Ac cording to an April 2008 Data monitor report, the global coal and consumable fuels market grew by 11.9 percent in 2007 to $249 billion in sales and is forecast to grow to $340 billion by 2012. Over 60 percent of this market was generated in the Asia Pacific region, with the Americas contributing 20 percent and Europe 19.9 percent. As discussed below, the leading company in the worldwide market is China Shenhua Energy Co, which accounted for 3.5 percent market share – almost doubling the 1.8 percent market share of the next-largets competitor BHP Billiton – indicating that this is still a highly fragmented worldwide market.
CHINA COAL MARKET: OVERVIEW
As demonstrated in the chart below, China possesses the third-largest coal reserves in the world and ranks first in terms of both coal output and, more importantly from an investment perspective, consumption. In recognition of this fact, China is currently implementing its 11th ‘Five-Year Plan’ (2006-2010), which emphasises securing the economy's future metals and mining resource needs. However, China has already seen its internal demand outstripping production. The Economic Intelligence Unit reports that as recently as early 2008 a coal shortage hit China, primarily due to the government closing large numbers of small or uneconomic mines. The summer peak usage period aggravated the shortage, thus accelerating the country towards becoming a net coal importer in 2008.
China is expected to account for over half of the growth in both coal supply and demand over the next 25 years. Furthermore, Wang Xianzheng, the head of the National Coal Association and the Deputy Director of the State Administration of Work Safety, has stated that China will restructure the industry to create large coal production bases and raise coal production by 400 million tons between 2006 and 2010.
THERMAL COAL MARKET: OVERVIEW
The thermal coal market is hot (pardon the pun) not only in China but also in the international arena. More importantly, at least in theory, it is open to foreign investors and acquirers.
China's thermal coal market has skyrocketed as a result of rapidly increasing demand for electrical power (approximately 70 percent of all coal consumption goes towards energy production). According to the Energy Information Administration (EIA), China currently generates 271 gigawatts (GW) of coal-fired power capacity. To meet growing needs, China will need to add nearly another 500 GW by 2030, tripling coal-fired capacity.
This massive increase in capacity means rapid growth in coal demand. In 2004, China consumed about 22.7 quadrillion British thermal units (quads) of coal in its electric power plants. By 2030, that figure will be closer to 56 quadrillion.
To put this situation into an even clearer historical perspective, as recently as 2002 China not only produced more than enough thermal coal to meet its own domestic needs but also supplied Japan with more than one-fifth of its thermal coal requirements. In 2007, China became a net importer of coal and it recently announced a ban on exports in an attempt to meet domestic demand. Further still, power plants have twice had to shut down this year as a result of insufficient coal reserves and it is expected that China's power demand could outpace supply by up to 10 gigawatts (GW) this year.
This situation is exacerbated by conditions in the global market. Both Japan and Korea have few domestic reserves and are seeking international sources. Further, it is expected that Mexico and South Africa will soon become major international buyers of thermal coal. At the same time, traditional international and regional suppliers such as Indonesia and Australia are finding it difficult to keep up with rising demand. Naturally, the net result has been a rapid increase in the price of thermal coal.
|National Development &||Responsible for development of the coal industry, including drafting|
|Reform Commission||strategies, plans and policies. Also approves large- to medium-scale industry|
|construction and sets coal pricing policy.|
|Ministry of Land & Resources||Responsible for approval of coal exploration, land use rights, transfer,|
|rent and issuance-related certificates.|
|State Owned Asset Supervision||Guides the reform and restructuring of state-owned enterprises and supervises|
|and Administration Commission||the management of these firms. The energy sector is of vital importance and|
|the performance of large coal groups is regulated and adjusted by SASAC.|
|State Administration of Work Safety||Responsible for developing and implementing safety regulations and,|
|the investigation of mining incidents.|
|State Administration of||In charge of all environmental effect reports and implementation of|
|Environmental Protection||environmental protection regulations.|
|State Administration for Industry||In charge of insurance, approval and annual checks of coal business licenses|
|& Commerce||and related administrative matters.|
|Ministry of Railway||In charge of coal railway transportation.|
|Ministry of Communication||Oversees coal transportation by railway, water and transfer in ports.|
|Ministry of Commerce||Formulates development strategies, policies and regulations for domestic|
|and foreign trade as well as international economic cooperation|
PERFORMANCE OF LEADING CHINESE FIRMS
With all this internal demand it would be reasonable to assume that companies like China Shenhua and the number two coal company China Coal, two companies which achieved IPOs on the Hong Kong Stock Exchange (HKSE) in the last few years, would be experiencing sky-rocketing stock prices. Reinforcing this assumption is the recent news (source: Reuters) that China Coal posted a 19 percent overall increase (27 percent domestic increase) in coal sales from a year earlier while increasing coal production by 14 percent. China Shenhua experienced similar results, increasing its production by 17 percent and its sales by 17.7 percent. However, recent performance of these two stocks (as shown in the chart below) clearly demonstrates a remarkable drop in the recent price (while still outperforming the Hang Seng index).
While generally outperforming the Hang Seng, and even taking into account the global downturn in global stock market performance, it is arguable that international and domestic demand would seem to warrant higher stock prices for the two largest coal producers in China.
Discussions with market participants and a review of publications from market commentators suggest a number of issues for potential investors in the sector. In particular, widely held views are that unfavourable policies and market environment, such as mineral rights issues, impartiality, and governmental controls, still create considerable challenges to the movement of private capital into mining.
CAPITALISING ON THE OPPORTUNITY
Given that global and domestic demand for thermal coal remains strong and that the underlying fundamentals would seem to suggest demand growing further still, how can foreign investors access the sector?We suggest that the following elements need to be integrated into an investment programme in the thermal coal industry in China:
“Widely held views are that unfavourable policies and market environment, such as mineral rights issues, impartiality, and governmental controls, still create considerable challenges to the movement of private capital into mining.”
As with investing in many sectors in China, thermal coal represents a tremendous opportunity but entry into the sector must be well planned and, then, the plan must be meticulously implemented to achieve the desired financial results.
Albert McLelland(firstname.lastname@example.org) is a senior managing director of AmPac Strategic Capital and a managing director of Sino-American Capital Holdings Limited. AmPac is a boutique investment bank that specialises in assisting foreign strategic and financial investors to build their businesses in China while Sino-American Holdings Limited is a merchant bank that specialises in investing and completing natural resource transactions in China. Simon Mak (email@example.com) is associate director of the Caruth Institute for Entrepreneurship at the SMU Cox School of Business. He specialises in technology and corporate entrepreneurship.