Surabhi Chopra

Thematic (Sector/Industry)

India Energy / Thematic (Sector/Industry)

Prices to correct by 6-9%: 2016 saw the price of coal more than double from its bottom of US$49/ton in Jan 2016 to US$114/ton in Nov 2016, before correcting to US$80/ton (Based on Newcastle XW1 index). This rally in coal prices was primarily driven by China’s domestic production cuts as China reduced its mine working days from 330 days to 276 days in order to relieve the financial stress on coal mining companies resulting from downturn in coal prices. Industry consolidation also supported price recovery. The supply tightened further on back of lower production from hydro-power plants due to lower-than-usual rainfall in China. However the speed and magnitude of the price recovery prompted Chinese officials to intervene once again and loosen production curbs ahead of winter. Meanwhile coal miners have started to increase production in response to better coal prices. Hence we expect the coal prices to correct by 6-9% or US$5-7/ton from US$80/ton to US$75-73/ton. Given that the world average cash cost for thermal coal is about US$50/ton (Exhibit: 4), we believe efficient mines will remain profitable.Coal to oil price ratio below historic average: Average cash costs have come down globally partially due to lower fuel prices, from US$64 to US$50/ton from 2012 to 2016 (exhibit:4). Currently coal to oil price ratio is about 43% vs 25% back in 2012. This makes the coal mine profitable at lower levels of coal prices, as fuel costs make 20-30% of cash costs. Just to put into perspective, if oil prices remains at US$48/barrel, going by historic average of coal price to oil ratio of 30%, the coal prices should be around US$56/ton.Prices unlikely to fall below US$70/ton. We however don’t foresee coal prices dropping below US$70/ton as we believe mines start to turn unprofitable, primarily in China and the government may intervene once again. China mine cash costs are higher due to higher transportation costs (form 20-40% of cash costs) resulting from infrastructure bottlenecks and smaller mines have higher interest rates as they rely on shadow banking though number of them likely to close as government eliminates inefficient mines by 2020. Furthermore, more than 80% of China’s thermal-coal mines are underground, the cost of which are higher than open-pit mining. China mine cash cost CFR Qingdao CFR is average US$68/ton,  FOB cash costs is US$60/ton. (source: Metalytics)Why coal prices likely to be capped at current levels. The prices are unlikely to go up meaningfully from here as India which is second largest thermal coal importer, have low power tariffs and to remain profitable the power companies try to pass the rise in coal prices to already financially stressed power distribution companies who cannot pass it to end consumers (electricity tariffs regulated) and hence reduce the power uptake. China coal mine overcapacity cuts not a worry. China considered the “swing” buyer being the largest thermal coal importer, its production capacity cuts is not going to impact the prices in the short to mid-term because there is total coal surplus capacity of currently 2 billion tons and net production capacity cuts are to the tune of 300 million tons per year.  (800m tons of “outdated” and in-efficient capacity to adding 500m tons of “advanced capacity”) till 2020.

Prices to correct by 6-9%: 2016 saw the price of coal more than double from its bottom of US$49/ton in Jan 2016 to US$114/ton in Nov 2016, before correcting to US$80/ton (Based on Newcastle XW1 index). This rally in coal prices was primarily driven by China’s domestic production cuts as China reduced its mine working days from 330 days to 276 days in order to relieve the financial stress on coal mining companies resulting from downturn in coal prices. Industry consolidation also supported price recovery. The supply tightened further on back of lower production from hydro-power plants due to lower-than-usual rainfall in China. However the speed and magnitude of the price recovery prompted Chinese officials to intervene once again and loosen production curbs ahead of winter. Meanwhile coal miners have started to increase production in response to better coal prices. Hence we expect the coal prices to correct by 6-9% or US$5-7/ton from US$80/ton to US$75-73/ton. Given that the world average cash cost for thermal coal is about US$50/ton (Exhibit: 4), we believe efficient mines will remain profitable.Coal to oil price ratio below historic average: Average cash costs have come down globally partially due to lower fuel prices, from US$64 to US$50/ton from 2012 to 2016 (exhibit:4). Currently coal to oil price ratio is about 43% vs 25% back in 2012. This makes the coal mine profitable at lower levels of coal prices, as fuel costs make 20-30% of cash costs. Just to put into perspective, if oil prices remains at US$48/barrel, going by historic average of coal price to oil ratio of 30%, the coal prices should be around US$56/ton.Prices unlikely to fall below US$70/ton. We however don’t foresee coal prices dropping below US$70/ton as we believe mines start to turn unprofitable, primarily in China and the government may intervene once again. China mine cash costs are higher due to higher transportation costs (form 20-40% of cash costs) resulting from infrastructure bottlenecks and smaller mines have higher interest rates as they rely on shadow banking though number of them likely to close as government eliminates inefficient mines by 2020. Furthermore, more than 80% of China’s thermal-coal mines are underground, the cost of which are higher than open-pit mining. China mine cash cost CFR Qingdao CFR is average US$68/ton,  FOB cash costs is US$60/ton. (source: Metalytics)Why coal prices likely to be capped at current levels. The prices are unlikely to go up meaningfully from here as India which is second largest thermal coal importer, have low power tariffs and to remain profitable the power companies try to pass the rise in coal prices to already financially stressed power distribution companies who cannot pass it to end consumers (electricity tariffs regulated) and hence reduce the power uptake. China coal mine overcapacity cuts not a worry. China considered the “swing” buyer being the largest thermal coal importer, its production capacity cuts is not going to impact the prices in the short to mid-term because there is total coal surplus capacity of currently 2 billion tons and net production capacity cuts are to the tune of 300 million tons per year.  (800m tons of “outdated” and in-efficient capacity to adding 500m tons of “advanced capacity”) till 2020.

Thermal Coal Prices Likely Peaked; Expect 6-9% Correction in Prices from Here. Take Profits