There may be some uncertainty about exactly what is the marginal level of cost of production, and a plethora of views on the future of the AUD that many believe underpins coal’s resurgence, but Asian investors don’t care. They want our product, and they’re willing to pay for it.
News of China’s slowdown was tempered at a recent IHS coal conference in Brisbane by a wider acceptance among developed Asian economies for lower-energy coal, which is lower than Newcastle spec but does the job for the end-users. Even India, which has been a sleeping super-cycle driver, is set to come into its own.
In a research note on Aussie thermal coal junior Cuesta Coal in March, Matau Advisory analyst Andrew Pedler noted that while China is expected to remain dominant in the longer-term in the metallurgical coal market, its slower rate of urbanisation is leading to slower growth.
Meanwhile, rising Southeast Asian economies and India are forecast to accelerate. The US Energy Information Administration noted last quarter that Chinese production and consumption of coal increased for the 13th consecutive year in 2012.
“China is by far the world’s largest producer and consumer of coal, accounting for 46% of global coal production and 49% of global coal consumption – almost as much as the rest of the world combined,” the EIA said.
“As a manufacturing country that has large electric power requirements, China’s coal consumption fuels its economic growth.”
While China’s gross domestic product (GDP) growth of 7.7% in 2012 was slower than its average GDP growth rate of 10% per year from 2000 to 2011, Ayaka Jones from the EIA’s Office of Electricity, Coal, Nuclear and Renewables Analysis told RESOURCESTOCKS that while the growth rate of coal consumption went up and down in the past few years, “I’m not seeing it flatten out”.
“As China increasingly makes an effort to mitigate the environmental impact of fast growth of GDP and energy consumption through energy efficiency improvement, development of cleaner energy resources including nuclear, renewables and natural gas, coal’s share in total energy consumption will decline as its growth pace slows down, but we see that coal consumption in China continues growing,” Jones said.
“China has become a net importer of coal since 2009 and will remain a net importer in the coming decades, because its domestic production, although continue growing, is not enough to meet demand.
“The reason for the increase in production and consumption is simply that the energy requirement to meet the projected economic growth is so huge and it takes time for alternative energy sources to develop. Coal will remain the cheapest supply for a long while.”
However, while China’s demand for thermal seaborne coal exceeded Japan’s in 2010, Pedler said India’s import requirements were forecast to double by 2022 from 93 million tonnes in 2012 to 186Mt in 2022.
“Australia supplied about 17% of global seaborne thermal coal in 2012 with a compound annual growth rate (CAGR) of 5.6% forecast to 2020, increasing its share to 20% over that period,” Pedler said. “Demand from Europe and USA is forecast to decline further due to legislation changes and stricter environmental regulations.”
Fresh from attending an IHS coal conference in Brisbane last quarter, Pedler related to RESOURCESTOCKS commentary by IHS presenters on the perceived shift from 6700 kilocalorie/kg NAR (net as received) thermal coal, which is basic Newcastle spec, to 5500 NAR as a trend towards some of the lower-energy coals, which are getting wider acceptance in Asia.
“The higher-energy coal is still very much in demand for Japan, as its boilers are specified on that energy of coal and the ash levels associated with Newcastle spec,” Pedler said.
“The Japanese don’t have as much tolerance for ash levels in the make of their boilers and power station layouts as do some of the Korean, Chinese and Indian power stations.
“So there is an increasing level of trade in the 5500kcal NAR thermal coal. That’s nothing to be scared of; it’s just a moving trend in demand for coal specifications.
“There was some discussion of some of the lower-grade Indonesian coals and the Chinese potential to ban really low energy like 4300 bituminous coal. The Chinese didn’t want to be seen shipping that in, because you’re actually shipping a fair bit of dirt and moisture, and paying full freight rates, more than if you were shipping a higher-energy coal. You’d rather be shipping calories.
“That makes commercial sense. The Chinese authorities are trying to prove their commercial sense because China has enough of that quality coal internally anyway.”
Putting China’s slowdown in perspective, Pedler said its steel production is still “surging along”, though with plenty of coking coal clearly still being produced, prices are “as low as they can reasonably go”
“I’ve been looking for cash cost curves in the coking coal markets for about the last six months and haven’t seen any, so maybe that’s a reflection of the fact that there’s a state of flux in what the costs actually are,” Pedler told RESOURCESTOCKS.
“It was commented on by several people at the IHS coal conference – including people in the audience as well as speakers – that they very much doubt you can get high-end, hard coking coal costs lower than $120/t. At the moment, $US120 seems pretty marginal.”
Immediate expectations, therefore, are that prices will pick up towards the end of the year then plateau, depending to some extent on what the currency does – and there are any number of predictions on that. This is where costs of production and just what price can realistically be called “marginal” comes into play.
Costs sprinted into the limelight in late May when the Queensland Resources Council warned that any move by the state’s government to increase royalties on coal will tip more producers into the red, with one quarter of the state’s production already being produced at a loss.
Fears were rising as to how deep the state’s June Budget would hit miners to plug its high debt burdens. QRC CEO Michael Roche said that “despite vigorous cost-cutting, 25% of the coal currently produced in Queensland is being done so at a loss, including half of all thermal coal production”
“Some of these mines are only staying open because production is a more palatable option than closing operations locked into transport costs levied on a take-or-pay basis,” he said.
“However, with one out of every 10 tonnes of coal currently produced in Queensland in the red to the tune of more than $14, some mines are at extreme risk of shutdown.”
Pedler said that last year, major coking coal customers had been observing the AUD currency, and the spot price had been reducing in line with the currency because the customers were mindful of the operating costs of the producers, and the customers, particularly the Japanese, did not want that production to go off line because they need it.
The IHS conference revealed forecasts for the thermal coal market as a little more optimistic, in that we are seeing an increase in commissioning, or plans to commission, thermal coal-fired power stations in Asia, including Korea and Japan – not just in the emerging countries.
“The Koreans, Japanese and Taiwanese are evaluating their power supply blends at the moment,” Pedler told RESOURCESTOCKS. “For instance, Japan used to have 30% nuclear as a power source and thought they might now be aiming at more like 15%, with at least some of the power being taken up by additional coal.”
On top of this, the US economy is clearly picking up and the Europeans appear to also be recovering. An improving outlook going forward is evidenced by the purchasing managers indices (PMIs) for the significant economies – that is US, Japan, Europe, China – are all ticking up into the +50 region.
“So in that context it appears that a lot of the market is either very close to or at its bottom, and we’d anticipate recovery some time in the next six to nine months,” he said. “We’re not talking dramatic recovery, but improvement.”
“For the Australians, clearly the direction the currency takes will be important. There are a fairly wide range of forecasts for currencies, ranging from 80c in 12 months’ time to 95c.”
While there are some concerns trade patterns for seaborne thermal coal, particularly from North and South America will be redirected toward Asia as demand growth from Europe and USA declines, Pedler said American production is “out of the money” as far as the Asian market is concerned, as they have an additional $US20-25/tonne shipping charge on top of costs, putting them in a “difficult spot”
Low priced US domestic gas was making US domestic coal less competitive and less profitable. He also noted a Wood Mackenzie report stating that USA’s compliance regulations are expected to force retirement of almost 40GW of US power stations in 2016.
Big-picture perspective was given at the IHS conference by Morgans mining analyst Tom Sartor, who reminded delegates that “this is a cycle”, and showed graphs starting in 2004 when media commentators preached that resources were “old economy”, and that the likes of BHP Billiton and Rio Tinto would never be great investment stocks again.
Clearly that changed.
It went through in increased demand cycle, compounded a lot by the fact that for two years running Queensland experienced devastating floods which disrupted supply, on top of increased demand which caused the absolute surge in prices that everyone keeps quoting – coking coal prices of $330/t – when referring to events since as a “collapse”
The reality, Pedler said, is that the price before that spike was not much above what it is now – the mid-price for the January quarter 2010 was $129/t. Prices hovering around $150-160/t late last year had producers warning it was down to marginal costs, yet here we are six months later at $120/t and they’re still producing.
He said the 2011 spike “wasn’t a natural phenomena, that was a function of the massive flooding in the Bowen Basin that stopped suppliers. It was an extreme anomaly. The media talks about the current price being a massive collapse, when really $330 was a massive spike”.
Still, with the current over-supply situation in the coking coal market, more cutbacks are anticipated in the Australian market, and likely more M&A or acquisitions, because Aussie juniors are defying the stereotype.
“Small companies are currently perceived to be struggling, but I know quite a few who have good, advanced projects and are still persevering to advance those projects, and they are attracting funding from overseas parties, mostly off take, and some investors,” Pedler said.
“Cokal, which has a high-quality coking coal project in Indonesia, is getting a lot of funding support out of Singapore.
“Cuesta Coal, with a thermal coal project near the old Blair Athol mine, is getting support out of Hong Kong; Bandanna has been talking to utilities and investors in Asia unspecified.
“They’re all companies that have brought projects through feasibility and are progressing them, despite what everyone is correctly assuming is only a relatively short-term lull, not a permanent dive to these levels.”
The good news to take-away here, he said, is that Asian investors have a long-term view regarding the need for significant supply of good quality product.
“Bandanna has something like a 40-year supply, and the utilities love thinking of that, because if the coal matches the specifications of the boilers, then that’s a good hit and they’d like to secure it,” he said.
“Similarly, Cuesta’s coal is very much like the Blair Athol coal which was very well taken up by the Japanese in particular, and should be in good demand by the Chinese also.
“So there are off take parties – being the steel mills and utilities – and also some investors, who perceive the value in these projects and that they are worth investing in now, which is effectively the lower end of the cycle.”
Further evidence of how the wider market sees the value of coal acquisitions is Glencore taking out MIM, which prompted coal and copper markets to lift – the very two commodities that everyone is hunting for, Pedler noted.
“The coal operations in MIM that had barely been able to service their debt had been treated rigorously by renowned industry professional Vince Gauci, who has a reputation as a quality trouble shooter for sorting out operations.
“Gauci turned them around and become cash flow positive.”
Of course, the markets had been disappointed with MIM for a while, its stock a serial underperformer, but the market doesn’t do the sort of forensic due diligence Glencore does. Pedler said Glencore is “on the record” as being a “very astute commodity trader”, as was the case with MIM.
