W

ith an economic slowdown affecting the four biggest coal importing countries of China, Japan, South Korea and India as well as the prolonged European debt crisis and the flooding in of coal supplies from non-traditional seaborne exporters such as Colombia and the US, the Indonesian coal sector remains under pressure. With this condition, we expect price underperformance (exhibit 1) to persist going forward.

Furthermore, Indonesian coal counters will suffer from the recent news of the government's plan to raise royalties on mining business licenses (IUP) holders, especially for PT Batubara Bukit Asam (PTBA), which is the most exposed to the policy since all of its concessions are under IUPs.

Hence, we have virtually maintained our reduced ratings on all coal companies under our coverage with the exception of PTBA and PT Borneo Lumbung (BORN), which both have “hold” recommendations given that their share prices have come down close to our target prices.

Coal demand will not pick up in a meaningful way in the near term as electricity demands from the above-mentioned countries, which contributed more than 50 percent of 2011’s seaborne coal trades (exhibit 2), are beginning to contract.

We note that China’s economic growth in the second quarter of 2012 (Q212) was below the 8 percent year-on-year level for the first time since the global economic crisis in 2008-09, while India’s Q212 GDP growth also decelerated to 5.5 percent y-y. Meanwhile, Japan’s and South Korea’s Q212 GDP was also weaker, experiencing growth of just 1.4 percent y-y and 2.4 percent year-on-year respectively (exhibit 3).

More damage is to come in quarters three and four of 2012 (3Q-4Q12), from heavy rains in China that boosted hydropower generation and brought down thermal power production (exhibit 4). In the past three months, China’s hydropower output grew to 19-34 percent year-on-year while on the flip side thermal power output was down by 2-5 percent year-on-year.

Data showed that hydropower contributed 22 percent of the total electricity generated in China in July 2012, while thermal power plants dipped below 80 percent for the first time since October 2010. We understand that Chinese coal imports are still growing strongly this year, however in our view this is not related to the fundamentals of coal demand but to decreasing international coal prices relative to domestic coal prices.

Hence, as China’s domestic coal prices started to fall in June, we expect coal imports to decline moderately in the second half of 2012 (H212) as the difference between domestic coal prices and international coal prices narrow.

We estimate coal prices in 3Q-4Q12 to stabilize at current levels, moving in the range of US$85-90/ton due to a lack of catalysts, bringing the average coal price in line with our full year coal price forecast to $97/ton.