Mark Gresswell, Director and Chief Analyst, HDR Salva, is a new contributor to the World Coal Association on Extract. He will be covering developments in the global coal market and helping to inform and educate readers on coal market fundamentals. The last two years have not been a happy time for thermal coal exporters. Weak prices have squeezed margins, often into the negative, and resulted in severe job losses, mine closures and production cuts globally. However, there is light at the end of the tunnel, and Salva Report is becoming increasingly positive on the outlook for thermal coal. The industry response to the oversupply and weak pricing environment has been to firstly reduce costs. This has been particularly dramatic in Australia, which was one of the higher cost regions. Salva Report’s recently launched Australian Coal Cost Curve shows mining companies have reduced costs significantly in a number of areas.
One focus area has been contractors, with boom-time contracts being reset for overburden removal, drilling and blasting, coal mining, and coal processing. A combination of lower labour rates, lower leasing costs, and lower capital costs for equipment have seen contracting rates drop across the industry. These factors, depending upon the contract and equipment employed, have dropped the costs for some projects by up to 20%.
Despite this, Salva Report’s Australian Coal Cost Curve shows around 40% of the 200 Mt of Australian thermal exports are currently loss-making on a cash basis relative to spot prices. While this is concerning, a number of these mines also produce semi-soft coal or high volatile PCI product which traditionally garner higher pricing. Also, many Australian thermal coal exports are priced at the Japanese benchmark which is considerably higher than the current spot price. So the picture may not be as bad as initially thought, and the cost reduction work done by Australian producers will stand them in good stead when prices recover.
Overall supply growth from the big six exporters – Indonesia, Australia, Colombia, Russia, South Africa and the USA – has finally slowed to less than 3%, which will help rebalance the market in the mid-term as demand catches up.
Export growth from Indonesia, which has typically been at least 20 Mt/y (and up to 60 Mt) over the past decade, has dropped to a trickle, up a mere 2 Mt in the first half of 2014. While Indonesia remains a low cost supplier, it faces a number of headwinds in the form of higher royalties, greater domestic demand (particularly from the power sector) and greater government control on the production and export of coal.
Australian growth remains strong, with exports up 8 Mt or 11% in the first half of 2014. The relatively fixed structure of take or pay contracts plus the generally large fixed costs associated with these coal mining businesses generally, incentivises additional exports in an effort to reduce per unit costs. This has certainly not helped the market rebalance in the short-term, but is entirely rational behaviour given the structure of the industry, particularly take or pay infrastructure contracts.
The USA, which had its highest export years ever in 2012 and 2013 (initially due to high prices internationally and then due to being pushed offshore as gas displaced coal domestically), has reverted to 2011 export volumes, while Colombia and South African volumes are flat. So the surge of supply growth we’ve seen since 2011 is slowing to a trickle.
As with Mark Twain, the ‘death’ of thermal coal is often announced prematurely. While it is true that coal prices have been subdued for quite some time, this is a factor of over-supply rather than weak demand growth. Indeed, the seaborne thermal coal market grew by over 40 Mt in 2013, almost 6% which is hardly the sign of a commodity where demand is weakening. Year to date demand growth in 2014 has been above 4%, still respectable by any measure. Volumes into China, India, Japan and SE Asia are at record or near-record levels, while Europe and the Americas are steady also. Indeed, it is difficult to find a major importing country that is reducing volumes by a material amount, so the demand picture remains solid.
More importantly, the outlook for demand growth is very strong. Salva Report has identified around 45 GW of new coal-fired capacity in Southeast Asia alone that will commence operations before 2019 – this is capacity that has financing and where construction has started. This does not include India or China, who have recently and consistently achieved coal-fired capacity additions of 20 GW and 35 GW per annum respectively, and which show no signs of slowing down. While some of the Indian demand for coal will be met by domestic production, given Coal India’s record we suspect the majority will have to be supplied by imports, which is good news for the seaborne market. China also may well increase its imports, although that will depend largely on government policy and the relevant pricing between domestic and seaborne coal into southern China.
In summary, a lower cost base, slowing supply growth and a robust demand outlook point to a brighter mid-term outlook for thermal coal exporters.
