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Troubles in China and Europe: Impact on coal prices
What we took away from the recent Coaltrans Asia conference in Bali was that long term prospects of coal remain buoyant, driven by worldwide energy demands
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hat we took away from the recent Coaltrans Asia conference in Bali was that long term prospects of coal remain buoyant, driven by worldwide energy demands. However, in the short term to mid-term, prices will remain unexciting. We shared the view of the consensus that prices will remain between US$80 and $100 per ton (our assumptions is $90/ton) in the near-mid term. We have therefore cut our rating on the coal sector from “overweight” to “neutral”.
The prices are going to remain unexciting in the near term because of the following reasons: The China bubble, the Chinese government’s cap on power prices and their encouragement of vertical integration, and the European crisis.
China’s economy is dependent more on investment and exports than on domestic consumption. The slowdown in the US and Europe will impact China’s exports, therefore slowing down China’s economy.
Separately, the government encourages investment in various sectors, to support the export from the country, but as the exports decline, there will be less investment in the economy. Less investment means less jobs in the country in turn reducing domestic consumption, again slowing down the economy.
Lower levels of investment and domestic consumption also mean a slowdown in the manufacturing sector, and therefore the coal requirements of power plants will decline. Examples could be cement and pulp & paper industry. Apart from this, there is a property bubble in China, and if it busts, it will lead to huge fall in the property prices. Fewer property would be built, and then it will lead to lower consumption of steel, and thus coking coal. This will limit the upside of coking coal prices. The cement industry also uses coal for power generation, which will also reduce with a slowdown in cement industry resulting from property bust.
Chinese government regulates the power sector in China. Coal markets are liberalized while electricity prices are still tightly capped to stem inflation and maintain “social stability”. The cap on power prices means that power companies can run into losses if coal prices were to rise significantly. To prevent this, Chinese coal prices are prevented from rising by too much. That being the case, if international coal prices were to rise, then China will use more domestic coal and import less, which will limit coal price rises internationally as China is a net importer of coal. Apart from the cap on the power prices, the country is also encouraging vertical integration of power companies. That means that power companies are encouraged to own their own coal mines, which is a plan designed to limit coal prices going up.
European countries mostly have a lot of debt. Their state budgets are therefore limited as they cannot borrow more funds to expense in their own zone. Therefore there will be less state spending and less investment in the eurozone. This will limit jobs in those countries and therefore domestic consumption; resulting, again, in an overall slowdown in the economy. Slowdown in Europe would impact its manufacturing industry, and therefore it would impact the coal demand. Also Europe imports coal from Indonesia. Our study on the coal stocks in our coverage shows that Bayan resources (BYAN) have the largest exposure to the EU with 16 percent of its total sales to Europe. This is followed by Indika Energy Tbk (INDY), Adaro Energy (ADRO) and Indo Tambang Raya Megah (ITMG) at 12 percent, 9 percent and 7 percent respectively. State-owned coal mining company PT Batubara Bukit Asam (PTBA) is the only company with no exposure to Europe, selling the majority (59 percent) of its production in the domestic market.
Though we are bearish on the near to mid-term coal prices, we are bullish on long term coal prices, driven by strong energy demands around the world. Speakers from various countries at the Coaltrans Asia conference were also very positive on long-term coal demands, given their rising power requirements. For instance, India’s power demand will rise from current 147 gigawatts GW to 225 GW by 2012, to 313 GW by 2017 and to 950 GW by 2030.
As far as China is concerned, it is expecting to double its power requirement by 2020. With this, about 60 percent of the coal output in 2007-2030 is projected to come from China. South Africa’s reserves are 31 billion tons, and annual sales are about 300 million tons out of which domestic sales are about 74 percent of the total sales.
The electricity sector dominates coal consumption, accounting for 60 percent of all coal pulled out of the ground. The South African representative at the conference mentioned that domestic electricity consumption will continue to dominate, thereby limiting the exports. Apart from increasing domestic demand in South Africa, speaker from Vietnam, mentioned that power demand domestically is going to rise significantly. It estimates that between 2011 and 2015, the nation’s power capacity is going to increase by 4,100 megawatt (MW) per annum; between 2016 and 2020, it will increase by 4,600 MW a year while between 2021-2025 it will increase by 4,800 MW per annum. Vietnam currently exports about 50 percent or 24 million tons of its coal, but going forward this number will fall to only 3 million tons, despite coal production rising from 48 million tons in 2009 to about 105 million tons in 2025.
Indonesia, which has rich coal reserves (resource of 104 billion tons, reserves of 20 billion tons), is expected to produce 270 million tons in 2010, about 206 million tons will be exported. By 2025 the production will rise to 405 million tons, out of which export will be 185 tons, implying a drop in export coal from 76 percent to 45 percent between 2010 to 2025. This will be driven by strong energy demands at home. Indonesia is expected to add a total of 20 GW of power by 2015.
As the worldwide demand for power is growing (India, China, Indonesia, South Africa and Vietnam are some examples), we expect long term coal prices to remain buoyant. However in the near future we expect prices to remain within the $80-100 per ton range, we have a neutral rating on the sector with Bumi Resources Tbk (BUMI) and PTBA as our top picks.
