February 27, 2014 / 8:26 AM / in 4 years

COLUMN-Asia utilities in dicey bet on cheap, low-rank Indonesia coal: Clyde Russell

--Clyde Russell is a Reuters market analyst. The views expressed are his own.--

By Clyde Russell

SINGAPORE, Feb 27 (Reuters) - Many power utilities in Asia appear to be making what seems like an increasingly risky bet: that poorer quality coal from Indonesia will remain cheap and plentiful.

Generators from India to Southeast Asia and China are building or planning new coal-fired units designed to run on low-rank, sub-bituminous coal from Indonesia.

Such coal has been growing in supply and currently trades at a discount of 24 percent to higher quality bituminous coal from rival supplier Australia.

But two factors are calling into the question the wisdom of building long-term projects reliant on low-rank Indonesian coal.

The first is that the Indonesian government is planning new rules and taxes designed to increase its revenue from coal mining, and the authorities appear not to mind if the result of these policies is a sharp reduction in exports.

The second is that the increasing demand for low-rank coal has boosted its price relative to better quality fuels, eroding the economics of burning the poorer quality supplies.

Across Asia there is currently 363 gigawatts of coal-fired capacity either under construction or in advanced planning, Paul Baruya, global analyst at the International Energy Agency’s Clean Coal Centre, told the Coal Markets conference in Singapore this week.

Of this, 109 gigawatts is in India, 106 gigawatts in China and the bulk of the rest in Southeast Asian countries including Malaysia, Vietnam and Indonesia.

The bulk of these new units use more efficient super-critical or ultra super-critical boilers and are planned to use coal with a calorific value of 4,000 kilocalories per kilogram (kcal/kg) or less.

This type of coal is abundant in Indonesia and much of that nation’s recent growth in exports has been made up of lower-quality grades.

In contrast, Australia, the second-largest exporter of coal used in power plants after Indonesia, typically supplies fuel in a range of 5,000 to 6,500 kcal/kg.

The major buyers of this higher quality fuel include Japan and South Korea, but Australian coal also goes into China and other Asian nations, although it is sometimes used for blending with poorer quality supplies.

While Indonesia coal exports reached a record 332 million tonnes in 2013, up from 310 million in 2012, the energy ministry expects them to decline this year to 301 million tonnes.

However, the risk is that exports will decline much more if the Indonesian government implements its planned changes to royalties and introduces an export tax.

NEW TAXES, PRODUCTION LIMITS

The government is proposing to raise the royalty duty to 13.5 percent for both major miners and smaller-scale producers, and it is also planning to introduce an export tax.

Under the current system, coal miners either operate under a Coal Contract of Work (CCoW) or a Mining Business Licence, known by its Indonesian acronym of IUP.

CCoW holders tend to be major producers and IUP operators tend to be smaller producers of mainly low-rank coal.

Currently IUP miners pay royalties at a significantly lower rate than CCoW producers, a system that was designed to encourage smaller companies to move from exploration to production.

Raising the royalties on these producers and imposing an export tax would render many uneconomic, especially in the current market of low global coal prices.

The Indonesian government is also planning on being more proactive in enforcing production limits agreed in both CCoW and IUP licences, another factor that may limit output.

Indonesia also has plans to build 13 gigawatts of new coal-fired power and authorities appear increasingly determined to ensure that coal for the domestic market is prioritised.

The government doesn’t want to repeat the experience of its oil and gas industries, where Indonesia went from being a major exporter to being a net importer of oil and it has started to buy liquefied natural gas from Qatar and Australia due to inadequate domestic supplies.

While these risks don’t suggest an end to Indonesia coal exports, they do indicate that export growth is likely to falter in coming years, and may contract.

This increases the likelihood that the gap between low-rank coal and higher-quality fuel will continue to close.

Indonesia sub-bituminous coal futures closed at $58.80 a tonne on Feb. 26, compared to the $77.30 for spot coal at Australia’s Newcastle port in the week to Feb. 21.

The gap of $18.50 a tonne is down sharply from the $30.85 at the beginning of 2014, not to mention the $32.54 this time last year, the $36.51 in late January 2012 and the $43.05 from three years ago.

Converting coal into heating value shows that at current prices, Australian coal works out in a range between $2.97 and $3.68 per million British thermal units (mmBtu), while Indonesia low-rank coal is between $3.26 and $4.18 per mmBtu.

While this is a fraction of the current spot Asian LNG price LNG-AS of $20.50 per mmBtu, it does show that the economics of using low-rank coal compared to high-rank supplies are already questionable.

Add to this the political risk inherent in relying on Indonesia and it appears that Asian utilities may be backing the wrong horse.

Editing by Joseph Radford

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