UBS Investment Research forecasts thermal coal recovery

Signs of rising power consumption in China coupled with supply constraints across the Asia Pacific region are all adding up to a tighter thermal coal market that will push up prices, UBS says.

The price of coal is likely to rise US$10 per tonne to US$90 per tonne in 2010 and to US$110 per tonne in 2001, before retreating to US$105 per tonne in 2012, UBS Investment Research argued in a note to clients on July 6.

The price for Newcastle coal, for example, has already gone up 15% to around US$60 per tonne from its trough during February to May.

Power consumption in China showed signs of improvement in June and UBS has upgraded its estimates for the country’s power growth from -1.2% to 1.5% this year. That implies a return to positive growth of around 7% in the second half of this year, the bank maintains.

Growth in power usage is primarily being driven by the light industrial manufacturing sector, although growth in heavy industrial manufacturing also showed signs of a slight recovery in June.

Citing statistics from Chinese utilities, UBS noted that power production improved significantly year-on-year in early June to -0.4% compared with -3.2% in May and -13% in January.

UBS is forecasting a tighter thermal coal market over the next 18 months as China’s “energetic” monetary and fiscal policies take root.

Supply fundamentals are also working in favor of higher coal prices. UBS points out that supply growth in Australia and Indonesia remains very low.

The investment bank’s equities research team forecasts that supply from Australia will remain under pressure until about 2011. For one thing that’s because railways must be completed to increase miners’ throughput capacity at port.

The credit crunch has also meant delays in expanding key infrastructure such as roads, ports, and rail lines.  In Australia, “delays in land allocation for railway construction is limiting throughput to ports, which is partially attributable for vessel queues once again regaining momentum,” the report states.

Similar problems prevail in Indonesia, where current regulations ban third-party use of railways and the use of 12-tonne trucks on public roads. To make matters worse is “an ambiguous new mining law” that has caused “a slowdown of investment in the mining sector over the past six months.”

Contributing to the supply deficit has been China’s recent shutdown of coal production in Shanxi province, a region that makes up about 25% of the country’s total coal production.

Mine accidents have forced the Chinese government to cut the number of small mines from 2,600 to about 1,000. As a result, Shanxi province is operating at 22% below capacity and the shutdowns are expected to last until the end of the year, UBS asserts.

In addition, coal producing countries including Russia, India, Indonesia, South Africa and China have started consuming more thermal coal to avoid depending on more costly crude oil.

China consumes about 2,800 million tonnes of coal and as a net importer of about 40 million tonnes of coal each year, its marginal demand is well above Australia’s and Indonesia’s marginal supply of 10-15 million tonnes a year.

“Chinese manufacturing is on the rise, having exhibited continuous positive growth throughout the economic slowdown, while Asia’s largest coal importers are exhibiting signs of a recovery in industrial production growth,” UBS concludes.