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Coal Demand Improves But Still Lacklustre

Commodities | Aug 08 2013

-Thermal coal growth returns, but soft
-Pressure to stay on coal prices
-Indian imports the greater opportunity
-Thermal plus coking coal projects best


By Eva Brocklehurst

2013 has been a lacklustre year so far for coal. Major headwinds for global coal prices look likely to persist but the Chinese market is showing signs of stabilisation. Growth in thermal coal consumption has returned on China's coastal market. Moreover, Macquarie notes slower supply growth has led to a fall in coal inventory at key Chinese power producers.

China's electricity demand growth has increased to 6% in the second quarter this year from 4% in the first. This was primarily from a recovery in industrial activity. There was a strong pick up in power consumption in mining, cement and transport. Growth in hydro power has slowed too, allowing thermal power generation to maintain market share so far this year. Chinese thermal coal imports are still soft, up 8% year to date but well down on the 44% growth seen in 2012.

Macquarie maintains Chinese imports are not just a factor of demand minus domestic production. China has been a market of last resort for coal, where international producers and exports try to offload excess tonnage when they struggle to find other buyers. This is made possible by the fact that Chinese domestic production is high cost. One reason behind the slower uptake by China this year has been India's draw on global supply. Thermal coal imports there have grown more than 40% year to date, as the country's dependence on coal power generation increases. India's demand may grow strongly but there are risks, according to Commonwealth Bank analysts. The country's economic development plan places coal power at the centre of the nation's energy future but India faces large problems producing and transporting domestic coal, seemingly offering an opportunity to grow thermal coal imports. Recently, India did allow some power companies to pass on costs of more expensive coal imports to consumers and this could pave the way for increased imports.

The other reason behind China's slower uptake of thermal coal imports has been slower-than-trend imports of Indonesian coal, which is sold at the greatest discount. Macquarie does not expect this flow to improve. The problem here is that, while Indonesia should remain the largest thermal coal exporter by volume and enjoy lower costs delivered to Asia, the country's lower quality coals will become an increasing issue as environmental policies dictate greater efficiencies and lower pollution from power generation.

The CBA analysts think slower thermal coal demand growth, driven by environmental concerns and more diverse electricity generating infrastructure, will combine with strong supply capacity and traded coal substitution to weigh on prices in the medium to longer term. Nominal and real cost deflation offers only a hard road to protecting margins and mine viability and, in turn, may further undermine cost support and prices. Demand growth for thermal coal is expected to weaken out to 2020, driven by China's power intensive industries moving inland, global environmental policies discouraging its use, growth in renewable energy, and emergence of natural gas as a cleaner and potentially cheaper substitute. All these factors contributed to the weak pricing environment this year.

 Australia's higher quality coal will likely provide an advantage but high costs continue to pressure Australian thermal coal exporters. The analysts find Australian thermal coal projects are the least attractive globally, because of capital cost intensity. Nominal and real cost deflation and a lower Australian dollar are needed to boost the competitive position of Australian thermal coal exporters. South African coal remains very competitive, given its superior cost position, while the US should remain the marginal producer, delivered to Asian buyers.

What about coking coal? Australian projects producing both coking (metallurgical) and thermal coal will likely be developed, given the better margin outlook, in the analysts' view. Nevertheless, coking coal demand growth should ease as China's steel production slows. Scrap steel usage is seen rising, displacing blast furnace pig iron. The best scenario is for improving Chinese steel quality and steel industry consolidation, which should support better demand for premium coking coals relative to standard types. Here, Australia's top quality coals from Queensland's Bowen Basin should ensure Australia stays dominant in seaborne supply of coking coal, even with current record high costs, although cost deflation is needed to preserve that position.

The reversal of the cost cycle will likely undermine cost support, with the result that, given more modest demand growth, the analysts at Commonwealth Bank have revised most medium and long term prices lower. Slower demand has precipitated steadily lower prices for the last 2.5 years and, combined with high capital and operating intensity, has caused new projects to be deferred or cancelled. Hence, long-run real (2013 dollars) coking coal price forecasts have been downgraded. Hard coking coal has been cut 18% to US$143/t, semi-hard coal cut 12% to US$122/t, semi-soft coking coal 1% to US$103/t. Long run PCI coal prices are unchanged at US$110/t. In the next three years, price revisions vary across the coal types but the most significant revisions apply to hard coking coal.

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