Whither China’s coal demand?

As China’s economic growth, retail sales and industrial production continued to slip during July, only investment managed to maintain a steady annualised rate growth of of 20%. The central government has been reluctant to introduce a stimulus package of the type seen in 2009. Instead it has restricted its actions to cutting interest rates and encouraging bank lending, but has been discretely encouraging certain provincial and city governments to invest. Changsha in central China has been the most flamboyant, with plans to invest RMB 830 billion (US $ 130 bn) on infrastructure, transport and environmental projects by 2012. The scale, pace and nature of these investment programmes have great relevance for international and domestic energy markets, especially for coal.


The demand for coal or, rather, the balance between supply and demand for coal in China is a major concern for coal mining companies and thermal power generators both inside and outside China. The country accounts for about 50% of the annual world production and consumption of coal and, therefore, minor changes in the relative balance of supply and demand within China can result in major fluctuations in the absolute surplus or deficit of coal supply which in turn have large repercussions on domestic and international coal prices.


Billions of dollars can be gained or lost by large coal mining companies depending on their ability to anticipate China’s future coal requirements. Ten years ago, at the time when China was exporting almost 100 million tonnes of coal per year from an annual production of 1.55 billion tonnes, the large coal mining companies in Australia were trying to estimate if and when China would change to become a major net importer of coal. They assessed that China would become a net importer of coal a few years later and made the necessary investments in additional capacity in their mines, as well as in rail and port facilities.


Sure enough, China’s exports of coal started to decline. In 2007 and 2008 exports and imports were approximately in balance. By 2009 China had become a net importer of just over 100 million tonnes of coal per year, equivalent to about 20% of sea-borne, internationally-traded coal and about 3.5% of China’s annual consumption of coal. Net imports rose further to nearly 150 million tonnes in 2010, with coking coal for the metallurgical industry accounting for 28% of these imports. This growth of demand for coal closely followed that of the economy as a whole. The annual rate of growth of coal demand rose to as high as 16-18% in 2003 and 2004, fell to 4% in 2008 as the recession took hold and then rose again to nearly 9% in 2010 and 2011 in response to the economic stimulus package. By 2011, total annual production had risen to 3.52 billion tonnes, more double than in 2002.


The economic slowdown which has taken hold in China during the current year has led to an oversupply of coal. In the first half of 2012, domestic coal production was 5.6% higher than in the same period last year, whilst consumption was just 2.8% higher. Over the same period, coal imports rose to about 140 million tonnes compared to 168 million tonnes for the whole of 2011. Meanwhile, stockpiles of coal have risen to an estimated 280 million tonnes, or about 8% of annual consumption. Some power generation companies have two months of stocks instead of the usual 15 days.


The oversupply of coal reflects a combination of factors. Some 70% of China’s coal is used in electricity generation. Electricity consumption rose at an annualised rate of just 5.5% in the first six months, well down on the 11% for 2011. Much of the rest of the coal supply is used by the metallurgical and chemical sectors, both of which have seen dramatic declines in output this year. The requirement for coal in the power sector has been further suppressed by high rainfall in central China which has fed the hydro-electric dams, effectively cutting demand for coal by a further 20 million tonnes.  At the same time, new coal mine capacity continues to come into production. In this year alone, an additional 200 million tonnes of new capacity will become available. The mines have kept producing because they can still make money even with prices falling below RMB 600 (US$ 95) per tonne. The picture is further complicated by the pricing system in which the coal supplied to power plants is sold at contract prices approved by the central government. In normal times these contract prices are significantly power than the spot prices, but today the situation is reversed. The oversupply has driven spot prices to levels below contract prices, and the power generators are trying to get out of their coal supply contracts.


But why have imports continued to grow, despite the domestic oversupply and the resultant huge stockpiles? The answer to that question lies principally in the longstanding problem of transport bottlenecks. China’s new coal mines lie in ever more remote parts of northern and northwestern China and the construction of rail capacity has failed to keep pace with mine output. Inner Mongolia alone exported 600 million tonnes of coal to other parts of China in 2011, but the combination of rail and road transport was insufficient to match the output of the mines. The region plans to double the rail capacity by 2014 with an additional 600 million tonnes.


With the country still heavily dependent on coal, China’s government will continue to promote investment in new coal mine capacity through its state-owned enterprises, not least to replace mines which become exhausted. Official announcements claim that domestic production in 2015 will be restricted to 3.9-4.0 billion tonnes, with demand reaching 4.2 billion tonnes. To meet these targets, the annual rates of growth of production and consumption will have to be constrained to just 3-4%. This is possible, but only if the economy remains in its present state. Any moves to stimulate the economy by promoting investment in infrastructure will see demand rise above this level.


For this multitude of reasons, those trying to forecast the impact of China’s economy on international coal markets face a number of uncertainties including the rate and nature of growth of the economy, the investment in new capacity, the amount of coal production, the capacity of the coal transport system, and even the weather. Small changes in China’s coal market have large implications for the international market.


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