Wayne Calder Deputy Executive Director, Bureau of Resources and Energy Economics

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Australia Japan Coal Conference 2014

Australia’s thermal and metallurgical coal export supply outlook

Wayne Calder

Deputy Executive Director, Bureau of Resources and Energy Economics
[Title Slide]
Good morning ladies and gentlemen. I am pleased to be able to present BREE’s perspective on the thermal and metallurgical coal export supply outlook to you this morning.

For those of you that are unfamiliar with BREE, we are an independent economic research agency within the Australian Government Department of Industry. We provide analysis and advice to government, industry and other stakeholders on issues affecting Australia’s energy and resources sectors. All our research, including the content I will cover today, is freely available on our website and I encourage you to have a look at some of our products.

[Key messages]
Throughout this presentation I hope to leave you with a few key messages.

Contrary to some reports in the media about the coal industry, including in Australia, we believe that the outlook for thermal and metallurgical coal remains positive over the medium to longer term.

In thermal coal, the demand for energy is projected to remain robust over the medium to longer term as emerging economies fuel their economic expansion and improve the standard of living for their citizens. Coal will remain an important energy source because of its affordability and reliability.

Increasing urbanisation and industrial output in these economies will also support steel demand as they develop new housing, infrastructure and industrial capacity. Obviously, increased steel production to meet this demand bodes well for metallurgical coal.

Coal is an important export for Australia; it is the second largest resource export after iron ore. The development of new production capacity over the past few years will allow Australia to increase its exports of coal to meet growing demand over the medium term. Higher export volumes will be a key factor supporting increased export earnings from coal.

Japan has been a prime destination for Australia’s coal exports. The trade relationship between Australia and Japan will continue to remain important over the long term, with Japan set to remain a major market for Australian coal.

[Macroeconomic outlook in key regions]
Before I get into the specifics of the coal industry, it is useful to look at the macroeconomic outlook for key regions to provide some context of the potential opportunities for growth in coal consumption. This chart demonstrates BREE’s GDP forecasts for five of Australia’s largest trading partners. Overall, the medium term outlook for these economies is generally positive. Growth is forecast to be driven by non-OECD Asian economies, particularly China, India and ASEAN. The performance of OECD economies is also forecast to improve, especially in the United States with a moderate recovery in the European Union.

However, this growth is not without risks. These include the degree to which the tapering of the United States Federal Reserve’s quantitative easing packages affects emerging economies through flow-on capital and currency effects and China’s ability to maintain its economic growth momentum while transitioning to a pattern of lower, more sustainable growth.

[Outlook for thermal coal]
Let’s now turn to the outlook for thermal coal.

While spot thermal coal prices have been declining over the past year, this has been the result of abundant supply rather than any shift away from coal-use. Thermal coal consumption is projected to grow over the medium to longer term as new coal-fired capacity is developed worldwide. This growth in consumption is expected to soak up the excess supply over the next few years.

[World electricity generation]
Since the prime use of thermal coal is in electricity generation, it is useful to look at developments in world electricity use and generation to understand the drivers of future growth in coal consumption and imports.

The International Energy Agency projects world electricity generation to increase by 27 per cent from 2011 to almost 28 000 terawatt hours by 2020. This growth will primarily be driven by emerging economies as they increase electrification to fuel their economic expansion and improve the standard of living for their citizens.

While coal may not exhibit the highest growth among the various fuel types, as you can see in the chart it will remain a key component of the world electricity mix. The role of coal is even starker in the projections for non-OECD Asia where the majority of economic activity will be centred over the medium to longer term.
[Electricity use and economic development]
Electricity is the cornerstone of economic development and an essential component of modern lifestyles. As you can see in this chart there is a clear link between economic growth and electricity consumption, a relationship that will underpin the role of coal into the future. If developing economies follow a similar path to their predecessors, as these economies expand their per person electricity consumption will increase.
[Electricity consumption per person and population]
Developed economies tend to have high electricity consumption per person, but typically have relatively small populations. Conversely, emerging economies tend to have low electricity consumption per person and larger populations. Given the size of the population in these economies, even if they achieve small increases in electricity use per person, this will translate into large absolute increases in total electricity consumption.
[Electricity generation capacity under construction and approved]
The next part of the story is to look at what generation capacity is being built around the world to support the growth in electricity generation.

Reflecting the likely increased electricity needs across Non-OECD countries over the medium term, the bulk of new electricity generation capacity is being developed in these countries. As you can see here the trends in generation capacity development are quite different between the OECD and Non-OECD.

In the OECD, concern about the effect of coal-use on the environment has prompted many countries to reduce the role of coal in the energy mix. This is reflected in the development of new capacity which is focused on gas-fired and renewable capacity (excluding hydro).

Outside of the OECD, economies are drawing on all available energy types. Around 300 gigawatts of coal capacity is being developed in Non-OECD economies (this is almost the same amount of total capacity under construction or approved in the OECD!). Almost 90 per cent of this coal-fired capacity is being developed in India and China alone.

[Thermal coal importers]
BREE projects world coal trade to grow at an average rate of 2 per cent to 1.2 billion tonnes in 2019. China and India are expected to be major contributors to this growth, with imports in other major importing countries expected to be relatively steady.

China is projected to remain a large coal importer over the medium term. While some provinces are being encouraged to reduce coal-use, coal is already a major component of the electricity generation mix and there is still a lot of coal-fired capacity under development. Given the relatively high cost of coal production and transportation in China, particularly in the mature mining provinces, imported coal will remain competitive. Further, imported coal tends to be higher quality which will help achieve some of their environmental objectives.

India is investing heavily in new coal-fired generation capacity to increase electrification and assist its economic expansion. India’s coal supply has been unable to keep pace with demand which has contributed to rising imports. This is projected to persist over the medium term, with many projects struggling to obtain the required approvals.

Japan has relied on thermal power as nuclear capacity has been closed. Because most coal-fired plants have been operating at close to capacity there is limited upside to Japan’s coal imports over the medium term to 2019. As such, Japan’s coal imports are projected to decline moderately over the medium term as nuclear capacity is restarted. However, beyond 2019, there is the potential for Japan’s imports to increase as new coal-fired capacity is being developed after the role of coal in the energy mix was reaffirmed in the Basic Energy Plan announced earlier this year.

[Thermal coal exporters]
Indonesia is expected to remain the largest exporter of thermal coal over the medium term. However, its exports are projected to decline as the Government strengthens its efforts to curb growth in production, and more coal is used domestically.

Exports from Colombia are projected to increase considerably over the medium term as new projects and infrastructure are developed.

[Outlook for metallurgical coal]
Let’s now turn to the outlook for metallurgical coal. Metallurgical coal prices have also been affected by abundant supply and relatively weaker demand from China. However, the medium term prospects for metallurgical coal are also reasonably healthy, underpinned by an expected increase in steel use in emerging economies as they develop new housing, infrastructure and industrial capacity.
[Peak steel consumption since 1973]
Steel consumption in emerging economies has grown rapidly over the past decade, yet many of these countries still have considerably lower steel usage rates compared to developed economies. Steel intensities in these emerging economies are unlikely to reach the levels of countries like South Korea and Japan, whose economies are based on relatively high proportions of exports of steel-intensive exports like ships and cars. Nevertheless there remains considerable growth potential in highly populated emerging economies that require further investment in housing, infrastructure and manufacturing to support their growing urban populations and industrial bases.
[World steel production]
China is expected to remain the largest steel producer over the medium term. Over the next five years China’s steel production is projected to increase to 874 million tonnes in 2019. Although mills are scheduled to close there remains ample capacity to deliver this increase and new mills in western provinces are expected to open as economic activity picks up and requires more steel.

India’s steel production is projected to increase to 107 million tonnes in 2019, supported by ongoing urbanisation and infrastructure investment. It is expected that the Modi Government’s reform agenda and infrastructure plans will support higher steel consumption over the medium term.

[Major metallurgical coal importers]
World trade of metallurgical coal is projected to increase to 337 million tonnes in 2019, with China accounting for most of the growth in import demand and Australia the bulk of exports.

China’s imports of metallurgical coal are projected to increase to 103 million tonnes in 2019, underpinned by increased steel production. While China is by far the world’s largest producer of metallurgical coal, domestic output is typically higher cost and lower quality than imported coal.

India’s plans to expand steel production capacity to support growing steel-use as investment in infrastructure increases are expected to take time to implement. India has some metallurgical coal production, but is likely to rely mostly on imports to meet growing demand over the medium term. India’s imports of metallurgical coal are projected to increase steadily to 46 million tonnes in 2019.
[Major metallurgical coal exporters]
Lower prices and high operating costs have removed the incentive to invest heavily in developing new capacity around the world. As such, there is unlikely to be any significant additions to supply from emerging producers and growth in exports from existing producers is projected to remain subdued.
[Outlook for Australia]
While the medium term outlook for coal is generally positive, in the short term the operating environment of low prices and high costs will be a challenge for Australian producers. Accordingly, Australian producers are working to improve productivity, reduce costs and remain internationally competitive to be in a position to take advantage of the projected growth in coal consumption.
[Average cost structure for Australian coal mines]
According to AME estimates, the cost of producing coal in Australia increased considerably between 2008 and 2012. Over this period, indicative average thermal coal costs increased by 45 per cent and metallurgical coal costs by 73 per cent.

The increase in costs were influenced by several factors including substantial capital investment in Australia’s mining industry; a persistently high Australian/US dollar exchange rate; shortages of skilled labour; higher capital and operating (particularly fuel) costs; and 23 years of continuous Australian economic growth.

Given the challenging operating environment of lower prices, producers have been exploring options for cutting costs. Some of the larger companies have taken options such as reducing exploration activity, purchasing fewer inputs, negotiating for better input prices, and changing working rosters.

These measures appear to be having an effect, with the average cost of producing thermal and metallurgical coal in Australia starting to decline.

[Australian production]
Over the medium term we expect to see the results of investment in new capacity translate into higher production volumes, particularly in thermal coal.

Australia’s thermal coal production is forecast to increase at a moderate pace over 2014-15 and 2015-16 as announced mine closures are more than offset by increased output from projects completed in previous years. From 2016-17, growth in production is projected to accelerate as several projects completed during 2015 and 2016 such as Maules Creek approach full capacity. Towards the end of the projection period, production will be heavily influenced by the start of production from the large scale projects being developed in the Galilee Basin in Queensland including Adani’s Carmichael mine (60 million tonnes a year) which require the development of associated rail infrastructure to move the coal to export facilities. It is expected that most of this new capacity will be destined for India.

Australia’s production of metallurgical coal is projected to rise at a more modest pace over the period to 2018-19 as additions to capacity are partially offset by the closure of mines that are no longer economic or have exhausted their resources.
[Australia’s thermal coal exports]
Australia’s exports of thermal coal are forecast to increase by 1 per cent to 196 million tonnes in 2014-15 reflecting moderate production growth. The value of these exports is forecast to be $15.1 billion.

Over the remainder of the period to 2018-19, Australia’s thermal coal exports are projected to increase at an average rate of 4 per cent to 239 million tonnes in 2018-19. This strong increase in export volumes will be a primary factor driving increased export earnings from thermal coal, which are projected to increase by 5.9 per cent a year to around $19.7 billion (in 2014-15 dollar terms) in 2018-19.

[Australia’s metallurgical coal exports]
Australia’s exports of metallurgical coal increased by 17 per cent to 181 million tonnes in 2013-14 supported by strong production growth. Exports are forecast to increase by a further 2 per cent to 185 million tonnes in 2014-15. The value of these exports is forecast to be $23.2 billion.

Over the remainder of the period to 2018-19, Australia’s metallurgical coal exports are projected to increase at an annual average rate of 1.5 per cent to 195 million tonnes in 2018-19. Export earnings are projected to increase by 3.3 per cent a year to around $28.2 billion (in 2014-15 dollar terms) in 2018-19, underpinned by higher volumes.

[Australia and Japan—a relationship of mutual dependence]
I would like to finish by emphasising the important relationship between Australia and Japan. Japan is by far Australia’s largest energy trading partner, it is the largest destination for our thermal coal and second largest for metallurgical coal. Similarly, Japan sources most of its energy needs from Australia. We are the largest supplier of both thermal and metallurgical coal to Japan.

In 2013-14 Australia exported 80.5 million tonnes of thermal coal to Japan worth A$7.7 billion and 42 million tonnes of metallurgical coal worth A$5.5 billion.

Japan has also been an important investor in the Australian coal industry. Since the 1960s, much of Australia’s coal export industry has been developed in partnership with Japanese investors. This has provided Australia with the financial resources required to develop coal projects and Japan with access to stable, high quality coal supply.

Australia appreciates its trade and investment relationship with Japan. This relationship will continue to be important to Australia into the future and will be facilitated by the Economic Partnership Agreement signed in July 2014.

We understand that Japan has faced many challenges since the Great East Japan Earthquake in 2011. Australia is in a good position to assist Japan in meeting its energy requirements through the provision of conventional energy sources and the collaborative development of new and clean energy opportunities such as low emissions coal technologies.
While the coal industry is facing some challenges at the moment, the future is far from bleak. Coal will continue to be prime input into electricity generation and the development of housing and infrastructure in emerging economies will support growth in metallurgical coal use.

Australia is well placed to meet future coal demand as production starts to increase following a long period of investment. Current operating conditions are not a new phenomenon for the Australian industry which has shown considerable resilience in the face of commodity price cycles and changing economic conditions in the past. We are confident that Australia will remain competitive and a major exporter of coal into the future.

Japan has, is and will continue to be an important partner for the Australian coal industry and we believe we can further strengthen these ties in the future.

Thank you for your attention.

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