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The current price environment of short to medium term coal oversupply is creating a downward pressure on prices and reducing thermal coal producers’ margins. Within this challenging business environment, coal producers need to identify new sources of incremental margin other than traditional production capacity expansion to enhance return on capital and reduce earnings volatility.
Accenture estimates expansion into trading, marketing and logistics to be a significant growth opportunity for miners to exploit market arbitrage. Today, multiple trading strategies exist for miners to increase margins by blending lower and higher calorific value coal and selling the mix in end markets, or by changing sourcing patterns by buying coal in slightly more depressed markets, like the US, and redirecting exports to higher value markets, like China. Coal Producers will need to consider this strategy if they are to remain competitive and hedge themselves against future risks. Accenture estimates that coal producers which can execute this value chain expansion into trading and marketing will enhance long-term financial growth and stability, particularly Asian Coal Players who have traditionally focused solely on upstream production assets.
The current thermal coal market dynamics indicate that oversupply into the market of an estimated 150 million tonnes is creating significant downward pressure on prices. Prices of thermal coal have fallen steadily by c30-50 percent over the past two years and by over 100 percent over a five year horizon. This has had a significant impact in reducing thermal coal producers’ margins.
We anticipate that prices have currently reached a floor where capacity rationalisation would prevent further downward price movements. The 85th percentile of the cost curve is currently for at $87/tonne for Australian export producers and at $64/tonne Indonesian producers . Current prices are clearly unprofitable for high cost producers.
In addition, volatility in the thermal coal price, which has averaged at 30 percent annually for coal, will remain, driven by uncertainty on mines’ throughout and changes in consumption patterns in end markets resulting from new shale gas supply in the US, domestic coal infrastructure improvements in China or carbon prices recovery in Europe.
However, Accenture expect the price of coal to recover in the medium to long term, because governments in the Asia Pacific region are likely to focus on achieving higher living standards at an affordable cost, with 190 GW of additional generating capacity is expected by 2030. Given coal’s low cost on an energy equivalent basis, we forecast continued use of the material to 2030 as a fuel source at similar proportions as there currently exists (28 percent)
Accenture’s analysis suggests that in current market conditions, blending can increase margins achieved on end prices by five percent to 15 percent, while location arbitrage can lead to a 10 percent to 15 percent increase on specific trade routes. As more spot volume is expected, APAC miners might look to seize this strategic opportunity as a means to expand into marketing and trading activities.
Analysis surrounding geographic arbitrage demonstrate it is more favourable for Chinese users to buy seaborne imports rather than source thermal coal from local markets whose product needs to be transported to the southern industrial regions from the north. This price arbitrage has been open for several years and can explain the decade-long trend towards higher levels of imports into China from zero in 2000 to 175 million tonnes in 2012.32 Questions will arise when domestic producers become more competitive as rail infrastructure from north to south reduces capacity constraints.
Indonesia had previously supplied the lowest-priced coal relative to other exporting countries although the United States has recently emerged as the cheapest supplier of coal landed in China following the shale gas revolution. However, the United States is expected to face important challenges in achieving greater scale given the limitations of its export infrastructure and logistics limitations from mine to port.
Analysis surrounding quality arbitrage utilises the fact that market prices are not fully linearly correlated to calorific value relative to the linear pro rata adjustments in contract specifications. This creates the opportunity for arbitrage of a potential upside of $10-$15 per tonne for selected coal supplies through direct substitution, or a smaller share of the potential upside available from blending with other supplies of lower calorific value.
Expanding in coal Trading & Marketing will require an upfront investment from producers at a time when coal mining revenues have contracted. It will require companies to hold more risk capital, whilst expanding into logistics, including the handling of storage and blending facilities, offshore terminals and chartering. This expansion into the downstream value chain can rapidly become a cost-intensive business depending on the asset ownership structure and operational processes. Indonesian or Australian miners could support these investments by tapping into their liquid assets, which are standing at relatively healthy levels, as compared to their global peers, or divert capital expenditure from planned mine expansions in the current over-capacity context.
Accenture estimates that coal producers which can take early advantage of this strategy will significantly enhance long-term financial stability and now is the time for Asia Pacific coal players to seize this growth opportunity.
Ogan Kose is the global managing director of Accenture Trading, Investments & Optimisation Strategy, which is part of Accenture Strategy & Sustainability Group. Kose has more than 15 years of experience helping commodity players with their earnings and risk management. His primary focus areas are commodity trading, risk management, investment evaluation and financial analysis, pricing, and commodity contract structuring. At Accenture, Kose has worked to help clients across multiple geographies, such as the United States, Europe, China and Southeast Asia. He holds Bachelor of Science and Master of Science degrees in chemical engineering (Imperial College, London) and a Master of Business Administration from Georgetown University. He is a member of the Global Association of Risk Professionals and is a financial risk manager. Kose is based in London.
Xavier Veillard is the Asia Pacific Director of Accenture Trading, Investments and Optimisation Strategy, which is part of Accenture Strategy & Sustainability Group.Xavier’s primary focus is corporate strategy and restructuring, financial valuation and commodity trading. Veillard has worked with Oil and Gas corporations, natural resources ministries, commodities traders and mining corporations in North America, Europe, Africa and Southeast Asia, supporting capital investment programs, assets commercial and capital structuring and asset-backed trading strategies. He holds an Honours Bachelor of Aeronautical Engineering from McGill University in Canada and a Master of Sciences in Mechanical Engineering from Imperial College London. Veillard is based in Singapore.
James Smyth is a senior consultant in Accenture Trading, Investment and Optimisation Strategy, which is part of Accenture Strategy & Sustainability Group. Smyth primarily focuses on commodities markets fundamentals analysis, commodity trading strategy and commercial optimisation. He has worked with multiple mining majors and juniors, national oil companies and oil majors. Prior to Accenture, he spent three years in the financial services industry, working for a global bank and for an asset management firm, within the fixed income, equity and commodity markets. Smyth is a Member of the Chartered Institute of Securities and Investment and holds a first class honours degree in economics from the University of Warwick. He is based in London.
October 25, 2013
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