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Regional report – Australia: back to the future

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World Coal,

Anthony Fensom explains how Australia's coal industry is planning for the future.

Rio Tinto's Mt Thorley Warkworth mine: the Supreme Court decision to uphold a bar on the expansion of the mine sent ripples through the Australian coal sector and highlights some of the regulatory uncertainty that is hanging over the coal industry. Image: Copyright © 2014 Rio Tinto.

Australia’s AU$ 60 billion coal industry has slowly adjusted to the “new norm” of lower coal prices, with the previous boom a distant memory. However, continued multi-billion dollar investments suggest the nation’s position as a major coal exporter is far from finished. Expanded production by the world’s second-biggest thermal coal exporter worsened the slide in prices, with the spot thermal coal price at the port of Newcastle hitting a four-year low in March of just US$ 72.98/t compared to its 2008 record of US$ 174/t.

According to Morgan Stanley, the price of the key fuel for power plants will average US$ 77/t in 2014. Two-fifths of shipments are losing money, as miners maintain exports due to take-or-pay port and rail contracts that require them to pay transport fees even without any shipments.

The Japanese annual contract price has fallen well below the benchmark US$ 100/t. In March, utilities agreed to an annual price with Australian coal exporters of US $81.80, the lowest price in five years. According to UBS, US$ 70/t may be the tipping point at which miners’ losses on sales exceed those on their freight contracts.

The take-or-pay contracts are attributed with helping finance around AU$ 6 billion worth of port and rail developments on the east coast of Australia during the past seven years, including Queensland’s Wiggins Island export facility and a new terminal at Newcastle. However, miners, including Yancoal and Anglo American, have admitted these contracts are leftovers from the boom that are now draining cash.

Prices of metallurgical coal have also slipped below US$ 100/t, well below the record US$ 330/t reached in 2011, with producers, such as Whitehaven Coal, expecting prices to drop even lower.

In a research note released on 15 April, ANZ cut its forecast for hard metallurgical coal to US$ 125/t, noting that “over 40% of the seaborne industry [is] not making money at current prices”. It also downgraded its forecast for thermal coal to US$ 77/t.

“Prices are currently hovering around the marginal cost of production, if not below,” Morgan Stanley research analyst, Tom Sartor, said. “It’s purely an oversupply problem for both thermal and metallurgical coal. That overhang is going to take another one or two years to work through, as it has in previous cycles of around six to seven years.”

While a lower exchange rate briefly improved sentiment, the Australian dollar’s recent rally back to around US$ 0.93 had “blunted the positivity in the market,” Balance Resources director, Michael Ryan, said.

In the meantime, miners have shed jobs and focused on cutting costs. According to the Queensland Resources Council (QRC), an estimated 8000 coal jobs were axed since May 2012, when prices started slumping.

In March 2013, the QRC estimated 60% of its members were operating in the “top two cost quartiles”. A year later, it noted the majority of mines were unprofitable, despite having moved into the lowest two cost quartiles.

Production surge continues at Australian coal mines

Yet despite lower prices, Australian coal miners have continued to ramp up production, partly due to their contractual obligations. In its Q1 2014 report, Australia’s Bureau of Resources and Energy Economics (BREE) forecast Australian thermal coal exports to increase by 3.7% to 195 million t in 2014, with additional output from the Rolleston, North Goonyella and Middlemount mines.

Over the medium term, the bureau expects Australian thermal coal exports to increase at an average rate of 6%/year to reach 257 million t in 2019, supported by the expected start of production at new mines in Queensland’s Galilee Basin, including the Alpha, Carmichael and South Galilee projects.

BREE said Australia would increase metallurgical coal exports by an average rate of 2.2%/year to reach 194 million t by 2019, helped by new and expanded mining projects including the Caval Ridge, Daunia and Grosvenor projects.

According to the Minerals Council of Australia (MCA), the coal investment pipeline consists of 93 projects worth around AU$ 118 billion, although BREE said in November 2013 that the resources investment boom had peaked. The slowdown has sparked fears of a future drought, with half of Australia’s mines forecast to close within 7 – 18 years, based on current reserves.

Among industry cutbacks, Glencore Xstrata’s decision in September 2013 to shelve its AU$ 7 billion Wandoan coal project in Queensland’s Surat Basin was a sign that the bullish days of greenfields expansion were over.

Nevertheless, increased production in coal-rich Queensland has still seen the state exceed its pre-global financial crisis level of coal exports. Transport minister, Scott Emerson, said the state’s ports were on track to top the 200 million t mark for fiscal 2014, up 11.5% on the previous year’s output.

And the investments have continued, particularly in Queensland’s emerging Galilee Basin, with the state government eager to promote the industry’s potential AU$ 28 billion expansion.

On 8 May, the coordinator-general of Queensland announced its approval of Adani Mining’s proposed AU$ 16.5 billion Carmichael coal mine and rail project near Clermont, subject to 190 environmental and social conditions concerning its construction and operation. In December 2013, the federal environment minister approved Waratah Coal’s AU$ 6.4 billion mine and rail Galilee coal project, including a 40 million tpa thermal coal mine and associated rail infrastructure. Also known as China First, the project was given 49 conditions, including providing AU$100,000/year for 10 years to a strategic fund to help threatened species.

In May 2013, the coordinator-general approved the AU$ 4.2 billion Kevin’s Corner coal mine in the Galilee Basin, comprising a 30 million tpa underground and opencast coal mine and associated infrastructure near the adjacent Alpha coal project.

Others in the pipeline include the AU$ 1.76 billion Byerwen coal mine proposed by QCoal and JFE in the northern Bowen Basin, along with Bandanna Energy’s Springsure Creek project near Emerald and BHP Billiton’s Caroona thermal coal mine in New South Wales (NSW).

Coal’s legal and political battles

It is has not all been plain sailing for the Australian coal industry.

In April 2014, the Queensland Land Court handed down a 149-page judgment on the AU$ 6.4 billion Alpha coal project, ruling that the proposal be either rejected by the state government or only be allowed to proceed with extra conditions to protect groundwater. The GVK Hancock project in the Galilee Basin comprises a 30 million tpa mine, as well as a 500 km rail corridor to transport coal to Abbot Point for export.

While environmental groups seized on the decision, analysts considered it far from the end for the project, noting that the court refused to enter into the debate on climate change. However, across the border in NSW, the industry was caught up in a corruption inquiry involving the previous Labor government and its business associates. In January 2014, the NSW government cancelled the exploration licence for NuCoal Resources’ Doyles Creek coal project, despite the threat of a AU$ 500 million legal claim, on the grounds that the licence had been issued corruptly.

In April, the industry was rocked by the Supreme Court’s decision to uphold the NSW Land & Environment Court’s bar on the AU$ 600 million expansion of Coal & Allied’s Mt Thorley Warkworth complex.

Project delays in NSW have been attributed at costing potentially AU$ 10 billion in lost investment, according to the NSW Minerals Council. A planning decision to reject the extension of Anglo American’s Drayton South project due to its local impacts was heavily criticised by the industry, with the council running a social media campaign in support of affected workers.

Despite pledges to remove red and green tape and create a “one-stop shop” for approvals, industry insiders expressed mixed views on progress. The so-called “water trigger” on projects imposed by the previous federal Labor government was formalised by the new coalition government against industry opposition, with a number of major coal projects potentially subject to federal review.

Increasing environmental activism has also frustrated miners, from protests over the potential impact of coal mines on Queensland’s Great Barrier Reef to arrests of demonstrators at Whitehaven Coal’s new AU$ 760 million Maules Creek mine in NSW. The MCA responded by launching its Australians for Coal website, aimed at regaining lost ground in the public relations battle. Spokesman, Ben Mitchell, said “tens of thousands of emails have been sent supporting Australia’s coal industry […] the tweet-to-email ratio is running vastly in our favour”.

The industry has also pushed for new exploration incentives, with data showing exploration in NSW alone had nearly halved in two years.

While miners welcomed moves by the Abbott government to repeal the carbon and mining taxes, the industry has faced increased state government royalties and a threatened hike in fuel taxes.

Meanwhile, safety worries have emerged, following the death of two workers at Yancoal’s Austar mine in April 2014, followed by another death a month later at Anglo American’s Grasstree mine in Queensland. Industry sources said safety might have suffered as a result of cost cutting on maintenance and the drive for increased production to boost cash flow.

M&A continues in the Australian coal industry

Merger and acquisition (M&A) activity has continued, with Chinese and South Korean buyers reportedly the most active. However, it has been largely at a project level, with major miners, such as BHP Billiton and Peabody Energy, keen to offload unproductive assets. Nevertheless, some larger M&A deals have been proposed, including the joint AU$ 1.4 billion bid by China’s Baosteel and Queensland-based rail company Aurizon for iron ore and coal miner Aquila Resources, as well as the AU$ 1.75 billion sale of the Port of Newcastle to a consortium of Hastings Funds Management and China Merchants Group. Queensland’s AU$ 2.5 billion Wiggins Island coal port is also seen as a potential target, potentially by pension fund investors.

At the junior end, Cockatoo Coal swooped for Blackwood Corp., which held 17 underexplored coal projects, including one near Cockatoo’s Baralaba mine.

“There are a number of junior coal mining companies,which listed when prices were higher and that are now running out of cash. They could seek to merge with other companies or be taken over by Chinese or other foreign companies, as what happened to Endocoal and Carabella,” said Lou Caranua, editor of Australian Longwall magazine.

Analysts said potential threats to Australia’s coal industry came from a possible slowing of Chinese demand and increased exports from Colombia, Indonesia and the US, along with a potential strengthening of the Australian dollar.

Opportunities could come from the growth of Australia’s so-called cleaner “eco coal,” with Brice Mutton, director of Cuesta Coal, seeing a disconnect between power plant operators and coal buyers in China, the world’s biggest coal consumer.

“China’s middle class is now the size of the US population, and they’re starting to demand cleaner air. So the issue gets down to having clean coal […] Power plant operators are going to want better-quality coal and Australia has that quality,” he said.

The MCA also endorsed Australia’s April free trade deal with top coal customer Japan, which eliminated tariffs on metallurgical coal and other minerals and energy exports. According to the International Energy Agency, coal demand will increase by 44% through to 2035 under current policies, with two-thirds of global demand from developing Asia. Industry experts expressed optimism on consistent growth, although few expect boom conditions anytime soon. “There’s a general view that in the medium term the outlook is stronger, particularly for thermal coal,” Balance Resources’ Ryan said, although he added that the outlook “remains subdued for the next two to three years”.

“I don’t think we’ll see another boom in five years, but we may see the market starting to rise. Coal prices are likely going to move in alignment with the long-term trend of the past 10 – 20 years, without the abnormal peaks and troughs we have experienced in recent years,” said David Arnott, group manager, Golder Associates. “It all comes down to working with a price for coal that is reasonable, keeping costs down and operating on that basis. There’s nothing to suggest coal won’t continue to be a primary source of energy and it’s still required in the making of steel, so the long-term outlook is positive.”

Written by Anthony Fensom. Edited by

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