Strategic context in which NWR operates 

Strategic context in which NWR operates

Our strategy and success is influenced by the economic factors which are faced by our customers as well as by the actions of our competitors. These impacts cover three main areas:

  • Economic environment (global and regional) NWR’s thermal, coking coal and coke products serve industrial consumers in the countries of the CEE region. The demand for, and pricing of, those products is influenced by the economic environment in each of these regions, notably the demand for steel, as well as by the international coal markets which influence coal prices.
  • Competitive environment Although NWR is the only hard coal producer in the Czech Republic, and the first to be privatised in the CEE region, we compete with other companies (predominantly in Poland) to supply coking and thermal coal to the regional market. As a coke merchant, we produce and sell coke to a range of steel producers - some of which also have the capacity to produce their own coke.
  • Cross-border trade The financial returns generated by our business are also influenced by currency fluctuations driven by exchange rate dynamics.

Global economyStrategic context in which NWR operates

The return to positive growth following the financial crisis of 2009 was stimulated by unprecedented fiscal and monetary intervention by governments around the world, particularly in Europe and the USA where the recession was most severe. The resulting rebound in confidence saw a fragile recovery in global trade and manufacturing, which continued throughout 2010 and into the first half of 2011. This recovery, however, was marked by the continued divergence of economic performance between developed and emerging countries with most OECD countries recording small growth rates in contrast to the near double-digit growth of some developing economies, particularly China.

A largely negative or uncertain outlook in the OECD countries was reflected in weak financial markets, and the performance of the real economy during the autumn of 2011 further dampened earlier signs of recovery. Consumer and business confidence around the world again deteriorated as doubts about the future direction of world markets took hold.

Strategic context in which NWR operatesCentral and Eastern European regional economy

As one of the region’s primary coal suppliers to steel industries and power generators, NWR’s business is dependent upon the strength of the CEE regional economy, which is itself linked to global economic activity. Imbalances in the world economy over the past number of years were mirrored by the diverging nature of economic performance and management between Europe’s regions. The recovery from recession in the EU was driven primarily by the core economies and particularly the strength of Germany’s exports growth.

However, the Eurozone’s periphery countries struggled to manage their escalating public debt issues with their difficulties compounded by growing pressure from the bond markets as their cost of borrowing rose to historical highs. Under these increasing strains Europe’s political leaders were compelled to mount a coordinated response to prevent the continent from falling back into recession. Whilst being undoubtedly affected, the countries within the CEE region have so far maintained a relatively strong fiscal position. The Czech economy recorded positive growth throughout 2011 and Poland, which was the only country in Europe to avoid recession in 2009, continued to outperform its neighbours. Domestic economies within the CEE region, especially in Poland, also maintained relatively healthy demand during the year since sustained infrastructure spending is required to bring the region up to western European standards. The banking sector in Poland and the Czech Republic is considered stronger than most in Europe and the governments’ fiscal positions are relatively stable.

International coal markets

Coking coalStrategic context in which NWR operates

Europe has a substantial shortage of coal and relies on imports for the vast majority of its consumption. The CEE region is an importer of coal in circumstances where domestic demand cannot be met by domestic supply alone. NWR serves mostly global customers, which link our regional markets to the dynamics of the international coal markets to some, albeit limited, degree.

2011 saw the continuing dominance of China, and to a lesser extent India, in the internationally traded coal markets as the rapid industrialisation and development of these countries continued to require vast amounts of raw materials (reference: Figure 4). China, for instance, now produces almost half of the world’s steel output and since becoming a net importer of coking coal in 2004, has been putting ever more pressure on the supply and price of coking coal.

Severe flooding at the end of 2010 in the Australian state of Queensland, where approximately 46 per cent of the world’s internationally traded coking coal originates, further disrupted supply in 2011. Along with the revival of steel production in the rest of the world, which benefited from strong demand from the recovering automotive sector, coking coal spot prices peaked back towards record highs during the year, trading at USD 340/tonne in the first quarter.

The deteriorating macroeconomic conditions in the second half of 2011 led prices back down from peak levels but there is a general consensus that international coking coal prices will remain resilient in the long term, given the underlying demand from developing Asian countries, and limited availability of coking coal supplies given infrastructure constraints in the short-term.

Strategic context in which NWR operatesThese changing dynamics within the international markets over recent years renewed the large mining companies’ justification for moving to quarterly contracts for their coking coal supply to the steel producers. A more liquid market now means the vast majority of contracts are settled on a quarter-by-quarter basis with increasing quantities also being sold on a monthly basis and on the spot market (reference: Figure 3).

Thermal coal

Unlike coking coal, thermal coal contracts usually cover a calender year period and as a result the market is more stable. The emergence of strong Indian demand growth in 2011 positively impacted international trade patterns overall. The trade flows from Australia to Japan and Korea also recovered during the year following the Japanese earthquake and subsequent move away from nuclear generation.

High growth markets such as India, along with renewed investment in electricity plants in developed countries including Germany and Poland, will ensure that coal will remain an important fuel source for the world’s electricity supply.

Regional coal markets

Coking coalStrategic context in which NWR operates

The market for coking coal in the CEE region will always be driven by steel production in the area. A relatively strong rebound by the regional steel producers at the beginning of the year was followed by growing uncertainty about the future direction of steel demand given the macroeconomic outlook. The steel output in our region, including the Czech Republic, Germany, Poland, Slovakia and Austria, increased by 2.3 per cent in 2011 compared to 2010 (reference: Figure 5).

Germany’s strong industrial performance during the year demonstrated the importance of quality export-driven manufacturing (reference: Figure 6). The Czech Republic has been one of the best-performing markets this year. Car production in the Czech Republic, for instance, grew by 12 per cent compared to 2010 whilst steel consumption per capita increased towards the levels of more developed economies. Construction activity in the region grew and in particular Poland’s ambitious infrastructure expenditure continued for much of 2011.

The demand and price for coking coal in the region reflected these steel dynamics during the year. Prices in the region are progressively being influenced by the international seaborne price but will continue to be somewhat insulated due to the long distance to major sea ports as well as local infrastructure constraints.

Thermal coal

For thermal coal, prices and demand remained stable in the CEE during the year since there has been little shift in the source of electricity and heat production. Germany’s decision to gradually close all its nuclear power plants in response to the Japanese crisis has further enhanced the share of coal in the energy mix in the region as the country looks to import more electricity from neighbouring countries. As shown in the following charts, Poland’s electricity demand is similarly expected to rely heavily on coal with over 90 per cent of its electricity coming from this source.

Strategic context in which NWR operatesCoke markets

Like coking coal, coke reflects the performance of the steel industry. The market in Europe is further characterised by the supply and demand balance between the merchant and integrated producers with the merchant coke makers subject to volatile swings in demand and prices as the market quickly moves in response to the business cycle. There is also a distinction between the two types of coke produced. Blast furnace coke is used in blast furnaces where pig iron is produced from iron ore. Foundry coke on the other hand is used mainly in larger furnaces where cast iron is produced as well as basalt-based insulation material from iron, scrap and other metallic components. There is generally a tighter market in Europe for foundry coke, which means it therefore commands a higher price than blast furnace coke.

Figure 9 shows that prices for both blast furnace coke and foundry coke started the year at historically high levels, which began to fall later in the year. This is seen more prominently in relation to blast furnace coke as steel producers relied to a greater extent upon supply from their own coke production facilities rather than on supplies from the merchant coke producers.

Competitive environment

NWR is the only hard coal producer in the Czech Republic and competes with hard coal producers in Poland to serve customers across the region. The Group is the second biggest producer of coking coal in the region overall and the fourth biggest thermal coal producer. It was also the first coal mining company in the CEE region to be made public with further Polish mining companies becoming public in subsequent years now promoting a more transparent and competitive environment.Strategic context in which NWR operates

These coal producers supply a well- -established steel industry in the region, which in turn supplies the manufacturing and construction industries. The long-term viability of manufacturing in the CEE region is very much dependent on this reliable supply of good quality coal to the steel industry. The high quality of steel manufacturing is reflected in the fact that steel operations in the CEE region remain amongst the most competitive in Europe and have received significant investments in recent years. They are usually considered last when the multinational steel companies are looking to cut back production.

Production of coal in the region has consistently fallen over the last decade as reserve depletion has led to deeper mines and ever more complex mining conditions. In addition, continued demand for coal-fired power generation and a strong automotive industry, utilising locally sourced steel, supports the dynamics of thermal coal, coking coal as well as coke. On the supply side, our competitive position is supported by structural underinvestment in the regional coal industry in general together with supply constraints upon imported coal products.

Since the Group’s stock exchange listings, NWR has invested heavily in modern mining techniques to access reserves safely and has maintained a strong competitive position within the region.

Strategic context in which NWR operatesOutlook

Continuing uncertainty amongst global financial markets prevails and overall economic indicators reflect sustained risk aversion in many areas of the real economy. Confidence in financial systems remains fragile due to the sovereign debt crisis.

The risks associated with a continuation of the sovereign debt crisis, recession pressures and a demand slowdown will drive mainstream investor confidence, particularly in the context of continued speculation about a challenge to the Euro.

The EU’s instability, however, masks a strong outlook for the countries in emerging Europe of which many are core to NWR. Long-term investment by the automotive sector and steel companies in the region, together with steel production forecast to grow by 2.52 per cent next year, provides a resilience to NWR’s markets and price outlook.

The 2012 growth forecasts for Poland and the Czech Republic partially mitigate the economic contagion associated with some countries in the Eurozone. Volatility in markets is likely to be a feature of 2012 but the opportunities which this may present for investors in more stable industries should be positive.