Wed, 24 Dec 2008
Katherine Hermawan, Analyst

The recent drop in the market price of coal from its record levels earlier this year will adversely impact earnings of Indonesian coal producers. Based on this factor, going forward, we expect weaker coal prices in line with the downtrend in oil prices, while higher supplies are expected on China's higher exports as domestic consumption slows.

Our view on possible lower coal prices is supported by the recent continuous drop in prices. With the Newcastle index closing at US$78/ton as of Dec. 19, having continuously declined from its 4th July peak at $194/ton, we place an underweight view on the coal sector.

With defaults on contracts beginning to emerge, we expect contracts to continue to be negotiated down. Hence, we expect prices to decelerate, averaging $126/ton in 2008, before plunging 58 percent to average $53/ton in 2009, slightly higher than our oil price assumption of $50/bbl.

Based on IMF and World Bank estimates, global economic growth would only reach between 1 to 2 percent in 2009, adversely impacting coal demand from both industry and power plant. In our view, coal demand could slow to the point that it could reverse previous market trends from what appeared to be significant undersupply to an oversupply situation.

Emerging signs of softening are undermining what had been a steady climb in coal prices as developing nations burned more of the mineral to generate electricity and run blast furnaces. Global recession will also restrict manufacturers and industries' operations, which will result in a reduced use of energy.

In the next two years, we expect that there will be no substantial increase in demand for coal, diminishing the previous large gap between supply and demand.

The thermal coal demand outlook is to be slower due to the coming global recession having a direct impact on household consumption on basic items including energy. This view is supported by China's data which has pointed to a slowdown in GDP growth in the third quarter of this year to around 9.5 percent year-on-year, the slowest since 2004, from 10.1 percent in the second quarter.

The IMF has also published comments on the forecast Chinese growth rate of 9.3 percent in 2009 as potentially overoptimistic and expecting additional downside risks to ensue.

Other supporting evidence would include China's industrial output in November which saw a slowdown in growth to 5.4 percent, plunging 11.9 percent year-on-year. China's coal imports in November fell to a near three-year low due to continued weak demand from power plants.

China's power output as of November fell 9.6 percent, while output from thermal plants experienced a sharp 16.6 percent decline. China imported 2.17 million tons of coal in November, down 38 percent on the previous month, while coal stocks at ports fell not because of higher consumption, but because of lack of coal wagons and delays in arrivals of ships.

Additionally, as stated in the news recently, Japan's November coal export volume has significantly decreased by 27 percent from the previous month compared with lower imports at *5.6 trillion, down by 14 percent from October 2008.

This situation shows stronger proof of a weakening global economy which will affect energy consumption from lower industrial output. As Japan has always been a major coal consumer in Asia, this slowdown is creating negative effects on the growth in coal demand for the coming year, affecting Indonesia as one of the biggest thermal coal suppliers in the world.

Previously, coal supply was a major concern globally because of lack of infrastructural support in major coal mining countries in the world (for example, Australia) and unfriendly natural occurrences worldwide.

However, we need to take into account that many coal mine acquisitions recently will significantly add to supply in the near future. Our UNDERWEIGHT rating on the coal sector suggests that fundamentals are currently deteriorating on the back of the global economic slowdown.

Hence, on the volume front, we have assumed minimum growth in the 2009 coal production of the five listed Indonesian coal mining producers with no exception.

The writer is an analyst at Bahana Securities



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