Indonesia will capture a larger share of the Chinese market, while Australia re-directs its coal towards other countries such as India.

As yet, it remains to be seen whether China will stick to its guns and press ahead with the coal ban. In an illustration of the fickle and often uncertain nature of China's policies, the country previously reversed plans to restrict low-grade seaborne coal following stiff protest from domestic utilities in 2013.

In this latest attempt to improve air quality, China will ban the import and sales of coal with ash and sulphur content of more than 40% and 3%, respectively, with effect from January 2015.

According to the directive released by the National Development and Reform Commission (NDRC) on September 15, heavily populated areas will be slapped with more stringent regulations.

The ash and sulphur content limits for cities in the southern Pearl River Delta, the eastern Yangtze River Delta and three northern cities including Beijing, Tianjin and Hebei will be much lower, at 16% and 1%, respectively.

The south-eastern cities are the biggest consumers of imported coal due to their relative proximity to major ports compared to most of China's coal mines.

The minimum energy requirement for coal that will be transported for more than 600km from their production site or receiving ports will be set at 3940kcal/kg, with a maximum ash content of 20% and a sulphur content of 1%.

Other limitations include coal with chemical content such as mercury and arsenic.

In our view, China’s latest coal policy will only have a limited positive impact on the environment. Coal-fired power plants will have to consume more lower-energy coal from Indonesia (which despite its lower calorific value, will not be affected by the ban due to its lower ash content) in order to generate the same amount of electricity.

For instance, a typical power plant will use as much as 40% more coal if it consumes 3700kcal/kg fuel instead of 5500-6000kcal/kg. As the sulphur content of Indonesian coal is similar to that of other sources such as Australia, the subsequent increase in sulphur dioxide emission from greater coal burning will partially negate the environmental benefit of a reduction in ash pollution.

A more aggressive way to tame coal pollution would be to implement a ban on coal imports with low calorific value at the same time.

We believe China's reliance on seaborne coal will continue over the coming years, and that coal-fired power generation will continue to dominate the bulk of China's energy portfolio over the next decade.

We forecast coal’s share in the country's energy mix to fall from 76.8% of total electricity generation in 2013 to 70.8% in 2023.

First, China has limited alternatives to burning coal with domestic gas output limited and liquefied natural gas (LNG) imports considerably more expensive. Second, Beijing's war on coal belies the fact that China is simply shifting the construction of many coal-fired power plants inland. Third, China’s clampdown on domestic miners will create a void to be filled by the seaborne market.

Indeed, the new coal policy by NDRC includes curbs on transporting low-quality domestic coal as well as a ban on domestic mining with high ash and high sulphur content. This could actually increase Chinese demand for coal imports, reinforcing our view that China will remain the key driver of seaborne coal demand over our forecast period to 2018.

While market opinions surrounding the impact of the ban on seaborne suppliers are divided, coal shipments from Australia and South Africa are set to take the brunt. Thermal coal with a heating value of 5500kcal/kg from these two countries will be worst hit since their ash content generally hovers around 23-25%, far exceeding the 16% limit set by China.

Around 50-80% of Australian coal exports to China will reportedly be affected by Beijing's latest ruling, putting at risk 30-45 million tonnes of coal volumes. Among the largest Australian coal operations that would not meet the restrictions on ash content include BHP Billiton's Mount Arthur mine, Glencore’s Mangoola mine, Rio Tinto’s Hunter Valley project, and Wesfarmers’ Curragh mine.

Admittedly, Australian coal miners could sidestep the ban by washing and blending their coal before exporting. However, the slump in thermal coal prices, currently trading at a five-year low of $US65/t, will undermine the economic viability of such practice. Australian miners will have to at least partially re-direct coal shipments to other coal-hungry countries in Asia.

Notably, India's growing appetite for coal imports will be an attractive outlet for Australia.

In contrast, we believe Indonesia will emerge as the biggest winner from China's coal ban.

The bulk of Indonesian coal exports are of ash content of 5-7% and sulphur content of less than 1%. Hence, the displacement of Australian coal in China's import mix will allow Indonesia to capture a larger share of the Chinese market, particularly with its proximity to China.

A key downside risk, however, is that exports from Indonesia are vulnerable to policy changes. The Indonesian government could forcefully impose a limit on domestic coal production in order to conserve reserves for the growing pipeline of coal-fired power plants in the coming years.

Other countries that will benefit from the ban include Russia and Colombia, which accounted for 10% and 0.2% of Chinese coal imports in 2013, respectively. Indeed, China's growing energy ties with Russia, exemplified by the ongoing construction of the China-Russia East Route natural gas pipeline, could enhance the shipments of Russian coal to China over the coming years.

Colombia is home to rich coal reserves with an ash content of around 7.0% and a sulphur content of 0.7%. Moreover, the expansion of the Panama Canal, combined with greater domestic development of road, rail, and port infrastructure, should enable Colombia to increase exports to Asia in the years ahead.

A shifting mix

If pushed through, we believe the coal ban will be a drag on Newcastle steam coal prices over the near term. While Australian miners could arrest the decline in Chinese coal demand by diverting more tonnage towards India, this is unlikely to take place overnight.

Nonetheless, the decline in coal prices will not be sustained over a multi-quarter horizon. Currently trading at $US65/t, thermal coal prices are already trading near the cost-support levels for many Australian miners.

A further fall in prices will thus result in production cutbacks and market tightness, lending support to seaborne prices over the coming quarters.