Citi Global THEME-book September 2013

Energy 2020
“The Unimaginable: Peak Coal in China” is the title of another “Must C” report from Citi’s global commodity team. This
builds on their extensive Energy 2020 shale work & well read report “Global Oil Demand Growth – The End is Nigh.”
The rapid build out of coal plants for power generation in China caused capacity to double between 2004-10 to near
700-GW. This growth was almost equivalent to the entire size of the US coal fleet ! By 2012 China’s thermal coal
demand accounted for 50% of global consumption, yet forecasts for continued strong growth look optimistic.
The team argue that downward shifts in China’s GDP & energy intensity, robust growth in renewables & strong
improvements in energy efficiency point to a possible peaking before 2020. They offer a range of scenarios.

Pollution is important & the global increase in carbon emissions by 2020 could be cut by a quarter. However this work
has significant repercussions for multiple global commodity markets & would impact coal export countries (e.g.
Mongolia, Australia, Indonesia, Russia & the US). Coal prices have fallen, but forward curves are in steep contango.
Heath Jansen & team highlight stocks exposed to coal, including Sell rated Bumi Resources & New World Resources.
For the diversified miners 21% of Glencore’s revenues are from coal, & 12% for African Rainbow Materials.
Adding to the changing mix in energy, the US DOE authorization of Lake Charles (2-Bcf/d) raises total US LNG export
capacity to 5.6-Bcf/d. Our commodities team’s initial estimate of 12-Bcf/d by 2020 may yet prove conservative

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A slowing, or peak, in coal demand adds to Citi’s metal & mining’s team Supercycle Sunset thesis. So too does
Johann Steyn & team’s recent Gold Book, which shows the top 10 gold companies have burnt $11bn in cash since
2000, despite a 4-fold increase in the gold price. Asset disposals / closures & lower gold capex are expected ahead.
With the large diversified miners being “forced into mining austerity” Heath Jansen asks if its working & concludes
that “mining rehab” will take time. The team maintain a Neutral sector view, with Rio their favoured large cap stock.
During 2005-12 Heath showed the large diversified miners saw commodity prices contribute ~24% to EVA, yet this
was whittled down to just +5.9% post costs, acquisitions, capex & net capital returns. While miners are now cutting
capex (by $19bn or 5%) & costs, EVA creation is likely to be unchanged given high grading of portfolios.

Heath expects it will take 1-2 years for miners to improve balance sheets & digest overcapacity in the current
commodity markets. While the sector has mean reverted to trade at a market yield, it screens badly on yield growth.
With mining capex cuts no longer new news, Natalia Mamaeva asks how much downside could occur if the bear case
materializes. Based on their mining capex model looking for 30% cumulative sales decline in equipment 2012-15, if
pricing fell 10%, implied group EPS downgrades would average 31% to our 2015 forecasts & 41% to consensus.
If aftermarket also declined, EPS downgrades could average 45% to our 2015 forecasts & 52% to consensus (at the
time of writing). We continue to remain cautious on mining capex names. Atlas Copco & Metso remain Sell rated.

Sofi Savvantidou & team recently suggested that the move to renewables & energy efficiency could see the
addressable market in volume for European utilities halving over the next 2 decades. In the US, Shar Pourreza
examines the impact of solar on utilities to conclude that the disruptive effects are evident & growing.
The perception of solar as being inefficient & requiring material subsidies are no longer accurate. Solar is already
cheaper than electricity at the plug in many countries (Germany, Spain, Portugal & Australia) & in several US states
(eg Georgia, Arizona & New Mexico). The US possesses some of the best solar resources in the world.
The biggest surprise in recent years has been the speed at which solar panel costs have reduced, but solar’s
technological nature means it will begin to get cheaper, vs conventional fossil fuels whose costs should rise.

“Most disruptively, not only does solar steal share of new electricity demand, it parasitically steals demand from
previously installed generation” & at the most valuable part of the demand curve. In addition the knock on effects of
this distributed generation is that fixed utility costs get spread over a lower ratepayer base, driving up costs for those
that do not participate in solar. This could then prompt others to install solar & a “death spiral” result.
Jason Channell has also highlighted the opportunity & threat of batteries to store solar power for use across the day.
The market is still in its infancy but both Germany & Japan are now subsidizing storage battery installation. In his
recent lithium-ion battery report, Tsubasa Sasaki notes Toshiba, Hitachi Chemical & top pick GS Yuasa should have
exposure to this market. GS Yuasa is also well placed in the auto battery market where Sasaki-san raises forecasts.

Since the original “Call of the Frontier” GPS publication in late 2011, strong performance & inflows have led Frontier
Market (FM) AUM to double. Maria Gratsova & Citi’s macro teams update their views & conclude that FM have
many of the characteristics that emerging markets did when they were first identified as an investable group in 1988.
In additional to strong demographics (double the EM rate), long-term catch-up & urbanisation aid growth. Consumer
markets are underpenetrated & infrastructure needs large. Surprisingly FM have higher average profitability levels
than DM. Wage gaps have opened up vs China for many FM. FDI levels are large (eg $50bn into Africa in 2012).
FM debt levels stand at ~40% of GDP vs >60% in 2000 & ~116% average today for DM. While there is scope for
institutional quality improvements, progress should help valuations. FM are underdeveloped & will equitize. Stocks
are under-covered (at 3.4 analysts on average vs EM at 14) & correlations to DM are low (42% vs EM at 75%)

Maria Gratsova publishes a separate report looking at preferred FM’s on a 6 month outlook & top stock picks.
Nigeria’s long term growth outlook is “impressive” & stock market the most liquid in FM. The market’s pullback since
June 2013 has left valuations looking attractive again. Kato Mukuru is positive on banks such as UBA & Access.
Fundamentally UAE benefits from Dubai’s strong regional hub position & its market should be buoyed by inclusion in
MSCI EM in May 2014. DP World is a preferred name from Roger Elliott, while Andrew Light has recently upgraded
Air Arabia. In Vietnam, Gaming company NagaCorp & shoe manufacturer Yue Yuen are highlighted.
Buy rated DM stocks offering FM exposure, included: SABMiller; Standard Chartered; Millicom; & Lafarge.


Acquisitions of Verizon Wireless & Nokia’s phone business boost M&A volumes & retires equity. Citi High Grade
Strategist, Jason Shoup, asks “When will the re-leveraging stop? Surely there must come a point when share
repurchases and leveraging acquisitions cease to make sense” as equities re-rate & the cost of debt rises.
However Jason notes that companies rarely buyback their stock at cheap levels, in fact the data shows they do the
opposite. Share repurchase & M&A is more about confidence. Jason concludes “there’s no reason to expect the
buyback craze to fade…it could gain momentum” & companies turn to the debt market to fund buybacks.
Confidence in DM GDP recovery has improved. In the UK Michael Saunders notes the last 3 months have seen the
biggest upgrade to consensus GDP forecasts since 2000. In Europe, 2Q GDP marked the end of a 6 quarter
recession. While risks remain, Citi’s global GDP progression for 2013-16 is forecast: 2.4%; 3.2%; 3.5%; & 3.7%

With debt financing still cheap vs equity financing, our strategy teams show de-equitisation continues to take place
(US companies alone have brought back >$1 trillion of their own shares since 2009, equivalent to 10% of average
market cap) & outperform (Rob Buckland’s global buyback screen was up 25% YTD, as of 19 Aug).
Equities have reversed the relative fund flows seen over the last 5 years, with equity inflows globally up $207bn in
1H13 vs $77bn into bond funds. Jonathan Stubbs’ “Capital Allocators are Coming” reports support this trend, while
Tobias Levkovich’s “Raging Bull” update says US equities fund flows could become a “torrent in the next few years.”
In addition to flows out of bonds, Tobias notes US household deposits have doubled in the past 10 years to nearly $9
trillion & are generating a negative real yield. Tobias highlights a “Raging Bull” basket, Rob Buckland a buyback
basket, Citi’s asset management team looked at plays on “Great Rotation” & Bill Katz upgraded TRowe Price to Buy.