Commodity Market Outlook, 2013-14 – Implications for Canada’s Transportation Sector

Patricia M. Mohr

Vice-President, Economics & Commodity Market Specialist, Scotiabank

Economic Trends and Trade Patterns CILTNA’s 12th Annual Transportation Outlook Conference

Fairmont, The Queen Elizabeth Montreal, Québec

May 7, 2013

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Scotiabank’s Commodity Price Index – Rebounds Modestly in 2013:Q1, but remains 15.7% below Near-Term Peak in April 2011

Scotiabank Commodity Price Index1

Index: Jan 2007=100

All Items1

October 2001 Bottom

New record high in July 2008

Arab Oil Embargo

1. A trade-weighted U.S. dollar-based index of principal Canadian commodity exports, including Metals & Minerals, Oil & Gas, Forest Products and Agricultural commodities. – Shaded areas represent U.S. recession periods. Data to March 2013.

Decline From April 2011 Near-Term Peak -15.7%,

March 2013 +1.6% m/m

-46% in 2008: July to Dec.

Scotiabank’s Commodity Price Index rose to a near-term peak in April 2011 – just prior to financial market concern over excessive Eurozone sovereign debt and the negative impact on global economic growth. The subsequent correction in commodity prices from April 2011 to December 2012 at 19.9% was less than half the slide during the 2008 recession. The All Items Index edged up in 2013:Q1 from the average in 2012:Q4, though market conditions remain skittish and prices moved lower again in April, with a mid-month correction in gold & base metal prices.

April 2011

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After losing significant ground in late 2012, Scotiabank’s Commodity Price Index started 2013 on a stronger note, rising 3.8% m/m in January. ‘Riskier’ assets such as commodities and equities were buoyed by the 2012:Q4 pick-up in China’s economy – with GDP accelerating to 7.9% from 7.4% in Q3, accompanied by raw material re-stocking -- a partial resolution of the U.S. ‘fiscal cliff’ (extension of the Bush-era tax cuts – excepting the payroll tax reduction – and stepped-up taxes on high-income earners) and expectations of some pick-up in the U.S. economy by 2013:second half. However, the Scotiabank Commodity Price Index inched down again by 0.9% m/m in February alongside another bout of ‘risk aversion’ linked to financial developments in Cyprus and mixed economic indicators from China. Traders were disappointed that physical copper demand failed to pick up in China after the mid-month Lunar New Year holiday. China’s State Council – concerned over escalating residential property prices – up 20% yr/yr in Beijing, 14% in Guangzhou, 12% in Shenzhen and 12% in Shanghai – announced a five-point plan to contain prices, including a 20% capital gains tax on housing sales. However, many of the measures were already in place and the plan calls for increasing land supply and speeding up home construction. Another ambitious target was set for affordable, ‘socially assisted’ housing starts for 2013 at 6.3 million units, after an extraordinary 7.2 million in 2012. Residential construction has an important impact on China’s demand for steel rebar and metals.

Commodity Prices Start 2013 on Positive Note, But Markets Remain Skittish

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The Scotiabank Commodity Price Index picked up again in March 2013 (+1.6% m/m), as a further surge in Lumber and OSB prices (a panelboard used in U.S. residential construction) and slightly firmer natural gas prices more than offset weaker base metal, precious metal and iron ore prices. Over the next two years, lumber, OSB and other panelboard prices are expected to climb irregularly higher and represent one of the most lucrative of the commodity market sectors. World economic growth should strengthen moderately by 2014. However, prices for a number of key base metals – copper and nickel – are likely to ease, as new mine development gradually comes on stream, based on capital spending commitments made some time ago. Zinc should outperform mid-decade alongside significant mine depletion. International potash shipments are also expected to rebound this year. The global mining industry appears to be entering a period of more cautious and disciplined capital spending to boost returns for shareholders. Some new mine development has been deferred – this development combined with ongoing demand growth in China and ‘emerging Asia’ will set the stage for a return of the ‘Bull Run’ in the second half of the decade. M&A activity in mining may heat up, as companies divest non-core holdings to focus on better cost and financial performance for shareholders.

Bull-Run in Commodity Prices Expected to Return in Second Half of the Decade

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65Values over 50 indicate expansion

Source: Markit, Scotiabank Economics. Data to April 2013.

Global Purchasing Manager Indices (PMIs) lost considerable momentum last summer, reflecting declining business ‘confidence’ worldwide, with buyers deferring orders and liquidating inventories. The PMI for manufacturing in China moved back over the 50 mark in October – indicating an end to inventory reduction and moderately stronger growth in 2012:Q4. China’s GDP growth picked up to 7.9% yr/yr in 2012:Q4 from 7.4% in Q3, yielding a ‘soft-landing’ of 7.8% for 2012 as a whole. However, China’s economy lost momentum again in 2013:Q1, with GDP decelerating to 7.7% yr/yr. In 2013, commodity prices should receive a modest lift from re-stocking of raw materials, after liquidation or deferred orders in 2012 – though sentiment remains skittish.

Global Purchasing Manager Indices Lost Momentum Last Summer, But Have Rebounded in China

Germany

Euro zone

U.S. China

China Official PMI in March: 50.9 PMI slowed again in April to 50.6

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China Industrial Production:

Jan-Feb 2009 3.8% yr/yr (a bottom) Mar 2009 8.3% July 2009 10.8% Dec 2009 18.5%

2010 14.4% China tightens monetary policy.

2011 13.7%

Q1 2012 11.9% Q2 2012 9.5% Q3 2012 9.1% Q4 2012 10.0%

Jan/Feb 2013 9.9% March 8.9%

G7 Industrial Production) U.S. +3.5% (Mar) Japan -6.1% (Mar) Germany -1.7% (Feb)

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China -- Vital to Global Commodity Markets

yr/yr % change China – Industrial

Production*

G7 Industrial Production

China’s Share of Global Consumption in 2012 Compared with the United States

(in brackets) Copper 41.6%

(9.0%) Nickel* 44.2%

(8.1%)

Zinc 43.8% (8.4%)

Aluminium 45.2% (11.1%)

*3 mth moving avg.

Four Base Metals: China 44.1%, USA 10.1%. *Japan 10.2%; excluding inventory accumulation in China Source: Scotiabank Commodity Price Index.

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World China UnitedStates

Japan Euro Zone

201020112012e

yr/yr % change 2008 2009 2010 2012e 2013f 2014f

WORLD* 2.8 -0.6 5.2 3.1 3.1 3.8

MEXICO 1.2 -6.2 5.5 3.9 3.4 3.9

CANADA 0.5 -2.5 3.2 1.8 1.5 2.3

UNITED

STATES 0.0 -2.6 3.0 2.2 2.1 2.7

CHINA 9.6 9.2 10.4 7.8 8.0 8.3

INDIA 5.2 7.7 9.0 5.0 6.0 6.5

BRAZIL 5.1 -0.2 7.5 0.9 3.0 3.5

JAPAN -1.1 -5.5 4.5 2.0 1.0 1.5

EURO ZONE 0.5 -4.1 1.8 -0.6 -0.5 0.9

GDP (% per annum)

*Scotiabank estimates. Average 1988-1997: 3.4% p.a. prior to the “economic take-off” in China and India.

Global Growth Should Strengthen in 2014, After Staying in the Slow Lane in 2013

In 2014, world growth should strengthen to 3.8% – moderately supportive of stronger commodity prices. U.S. GDP 2.7%, China 8.3%. U.S. Federal Gov’t Deficit: FY2012 US$1.089 tr; 2013F US$930 bn.

A ‘seismic’ shift in global growth has occurred from the G7 to ‘emerging

markets’ (especially in Asia).

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ONCE IN A DECADE CHANGE IN LEADERSHIP IN CHINA – As Important To The Global Growth Outlook

As The U.S. Presidential Election November 8-15, 2012 – date of the 18th National Congress of the Communist Party of China, where a new leadership was established for only the fifth time since Mao Zedong – followed by the National People’s Congress (parliament) in March 2013. A large number of officials have changed. New Fifth Generation Leadership: President (Head of State and Secretary-General of the Communist Party of China): Mr. Xi Jinping; previously Mr. Hu Jintao Prime Minister (Head of Government): Mr. Li Keqiang, previously Mr. Wen Jiabao.

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China – Policy Continuity Expected Under New Leadership China is expected to continue pursuing the economic initiatives in the 12th Five-Year Plan, unveiled in March 2011, though the new leadership is expected to seek more market-related solutions (less central planning), be more ‘populist’ and emphasize government over party interests. Mr. Jinping pursues the national “dream”. The 12th Five Year Plan (2011-15) seeks more ‘balanced’ economic growth – with less emphasis on export expansion & investment and greater focus on domestic consumer spending, development of the ‘service’ industries including the financial sector and ‘New Economy’ growth; other key objectives -- productivity gains through ‘economic restructuring’ – e.g. closure of smaller, less efficient plant & rationalization into larger, lower-cost entities (the steel & iron ore industries); reducing industrial energy intensity; a focus on developing the Western & Central parts of China, away from the heavily industrialized Eastern & Coastal areas, as initiated by President Hu Jintao; raising household incomes & living standards and building an environment-friendly society. In practice, progress on ‘rebalancing’ China’s economy towards domestically-led growth (e.g. via consumer spending) was not significant in 2012. Retail sales slowed to 14.3% in 2012 from 17.1% in 2011. What is evident is that China is no longer pursuing ‘economic growth at any cost’. A subtle shift is underway, with China comfortable with a slower, more ‘market-determined’ advance (official target was 7.5% for 2012 and is 7.5% for 2013).

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Infrastructure Spending Program Announced Last September To Spur Growth

However, noticeably weaker economic indicators in China in August 2012 triggered a RMB1 trillion (US$160 bn) infrastructure spending program – approved by the National Development and Reform Commission (NDRC) – 60 infrastructure projects including 25 urban rail transit projects in 19 cities (subway systems), 13 road construction projects, 10 civil projects and 7 port & navigation channel projects. Will boost GDP by 2% (0.5% p.a. over four years). The stimulus package was about ¼ of the massive RMB4 trillion announced in November 2008 in the face of the ‘Great Recession”. In addition, local governments have increased the pace of ‘land supply’ to support residential construction. After reducing inventories of raw materials and consumer goods last summer and early Fall, China’s economy picked up moderately in late 2012, bolstered by stronger infrastructure spending as well as consumer incentives to buy power or fuel-efficient household appliances and small cars. Home sales have picked up again and ‘floor space under construction’ rose 15.4% in October, with residential construction up 10.6%. Rising confidence in the new ‘leadership’ is likely to boost business investment and consumer spending as 2013 unfolds.

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Medium-Term, The ‘Emerging’ Markets Will Remain Supportive for Commodity Prices

China United States Western Europe Japan India

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Vehicle Penetration – 2011 (Vehicles per 1,000 people)

Aluminium usage in automobiles in China has recently been an average of 127.5kg per vehicle compared with 145kg in the USA. As such, there is good potential to increase aluminium usage in China.

Huge Potential for Oil & Metal-Intensive Motor Vehicle Sales in China China’s population: 1.354 billion

China’s potential GDP growth is slowing -- in 2012: 8.5%, 2015-20: 7.0%p.a., 2025-30: 5% p.a. with less under-utilized labour and slower capital formation.

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Federal Funds – Effective Rates

per cent

Federal Funds Target Rate is 0-25 bps in May 2013. Very low funds rate will be warranted until U.S. unemployment rate falls below 6.5% (currently at 7.5%). Scotia Economics does not expect an exit in 2013 from Fed asset purchases of US$85 bn per month, though an end to MBS and some scale-back in Treasury purchases is likely in 2014.

The Fed Is Determined to Strengthen U.S. Employment Recovery – Signals Accommodative Monetary Policy Until Unemployment Falls to Normal

“Real” Federal Funds Rate (Adjusted for Inflation)*

per cent

* Inflation-adjusted with the U.S. Personal Consumption Deflator (PCE) and the core PCE. Shaded areas represent U.S. recession periods. Fed intends to keep inflation expectations 1-2 years ahead anchored at 2.5%.

Average

March 2013 = -0.80% Average = 1.99%

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15U.S. Industrial Activity Revives yr/yr % change

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U.S. Industrial Production

U.S. Motor Vehicle Assemblies

U.S. Payrolls

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Latest Data: Advance in Payrolls

April/13

Gain in Past Year

yr/yr % change

North American motor vehicle assemblies strengthened to 15.8 million units in 2012 (+17%) and are forecast to climb to 16.5 million in 2013 (+4.4%) and 17 million in 2014 (highest since the 17.6 million peak of 2000). Output in Mexico reached a record 3.1 million in 2012, lifted by Mexico’s free trade agreements with Japan, the EU and the USA.

U.S. employment recovery has been 5-times

less than normal.

+165,000

+2,077,000

Strong Auto Assemblies Buoy U.S. Industrial Activity In 2012-13,

But Employment Gains Have Been Sub-Par

U.S. Consumers

Replace Aging Fleet,

Japanese Assemblers re-stock in Early 2012

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Currency Trends

March 1973=100

Canadian Dollar

U.S. Dollar Trade-Weighted

Data to May 6, 2013: euro US$1.3057; Cdn$= US$0.9911; US$ = 6.1666 Rmb. Expected stronger US dollar against Sterling and euro in 2013.

US cents

euro

Chinese Yuan

US cents

euro: peak US$1.60 July 15, 2008

U.S. Dollar Trends

Canadian Dollar Loses Ground

Canadian dollar has slipped below par to U.S. currency

alongside a somewhat stronger U.S. dollar and a

weaker trade performance; Canada’s triple-A credit

rating remains supportive

US cents

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500Lumber – ‘A Star’ is Born

US$ per mfbm

Lumber prices have recently approached the peak of US$460 on August 27, 2004 during the U.S. housing ‘boom’ of 2004-05. Lumber price forecast: 2012 US$299; 2013 at least US$375; 2014 US$400. The equivalent of 140 sawmills were closed from 2006-12 in USA & Canada.

Western Spruce-Pine-Fir 2x4 Lumber,

B.C. Interior (bellwether for North

America) 0.0

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2.5U.S. Housing Starts

million units annualized

Shaded area denotes U.S. recession period. Large overhang of homes for sale is largely gone, with U.S. housing starts expected to post a multiple- year recovery. At the same time, Chinese demand is growing for Western Canadian lumber.

U.S. Housing Starts

Data to March 2013.

Extraordinary Price Recovery in Lumber & OSB, As a Modest Improvement in U.S. Housing Starts Hits a ‘Wall’ of Limited Supplies

U.S. Existing Homes For Sale (months' supply) 2004: 4.3 2005: 4.5 2013 March: 4.7

May 2, 2013

US$345 (Temporary Seasonal

Dip)

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2,000US$ per ounce

Gold Prices London PM Fix

Jan. 21, 1980 peak US$850

March 17, 2008 US$1,032.70,

following collapse of Bear Stearns *

London PM Fix on May 3, 2013: US$1,469.25.

+ New Record:

Sept 9, 2011 spot US$1,921.15

2007 697 2008 872 2009 973 2010 1,225 2012 1,672 2013F 1,480-1,520 2014F 1,350

Price Outlook (US$)

Gold prices have been on a ‘Bull Run’ since 2001 – with high government debt and deficits triggering a loss of investor confidence in paper currencies (the two reserve currencies – the U.S. dollar and euro). Gold prices drifted lower through most of 2012, with traders awaiting QE3. However, announcement of a third round of quantitative easing by the Fed (QE3), combined with the ECB’s proposed bond purchase program, propelled gold back to a high of US$1,791.75 on October 4 in London. Gold has languished again in early 2013 due to 1) a shift of investor interest from gold to equities in anticipation of a moderate pick-up in the U.S. economy in 2013:H2; 2) the unlikelihood that the Fed will need to apply even more ‘quantitative easing’ to kick-start the U.S. economy; 3) a tax by India on gold imports; and 4) the failure of Basel III to include gold in the LCR for banks. While the Fed will maintain its ‘asset purchase’ program until the end of 2013, the mere discussion of when it will be withdrawn unnerved the gold market .

Gold Prices Lose Momentum

The recent disconnect between historically high gold prices and low equity valuations may reflect rapid operating and capital cost escalation in recent years, linked to declining ore grades and fewer super-giant discoveries than in the 1980s and 1990s. Technical innovation is needed to cut exploration, mining & processing costs.

Potential Cyprus sale of 10t of gold, triggers sharp selloff in mid-April.

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Copper Prices Begin To Ease Alongside ‘Brownfield’ Mine Expansion

US$ per pound New Record High: US$4.60 on February 14, 2011

LME cash settlement prices. + Latest data: May 3, 2013: US$3.23, still yielding a lucrative 34% profit margin over average world breakeven costs including depreciation, interest & indirect costs. ++ Dec. 24, 2008: US$1.26.

*

Low During Credit Squeeze (Dec. 24, 2008)

Price Outlook 2009 US$2.34 2010 US$3.42 2011 US$4.00 2012 US$3.61 2013F US$3.40 2014F US$3.20

++

Extraordinary recovery in copper prices in early 2009 reflected buying by China’s State Reserve Bureau, massive credit expansion and a rapid rebound in China’s industrial activity. The strength of copper prices in the past five years has reflected only limited global mine development -- up 1.7% per annum from 2008-2012 -- in the face of strong demand growth from China and the rest of the ‘emerging’ world. China’s refined copper consumption: 2009 2010 2011 2012 2013F 2014F +25% +10.8% +8.5% +5.0% +8.5% +6.0% End-use indicators for copper (air conditioners, power cable, interconnect markets) point to stronger demand ahead in China in 2013.

LME Copper Prices

Global supply & demand conditions for copper were in ‘deficit’ in 2011, but are gradually shifting into modest ‘surplus’ +

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LME Copper Prices Likely To Ease Over the Next Several Years LME copper prices are currently US$3.23 per pound – yielding a 34% profit margin over average world break-even costs including depreciation, interest, indirect & cash costs. World demand for refined copper was largely flat in 2012, as higher consumption in China (up 5%), the Middle East including Turkey (up 6.2%) and the United States (up 1%), just offset an 8.5% plunge in Western Europe and surprisingly weak demand in South Korea, Malaysia and Taiwan. At the same time, while mine expansion failed to meet expectations, given technical problems and lower ore grades at a number of major mines – especially in Chile (Collahuasi, Los Bronces), Zambia and Indonesia (Grasberg) – overall mine output still managed to increase by 3.9%. The net result, copper appears to have slipped into a modest ‘surplus’ in 2012. Global consumption should pick up again in 2014 & 2015 (+5% per annum). However, world mine production will finally increase more substantially by the second half of 2013 and in 2014 (+8%), pushing down copper prices. ‘Brownfield’ expansion at existing mines in Chile, Peru, Zambia and the DR Congo will rev up and a number of major ‘greenfield’ projects will come on stream (e.g. Oyu Tolgoi in Mongolia, Antapaccay, Toromocho & La Bambas in Peru, Mt Milligan in Canada, Caserones in Chile and Boleo SxEw in Mexico). Copper prices are likely to ease below the US$3 mark by 2015. Later in the decade, copper prices are expected to rebound again to US$3.50, given high capital costs for new mine development.

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Zinc – The Next Big Base Metal ‘Play’

US$ per pound

LME official cash settlement prices. May 3, 2013: US$0.83; Stronger U.S. auto sector is boosting demand for galvanized sheet.

Zinc demand will be boosted mid-decade by a recovery in G7 construction activity

Credit Crisis Late 2008

Global supply & demand conditions for refined zinc shifted into a surprising ‘deficit’ in 2012, as Chinese producers temporarily shut down smelters in view of low treatment charges on domestic and imported ‘concentrates’, poor profitability and tight credit from Chinese banks. China’s smelters reduced output by an unprecedented 5.4% to 4.8 mt in 2012, shifting the global zinc ‘concentrate’ market into a moderate ‘surplus’. On a more positive note, the supply & demand balance for both smelted/refined metal and ‘concentrates’ will likely be in ‘deficit’ by mid-decade due to significant mine depletion and inadequate zinc mine development. The following mines will deplete in the 2013-16 period: Brunswick & Perseverance in Canada, Century in Australia, El Mochi in Honduras and Vedanta’s Lisheen mine in Ireland. In the second half of the decade, zinc demand will be boosted by a recovery in G7 construction activity. Residential construction was exceptionally weak in the United States, following the 2008 ‘Great Recession’, but is starting a multiple-year recovery.

Zinc Price Outlook 2009 US$0.75 2010 US$0.98 2012 US$0.88 2013F US$0.92 2014F US$1.10

Zinc prices could climb as high as US$1.50 in 2016-17 LME Zinc Prices

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Nunavut/Labrador Trough New World-Class Iron Ore Region

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Spot Iron Ore Prices Delivered To China, Important for Labrador Trough & Nunavut

• March 2013: US$139.87 per tonne; April US$137.40.

• Current iron ore prices are profitable, but slightly below a year ago and well below the extraordinary peak of US$187 per tonne in early 2011.

•

US dollars per tonne

Iron Ore Concentrates, 62% Fe, basis Qingdao & Tianjin, China*

Representative of spot prices from Labrador/Northern Quebec to China.

Spot prices for iron ore delivered to northern China rebounded from a low of only US$87 per tonne in early September 2012 to a high of US$158.90 in early February 2013, before edging down again to US$137 in April. The rally in prices reflects a pick-up in China’s economy in 2012:Q4, with steel producers revving up their output and re-stocking iron ore, after last summer’s correction. Stocks at 30 Chinese ports = 68 mt now, down from 75 mt in early 2013 and a peak of 101 mt in 2012. While profit margins at steel mills are reportedly weak, actual steel output in China was quite strong in 2013:Q1 (+10% yr/yr) (contrary to reports).

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Iron Ore Benchmark Prices More Competitive Market Conditions

Ahead

•dmtu = dry metric tonne unit. •Producers will be challenged to compete with Western Australian iron ore with cash costs of only US$40-60 per tonne and ocean shipping costs of US$7.60 to Beilun, China. Higher-cost Chinese mines will close, making room for capacity expansion in Australia, Brazil, West Africa & Canada.

Pilbara Blend/Newman Fines, Australia to Japan, China & North Asia

US cents per dmtu FOB loading port Fiscal Years

forecast

The quarterly contract price for Pilbara Blend/Mt. Newman fines (FOB loading port in Western Australia) – the key international benchmark – was settled at about 215 US cents per dmtu in FY2013:Q1. Prices remain quite profitable for Rio Tinto and BHP Billiton in the Pilbara region, yielding a 67% margin over cash costs at the port. However, the pace of China’s steel production growth will likely slow in 2014-16, cutting the growth rate in world iron ore demand to 3.7% per annum. At the same time, large new and very low-cost supplies will be developed in Western Australia, with world supplies increasing by 8.4% per annum. The net result, market conditions will shift into ‘balance’ by 2014-15, with a risk of ‘surplus’ in 2016. In view of expected lower prices mid-decade and given the correction in China’s iron ore imports last summer, companies are now examining project development more critically, with some mines deferred and operations reconfigured to cut costs.

JFY 2009 97 2010 210 2011 265 2012 197 2013F 188 2014F 180 2016F 145

‘Great Recession’

Annual Averages

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2012 2020 Change Mt % of World Mt % of World Mt % of World

Australia 527 25.8% 900 29.6 373 3.8% Brazil 421 20.1% 750 24.7 329 4.6% China 362 17.7% 225 7.4 -137 -10.3% India 181 8.9% 240 7.9 59 -1.0% Russia 106 5.2% 128 4.2 22 -1.0% Ukraine 81 4.0% 86 2.8 5 -1.2% South Africa 65 3.2% 85 2.8 20 -0.4% USA 50 2.4% 58 1.9 8 -0.5% CANADA 40 2.0% 118 3.9 78 1.9% Iran 31 1.5% 32 1.1 1.0 -0.4% WORLD 2044 3042 998 nm Guinea 2 nm 105 3.5 103 3.5% Sierra Leone 8 0.4% 50 1.6 42 1.2%

Potential Supply of Iron Ore

Top Ten Countries

Wet saleable metric tonnes

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1,000Potash Prices

US$ per tonne Offshore Sales

Spot Potash Prices (FOB Vancouver)

Spot Prices 2008-09 US$633 2010 US$351 2011 US$459 2012 US$476 2013:April US$405

Potash – Deferred Orders by Overseas Buyers in 2012 World potash deliveries totalled about 51.9 million tonnes of KCL in 2012 – 8.1% from 56.5 million in 2011. While China’s MOP imports rose during the first ten months of 2012 (+10% yr/yr), China delayed signing new contracts for seaborne shipments in 2012:H2. India also deferred new contract orders following completion of its 2011:H2 contract shipments with Canpotex in first-half 2012. Indian potash demand has been weak since 2011 – the result of a reduction in government subsidies – due to government budgetary challenges as well as an increase in urea subsidies at the expense of potash and phosphates (to assist domestic urea manufacturers and guarantee a 12% return on equity); most of the urea consumed in India comes from domestic production, while potash and phosphate rock must be imported; a 25% depreciation of the Rupee from mid-2011 to mid-2012 also lifted potash prices in local currency terms, though the rupee edged up again in 2012:H2. Delays in new contract volumes to China and -- particularly India -- encouraged other buyers (e.g. in Malaysia & Southeast Asia) to delay orders, expecting lower prices. The slowdown in global growth and weak business confidence in 2012 caused order delays for many raw materials in the summer and early fall. The net result, Canpotex on December 31, 2012 announced that it reached agreement with ‘Sinochem Fertilizer Macao Commercial Offshore’ to supply 1 million tonnes of potash from Jan-to-June 2013 at about US$400 per tonne cfr China (-US$70 from the previous US$470 contract price established in March 2012). Canpotex agreed to a significant price decline (though less than asked for by buyers), in return for a substantial pick-up in shipments.

Forecast

2013 US$425 2014 US$475

Shipment recovery expected in 2013, limited price pick-up.

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Potash Outlook for 2013 – Strong Spring Application in North America and Restocking by Buyers

While CBOT corn & soybean prices have eased from spectacular record highs last August, prices remain historically high for U.S. & Canadian farmers – pointing to strong Spring fertilizer application, after good application last Fall. Cold weather and high snow cover will lead to quite late spring planting this year and buyers wish to limit inventory. Nevertheless, Potash Corp’s North American sales volumes nearly doubled yr/yr to 0.8 mt in 2013:Q1. The recent contract between Canpotex and China has set a floor on overseas potash prices in first-half 2013 and should spur the resumption of spot orders from Southeast Asian buyers. Strong prices for soybeans & corn should keep application strong in Brazil. India has been seriously under-applying potassium -- leading to an imbalance in nutrient application of growing concern to India’s fertilizer association and contributing to low crop yields. N:K ratio is now 9:1 down from a peak of 4:1 (optimal is 2:1). If India is to improve its yields —important to food security – it must step up potash application again. Based on the 2011-12 crop year, India produced 15 tonnes of grain per tonne of fertilizer used compared with about 32 tonnes in the United States and the world average of 25 tonnes (also dependent upon good farm practice and machinery & equipment).

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60World Potash Deliveries*

million tonnes KCI

Growth Markets: China & Brazil

* Imports & domestic shipments. • 1993- 2012 about 3% p.a.; 2001-07 4% p.a. • Potash demand in China and Brazil has more

than doubled from 2000-12.

India is expected to increase its potash demand in 2013 to about 4 mt, after applying a mere 3 mt in 2012 (previous peak was 6.3 mt in 2010). In February 2013, India signed a new contract with Canpotex for 1.1 mt at US$427 per tonne cfr India (significantly lower than the US$470/530 previous contract price), but higher than expected. India also signed a 1.0 mt contract with BPC at the same price. However, the pick-up in shipments to India will likely be modest, with the NSR likely cut again in 2013. World potash deliveries should rebound to about 56 mt in 2013, as buyers restock. While there is currently resistance to higher spot prices in Brazil and Southeast Asia, Potash Corp’s overseas sales volumes climbed by 69% yr/yr in 2013:Q1. The Latin American market started the year at a record pace.

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‘Geopolitical Supply Risks’ Will Keep International Oil Prices High in 2013

US$ per barrel

Arab Oil Embargo

Iranian Revolution Gulf

War Iraq War

Record High: July 11, 2008: US$147.90

2008 US$99.62 US$97.95 2009 US$62 US$62 2012 US$94 US$112 2013F US$94 US$108 2014F US$96 US$110

*

While global petroleum consumption should rise by 1 mb/d (1%) in 2013, non-OPEC supplies could increase by 1.1 mb/d, centred in the United States (0.8 mb/d) and Canada (0.2-0.3 mb/d – held back by a high level of maintenance this spring at oil upgraders). However, ‘geopolitical supply risks’ remain, recently intensifying in Nigeria and Libya.

Scotiabank Commodity Price Index

+

Price Outlook

WTI Oil Brent Oil

Saudi Arabia stepped-up its oil production above the ‘call’ for OPEC crude in 2012:H1 to offset the loss of Iranian oil due to sanctions and prevent high oil prices from derailing an already fragile world economy; this move accounts for the significant decline in oil prices in 2012:Q2. However, prices rebounded in early July alongside the EU embargo on Iran, U.S. banking measures aimed at curbing oil exports from Iran and positive investor reaction to proposals at the EU Summit to steady Eurozone financial markets. Iranian oil exports have fallen by 1 mb/d yr/yr. The IAEA has made little progress in curbing Iran’s uranium enrichment and inspecting its nuclear facilities. In 2013, world supply & demand conditions should be roughly balanced, but not tight, with the ‘call’ for OPEC oil around 29.9 mb/d compared with actual output of 30.4 mb/d to date. Spring refinery maintenance is currently unusually high.

Despite slow growth in petroleum demand (+1%), international oil prices will remain high in 2013 – underpinned by ‘geopolitical supply risks’ in the Middle East & Africa.

+ May 6, 2013: US$95.28

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The Most Critical Economic Issue Facing Canada – Inadequate Export Pipeline Infrastructure Wide Discounts on Western Canadian Select Oil

US$ per barrel

Oil Price Differentials (US$/bbl) Brent - WTI WTI - WCS 2006-10 Avg. $0.06 $17.43 2012 $17.09 $21.00* 2013:Q1 $18.27 $32.00* April $11.58 $23.07

Brent

WTI Oil

WCS Heavy Oil

Building export pipeline capability to B.C. coast is key priority for Canada

Three Ways to Address Challenges: 1) To guarantee ‘world’ prices

for Western Canada’s oil – as well as volume growth – there is a critical need to expand pipeline or rail infrastructure to the B.C. Coast to tap Asia/Pacific markets;

2) Reverse pipelines in Eastern Canada to allow Western Canada’s crude to reach refineries in Montreal & Atlantic Canada, currently dependent upon more expensive imported crude;

3) With refined products sold at ‘world’ prices, integrate forward into refining to capture the full value of the crude.

Source:* TMX/Shorcan Energy Brokers

Risk that wide discounts on light crudes could emerge due to rising U.S. supplies from North Dakota Bakken & Eagle Ford.

U.S. approval of northern leg of Keystone XL? 600,000 b/d of West. Can. crude is now being railed to higher value markets across North America.

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High LNG Prices in Japan & Asia Favour Canadian & U.S. LNG Exports

US$ per mmbtu * Avg. LNG import price into Japan; Japan turned to imported LNG & oil when nuclear reactors were shut in 2011-12.

*LNG prices delivered to Japan: peak at US$18.07 in July 2012, late February 2013: US$16.81. Source: LNG Japan Corporation. Steam coal lost competitiveness in 2012, but could rally back with natural gas at the US$4.00 mark. LNG exports should be the trigger for a large ‘structural’ increase in natural gas demand and stronger prices later in the decade.

NYMEX Natural Gas Prices

Nymex Natural Gas Prices (US$ per mmbtu)

2008 8.90 2009 4.15 2011 4.03 2012 2.83 2013F 4.00 2014F 4.50

Natural gas is the fuel of choice for North American manufacturers, recently rejuvenating the U.S. petrochemical and fertilizer industries. Development of 20 new U.S. natural gas ‘shale’ basins – made economic by new multi-stage fracture drilling technology – has lowered the industry cost curve. NYMEX prices fell to a decade low of US$1.91 per mmbtu on April 19, 2012. This price level was unsustainably low; the vast bulk of North American natural gas cannot be produced profitably at prices below US$2. Most ‘dry’ natural gas shale producers require at least US$3 to generate a reasonable rate of return. More recently, prices have rallied over the US$4 mark alongside unseasonably cold and prolonged U.S. wintry weather, pushing gas-in-storage down 4.2% below the 5-year average. Gas-targeted drilling rigs have dropped by 41%, with energy companies shifting focus to oil, though the tie-in of already drilled gas wells has limited the impact.

LNG Prices in Japan*

30

Equity Sales & Research Scotiabank is a leading provider of Equity Research on Transportation, Base Metal, Oil & Gas, Forest Products and Fertilizer companies. Corporate Banking – Global Mining In 2012, Scotiabank was ranked as the No.1 lead arranger (by deal count) in the Canadian and North American mining sectors; the most international of the Canadian banks, with offices in Beijing, Shanghai, Chongqing and Hong Kong, operations across Asia Pacific including India, Malaysia and Thailand and throughout Latin America (including Mexico, Chile, Peru, Brazil and Colombia), London and New York. Investment Banking and M&A Advisory Services #1 Canadian Equity Issuer and a leading mining underwriter January 2011 to present. Landmark Transactions: -- Exclusive Financial Advisor to Red Back Mining’s C$8.0 billion merger with Kinross Gold – Fourth largest M&A transaction ever completed in the gold sector. -- Co-Bookrunner on Barrick’s US$4.0 billion equity offering – the largest equity offering in Canadian history and the largest equity financing ever made in the international gold sector. -- Sole Financial Advisor to China Investment Corporation in their landmark private placement in Teck Resources (US$1.5 billion) -- largest investment in a mining company by a Chinese investor in Canadian history. Scotia Waterous -- a world leader in upstream Oil & Gas M&A and Divestiture mandates, with offices in Hong Kong, Singapore, Calgary, Houston, Denver and London; Co-Bookrunner of Gibson Energy Initial Public Offering (C$568 million ) – the largest Canadian IPO in 2011. Advised BHP Billiton on acquisition of Petrohawk Energy and Chesapeake’s Fayetteville assets.

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34

Disclaimer

TM Trademark of The Bank of Nova Scotia. Used under license, where applicable. This report has been prepared by Scotia Economics as a resource for the clients of Scotiabank. Opinions, estimates and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. Neither Scotiabank nor its affiliates accepts any liability whatsoever for any loss arising from any use of this report or its contents.