The coal price pincer tightens

Earlier this week, I prognosticated that Australian coal exports could soon be facing hard times due to:

Increased competition from US coal exports, due to domestic coal-to-gas switching arising from the US shale gas boom; and
A shift away from coal fired electricity generation in China due to rising pollution concerns.

My views seem to have received support this week from seperate quarters.

First, today’s Reserve Bank of Australia’s (RBA) quarterly Statement on Monetary Policy, which contains an entire chapter devoted to the coal market, describes the growing competition from US coal exports and the downward pressure this is creating on coal prices:

A key driver of the fall in thermal coal prices over 2011 and 2012 was an increase in the volume of exports from the Americas. Exports from the United States rose by over 50 per cent in the first half of 2012, after almost doubling over the previous two years from low levels (Graph A2). US coal exports increased as domestic energy demand shifted to gas. This followed a decline in US natural gas prices over 2011 and into 2012 as production of unconventional gas from shale rock increased. While some US coal producers responded by reducing production, others took advantage of low global freight rates to increase their exports of coal to Asia and Europe. The reduction in demand for coal in the United States also meant that US imports of coal declined. In response, countries that exported to the United States, such as Colombia (which had supplied around 80 per cent of US thermal coal imports in 2011), have increased their exports to other countries.

The RBA also describes how coal supplies from Indonesia – the world’s biggest coal exporter – have also surged, which is combining with increased supplies from Australia and elsewhere to push-down prices:

Increased production of thermal coal by the large exporters of coal has also weighed on prices. The rapid expansion in Indonesian coal exports over the past few years has been driven by high rates of investment in resource extraction. In Australia, largescale expansions to infrastructure, predominantly at the Port of Newcastle, have supported the growth of exports. Further, shipments from major exporters such as Russia and South Africa, which supply both the Atlantic and the Pacific markets, have also increased over the past couple of years.

It seems that I might also have been right on the second headwind, with China this week announcing that it would cap coal consumption at 4 billion tonnes from around 3.9 billion tonnes in 2012. From The SMH:

China’s decade-long boom in coal-driven heavy industry is about to end as the leadership shifts priorities towards energy conservation, say officials and policy advisers.

The advisers predict China’s coal consumption will peak at only a fraction above current levels after the State Council, or cabinet, last week set an ambitious new total energy use target for the five-year plan ending 2015.

“Coal consumption will peak below 4 billion tonnes,” Jiang Kejun, who led the modelling team that advised the State Council on energy use scenarios, told Fairfax Media.

“It’s time to make change,” said Dr Jiang, who is director of the Energy Research Institute under the National Development and Reform Commission (NDRC). “There’s no market for further development of energy-intensive industry”.

The imminent stabilisation of coal usage…[would]…trigger a negative income shock to Australia, the world’s biggest exporter or coal and iron ore, with significant implications for government budget forecasts.

Dr Jiang said the energy targets would bite hardest with energy-intensive heavy industries such as steel – dependent on iron ore and coking coal – which he said had saturated their potential markets and could no longer make money.

Thermal coal-powered electricity generation would continue to expand at a low pace…

Professor Pan said energy security remained the primary motivation behind the measures but last month’s record pollution readings in North China had contributed to the hardening of political will.

“Chinese people have done enough tolerating such bad air,” he said…

Officials at NDRC have been telling visiting delegations in recent days that coal consumption will peak below 4 billion tonnes and the government would do “whatever it takes” to hit the overall energy use targets.

Professor Pan predicted coal consumption would peak at less than 4.2 billion tonnes by 2015 while other global commodities markets would be hit at least as hard.

He said a continuing increase in coal-powered electricity generation would be offset by a production plateau in key heavy industries.

“I don’t think there will be further scope for expanding iron and steel production, or cement,” he said.

So according to the article, China’s new energy targets are not just expected to reduce growth of thermal coal consumption, but also stifle growth in Chinese steel production, which in turn would limit consumption of coking coal and iron ore. These three commodities – iron ore (23% share) and coking and thermal coal (combined 16% share) are Australia’s three biggest export commodities (see next chart).

If enforced by the Chinese authorities, the cap on energy use would, in the process, cap the volume Australian iron ore and coal exports, just as new global supplies are scheduled to come on line. The combination of these factors could potentially lead to sharp falls in export prices, leading to reductions in Australia’s national income.

So far, Australian energy analysts seem highly sceptical that China can meet its energy targets, describing the targets as “aspirational” only and arguing that it would lead to an intolerable drop in the GDP growth rate:

UBS commodities analyst Tom Price said… the National Development and Reform Commission’s targets basically called for ”flatlining” energy use, an unreasonable forecast because China depended on coal for 80 per cent of its power. ”It’s highly likely their coal consumption rate will continue to lift by at least a couple of per cent,” he said, describing the 4 billion-tonne target as a ”nice academic exercise”.

One senior energy industry executive based in Australia questioned whether China set an ”aspirational target”.

The real question, he said, was whether China’s leaders were ”ever going to ration energy in order to achieve some emissions objective … [and] throttle economic growth”…

”They want to try and put a limit on coal? We’ll have to see how they go with that,” he said. ”There’s a long way to go before [China’s] coal demand peaks. It’s certainly not going to peak in this five-year plan.”

Even though there are doubts over whether China’s energy target will ever be enforced, there is likely to be a shift away from heavy commodity use as the Chinese economy transitions from commodity-intensive, infrastructure-led, growth towards more sustainable (and less commodity-intensive) consumption-led growth. And this transition is only likely to gather speed as pollution concerns rise and social resentment grows.

Energy target or not, the growth in commodity demand from China is likely to fall in the face of rising global commodity supplies, which can only be bad for Australian export prices and national income.

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