Market Analysis

(Continued from Part One.)

Both Australia and Brazil are running close to capacity in meeting current Chinese demand. Indeed, part of the recent price spikes has been due to weather-related disruptions from those markets and a lack of alternate supply options. India, the third largest global seaborne IO supplier, has just announced a quadrupling of its export duty from 5 to 20 percent on iron ore fines, which makes up the majority of its exports to China. We don’t hold with R.K. Sharma, secretary general of the Federation of Indian Mineral Industries, and his statement in a Reuters article that “This will make the exports of (Indian) iron ore uncompetitive in the global market.” The Indian IO producers’ cost of production is way below the export price and they can absorb the tax increase, but it will certainly support current price levels and dissuade producers from chasing market weakness downwards. The other major constraint on Indian supplies is the impending arrival of the monsoon period in mid May. Last year an extended monsoon impacted shipments for some four months, and finally, Indian political machinations add uncertainty, with Karnataka, Orissa and Goa all experiencing various degrees of export blockades.

So the supply market remains constrained and yet the figures suggest demand is rising:

Source: Credit Suisse

Global Pig Iron production is rising, as this graph from Credit Suisse shows, while within China, blast furnace capacity utilization has been rising since November and is currently at around 95 percent. With an end to Beijing imposed and weather-related electricity rationing, and the imminent onset of the Chinese peak demand period for the construction markets in March to May, the bank believes any current weakness in demand will be reversed in the second quarter. Nor does the bank hold that stocks are high; yes, in absolute terms they are higher, but so is consumption. The key measure is days of cover and on that basis cover is down from 32 days in late December to 29 now.

Source: Credit Suisse

Lastly, PMI data has remained firmly positive from all the major industrial regions: North America, Europe and Asia for the whole of 2010 and even finally Japan in 2011, pointing to increased demand in spite of what may or may not happen in China.

The main risk to Credit Suisse’s bullish stance is a concern that the authorities may tighten credit too much, as they did in late 2007/early 2008. However, the bank has identified lead indicators that showed the impending crunch before trade began to be impacted. Peoples Bank of China’s rising borrowing costs in the first half of 2008 showed that companies were being starved of cash and monitoring of these indicators would provide timely evidence if the same problem is reoccurring in 2011. The balance of probabilities, the bank believes, is that sufficient credit is still available for continued strong expansion of the Chinese construction and manufacturing sectors, but insofar as risks exist, this is the measure to be watched.

So if the forward curves have it wrong and the price is going to rise again in Q2, just how far does the bank think it could go this year? Potentially as far as $250 per ton CFR China, the report says. While China is the world’s largest iron ore consumer by far and the price setter for the whole Asian market, price trends there are not happening in isolation to the rest of the world, as Cliffs Natural Resources’ recent record financial results show. Prices in all markets, even markets less reliant on spot pricing like North America, are ultimately driven by events in Asia. Let’s hope for steel makers and steel consumers that the bank has got it wrong.

–Stuart Burns

The Iron Ore (IO) forward price curve is a fair reflection of popular sentiment regarding the likely direction of iron ore prices in Asia.

Source: Credit Suisse

As MetalBulletin reported this week, IO prices are softening for the first time since October in the face of weak Chinese demand and falling steel prices in China. The fear is that rising oil prices will impact global growth, rising iron ore stocks at ports are reflective of falling steel production and concern that current weak demand is a result of too much tightening by the Chinese authorities.

Source: MetalMiner IndX

As our chart shows, Chinese finished steel prices certainly have eased of late particularly for construction-related products such as rebar and beams, whereas prices for cold rolled steels, used more in automotive and white goods have merely plateaued. To add to steel makers’ woes, according to a Reuters article, quarterly contract prices are set to rise substantially from the first quarter — Vale estimates by some 20 percent — continuing a trend that has been ongoing for all of 2010 as this graph from Credit Suisse research shows.

Source: Credit Suisse

The quarterly price is set on the average of the previous three months spot price and hence lags the market, so IO consumers could be excused for thinking the quarterly rise will be temporary; but Credit Suisse suggests otherwise. In a report to investors the bank systematically analyzes the critical price drivers and sees more upside than downside for just about all of them.

In part two we review those drivers and what they tell us about the likely direction of prices going forward.

–Stuart Burns

For supporters of carbon pricing in the US, a recent report by Credit Suisse for investors on plans being developed by the Australian government could illustrate what such national — rather than global — climate change solutions would bring. The plan could result in a carbon tax being introduced in Australia by July 2012 if a multi-party committee formed from representatives of the Labor government, the Greens party and two independent members gives the green light. According to a Credit Suisse report to investors, the plan for a carbon price mechanism will start with a fixed-price carbon tax for a period of three to five years before transitioning to a cap and trade emissions trading scheme thereafter.

Australia’s two main steel producers are One Steel and Bluescope, both integrated steel producers using the blast furnace and the electric arc production methods. As with steel producers in the US, carbon emissions per ton of steel have gradually reduced in Australia such that both producers operate some of the most efficient plants in the world. Nevertheless, Credit Suisse’s analysis suggests the impact on both producers could be so severe that it would cause their merger in order to survive. The bank estimates the impact two ways: firstly, if no credits are granted to the companies concerned; and secondly, if credits are granted for a large part of the production capacity under a set of proposals being reviewed. At full production, OneSteel generates 4.6Mtpa of carbon, of which all but 0.78Kt would be granted credits under the CPRS proposal. Assuming no credits, full exposure, and a $10/t cost, the annual carbon tax would impose a $46 million annual charge. Under the CPRS proposal it would be $7.8 million. Assuming no credits, full exposure and a $25/t cost, the annual carbon tax would be $115 million. Under the CPRS proposal it would be $19.5 million.

For larger BlueScope, the numbers are even higher. At full production, the company generates 12.6Mtpa of carbon of which all but 0.69Kt would be granted credits under the CPRS proposal. Assuming no credits, full exposure, and a $10/t cost, the annual carbon tax would be $126 million. Under the CPRS proposal it would be $6.9 million. Assuming no credits, full exposure, and a $25/t cost, the annual carbon tax would be $315 million. Under the CPRS proposal it would have be $17.25 million.

The tragedy is that imposing a carbon tax in Australia would not reduce one ton of carbon being released into the atmosphere. As the proposals stand, all that would happen is the firms would be forced to rationalize production (in Credit Suisse’s opinion, forcing the merger of the two companies in the process) and encouraging imports of lower priced steel from places like China, India, Vietnam and South Korea. If Australian producers in isolation have additional taxes applied to them in this arbitrary manner, it would result in the hollowing out of Australian steel making and the support of overseas, unregulated, steel production in other Asian supply markets. In the words of Paul O’Malley, CEO of Bluescope during an Inside Business ABC News interview: “I think to really reduce greenhouse emissions we have to reduce global emissions. I think if you look at the experience in Europe, production emissions are flat since 1990, so Europeans are a claiming victory, but carbon consumption has increased 47%. So there has been a hollowing out of manufacturing in Europe and a moving or a hiding of that carbon overseas. I think if the same program is put in place in Australia, effectively you’re assuming that policy is that they (the government) don’t want (steel) manufacturing in Australia.

So does that make all carbon tax plans pointless (unless coordinated) globally? Some people think so, but one solution could be to impose a carbon tax on imports too; at least that would have the benefit of both leveling the playing field for domestic producers and encourage overseas suppliers to reduce their carbon footprint by employing the latest technological innovations available. Unfortunately, politicians rarely look at the bigger picture and the debate in the US needs to be opened up to consider the detrimental impact cap and trade and/or carbon tax policies have had or are likely to have elsewhere in the world before getting too far down the road in applying them at home. Unless we want further hollowing out of our domestic steel industry and the loss of yet more steel manufacturing jobs overseas, we need to ensure that any discussion in Washington includes plans to maintain a level playing field with overseas producers.

–Stuart Burns

A few months ago, the recent fall in the copper price would have been met with expressions of delight by copper buyers keen to take advantage of “buying on the dips in what was widely expected to be a bull run on the copper price. When the price topped $10,000 per metric ton on the LME last month, copper bulls’ optimism seemed entirely vindicated. So what should buyers make of the current price, which is back to the mid $9,000s, having slipped some 7 percent from it’s highs? Is this a dip to take advantage of? What is driving the price down (and is this just a temporary drop)?

A Reuters report by Melanie Burton points the finger of blame at unrest in the Middle East. More than anything, the speed of events and domino effect from country to country is causing widespread concern that oil supplies will be compromised and, with it, global growth. Even if oil supplies continue to flow freely, the rise in the oil price is seen as a significant likely driver of inflation which will dampen growth. Quoting Steve Hardcastle, head of client liaison at Sucden Financial, the report states: “Energy prices will impact consumption. They could also impact inflation levels in China, which means potentially further involvement by the Chinese monetary authorities.” Nor are just metal and oil prices affected — stock markets fell around the world with Wall Street having its worst day since August as investors turned risk-averse. That same risk-averse sentiment drove speculative holders of copper to liquidate positions contributing to price falls.

The above explanation, while entirely accurate, is only part of the wider copper story though. In a separate article, written by veteran Reuters metals columnist Andy Home, the latest International Copper Study Group (ICSG) monthly copper market report is used as the basis for a deeper examination of the global supply/demand situation. Using the ICSG’s approach, the copper market was 400,000 tons in deficit in the first 11 months of 2010, compared to a surplus in the same period of 2009. However, the ICSG calculates Chinese copper consumption as domestic production plus imports, plus/minus changes in visible stocks and exchange stocks. The devil comes in the imports figure, according to Andy Home — up to 500,000 tons of copper were imported last year and held by financial arbitragers. With demand from Chinese consumers driving demand and the copper price rising, these financial players were on a one-way bet; but as consumers have stopped buying, the arbitrage window has closed, as this chart form Reuters shows.

Source: Reuters

As the article points out, 500,000 tons of stock is more than is held in the entire LME warehouse system (or, looking at it another way, more than the supposed 400,000-ton supply deficit calculated by the ICSG). Which brings us back to how real this deficit is. If such a significant portion of the “demand is imports driven by the financial community and not consumers, how real is this deficit? With consumers staying out the market, physical premiums have collapsed to zero and metal — admittedly only in small volumes — has begun to be exported from China. South Korea is the nearest LME warehouse and stocks there have risen to 34,600 tons since the start of this year. If the trickle picks up it is almost certainly a sign that prices will have further to fall, so rather than jumping in to buy on the dips, copper buyers may be advised to keep an eye on those LME stocks, particularly in Asia, on the SHFE stock levels and on reported physical premiums. Further Middle East unrest or not, copper may be in for a period of consolidation — if not an extended decline — from current high prices.

–Stuart Burns

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As a former metals trader (not ring, mind you, but import/export), I learned many tricks of the trade, so to speak. Unscrupulous traders once (perhaps still) easily circumvented US law in a variety of ways by creating false companies, transshipping products (knowing full well the products would end up in the hands of US adversaries) and outright falsifying the actual “end use of said product.” Nonetheless, sometimes laws get circumvented legally because the language of the law lacks specificity. But as an ex-Arthur Andersen consultant, I can appreciate the difference between the letter of the law and the spirit and intent of the law (Enron anyone?). Our contacts in the rare earth metals world tell us that tantalum scrap traders have found profitable ways to skirt the new Dodd-Frank Conflict Minerals Law.

These scrap dealers have followed market developments closely, attending any/all meetings and conferences having to do with conflict minerals. According to our source, traders have said to him, “nothing is going to change, African origin material will find a way to get into the market.”

To understand how the scrap supply chain works, we refer to an earlier MetalMiner post covering tantalum forms: “Tantalum comes in basically three forms: tantalum ore and concentrate (where our sources tell us long-term pricing could easily exceed $120/lb with African spot prices at $60/lb, though one can’t actually buy African tantalum at that price), tantalum oxide/salts (which essentially double the ore prices) and finally, capacitor-grade tantalum powder, now at approximately $300/lb, according to our sources. It’s this last grade that finds its way into the electronics we own. With tantalum prices mounting, the lure of finding loopholes in the law may prove too tempting. So we inquired how the tantalum scrap supply chain may operate in comparison to the non-scrap supply chain.

Basic premise: Tantalum oxide concentrate currently in the $120-$150/lb range with Congo ore currently in the $40-60/lb range, an approximate $100/lb difference.

We have identified the following approximate costs and process steps to use scrap and avoid traceability requirements:

  1. Extract metal from concentrate $15/lb
  2. Refine metal to powder $15/lb
  3. Refine metal powder to ingot $15/lb
  4. Chop to ingot $10/lb (this is the only additional cost and is not traceable)

The scrap chain would still allow for an increase in the basic price of Congolese material. From a price perspective, the above-referenced process still undercuts or matches the “clean material.” In other words, the “alternative non-regulated supply chain” can operate profitably at today’s tantalum market prices.

The Enough Project, original advocates of the legislation, along with the NGO Global Witness, are said to have begun work anew with the SEC to explain the loophole within the law. Clause 1502 of the legislation defines what needs to be reported to the SEC, but the portion of the law relating to scrap and recycled materials contains some ambiguity, as our guest blogger Lawrence Heim of The Elm Consulting Group International will elaborate on in a follow-up post tomorrow.

In the meantime, buying organizations will want to pay careful attention to both the new legal requirements as well as this new loophole. For the latest in complying with the SEC conflict minerals law, check out our free resources (including more articles and exclusive white-papers).

 

(This is Part Two of a two-part series. Read Part One here.)

Global demand is irrefutably rising — Alcoa estimates at 12 percent this year, after a 13 percent rise last year. Reuters suggests it could be 15 percent saying this year it could reach 45 million tons compared to 39 million last.

All of this sounds bullish, right? Supply is being constrained, demand is rising strongly and even the stars are aligned for a push higher. Well, no, says the counter argument. Ed Meir is quoted in the article as pointing out that the production capacity the Chinese have idled can easily be turned back on; indeed, previous closures in the second half of last year were reversed in some situations. Truly, China has a massive overhang of production capacity, some of which has barely seen the light of day in 2010 before being temporarily idled to meet environmental limits. Producers must be desperate to get this back on stream and with the cost of production around $2100 per ton in China they would be making healthy profits if they were able to do so.

 

Meanwhile global stocks are still huge — in the region of 10 million tons (if reported and unreported are combined) — and the market remains in surplus, estimated in a Reuters survey to be around 383,000 tons in 2011. Having said that, there is a huge range depending on who you speak to: the survey ran from 1 million tons deficit to 1.5 million tons surplus as the possible outcomes for this year!

The 800-pound gorillas are those long-term finance deals that are tying up so many millions of tons of primary metal in warehouses. We have written about this situation many times before, the death knell has been sounded on numerous occasions, either due to a flattening of the forward price curve, or rising warehouse rents, or rising finance costs most likely due to rising interest rates. For the time being, the deals continue, but detractors say that if that metal starts finding its way back into the market (and the first sign will likely be falling physical premiums) expect the aluminum price to drift south.

If you were expecting this analysis to finish with blinding insight into which direction the price is going this year, we are sorry. Our money is on a continuation of the status quo, and the risk is, in our opinion, more to the downside than the up. Prices could drift off to $2300 this year, maybe $2200 as premiums weaken or those Chinese smelters restart in any significant numbers. The upside has to be capped by the surplus most observers think we will experience this year, but could still be around $2650-2700 per ton. Keep an eye on those physical premiums and reports of Chinese smelter re-starts.

–Stuart Burns

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An intriguing article in Reuters this week indirectly addressed the question that has absorbed many aluminum consumers this year —   should I be long or short? (or if not short, then buying hand-to-mouth in preparation for a price drop). The article approaches the topic from the direction of investors who have seen the copper price triple since December 2008 and the aluminum price double since early 2009. Lately however, copper prices have dropped back and yet aluminum prices have held relatively firm. Indeed, in the face of relatively lackluster buying of physical copper, aluminum premiums have remained firm, even reaching record highs of over $200 per ton in Europe this month.   The article rightly goes on to pour cold water on the suggestion that aluminum is the new copper and will benefit from substitution at the expense of copper. But the examination of whether the aluminum price will remain firm or fall remains an interesting one for anyone active in position-taking or exposed to price movements.

The chartists would have us believe the aluminum price shows all the symptoms of a metal due to run up to $2800 per ton, as this graph from Reuters purports to show.

Source: Reuters

Sorry if I sound less than convinced. I am not a supporter of predicting price movements from charts, seeing it as analogous to reading tea leaves. However, I am aware that some do follow astrologers’ predictions and hence, prophecies can become self-fulfilling. I also accept that on occasion, chartists have correctly predicted price movements, but then so have I. In this case though, we would be staggered to see aluminum run up to $2800 per ton anytime soon, but we include the data as it is a potential driver.

Quoting from the article, according to the International Aluminum Institute, China produced 16.131 million tons of aluminum last year compared with 12.964 million tons in 2009. “China was effectively using cheap energy to produce aluminum and exporting it to the West,” said Julian Treger, fund manager at UK-based Audley Capital. “They will shut down some of their capacity and that will be bullish. They don’t want to export cheap energy to the West any more, they will cut back production.” China’s energy cannot be characterized as low-cost today, unlike the new Middle Eastern smelters with very low-cost gas supplies. Most of China’s aluminum smelting relies upon coal-powered electricity production or precious hydroelectric capacity, power desperately needed for more value-add industrial uses and for rapidly rising domestic consumption. Some 40+ percent of the cost of aluminum production in China comes down to electricity, compared to an average of 30 percent elsewhere. China truly exports high-cost aluminum in a low value form by exporting primary and lower value-add aluminum products. You can’t fault Beijing’s attempts to dissuade exporters of lower value aluminum products.

(Continued in Part Two.)

–Stuart Burns

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When it comes to economic indicators, perhaps the most important category for the steel industry specifically is construction, and several sources over the past week have given us mixed signals as to what 2011 will really look like when it comes to domestic construction demand. Based on reports and surveys from the  United States Geological Survey (USGS) and Bloomberg, let’s try to see if a big picture emerges.

On the more depressing side of the construction equation, the USGS recently released a report showing the production trends of several mineral commodities from 2009 to 2010. Gypsum, cement, sand and gravel, crushed stone and zinc were all down by double digits in Q4 2010 (from Q3 2010): construction-use sand and gravel production, for example, dropped 25 percent.

The only commodity that fared well: iron ore. Having only risen 2 percent from Q3 to Q4 in 2010, total production of iron ore in 2010 was up a remarkable 87 percent from 2009 totals. According to the USGS, this had as much to do with mine shutdowns and inventory contraction in 2009 as it did with slightly improved economic conditions the following year.

This general assessment of an “improving economy seems to have spilled into the beginning of 2011. Housing starts were up in January by 15 percent, or a 596,000 annual rate, according to Commerce Department reports. But that positive statistic is misleading, because the jump is attributed to multifamily homes, and not to single-family unit starts, which indeed dropped. Overall, then, the housing market is still anemic.

“Housing activity is going to remain at depressed levels this year, Ellen Zentner, a senior macro economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, told Bloomberg. “We’ve got home prices that have taken another leg down and will probably stay down through midyear.

Another troubling sign is the decline in building permits, which “dropped 10 percent to a 562,000 annual pace in January, according to the article. Permits were up 15 percent in December, but that was another false indicator of growth, since builders applied before the end of the year to avoid new building codes going into effect.

In a separate Businessweek report, a survey of indicators showed that wholesale costs were up for the seventh consecutive month, capacity utilization was down, and mining production was down but that manufacturing overall was up 0.3 percent, and the ISM’s factory index was reported at its highest since mid-2004. This all appears to be good news for firms like Parker Hannifin, a Cleveland-based manufacturer, which makes construction equipment (among much else) and whose order books are evidently regarded as a litmus test for the health of the overall construction sector.

“We’re pretty bullish as far as what the future order pattern is, Thomas Williams, executive vice president and operating officer, was quoted as saying on a conference call Feb. 9. “Our backlog is building, he said, and “we’ve got ramp-up in volume.

The truth is, no one really knows where the housing market will end up this year. Much of domestic production can be attributed to growing international demand, and housing starts tell a partial picture current unemployment rates may tell the most important story of future economic conditions, and so far, those are still not looking good.

–Taras Berezowsky

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In supporting that last argument in Part One, it is observed that China is reducing its holdings of US-dollar treasuries — it has been a net seller for the last two months. According to the U.S. Treasury department’s Web site, in November 2010, the country lent the U.S. $895.6 billion, which was down 3.6 percent from the same period a year earlier. “China has shortened all their maturities to less than 5 years and now they are not as strong in the auctions,” argues Chuck Butler, president of EverBank. Speculation is bubbling that the country is shying away from the dollar to make more room for another asset; could that be gold?

But others have poured scorn on the idea. Jon Nadler, senior analyst at Kitco.com, argues that China loves growth too much to switch to a gold standard, and “forget about 8% growth.” If China supports its currency with gold then it will be forced to limit the amount of money in circulation, which could hurt the economy. “This is a far-fetched dream by the gold bugs,” he has said.

Putting the yuan onto a gold standard may not be the intended outcome, though; we would suggest an alternative objective might be to soak up excess liquidity in the economy and hence reduce inflationary pressures. Encouraging citizens to buy cars, white goods and electronics is good for industry, but the rate of growth has been so rapid aided and abetted, one should add, by the stimulus measures introduced by Beijing in the aftermath of the financial crisis and has since largely wound down that it has brought price inflation with it. Raising interest rates and bank reserve requirements has the desired effect of slowing demand, but at the additional cost of raising costs for industry. Giving the population something else to speculate on apart from property prices could be the intent. Nor can we see how encouraging the public to buy gold furthers the aims of a currency reserve standard — India has been the largest importer of gold for many years, most of it bought by the general public, yet the rupee is a long way from the front runners as the next reserve currency.

Whatever Beijing’s intent, it has undoubtedly supported the gold price over the last year and that policy is, like so many other metals, likely to impact gold prices this year and next to an even greater extent.

–Stuart Burns

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Just why are the authorities in Beijing so actively supporting widespread purchases of gold and financial gold instruments? China has also been telling its citizens to buy gold, promoting different gold funds, giving investors access to overseas products and launching a global gold contract based in yuan by the Chinese Gold & Silver Exchange. On the face of it, this seems like a strange position to take; at the very least we have come to expect governments to be neutral on their citizens’ investment choices, sometimes downright negative such as raising interest rates to dampen property or stock market bubbles, but rarely so overtly supportive towards investing in speculative and volatile commodities. One has to ask: what would the social fallout be to a collapse in the gold price, and would there not be some resentment in being so aggressively encouraged to buy?

China’s desire for gold is not solely reserved for the man and woman on the street. According to a Reuters article, gold imports into China soared in 2010, turning the country, already the largest bullion miner, into a major overseas buyer for the first time. The same article said China imported 209 tons of gold in the first 10 months of last year, versus 333 tons by India for the whole year, making China second to India the largest gold market and accelerating fast enough to take top slot this within a year or two. The US by comparison bought 233.3 tons.

Theories abound as to why China is buying gold both for its central reserve (which now stands at 1054 tons, or about 1.8 percent of it central bank reserves), and encouraging its citizens to hoard gold as well. The front-runner is that China is on a drive to have the yuan accepted as the world’s reserve currency and amassing gold will improve investor confidence, if you like a return to a gold standard. If that were really the plan, China would have a profound impact on the gold market. As TheStreet.com points out, China holds $2.85 trillion in foreign reserves, which means the country would need to buy roughly 66,000 tons of gold to fully back its currency. Even if the country raised its holdings to just 3 percent, the country would need to buy 1,000 tons. The article goes on to point out that technically, a full gold standard isn’t an option. Under the IMF’s first amendment to Article IV of Agreement, ratified in 1978, participating countries are not allowed to peg their currency to gold, but that doesn’t undermine the attraction of carrying large gold reserves as an expression of solidity.

(Continued in Part 2.)

–Stuart Burns

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