CBA's outlook for Australian coal

By Paula Wallace

The commodities analyst from CBA said one theme which is being overlooked as the world economic recovery gets under way is costs.
Using AME data, Shaw has tracked Australian thermal coal mine costs (FOB) against world ex-Australia mine costs.
What it shows is that costs will lag the commodity price cycle, and particularly so for inputs priced over the long run such as freight and labour.
“Now is the time for operators to be pursuing productivity and efficiency savings to secure lower cost structures ahead of the next price up-cycle,” said Shaw, otherwise we may once again be lamenting infrastructure constraints.
“It would appear that operators should begin by targeting costs and efficiencies in the ‘mining and processing’ category.”
The CBA’s view is that the Australian Dollar will modestly lift further from where it is currently. In the absence of a corresponding lift in spot/contract prices this will put further pressure on margins in coming months.
So far this year, Chinese coal imports have played an “incredible role” - the combination of an attractive domestic/international pricing arbitrage and tight domestic supplies – seeing the Asian giant enter the spot coking and thermal coal markets.
According to Shaw, this has revealed some key spot coal price points around which Chinese domestic supply tends to react.
“An FOB price of US$60-70 per tonne for Newcastle spot seems to be one of these price points.
“And in coking coal, a price anywhere from the current benchmark contract of US$129 per tonne to US$150-160 per tonne seems to invoke a domestic response,” said Shaw.
He said the Chinese Government’s increased willingness to close small mines on safety concerns makes its domestic supply more uncertain.
“But consolidation and modernisation of the Chinese coal sector will mean that the small mine share of production – currently up to 60 per cent in Shanxi province – will reduce over time.”
According to Shaw, China will play a more important role in seaborne coal markets in the months and years ahead than it has done in recent months.
The CBA expects coal prices to lift modestly in 2010 before spiking higher in 2011 and 2012.
“We project long run thermal coal prices in line with historical real average prices of US$70 per tonne in 2008 terms.
“While real long run high quality coking coal prices are projected at US$130 per tonne in 2008 terms, above historical average,” said Shaw.
In terms of demand for Australia’s export coal, the CBA does not believe that true underlying demand will be revealed for another six to nine months.
“But beyond that into 2011 and 2012, the outlook is good,” said Shaw.
World steel production is recovering, although China’s share at almost half of total world production, is up a quarter compared to its share of around 40 per cent before the global financial crisis.
One element of the CBA’s view which has not changed as a result of the world’s financial woes is the potential impact of longer term economic development.
When you look at real GDP per capita and the consumption of steel and electricity, the latter rises as economies develop and incomes grow through time.
“China and India currently sit below the west…This suggests a strong longer term outlook for commodity demand,” said Shaw.
It’s perhaps unsurprising that the US Energy Information Administration’s (EIA) 2009 energy outlook suggested that coal fired power will contribute strongly to total growth in the world’s energy supply over the next few decades.
Interestingly, Shaw pointed out that although carbon policies are expected to impact the rate of growth of coal demand, the EIA projections shows accelerated coal consumption growth in 2020-30 once carbon solutions are deployed on commercial terms.
Shaw also suggested that the launch of battery powered cards from 2010 poses a “huge strategic issue for the grid”.
“The concept of battery powered cars is certainly attractive,” said Shaw, “but the implications for the grid, and utilities and profound and little understood at this time.”
Shaw said it is clear that countries such as China and India are taking a long term view of their resources requirements.
“We think they will continue to seek security over upstream supply.
“This will occur via direct equity investment, overseen by FIRB, or via debt/project finance tied to offtake agreements.
“With the right balance of regulatory oversight and commercial transactions, Australian coal operators have the opportunity to ramp production, and export revenues, significantly in coming decades.”

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