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Indonesian coal sector set to consolidate

Prices have been soft, and it may take a while for a stable turnaround to come

The Indonesian coal sector is primed for a shake-up. Dark clouds are hovering over it, presenting rich pickings for cash-rich coal producers and investors on the hunt for a bargain - PHOTO: AFP

[SINGAPORE] The Indonesian coal sector is primed for a shake-up. Dark clouds are hovering over it, presenting rich pickings for cash-rich coal producers and investors on the hunt for a bargain.

However, this will take some time to bear out as the industry waits to ride out the bottom of the cycle. Observers add that the industry is also awaiting more regulatory certainty from the new government of Joko Widodo, or Jokowi, as he is popularly known.

Demand for thermal coal - of which Indonesia is the world's largest exporter, controlling 40 per cent of the total seaborne market - is seen to be in structural decline, as costs of alternative energy sources such as shale gas fall and as environmental policies become stricter in countries like China and the US.

Add to this scenario the ballooning supply of coal: US coal exports are growing, Indonesia is stepping up production and Colombia is boosting output to a record this year.

Scott Dendy, the Asia-Pacific head of McCloskey Coal at IHS Energy, said: "Prices have been declining for over two years now, and there is little further cost-cutting that can be done. To this end, we believe prices are near the bottom, but there'll probably be a few false dawns before stable recovery emerges."

In Indonesia, the consolidation will weed out the less efficient or over-leveraged operators, he said.

Alberto Migliucci, chief executive of Petra Commodities, a boutique investment advisory firm in mining and oil and gas, agreed, and predicted a wave of mergers and acquisitions (M&A), with the cash coming not just from corporate cash hoards but also from personal wealth.

Singapore companies are among those rolling up their sleeves for the action.

In July, private-equity player Tembusu Partners invested US$7.5 million in Param Mitra Coal Resources Pte Ltd. The companyholds two operating coal mines in Kalimantan with a resource base of about 500 million tonnes.

Mr Migliucci said: "Private-equity players are experts at sourcing assets when they're relatively cheap . . . A lot of the Asian private-equity guys - whether out of Hong Kong or Singapore - are looking.

"Financial investors are selective in buying coal assets as the down-cycle could last longer than expected . . . so there may be a bit more time to wait before we see full steam on the M&A front."

First, there needs to be certainty.

Erlend Engelstad, a senior analyst at brokerage firm Marex Spectron, noted that president-elect Jokowi has pledged to improve transparency in his government and to ease regulatory pressure for exporters.

Coal represents about 14 per cent of Indonesia's total exports. The commodity, which accounts for 40 per cent of all power generated globally, is mostly produced and consumed domestically; the seaborne export market makes up only 14 per cent of global demand.

With China taking stricter environmental measures - it will ban all coal use in Beijing by 2020 to rein in the city's bad-air days - and supply continuing to expand, short interest in coal players has built up.

Financial data provider Markit said the average short interest in US coal firms such as Walter Energy Inc and Arch Coal has surged in the past 11/2 years, and stands at 3.85 per cent of outstanding shares.

Markit analyst Simon Colvin said: "In the ever- shifting debate on future sources of energy, few sources of energy have fewer friends than coal. The once-ubiquitous commodity has lost popularity in a world increasingly focused on reducing the environmental cost of energy production."

But try as they might to reduce carbon intensity, policy-makers will find it hard to change their countries' energy profiles significantly without compromising on their economic competitiveness, said Standard & Poor's in a July 21 report. The ratings agency thus expects demand for coal, especially in India and China, to continue to grow in absolute terms in the next five years, although at a lower- than-historical rate.

In the short term, the situation looks dismal. The supply glut that has driven coal prices to their lowest since 2009 will more than double from 6.8 million tonnes this year to 14.9 million tonnes next year, said Morgan Stanley in a July 8 report.

Miners such as Vale and the Peabody Energy Group are starting to cut supply.

But Peabody's chief executive Gregory Boyce expressed optimism during a conference call in July, saying the firm is starting to see signs of rebalancing, although seaborne coal markets remain over-supplied.

He said: "More than 2,000 smaller mines (in China) are expected to close by 2015, as the growing amount of Chinese coal production is uneconomic."

Out of the rubble left behind by the pressure of low coal prices will arise new - and perhaps bigger - players. Petra's Mr Migliucci said: "Within six to 18 months, we'll see much more consolidation, and the coal sector will be a different place from now."