Thanks to a plateau in coal demand for power generation and a decline in coal demand for other purposes, China’s domestic consumption could remain virtually stagnant over the next five years, suggest Deutsche Bank analysts. Michael Hsueh said in his March 24 research note titled “Thermal Coal: Surpluses are here to stay” that he anticipates that price pressure will generally remain to the downside for thermal coal.
Slowing growth in power consumption in China
On the back of softening demand in China and India’s greater reliance on domestic coal resources, Hsueh argues that longer-term forward balances look as wide as ever. He points out that China and India rank third and fifth in the world in coal reserves, behind the U.S., Russia and Australia:
Tracking slower power demand growth in China, Hsueh points out that growth in power consumption in China has slowed in the past several years from an average pace of 10.7% p.a. over the 2006-11 period to only 5.0% p.a. from 2011-15 and 2.4% yoy last year. The DB analyst believes a slower pace of power consumption growth going forward, coupled with growth in power generation from wind, nuclear, hydroelectric, solar and biomass, may allow the government to place less emphasis on thermal coal.
However, the DB analyst anticipates that China’s domestic thermal coal production will rise slowly, only at 1.3% p.a. as the small mine consolidation program continues and the government focuses on controlling overcapacity. The analyst believes this would result in a slow narrowing of its seaborne import demand with the potential for net exports by the end of the decade:
On India, the analyst points out that with Coal India enhancing production from 494 mt in FY 15 to 693 mt in FY 20 in Indian coal equivalent terms, Indian import demand could drop from roughly 160 mt in 2015 to 90 mt in 2018.
Indonesia and Russia could face margin pressure
The DB analyst adds that with Indonesian costs now being toward the top end of global seaborne costs on a weighted average basis, he has lowered his expectations of this year’s Indonesian export supply by the largest increment from 361 mt to 331 mt. The analyst notes that Indonesian producers are under pressure to reduce costs by lowering strip ratios and reducing overburden removal by 15-20%, according to SX Coal.
Hsueh argues that currencies are having an outsized effect on cash costs, although producer costs are only partially denominated in local currency. The analyst points out that the Indonesian rupiah has lost only 3% this year, against its average value in 2015 versus the dollar. He notes that this compares favorably against the Russian ruble and South African rand, both down 26% from their 2015 averages:
The DB analyst believes that among the top five exporting countries (Australia, Russia, Indonesia, South Africa, and Columbia), Indonesia and eventually Russia will be under the most pressure from narrower margins in 2017, and consequently, these exporters may see volumes fall in response to lower seaborne demand.
Hsueh points out that only Indonesia retains an energy-adjusted price advantage into southern China compared with Chinese domestic coal shipped from Qinhuangdao to Guangzhou. The analyst notes that Qinhuangdao can be said to be leading the market lower in terms of pricing despite a consistent backwardation in the forward curve since 2014. The DB analyst argues that irrespective of the reason for the backwardation, he doesn’t believe it to be a sign of an impending recovery given the long-term outlook, which involves a series of consecutive annual declines in seaborne demand for the next several years.
The DB analyst concludes that prices will remain under pressure for the foreseeable future, while producers are forced to rationalize operations to enhance margins where possible and trim volumes otherwise.
