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International Commentary

The coal market is currently tighter than ever and there are two main factors that suggest this trend will continue. Long considered a reliable and relatively inexpensive source of energy, coal is suddenly now in short supply. Rising demand for energy and infrastructure problems in major exporting countries should keep the market very tight. One can reasonably expect steam coal prices to be well supported by increasing demand.

Despite concerns over its carbon emissions, coal has experienced a renaissance in recent times and materialized as a vital generation feedstock fuel with plentiful global reserves. Suddenly, it is now in short supply, while strong demand is globally boosting prices higher. The coal market is currently tighter than ever and there are two main factors that suggest this trend will continue: the first is the strong demand for coal, particularly from China and India. Second, infrastructure constraints in major producing countries, mainly due to a mismatch between coal production and consumption bases in China and Asia, represent a long-term structural constraint to coal supply growth. The structural tightness on the coal market is mainly the result of continuously rising demand for energy, which is increasingly being met by coal-fired power.

In its "World Energy Outlook 2007", the International Energy Agency (IEA) expects coal to see the biggest increase in demand among all primary energy sources, mainly due to the robust demand in China and India, where most electricity is produced by coal.

In the IEA's base-case scenario, China and India are predicted to account for around 60% of total world coal demand in 2030, up from 45% in 2005.

In China, the surging demand for steam coal, primarily for producing power, is increasingly turning the country into a net importer. Moreover, China also faces supply issues: Its coal production is increasingly mined in northern regions at a substantial distance from the main consuming regions on the south coast. The increased demand for coal transport that has resulted in rail and port a bottleneck not only limits domestic supply, but also increases domestic transportation costs, which makes imported coal more competitive. In early 2007, China was for the first time in years a net importer of coal, while it has traditionally been one of the major exporters in the seaborne market.

According to the IEA, energy demand in India has been rising by around 3.2% p.a. over the period from 2000 to 2005, while per capita energy demand is still extremely low at around one tenth of the OECD average. In order to meet its energy demands, India is increasingly dependent on imports. This has also affected the coal sector, as India's economy relies heavily on coal, which accounted for around 39% of total primary energy demand in 2005. Production in India is already insufficient in quantity and quality to meet its domestic needs, and imports have increased fairly sharply over the last few years. Even though India has large coal reserves, they typically have high ash content and thus imported coal is needed to reduce pollutants.

Whereas these developments on the demand side support prices in the long run, the recent upsurge in coal prices was the result of a series of short-term supply disruptions in China, Australia and South Africa. The three main events in early 2008 were the flooding and rain in Australia that interrupted exports, supply disruptions in South Africa and heavy snowstorms in China, which caused a break in Chinese exports. However, all these short-term supply disruptions are only the symptoms of one major short-coming that will take years to overcome: the insufficient coal transportation infrastructure. In Australia, one of the largest exporters of coal at around 112 million metric tons (mt), strong growth in export volumes over recent years has brought the coal transportation system close to its capacity limits.

Until at least 2010, when a third coal terminal at Newcastle is scheduled to be completed, coal supply infrastructure in the Hunter Valley is expected to remain constrained. Rail and port constraints are also affecting South Africa's ability to respond to growing global demand for coal. Exports are estimated to have fallen slightly to 67.2 million mt in 2007 due to capacity constraints at the Richard's Bay coal terminal. The Phase V Expansion Project, which should see the terminal expand from its current annual throughput capacity of 72 million mt to 91 million mt, should bring some relief upon its completion by the end of 2009. However, as Australia and South Africa are not expected to increase exports in the near future, the rising demand for coal has to be met with increased production from Indonesia, USA and Russia.

Furthermore, coal prices should be supported in the long run by rising mining costs driven by higher labor and maintenance costs. Additionally, the structural trends of declining quality of coal deposits and less favorable geographic locations of coal mines should also keep production costs up. Nevertheless, coal is still an inexpensive source of energy and appealing due to its cost competitiveness at about half the cost of natural gas and a quarter of the cost of crude oil. As many now expect high crude oil prices to persist, the below-parity cost of coal should support its rising market share in the global energy market.

Overall, expect steam coal prices to be well supported by increasing demand. Coupled with supply problems in major exporting countries, expect the supply deficit in the steam coal market to persist over the next few years. Rising Chinese and Indian imports should continue to offset supply growth that one can expect to come mainly from Indonesia. Traditional thermal coal suppliers, such as Australia and South Africa, are likely to be struggling to bring more coal on the market due to infrastructure constraints until at least the end of 2009. This should further add to the tightness in the coal market. Consequently, one can expect coal prices to increase over the next few years.

Coal will play an important role in meeting the world's growing need for energy. However, a major challenge will be to reduce its greenhouse gases and other emissions through new technologies like clean coal or zero emission technologies in order to reduce negative environmental impacts.