International Thermal Coal – Will Current Trends Continue?
By Dr. Lars Schernikau, HMS Bergbau Group
After two strong years for international thermal coal markets, Q1 and Q2 2019 remind us of 2016 again. While high prices during 2018 were beneficial to coal producers, late 2018 and the first half of 2019 were reminders that nothing lasts forever. The downturn demonstrates the fundamental volatility in coal markets.
This article looks at supply and demand factors, and policy influences, to assess future trends for international thermal coal.
Coal Trends – the Big Picture
During the first half of 2019, one development continued to stand out: the U.S.-China trade conflict and its ripple effect on almost all markets – commodities, equities and debt. Some economists are asking if this conflict is the beginning of the end of globalization. Is business becoming local again? Globalization is not over but its face is changing. The world is becoming more global every day and at the same time more local. Decentralization is fueled by the “trade wars” and also by digitalization, allowing local products and information to be consumed locally more efficiently. But the principal element of globalization is the increase in individual travel and global availability of data products and services, and that remains the key driver for the world’s continuing global marketplace evolution.
What impact is this having on the coal market? Coal has always been about logistics and quality, offered at the most competitive price. The speed at which information travels and the resulting volatility in the form of overshooting and undershooting have also impacted coal. However, the key driver remains the demand for coal-fired electricity which in turn is driven by population growth, power demand per capita and coal’s power sector market share.
Both population and global power demand per capita will continue growing, due to factors including electric vehicles and the continued digitalization of our world. The question is what happens with coal’s share of electricity generation.
International policy is creating headwinds against coal due to concern that CO2 from fossil fuel burning is the main reason for global warming (though warming of only one degree Celsius since the Industrial Revolution has occurred).
The problems of intermittent renewable power have not yet fully hit the “renewable” economies except through increased electricity prices. These increased power prices are negatively impacting competitiveness for energy-intensive industries, and Germany is an example of that.
Coal’s share of electricity generation continues to decrease in the “established” territories such as Europe, the Americas and China, and to increase in the “newly rising” territories such as Southeast Asia, Egypt, Pakistan and in the future Africa. The larger importers in Asia such as Japan, Korea, Taiwan and even India are likely to stay at current percentage levels for some years to come even though gas is pushing against coal (despite the little-known fact that the greenhouse gas footprint of liquefied natural gas is higher than coal’s, considering production, processing, transportation and combustion, instead of only considering combustion as virtually all media comparisons do).
Coal Trends – Supply Side
The coal industry has seen extraordinarily low investments for the past five years. This changed the supply balance and resulted in increasing prices. The current low prices seem counter-intuitive, yet prolonged higher prices may have the adverse effect of coal pricing itself out of the marketplace earlier.
Glencore – despite more recent media reports of a production cap – is one of the few larger companies ready to commit some capital, but others have different plans. South32 is divesting, Anglo is cautious about steam coal, Rio Tinto has effectively retreated and BHP is focusing on adding non-coal resources. Many U.S. producers are concerned about politics, economics or their investors. Indonesia and Russia have been able to continue to invest small amounts, but the cost of capital is increasing as larger and mostly Western banks and funds look at coal more carefully or are retreating altogether. Over 300 investors with more than $32 trillion in assets have signed on to the “Climate Action 100+” initiative. What remains is more expensive capital deployed in countries that are often not as environmentally strict. In the end, this is not good for our environment nor the industry.
In 2018, Indonesia and the U.S. expanded exports (about 25 Mt and 10 Mt respectively). The Indonesian government surprisingly announced it will grant substantially higher 2019 export quotas to most export miners. This decision put downward pressure on coal prices and seems driven by Indonesia’s need to collect more foreign exchange due to the Indonesian rupiah’s devaluation. The price correction in Q4 2018 and Q2 2019 was also driven by increasing lower calorific value (CV) production in Indonesia. Most of Indonesia’s export capacity expansion in 2018 and 2019 is in the range of 3,400-5,000 gross as received (GAR), so certain oversupply is expected here.
Russia will continue to increase its exports of 5,500 to 6,000 net as received (NAR) products, and South Africa will not expand, but lower CV coal will be limited. Australia does not seem to have extra capacity in the short term, and Colombia also appears limited. The U.S. will compete only when prices are high enough.
While the cost of production continues to increase due to geology, labor, machinery and fuel, the produced coal quality continues to diminish. The average CV of export coal has dropped over 10 percent in the past 15 years, from about 5,900 kcal to 5,200 kcal. The wide price gaps seen between higher and lower CV coal may result in consumer adjustments to burn a wider range of coal and to switch faster.
Coal Trends – Demand Side
In June 2019, media mogul Michael Bloomberg announced a new pledge of $500 million to bring down coal, with continued targeting of U.S. coal power plants. Meanwhile, the U.K. has essentially ceased coal burn and Germany plans to stop coal burn by 2038. What about the rest of the world?
In the short term, China’s demand fluctuations continue to rock our industry. 2018 imports were up compared to 2017 despite the end-ofyear pullback and resulting turmoil. For 2019, it appears Chinese imports will be lower than 2018 but hopefully still above 2017. The first half of 2019 confirms this trend. Of course, China’s growth is slowing but this is not a problem as the base for growth is much higher. Power demand continues to increase, as services, homes and even manufacturing become more power intensive. Urbanization and mine closures continue to drive coal imports. Countering these trends are a substantial policy shift into renewables, international pressure to reduce dependence on coal and increasing investments in more efficient Chinese domestic coal production. Also, new transmission infrastructure allows electricity to travel farther from inner China. The net effect of all of this is unknown, but China will keep importing and import levels will be volatile. In 2019, China may start earlier in Q4 to curb imports than in 2018. In summary, demand “miracles” supporting coal prices for the remainder of this year are unlikely.
India’s demand increased most in 2018 (20-25 Mt) and remains strong in 2019. Although the country remains structurally short of coal, it doesn’t shy away from backing off power plants when coal prices are deemed too high. India is likely to keep importing at these higher levels for several years; even government power companies are back in the import market now after a few years of abstinence from coal imports. For producers, especially in Indonesia and South Africa, this is good news. However, competition from the U.S., Mozambique and sometimes even Russia and Colombia will keep South Africa and Indonesia in check.
Southeast Asia and Pakistan also saw increased coal demand in 2018 (20-25 Mt). Looking ahead, Vietnam is expected to add over 30 gigawatts (GW) of coal-fired capacity in the next 15 years, Indonesia another 25+ GW, Bangladesh 10+ GW and Pakistan 5+ GW. In addition, increases are coming from Malaysia, Philippines, Myanmar, Cambodia, Egypt and a few others.
Europe, despite its negative policy on coal, remains structurally short of coal and is an interesting playing field, especially for the U.S., Colombia and Russia.
Wrapping it all up
Coal is key for affordable, clean and safe energy and there is no viable alternative in place. Because of the lack of investment, coal is in fact an ever more interesting investment play.
On volume: 2019/20 will see continued albeit slow increase in international steam coal demand and therefore trade.
On price: Current low prices cannot last and will rebound … when remains anyone’s guess.
On freight: Freight rates were high in 2018, but after years of fewer new builds (from 2012 highs to 2018 lows) vessel capacity will finally grow in 2019. Freight rates in 2019 have been slightly below 2018, but the oncoming sulphur restrictions for fuel will make for an interesting Q4 2019 and likely push freight rates back up.
On the fundamentals: Investments in coal are scarcer, costs are up and high CV coal is more impacted than lower CV coal. Despite current depressed markets, years of higher steam coal prices are likely. The higher pricing picture is even more dramatic in coking coal.
Dr. Lars Schernikau is a shareholder in HMS Bergbau Group of Singapore and Germany, a company marketing coal, petcoke, ores and other bulk products from the U.S., Asia and Africa. Dr. Schernikau is the author of two industry trade books on the economics of the international coal trade (2010, 2017).