Seaborne Thermal Coal – the Next Bull Market
Ed note: This article was originally published in Issue 2, 2015 of American Coal Magazine
By: Mark Gresswell, HDR
If we were to assess the future of the global coal sector from reading the mainstream press, we could safely assume that the last mine was about to close and that draglines and long walls would be museum artifacts within a decade. Thankfully some of us still analyze the fundamentals of commodity markets rather than just push an ideological position, unconstrained by the inconvenience of facts.
Mark Twain famously noted, “Reports of my death have been much exaggerated.” This very much applies to coal, particularly the seaborne thermal market, on which this article focuses. Global coal markets, including domestic markets in the USA and China, have endured a very difficult period since mid-2012. However, in our view, the reasons for this are cyclical rather than structural, and the outlook is far brighter than many assume. This view leads us to have a rather bullish take on seaborne thermal coal. Although we are, in no way, downplaying the headwinds American coal operators face over the next couple of years.
Let’s first understand why markets are currently weak. There are two reasons:
- Massive supply growth from 2010-12 resulted in a glut of coal in the market, pushing prices down. From 2010-12, over 250Mt was added to the market, a 43% surge in supply (chart below). This was largely due to high prices (above US$80) from late 2007 onwards, which incentivized new supply. All major exporters—Indonesia, Australia, South Africa, Russia, Colombia and the United States—increased volumes over this period.
This massive surge of new supply had the obvious effect of reducing prices, which fell from around US$140 in early 2011 to around US$60 at present. These weaker prices, in turn, have resulted in a sharp slowdown in supply growth since 2013, as the market tries to rebalance and stabilize prices. Just as the market reached some equilibrium in mid-2014, the second factor came into play, namely:
- China, the world’s largest importer of thermal coal at the time, started to sharply lower its imports in Q4 of 2014, in an effort to protect a domestic coal production sector under significant stress. This slowdown accelerated sharply in 2015 (chart below).
In recent months, Chinese domestic coal prices and thermal coal import levels have stabilized, indicating that the domestic market has been able to balance supply with demand, which will also support the seaborne market.
And seaborne prices have remained remarkably resilient in 2015, falling only US$4 while the major importer (China) has reduced its intake by 40%. This indicates a market that is very close to the bottom. And looking forward, the fundamentals are bullish.
Demand Growth is Compelling
As with many markets, Asia has emerged in the last decade as the driver of demand for seaborne thermal coal. In 2004, Asia accounted for just over half the global seaborne thermal coal market, which was around 470Mt in total at the time. Japan, Korea and Taiwan were the major importers, along with Europe, which was the largest market (chart below left).
Fast-forward to 2015, and the market in total has approximately doubled to 960Mt. However, the largest change has been in the composition of the market with India now the largest importer and China and other Asian markets emerging as significant importers. As a total, Asia accounts for over 75% of the market and has accounted for almost all growth over the decade (chart below right).
We expect this growth to continue for the next decade. There are some very compelling fundamental drivers of this growth:
- Market size-over 3.7 billion people live in Asia, almost half the world’s population—Asia contains nine of the world’s twenty most populous countries—China, India, Indonesia, Pakistan, Bangladesh, Japan, the Philippines, Vietnam and Thailand. And many of these countries (with Japan and China the obvious exceptions) have high birth rates and population growth.
- Economic growth – while countries like Japan and Korea are in the advanced stages of economic development with gross domestic product (GDP) levels comparable with the world’s leading economies, large parts of Asia are still very early on in their economic development.
- Low electricity consumption rates – closely related to the point above, outside Japan, Korea and Taiwan, the rest of Asia has very low electricity consumption rates. For example, China’s per capita consumption (3400kWh) is only half of Japan’s (6800kWh), while India (530kWh) and South East Asia (660kWh) languish even further behind.
- Coal is by far the cheapest source of electricity in Asia. Unlike Europe and North America, where gas (shale or natural) competes strongly with coal on a fuel cost basis per unit of electricity provided — with the help of carbon pricing — coal is far cheaper than gas for producing electricity in Asia. There are relatively limited gas reserves in Asia, and gas imports are too expensive.
This is a compelling demand picture, which is being backed up by investment. India is consistently commissioning around 20GW of new coal-fired capacity every year, while North Asia (Japan, Korea and Taiwan) has over 20GW of new capacity coming online by 2020. Flying under the radar is South East Asia, which is scheduled to commission over 25GW of new coal-fired capacity before 2020. All of the new capacity mentioned here for North Asia and South East Asia will rely entirely on imports, while India’s growth will also largely depend on seaborne thermal coal. China continues to invest in coal-fired capacity, albeit at a lower rate, and its import requirements are much more complex to assess.
Even assuming China’s imports do not increase from 2015-20, the incremental demand for seaborne thermal coal in Asia over this period will be well above 200Mt, and may even approach 300Mt.
In summary, the world’s largest and fastest growing region has a long way to go in its overall economic development, which will drive rapid electricity consumption growth — powered predominantly by coal, the most economic fuel in Asia.
Supply Growth is Constrained
Given the growth in demand above, the question then becomes how will supply respond? There are six major exporters of seaborne thermal coal, who supply over 95% of exports. These are Indonesia, Australia, Russia, Colombia, South Africa and the United States. From 2004-13, these suppliers combined to increase exports by an annual average of 50Mt, but since then volumes have contracted.
The ability of exports to grow quickly has been severely constrained in recent years:
- New investment in thermal coal mines globally has plunged since 2011 as prices fell, and it is very difficult to find new sources of supply being developed;
- Indonesia, by far the largest supplier globally, is under severe pressure from high costs (as they are denominated in USD), weaker demand from key markets, and sharply rising domestic demand for coal, which reallocates coal previously bound for export markets. Exports from Indonesia could fall as much as 40Mt in 2015;
- South Africa and Russia are infrastructure-constrained and cannot ramp up volumes significantly.
- The United States’ coal industry is under massive pressure, from a combination of low gas prices, and air emission regulation being driven through the EPA. Mine closures and corporate bankruptcies are unfortunately becoming commonplace.
Australia and Colombia are the two seaborne suppliers who are still increasing volumes, as they remain competitive into key markets (Asia for Australia, Europe for Colombia) and are not particularly constrained by infrastructure. However, the growth from even these suppliers is not even close to matching the demand requirements projected above.
Combining this anemic supply outlook with the bullish demand picture, the fundamentals for seaborne thermal coal over the next 5-10 years are very strong, and will result in a period of sustained price increases – otherwise known as a bull market. You heard it here first….
Mark Gresswell is an HDR director and chief analyst based in Brisbane, Australia, providing economic and market analysis to North America and global clients. HDR specializes in engineering, architecture, environmental, and construction services for the mining sector, with more than 225 locations around the world (www.hdrinc.com).