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Wood Mackenzie: Rio Tinto deal to revitalise Glencore's hard coking coal production profile

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World Coal,

In the past week, Rio Tinto has announced three separate deals for a total of US$4.15 billion cash that will complete its exit from coal. This includes US$1.7 billion for the sale of interests in Hail Creek and Valeria to Glencore, the recently announced US$2.25 billion for Kestrel to Adaro Energy and EMR Capital and US$200 million for Winchester South to Whitehaven Coal.

Viktor Tanevski, a senior research analyst at Wood Mackenzie, has offered the following analysis of Rio Tinto’s divestment from coal and its significance for Glencore:

The deals add further cash to Rio Tinto's balance sheet as it continues to de-lever and re-allocate capital. The sale of Winchester South could also unlock potential coal output that would have likely been delayed under Rio Tinto's ownership given competing portfolio interests.

What do the Hail Creek and Valeria acquisitions mean for Glencore?

The announced US$1.7 billion acquisition by Glencore for Hail Creek and Valeria represents a 41% premium to our valuation for Hail Creek, assuming a zero valuation for the Valeria project. We estimate the deal was struck at an implied long-term benchmark hard coking coal price of US$146/t and a benchmark thermal coal price of US$83/t (flat real 2018 terms), which signals greater confidence in higher longer-term prices.

Glencore's metallurgical coal production is expected to rise by 67% from 2017 to 2019 to 15 Mt with Hail Creek added to its portfolio (excluding the impact of yet to be finalised transactions relating to Hunter Valley Operations and Tahmoor). The deal will revitalise Glencore's hard coking coal production profile which has declined with the closure of its Oaky No. 1 mine in 2017, the winding down of coking coal production from its NCA assets and the conclusion of the sale of Tahmoor to SIMEC.

As part of the deal, Glencore will also marginally add to its Australian thermal coal supply with Hail Creek’s high ash thermal coal product. It also offers a longer-term opportunity to develop Valeria as a replacement for its Clermont thermal coal mine which is estimated to close in 2026.

The deal will increase Glencore’s margins. We estimate a total average margin of US$64/t for its metallurgical coal post deal in 2018, and a thermal margin at US$37/t. Even though we estimate Hail Creek to lie within the fourth quartile of the seaborne metallurgical coal cost curve it attracts a very good return due to its high quality.

Hail Creek's high (25%) ash thermal coal attracts a healthy margin because it only incurs processing and re-handling costs. There are no mining costs associated with the thermal coal product, which is derived from coarse plant rejects. The value of the assets is highly sensitive to price and this represents both the main upside and downside risk for Glencore.

While the total consideration is at a premium to our valuation, the break-even price is only marginally higher than our long-term valuation price assumption. An increase of only 12% is required to bridge the consideration - valuation gap.

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