Lots of steam still left in coal exports but renewable building a head

Any secular shift to thermal coal demand would be a situation of critical importance to major miners such as Australia and Indonesia. But to date the evidence suggests otherwise.

" Markets inevitably are affected by the vagaries of both supply and demand as well as policy and the cost of generation"
Mark Lawson, Journalist and author

Coal prices, having slumped, have increased sharply in the latter part of the year. Although the coal industry faces strong market headwinds, the undoubted growth in the renewable market, notably wind and solar, in aggregate remains a small factor in global markets.

It is important to too note coal is not all the same. Coals ain’t coals. About 60 per cent of Australia’s coal exports is coking coal used in smelting iron ore into steel, metallurgical coals, which is unaffected by the surge in the use of alternate energy. Even among thermal coals, there are vastly different markets for different grades of coal.

Steaming or thermal coal is supposedly in competition with green energy but, as noted in a Commodity Insight bulletin produced by ANZ Research in late July, prices for thermal coal have picked up from a 10-year low of just $US49 a tonne since January. This is by no means a uniform phenomenon, particularly with regard to greenfield energy generation and different national policy, but it is the direction of global pricing for the moment.

MARKET CONDITIONS

Markets inevitably are affected by the vagaries of both supply and demand as well as policy and the cost of generation.

Buoyed by a 25 per cent gain in oil prices since the beginning of the year, China’s efforts to cut supply, coupled with supply disruptions in both Indonesia and Australia due to heavy rain, saw coal prices edge above $US77 a tonne in September.

This is still well down from the nearly $US130 paid in September 2011 at the height of the resources boom. But it is a sufficient improvement to prompt mining company Glencore to restart its mine at Collinsville in Queensland and cause the share price of PT Adaro Energy, operator of Indonesia’s largest coal mine, to more than double this year.

An analysis of the thermal coal market produced by the Reserve Bank of Australia as part of its June quarterly bulletin in 2015 points out the vast bulk of thermal coal is consumed in the same country in which it is produced with China accounting for about 50 per cent of total production. But both Indonesia and Australia produce far more thermal coal than they consume and export the excess, particularly to Korea, China, Japan and India.

Increasing demand from China fuelled the spike of 2011 and both the ANZ bulletin and the September Resources and Energy quarterly produced by the Office of Chief Economists agree China is also behind much of the latest price surge, driven by government mandated closure of domestic production.

The prevailing view of China analysts is this is in order to boost prices for remaining producers, who are large employers but unprofitable at the rock bottom coal prices of earlier this year. Moreover, Chinese media reports indicate many of the mines closed down had been operating illegally.

As the Resources and Energy Quarterly also notes, another issue was the spike in electricity demand over China’s hot summer, as well as disruption and mine closures in Indonesia. Heavy rain since early July, a typically dry period, has caused flooding in deeper pits, and disrupted production and hauling activity. Those issues are likely to hamper production throughout 2017.

India is another growing energy market, buying coal mostly from Indonesia as the coal from that country is a better fit for its generators, although Australia also has a large slice of this market.

BACK IN THE BLACK

Daniel Hynes | ANZ Research

• Thermal coal prices topped $US100/tonne in October as exporters struggled to react to the shifting dynamics in the seaborne market. Led by China’s sudden reliance on the international market, import demand in the Asian region has surged higher in recent months.
• Despite efforts to limit the impact of capacity closures on utilities in China, we expect import demand to remain strong. Japan buyers have also played their part in the current price rally. A move to more spot purchases (due to high contract prices) came just as Chinese imports surged, catching some consumers short.
• Despite prices now making virtually every producer cash flow positive, an immediate supply response is likely to be muted. Therefore, prices are likely to be dictated by China’s policy measures. If coal output can be temporarily raised leading into the northern hemisphere winter, we could see prices slip over the next couple of months. Even so, we expect spot prices to remain above $US80/tonne over the northern hemisphere winter.

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RENEWABLES

Renewables certainly play a part in the energy mix with their use in Australia increasing and, by one count, 25 per cent of China’s energy production now coming from renewables. Another report from the Office of Chief Economist, the Australian Energy Update 2015, attributes a dip in brown coal production to renewables.

Brown coal is not exported from Australia and is typically associated directly with power stations, such as the pits near the La Trobe Valley power stations in Victoria (one of which, Hazelwood, is scheduled to close in 2017).

For high quality “black” thermal coal producers, renewables such as wind and solar power have yet to make a real impact on their overseas markets. The bulk of the 25 per cent penetration figure cited for China, for example, in fact refers to hydro-electricity from projects that have been in place for many years.

A 2014 report by the International Renewable Energy Agency estimated that about 2.5 per cent of power on the Chinese grid at the time was from wind farms although that figure has clearly been growing strongly.

A count of existing, proposed and under-construction projects in China in the September issue of The Resources and Energy Quarterly shows although hydro and nuclear power are gaining ground against coal, capacity for 'other renewables' (including wind and solar) proposed and under construction remains tiny (although the capacity figures for those green projects are still impressive when quoted in absolute terms).

This point is also made in ANZ’s Commodity Insights which points to substantial increases in the use of hydropower, including a 3.5 per cent year on year increase for the year to June.

A major problem for the growth of other renewables in China is the country’s electricity grid is still primitive compared with Western grids and is run completely differently. A report by the US policy analysis group The Wilson Centre, points out the Chinese grids confusingly remain both provincial government-owned and largely unregulated except for price. The price-setting mechanisms, however, are opaque and electricity use on grids is determined by a quota system and not by cost of generation, as happens on Western grids.

Meanwhile, technological advancement is also present in the thermal coal industry. There is increased confidence in the longer term market as the “better quality” thermal coal processed through new power-gen high efficiency low emission technology (HELE) - which already exists - can deliver up to 35 per cent less emissions than older technology.

Offsetting this of course is growing price competitiveness of renewable generation of all kinds, coupled with improving storage technology such as batteries.

Given the long life of generating assets – typically 40 to 60 years – valuations of assets, or particularly commitment to new assets, is particularly fraught.

India

India has made commitments, at least by announcement, to renewables with a Department of Industry report ‘Coal in India 2015’ stating the government intends to build more than 100 gigawatts of renewable capacity by 2025 but already has 113 gigawatts of coal-fired capacity under construction or approved.

The challenge for India, as indeed it is for base load generation everywhere, is to balance the effective output with demand. The most productive wind farms for example produce at up to 45 per cent of installed capacity (depending on technology and wind) compared with 80-90 per cent for coal plants (coal generators obviously only really on coal supply, not sun or wind). In any case, the Indian grid remains so primitive and prone to blackouts, major users keep diesel generators.

Australia’s most significant customer, Japan, currently has relatively few green energy projects producing energy.  However this too is by no means a static situation. Japan was heavily reliant on nuclear power generation prior to the 2011 Tohoku earthquake and tsunami and consequence nuclear disaster at Fukushima.

While Japan inches towards restoring some nuclear generation it is also investing more heavily in renewable projects, including wave generation and hydrothermal. The spike in coal demand in Japan then has been more reactive to a particular event than a long term trend.

BHP Billiton economist Huw McKay, in a note “How much spark is there in the solar and wind revolution?”, says “in 2015 wind accounted for only about 3½ per cent of power supply and solar accounted for around 1 per cent. And despite the fact that the ‘continuous revolution’ will see the combined share of wind and solar in power generation triple in the coming quarter century, the world will still require roughly four-fifths of its growing total energy needs (of which power is a subset) to come from non-renewable sources.”

As the Commodity Insight bulletin points out, coal faces considerable problems from a range of factors including hydropower in China and the Indian government’s declared policy to reduce imports. Gas has also taken large slices of the power market in the UK and UK (which do not use ASEAN coal). But for miners in Australia and Indonesia, renewables are not a threat. Yet.

Longer term, government policy, incentives, cost reductions due to improving scale and technology and improving storage solutions such as batteries may change the picture. For the moment though, coal producers only have more traditional competition and volatility to worry about.

The big question is how will the shift to renewables occur? Will it be rapid, stranding assets? Or gradual as the price and reliability of renewable generation improves incrementally. For providers of long term investment capital, when long term can mean half a century, timing is critical. So too for policy makers grappling with immediate economic needs and the necessity of combating climate change.

Mark Lawson is a journalist and author