Industry Trend Analysis - China To Stir Coal Market Again In 2017 - FEB 2017

BMI View: The Chinese government ' s aim to balance environmental protection with cheap and stable coal supply to households and steel mills will generate significant volatility in the global coal market in 2017. The country will shift to cleaner sources of coal through heightened consolidation of 'dirty' mines while increasing production from ' cleaner ' mines in order to remain on track to attaining self-sufficiency.

China will generate significant volatility in the global coal market in 2017 as the government strives to balance smooth and cheap coal supply to households and steel mills with environmental concerns against coal use. After provoking a policy supply shock in the coal sector in 2016 which sent prices rallying, authorities are now aiming at keeping coal prices more stable in 2017. The government announced plans to cut coal capacity while ensuring stable supply this year, which we believe will prove delicate to balance. We list below China's most recent coal policies:

  • In January 2017, the government cancelled 85 (18 more were cancelled in 2016, making the total number 103) coal-fired power plant projects due to environmental concerns. These were worth about USD62bn, spanning 13 Chinese provinces and were either planned or under construction, eliminating 120 gigawatts of future coal-fired capacity, 54 gigawatts of which were already under construction.

  • This comes after the government announced in December 2016 a five-year target to cut 800 million tonnes (mnt) of coal producing capacity by 2020. To put things in perspective, we estimate China to produce 3,316mnt of coal in absolute terms in 2017. Nevertheless, although the overcapacity reduction drive in the polluting coal sector will be stronger in 2017, Xu Shaoshi, director of the National Development and Reform Commission (NDRC), said that the government will ensure stable supplies of coal even as cuts take place.

  • In H116 the government implemented output reduction policies such as reduction in working days from 330 to 276 per year for coal mines.

  • After strong consolidation in the coal mining sector in H116, the government urged miners to restart production and eased restrictions after thermal and coking coal spot prices increased dramatically and hurt the Chinese steel industry. In September 2016, Chinese state-owned coal miners agreed to increase coal output in an attempt to mitigate the sharp rise in prices. Thermal coal prices at Qinhuangdao port eventually reached a peak of USD104/tonne in November 2016 before retreating to USD86/tonne in January 2017 with mine restarts. Similarly, Australian coking coal prices retreated to USD168/tonne in January 2017 from a peak of USD273/tonne in December 2016.

Once the winter heating demand peaks around March 2017, we expect the government to resume its capacity reduction drive, once again putting prices under pressure and generating volatility in the coal market in order to achieve domestic outcomes.

China To Generate Price Volatility Ahead
Thermal And Coking Coal Prices (usd/tonne)
Note: Thermal c oal i ndex is China Qinhuangdao Port Thermal Coal 5500kcal/kg & Coking coal i ndex is SBB Premium Hard Coking Coal Australia Export Source: Bloomberg, BMI

Capacity - Not Output - Reduction Policies Ahead

We expect Chinese authorities to be cautious with their coal sector consolidation policies in 2017 so as not to repeat the coal price rally of 2016. Unlike policies aimed at reducing output, such as the reduction in working days from 330 to 276 per year for coal mines that was announced by The State Administration of Work Safety in early 2016, the government will now focus on shutting down 'idle', 'outdated' and 'inefficient' mines. Thus, capacity will be reduced, mainly by consolidating smaller mines that were not in production in the north-east of the country. Meanwhile, country-wide output will not be reduced as larger producers in the western regions of Inner Mongolia and Xinjiang will ramp up output in light of high current prices. We forecast coal production to decline for the fourth consecutive year in 2017, but the decrease will be much less drastic than in 2016 (see table at the bottom).

Closing redundant mines reduces the fixed costs per unit of output, which increases miners' profitability. Along with an improvement in coal prices over the years to 2021, this will stabilise production from 2018 onwards. Despite falling prices since the peaks of November and December 2017, mines are still profitable at current price levels. With China's aim to attain coal self-sufficiency, and coal consumption expected by the authorities to reach 4.10 billion tonnes (bnt) by 2020 from 3.96bnt in 2015, we do not expect policies to encourage output cuts in the coming years like in 2016. The Chinese government expects 3.9bnt of coal production in 2020, up from the 3.75bnt produced in 2015. Nevertheless, risks remain as to how private miners will react in the face of low prices in the coming years, whether they reduce output to increase prices or leave the market altogether due to financial woes.

Coal Production To Stabilise Despite Capacity Cuts
China - Coal Mine Production & Production Growth
e/f = BMI estimate/forecast. Source: BMI, Energy Information Administration

Government Support For Cleaner Coal To Continue

China's pledge to protect the environment will be driven by attempts to shift coal production from smaller, inefficient and 'dirtier' mines to larger, efficient and 'cleaner' mines rather than curbing absolute coal production. While the country will slow its coal consumption and production growth over the coming years, absolute production and consumption will still increase. The replacement of 'dirty' coal with cleaner supply to improve air and water quality will remain the main target of the government, and not the reduction in coal output, which would further distance the country from its self-sufficiency aim. Thus, apart from idled mines, the 800mnt of capacity that the government aims to cut down on will also stem from mines that are technologically 'outdated' and cannot produce clean coal. However, the government will remain wary of any reductions in total output lest the 2016 situation of soaring prices recurs, and thus order larger, cleaner mines to increase output. Coal-fired power generation will continue to be China's dominant energy producer over the coming years, although we forecast coal's share in the country's energy mix to fall from 67.4% of total electricity generation in 2017 to 53.2% in 2026. At the same time, the country's share of renewables in the energy mix will increase over the years. At present China is the world's largest wind and solar powerhouse, although accounting only for 6.9% of total electricity generation in the country.

Coal To Remain King
China - Power Generation From Select Sources (% of total electricity generation)
e/f = BMI estimate/forecast. Source: EIA, BMI

Capacity Reduction Target To Be Met With Re-centralisation Of Power

We expect the ongoing re-centralisation of power in Beijing to ensure that capacity reduction targets are met in 2017, not just in the coal sector but also in other oversupplied sectors in China. In October 2016, the Chinese Communist Party's (CPC) sixth plenary session of the 18th CPC Central Committee saw the elevation of President Xi Jinping's political status to the 'core' of the party's leadership. President Xi's strengthening political position and re-centralisation of power will allow supply-side reforms to progress more smoothly in the coming years, with less resistance from local governments. While this is positive for the achievement of domestic goals, it also generates significant volatility in global markets, as the government is now more capable of enforcing policies as and when it deems necessary with less time lag or resistance. Just as the government can curb capacity or output without delay, it can also order the restart of mines to boost output if necessary. As an example, despite wanting to benefit from higher coal prices, coal miners in China were forced to increase production in late 2016.

China - Coal Forecasts (2012-2021)
2012 2013e 2014e 2015e 2016e 2017f 2018f 2019f 2020f 2021f
e/f = BMI estimate/forecast. Source: National sources, BMI
Coal Mine Production Volumes, % y-o-y 3.80 4.60 -2.50 -5.20 -4.00 -1.30 0.10 1.00 1.90 2.80
Coal Mine Production, mn tonnes 3,620.60 3,787.15 3,692.47 3,500.46 3,360.44 3,316.76 3,320.07 3,353.27 3,416.99 3,512.66
Coal mine production, mn tonnes, % of global 45.9 46.7 45.4 44.9 45.0 44.0 43.4 43.0 44.3
Generation, Coal, TWh 3,601.500 3,959.000 3,907.533 3,788.353 3,693.644 3,597.610 3,644.379 3,695.400 3,747.135 3,780.860
Generation, Coal, % y-o-y 2.685 9.926 -1.300 -3.050 -2.500 -2.600 1.300 1.400 1.400 0.900
Generation, Coal, % total electricity generation 75.440 75.444 73.784 71.768 69.511 67.371 65.768 64.207 62.838 61.278