China Coking Coal: Shifting Import Dynamics

BMI View: China will remain reliant on the imports of coking coal over the coming years due to t he country's poor endowment of coking coal resources and the government's initiatives aimed at conserving domestic resources for efficient and sustainable use. Healthy mine supply in overseas markets will ensure that Chinese import demand will be easily met, particularly when pertinent efforts are made by Mongolia to alleviate infrastructure bottlenecks. While Australia will remain the barometer for benchmark coal settlements, its position as the low-cost producer has eroded and the competitiveness of the industry is being reshuffled with the growing prominence of other suppliers such as Russia, Canada and Mozambique.

Despite our downbeat view on the Chinese steel sector ( see: 'Consolidation Catching Up With Bloated Steel Sector ', April 19), we believe China will remain reliant on imports of coking coal over the coming years. Unlike thermal coal, coking coal is a geologically scarce resource and the threat of substitutes is relatively low. While direct reduced iron (DRI) and secondary steel production from scrap metal are alternatives to pig iron from blast furnaces, we believe these alternatives are unlikely to have a material impact on coking coal consumption anytime soon.

Reliance On Seaborne Coal To Persist
China - Select Indicators (% chg y-o-y)

The poor endowment of high quality coking coal resources in China, coupled with the government's initiatives aimed at restricting domestic production and discouraging exports, has turned the country into a net importer since 2009. According to the International Energy Agency (IEA), net imports constitute around 8% of domestic supply on average.

Production Growth Slows
China - Coking Coal Production & Growth

In line with the challenges facing the broader coal industry, the problem of cost inflation driven in large part by rising wages and increasing mine depth has taken its toll on production in recent years. Industry sources suggest that the potential for future production growth is limited in Shanxi, where approximately 55% of China's total coking coal reserves, or 13% of the global total, are located.

Limited Growth Potential
China - Coking Coal Reserve & Resource Distribution By Province (%)

In an effort to conserve domestic resources for efficient and sustainable use, the Chinese government has drafted a new policy document for the coking coal industry. Under the new measures, a cap on domestic production will be implemented and restriction on capacity expansions and production rates will be placed on individual mines. A minimum rate of resource recovery will also be imposed in order to minimize the amount of coal left in the ground. This notwithstanding, the Chinese government applies a system of export quotas in addition to export taxes for coking coal and coke of 10% and 40%, respectively.

Mongolia In Firm Lead
China - Coking Coal Imports By Country (2012)

We believe healthy mine supply from countries such as Mongolia, Mozambique and Russia will ensure that Chinese demand for coking coal imports can be easily satisfied through overseas market. However, we are aware of the trade-offs that come with each of these supply options and have adopted a multi-pronged approach to analysing the export competitiveness of major suppliers.

Reshuffling The Cards
Select Countries - Exports of Coking Coal To China (kt)

Mongolia A Clear Leader

We believe Mongolia will export greater amounts of coking coal to China over the coming quarters as efforts to alleviate transportation bottlenecks gain steam ( see: 'Chinese Coal Demand Fuels New Rail Project', May 24). The development of rail infrastructure will lead to greater cost-efficiencies and enhance producer margins, making exports from the country more competitive. The Tavan Tolgoi mine in the South Gobi Desert, home to the world's largest high-quality coking coal deposit, is well-positioned to feed China's appetite for coal over the long term particularly when major miners such as Anglo American have expressed interests to further develop the coal mine in recent months.

Mongolia & Mozambique Forging Ahead
Select Countries - Coal Production Growth (% chg y-o-y)

The construction of coal handling and processing plants (CHPP) in Mongolia will enable producers to further move up the value chain by exporting washed coal to Chinese consumers. Nonetheless, as a relatively immature mining jurisdiction, we are aware that the constant wrangling between the Mongolian government and foreign investors over mining contracts and legislation remains a key threat to the continued flow of exports to China. In a cautionary tale to the stability of future supply, coal shipments to China were halted between January and April 2013 as state-owned miner Erdenes Tavan Tolgoi (ETT) attempted to solve its funding woes by raising prices of coal exports to the Chinese.

Prices Vulnerable To Weather Disruptions
Hard Coking Coal Benchmark Contract Price (US$/mt)

Australia Losing Competitiveness...

In contrast, we note that China may import less coking coal from Australia over the coming years. Supply from Australia is vulnerable to weather-related disruptions on a regular basis. The Queensland flooding in 2011 caused prices of coking coal to surge to US$330/tonne coal in Q211 after producers and exporters were forced to declare force majeure.

An evidenced by the closures of the BHP Billiton's Norwich Park and Gregory coal mines last year, an increasing number of Australian miners are hunkering down in the face of escalating cash costs due to wage inflation, depleting reserves and declining labour productivity. The introduction of the carbon tax and the Minerals Resource Rent Tax on coal mining companies in July 2012 will further diminish the profit margins of mining companies amidst an already difficult operating environment. The capital intensity of Australian coking coal mines is estimated to be the world's highest, with BHP reporting a surge in cash costs from US$68/tonne in 2007 to more than US$177/tonne in 2011.

Rising Costs Threaten Mining Projects
Australia - Coking Coal, Average Mining Cash Costs (US$/tonne)

In our view, all these problems could sow the seeds for further project cutbacks and subsequently Australia could cede a larger share of the seaborne market to lower-cost regions such as Mongolia and Mozambique.

Moreover, port bottlenecks in Australia have been a recurrent issue over the past six years, with dry bulk vessels often queuing for weeks before loading. Coal exports are currently serviced by nine major coal ports and export terminals in the states of Queensland and New South Wales, with a combined handling capacity of 393mntpa (million tonnes per annum) in 2011. While several new projects are expected to lift export capacity by another 60mntpa by 2015, we caution that some of these projects may fail to reach full fruition should major miners embark on aggressive spending cutbacks ( see: 'Falling Prices Jeopardise Viability Of Anketell Point Port', May 24).

...And Tipping The Scale In Favour Of Other Countries

We expect Russia and Canada to maintain their prominence and remain the important coking coal exporters to Chi na over the coming years. Amid the rush to expand production capacity, a series of plans to improve transportation facilities have been unveiled in these countries.

Vanino , t he second-largest coal port in Russia, will be increasing its handling capacity at the Far East from 13.5mntpa to 18.5mntpa by 2013. Similarly, a new port is being planned at Murmansk by Siberian coal miner SDS . The seaport, which will allow SDS to export up to 18mntpa once it becomes operational in 2015, will mark the start of an alternative route for shipping coal to Asia through the Arctic. Aside from Russia, several coal developers including Xstrata Coal , Posco and Teck Resources will continue to lift output in the coking coal rich Peace River region of British Colombia , Canada .

We believe Mozambique is on the verge of becoming a key African coal exporter as several new projects and expansion plans come online in the coming years. With little domestic demand for coal, the bulk of output will be channelled towards the seaborne market and export to China and India.

Export Potential Hindered By Infrastructure Shortfall
Mozambique - Coal Mines

However, the paucity of sound infrastructure in Mozambique will constraint the country's ability to capitalise on its coal resources, as spotlighted by Rio Tinto's US$3bn write-down of its Benga mine in January ( see: 'Rio Tinto's Move To Diversify Not Without Challenges', January 24). The Sena railroad, the railway line from the mines to the port of Beira, is Mozambique's only existing route for coal exports and does not at present have sufficient capacity to transport coal volumes.

Majors attracted by the massive coal reserves in Tete Province are having to contend with dilapidated and insufficient freight transport network for taking goods to market ( see: 'Lagging Freight Transport Network Risk To Mining Projects', May 16). Additionally, we note that coal deposits in the country are in faults, resulting in very low wash yields of 20-25%, compared with 50% in China and 70% in Australia.

Wyoming Leads In Production
US - Map of Coal Producing States, % Contribution To Total

Persisting Challenges For US Coal

While an increasing number of US coal producers are staking their future on exports to the Chinese market, we believe the feasibility of this should be viewed with a wary eye. The construction of port terminals will continue to encounter fierce resistance from the local community and environmental groups ( see: 'US Coal: Exports No Panacea', April 22). Although exports from the US will continue to grow, the country is unlikely to displace the prominent suppliers in Asia, which enjoys a significant freight advantage, from the seaborne market over the coming years. With nearly 70% of coking coal mined in the US being exported, many of the coal producers in Appalachia will face an increasingly challenging outlook amidst the growing domestic hurdles and intensifying competition from other countries.

This article is tagged to:
Sector: Mining, Freight Transport, Shipping
Geography: China, Australia, Canada, Mongolia, Mozambique, Russia

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