Rising coal demand in Asia-Pacific 0 comments

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One of the more visible trends developing in recent months has been the rising prominence of coal as an energy commodity, with coal prices rising along with surging demand and brokerages setting amazing price targets on key coal producers like Shenhua (China's top coal producer) and Singapore's Straits Asia surging in sympathy.

The key reason: China has become a net coal importer of coal. Together with iron ore and cement, coal now forms the triumvirate of commodities widely seen to be responsible for the surge in the Baltic Dry Index of late; the BDI measures the charter rates of bulkers and is an indicator of dry-bulk trade.

Coal is usually divided into thermal coal and coking coal; the former is used for steam generation to produce electricity while the latter is used for producing steel. According to IEA (International Energy Agency) figures, international thermal coal trade has grown much more significantly than coking coal, almost doubling to 590Mt in 2006 from 1996, compared to coking coal's puny ~10% growth over the same period to 220Mt.

The prices of both thermal and coking coal are projected to rise continuously over the medium-term; the former due to its being the fastest-growing energy source as rising oil prices prompt users to switch fuels, the latter due to rapidly rising steel production in China and India. The attractiveness of the substitution trend can be seen in their relative prices in 2006:













The swing of China from net coal exporter to net importer is significant because it is both the world's top coal consumer as well as its top producer. China produces about 2.5X as much as the next biggest coal producer (USA). Hence the swing to net importer suggests significant future growth in demand-supply imbalance, in absolute terms. At the same time, it also becomes a source of competition for global coal imports to the incumbent biggest importers: Japan, South Korea, Taiwan --- all in the Asia-Pacific! Not to forget the rapidly expanding economies of India and Vietnam. No wonder there is sudden bullishness on coal.

Although the upstream segment of the value chain is poised to benefit the greatest and has come in for market attention recently, the demand pull effect should pull margins upwards along the entire value chain. This would include marine logistics service providers (owners of tugs and barges), supply chain managers (that manage the movement from source to destination), shipbuilders (which build the bulkers). There is still value in many of these related stocks. As for main country beneficiaries, one only has to look at the main incumbent coal exporters: Australia and Indonesia. Of the two, Indonesia (see "Southeast Asia as an energy resource hotzone") seems to have better investment potential because of (1)environmental concerns in Australia; (2)port congestion problems in Australia that cannot be resolved in the short-term; (3)higher composition of thermal coal export(80%) as proportion of total coal exports for Indonesia. Thermal coal is seen as the more critical resource as power generation cannot be outsourced, while steel can be imported (indeed, China is itself trying to limit steel production). However, if Indonesia decides to cut exports and save the coal for its own domestic needs (as in the case of natural gas), then it might drive supply further down, and coal prices further up.

References:
(1) World Coal Institute
(2) China Coal Market Analysis and Forecast: Sep 2007
(3) Bloomberg report Sep 13: Indonesian Coal Shares Surge as China Exports Decline