The cheap energy glut

By Leith van Onselen

For decades, coal has been a linchpin of Australia’s export base. Prior to the China-led commodity boom, coal exports – both thermal and coking – accounted for between 10% and 15% of Australia’s total merchandise exports. Until late-2009, coal was also Australia’s biggest export commodity, only recently ceding its advantage to iron ore, courtesy of China’s fixed asset investment splurge in the wake of the Global Financial Crisis (GFC).

Despite falling to second place on the export rankings, the value of coal exports, as well as coal’s export share, has grown considerably since 2004, as Australia’s once-in-a-century commodity boom gathered pace.

However, there are reasons to believe that coal’s future is not too bright, as a number of dynamics converge to knock coal of its place amongst Australia’s export elite.

The situation looks particularly worrying for thermal coal, which is exported primarily out of New South Wales’ Hunter Valley and is used for electricity generation. Newcastle thermal coal prices have hit three-year lows, with prices seemingly being crunched by two inter-related dynamics.

First, the shale gas boom in the US has seen significant coal to gas switching in power. As a result, US coal is being redirected into the seaborne market, which is adding to supplies into Asia and depressing prices globally.

According to the Energy Information Administration, the US used 18% less coal for electricity generation in the first half of 2012 than in the same period in 2011, and 27% less than in 2008, which was the year coal consumption peaked. And by March 2012, coal’s share of the US electricity-generation market had fallen 34%, from 47% just three years earlier. All over the US, coal-burning electricity plants are reportedly closing down or converting to natural gas, whose prices had fallen by -56% in the year to April 2012.

The US is the world’s second biggest coal producing nation after China. With coal being displaced domestically by cheaper natural gas, the US is moving to export its excess to the rest of the world, helping to push down coal prices globally. Indeed, US coal exports reportedly rose 56% between 2009 and 2011, according to Businessweek.

Meanwhile, China is rapidly shifting away from coal-fired electricity generation and into renewable energy. Chinese coal-fired electricity production in August 2012 was -7% lower than August 2011. Moreover, Coal’s share of total Chinese electricity production fell from 85% in February 2012 to 73% in August, with the difference made up by renewables.

Rising global supplies and falling demand in China obviously does not auger well for Australia’s thermal coal industry, which is facing significant further reductions in income as well as potential cuts to mine expansion plans, mine output, and employment.

And the fallout from increased gas supplies does not stop there. Natural gas exports – Australia’s fourth biggest export commodity by value (behind iron ore, coal and gold) – are also under threat from low cost US gas. In September, reports emerged claiming that Japan was attempting to sever oil-linked pricing for Japanese liquefied natural gas (LNG) imports.

Oil-linked pricing for Japanese LNG imports began in the 1960s. The gas price was linked to the price of oil because it was the substitute for Japanese power generation at that time. At an oil price of $US100 a barrel, LNG landed in Japan from Australia costs around $US14 per gigajoule.

However, with the LNG price in the US now falling amid the shale gas revolution, and the associated talk of large-scale exports from the US and Africa, the Japanese have sought to end the oil-linked pricing system in order to ease Japan’s soaring energy costs.

The Japanese have a history of making sensible decisions with energy supply, acceding enough pricing power to suppliers to cover the high capital costs of supply development, usually via long-term contracts. The move by the Japanese to break the oil benchmark should be seen, therefore, as an acknowledgement of a developing and long-term gas glut. US domestic shale gas costs around $US3 a gigajoule, around one-fifth of Japanese LNG import prices from Australia.

So, there a number of emerging risks for Australia therefore. Firstly, we risk losing significant export share to North America and Africa. There is also the potential for downward adjustments to existing supply contracts under price review clauses, which could further curtail Australian gas export income. Both of these undermine the assumption that the current mining boom has a “third phase”   as net exports drive GDP growth because the investments of today yield high export volume and value growth tomorrow.

Secondly, until recently, the expansion of Australia’s coal and gas industries was viewed as ‘locked-in’, underpinned by a lack of competition in supply from abroad, growing demand from Asia, and, in the case of gas, long-term supply contracts. However, with low-cost supplies emerging in the US and Africa, pricing power is shifting back to the customer. Coal expansions are already swiftly being pared back. But with all the uncertainty surrounding the price outlook for gas, there is an increasing risk that the $180 billion pipeline of planned LNG projects will also erode, jeopardising Australian jobs and growth already under pressure from the coal slump.

Twitter: Leith van Onselen. Leith is the Chief Economist of Macro Investor, Australia’s independent investment newsletter covering trades, stocks, property and yield. Click for a free 21 day trial.

Unconventional Economist

Comments

  1. “The construction of the worlds largest LNG mega-complex here on Curtis Island has been built upon the notion that going forward from now, the world was going to be severely constrained for conventional energy because Chindia would be gobbling up most of the worlds available coal supply. This is now looking less lkely to be the case”.

    I made that quote some time ago and still think it’ll turn out on the money.

    Construction is still going forward everywhere here though – Gladstone airport is as busy as LA X flying workers in and out, the LNG plants are still going, Wiggins island coal terminl expansion still seems to be going, my father just got back from a trip out west and says that LNG infrastructure – machinery and endless truckloads of pipes – lines the roads everywhere south of Emerald. And I haven’t yet heard BHP recant on it’s plans to increase it’s coking coal output from here by 50% over the next 2 years.

    But unless the current global trajectory changes significantly, more and more of these projects will be put on the shelf.

    I think the great likelyhood is that the peak of the Australian resource boom is now behind us – my fellow central Queenslandians just haven’t realised it yet.

  2. Moreover, Coal’s share of total Chinese electricity production fell from 85% in February 2012 to 73% in August, with the difference made up by renewables.

    Are you sure about this Leith? The quote from the Peter Martin story is:

    Professor Garnaut said China had exceeded its ambitious emissions targets, cutting coal-fired generation by more than 7 per cent in the past year. A rapid expansion in hydroelectricity, and wind, biomass, solar and nuclear power, had pushed down coal’s share of energy production from 85 to 73 per cent.

    He includes nukes in there, and I reckon most of the renewables would be hydro.

    While there might be a glut in coal and gas, is there a glut in that most important of commodities: oil ?

  3. The USA is fast moving to the position of the largest oil and gas producer in the world. On one hand that will drive down prices, but on the other hand it will drive their economy and the global economy forward.

      • Let me quote Kurt Cobb:

        The media have become unwitting accomplices in an oil industry propaganda machine that seeks to soften up the American public for an orgy of drilling — one that will only drain America’s limited oil resources more quickly while achieving neither energy independence, nor lower prices, nor an urgently needed transition away from finite petroleum, a transition that would free us from the tyranny of oil and the companies that control it.

        From Why the U.S. is NOT the new Saudi Arabia

        • Cheers R2M,

          I’m going to have another whinge about the formatting of quotes being so ridiculously thin that they are unreadable without significant effort.

          Not sure who can help fix this as I’m not sure of the source of the problem. This is just to help people who use quotes to be aware that not everyone is able to read them (you could try using italics).

          • well how about it, site owners?

            I know that us tight-arses (speaking only for myself, I just like to refer to myself in the plural) aren’t paying for any of this, but can ya fix it for us?

  4. reusachtigeMEMBER

    Today is a good day for a wager, so who would lay money on Tinkler going bust? He is the aspirational bogan poster boy after all and has therefore lived it up as extravagantly as he can, right up until it’s all gone.

  5. Given the huge production drop off in the new shale gas wells (some wells record a 75% fall in production over just 1 year) I cannot help thinking that drilling in the US will need to remain at a pace to keep up with all this increasing new demand. Yet, indications are that low US pricing is pushing many drillers to the sidelines. Looking at US nat gas prices, a bottom appears to be in however that does not mean a return to high prices just yet.

    As this all effects coal demand/production in the US and therefore globally, what we have is an extremely fluid market situation that is being buffetted by many extranious factors, the outcomes for which still remain unclear. There is significant risk in taking any position.

  6. The silver lining to this situation is twofold: we have a lot of uranium, and it should keep domestic energy prices down.

  7. Over the longer-term horizon and excluding hitherto undiscovered energy sources fossil fuels will continue to be utilised.

    Shale gas plays likely to prove unspectactular, natural gas demand will increase as will demand for coal. Green technologies are unrealistic on scale and will remain prohibitively costly.

    Sure, there may be some short-to-medium term volatility, but long term, investment in natural gas will prove its worth.

    • Very soothing. Like to back it up with some evidence or further analysis, esp. the part about pessimism on shale oil?

      • For various reasons I broadly subscribe to the views presented by Nicole Foss (and was fortunate hear more first hand when Foss was in Perth earlier this year). Read these, you might find them of interest.

        http://theautomaticearth.com/Energy/renewable-energy-the-vision-and-a-dose-of-reality.html

        http://theautomaticearth.com/Energy/unconventional-oil-is-not-a-game-changer.html

        http://theautomaticearth.com/Energy/get-ready-for-the-north-american-gas-shock.html

        ps Foss (a nuclear scientist) provided prompt accurate analysis of the severity of Fukushima at the very time ‘experts’ were downplaying the likelihood of damage to other reactors and release of contaminated fluids.

        Everyone has a weakness, Foss is mine!

        • In addition, I like Grantham. He recognises that over time resources, forestry and farmlands will each rise in importance – it is inevitable.

        • 3d1k I had a look at the article you suggested by Nicole Foss and is so much like reading Nexus magazine.
          There are quite a few mistakes like “The gearbox of a two-megawatt wind turbine contains about 800 pounds of neodymium and 130 pounds of dysprosium”. There are no rare earths metals into the gearbox. There are rare earth metals in the permanent magnets inside the generator but when people write things and are not paying attention to what they do I tend to look with skepticism at the whole lot. There are other things that are wrong but I don’t want to go in that as this isn’t the purpose of my comment.

          Let’s do some maths:

          1. An onshore wind turbine with a capacity of 2.5–3 MW can produce more than 6 million kWh in a year – enough to supply 1,500 average households with electricity.
          2. In Australia we have roughly 9 million households.

          So we could cover just by using wind all the consumption of the private households with 6000 wind turbines.

          With a price of 1 million a pop that translates to 6 billion dollars!

          I agree is a very rough calculation and I didn’t take in account storage, distribution, losses etc. But I haven’t taken in account the photovoltaic panels either that are actually producing something.

          My point was not to take any article out there as the absolute truth. There are lots of vested interests or some people are just misled.

          With physics and engineering is much easier than with economics to take the pen and check someone assumptions.

          • VonZ, thanks for that. I’m no expert in the field but have previously found Foss to be very good.

            This US paper prepared by an arm of the US Government provides an in-depth analysis of wind turbine capacities, components, projected costings and resource utilisation – page 15 covers raw earth usage – might be of interest. Cheers.

            http://pubs.usgs.gov/sir/2011/5036/sir2011-5036.pdf

        • I’m a Foss fan too 3d1k. You’re starting to make sense to me, which means I have to up my meds dosage I guess. 😉

    • Green technologies are unrealistic on scale and will remain prohibitively costly.

      You do realise that this must change at some point in the future. No matter how nutty your belief system — and there are some real fruitloops here — humanity must at some point stop using fossil fuels and use something else.

      I’m not saying that will be in 10 years time, 50 or even 1000, and I’m not saying it will necessarily be wind, solar, tidal or whatever. It could be fission, it could be fusion, it could be big solar panels in space, I don’t know, but there is no f***ing way that we can use fossil fuels forever.

      Just sayin’

        • MineBot, I have no illusions about how staggeringly difficult it will be to transition to a 100% renewables and/or nukes energy supply. That doesn’t change the fact that it must happen.

          The only alternative is that we make do with much less energy.

          Please outline a long-term scenario where we use fossil fuels forever (and you can assume climate change is a hoax).

          • That is a problem for our great great grandkids to worry about.

            Why should the self-interested, “greed is good”, me, me generation have to worry about that?? Be optimistic!!

          • Apparently not.

            Curiously the MineBot seems to have taken on board the Peak Oil Doomer view that renewables won’t cut it, unconventional oil won’t cut it, and shale gas isn’t a long term proposition — views which in many ways agree with — but he completely fails to tell us what will replace fossil fuels.

            His argument goes like this: Fossil fuels are becoming increasingly scarce and expensive, but nothing can replace fossil fuels, therefore we must keep using fossil fuels.

            You really can’t argue with that kind of logic.

          • In a roundabout way, yes. I think that for all the reasons Foss outlines Green energy will wither, return to fossil fuels will be embraced. Where I differ is that I expect a new energy source to be discovered (eg thorium et al) which will revolutionise just as the industrial and tech revolutions have. It’s gonna be OK!

          • Ok, so you’re going with some-magical-new-energy-source-will-save-us and in the meantime we should press on with business-as-usual because “it’s gonna be OK”?

          • “It’s gonna be OK” is actually a rational point of view. The chief advantages of our species have been our ingenuity and adaptability.

  8. Hey Leith,

    That is a nice article, with a short term view.

    The extraction of shale (economically) is not predicated on a $3gj price at all. Gas production has almost dried up; the focus is now primarily on oil, which is now having a large effect on oil prices.

    Shale production takes along time to plan, drill and complete the well.

    Japan “wants” non oil linked pricing. They may well get it, but they will just be accpting a different kind of risk!

    Suppliers need long term and stable contracts. The same reason why the first post on this thread is incorrect; gladstone is built on 20year supply contacts. Australia attracts a premium over other suppliers such as africa and qatar!

    The glut will clear in time!