MARKETS

Only the cheap will survive

IT IS all about costs, not that anyone in the coal business needed <i>Hogsback</i> to tell them that as the industry is buffeted by a series of fresh financial and political attacks.

Tim Treadgold

Whether it was the US President Barak Obama, or one of Australia’s own coal mining leaders, Mark Cutifani, the message delivered over the past week has been the same – cut costs or you will struggle to survive for a simple reason: coal supply is dramatically exceeding demand.

Dressed up anyway you like the challenge for coal mining is as simple as the supply and demand equation first explained more than 200 years ago by the Scottish economist Adam Smith.

It was through Smith’s observations that the business world learned its two most important lessons.

Firstly, that supply of anything rises to meet demand. Secondly, that when supply exceeds demand prices fall.

Blaming politicians, environmental pressures, or the global banking crisis that has dented growth in Europe and China is a pointless process because there is little anyone in the coal industry can do about any of those factors.

Complain yes, but the only response available to miners is to adjust the only thing that can be adjusted, and that is the cost of production.

Mining is a “price taking” industry that must accept what customers are prepared to pay.

Anglo American chief executive Cutifani effectively said as much in his talk to the annual gabfest of the Minerals Council of Australia in Canberra, warning that with the price outlook grim all forms of mining had to adjust by lowering their costs.

“It does look pretty grim, certainly for the thermal coal industry,” he said.

Top of Cutifani’s list of coal problems was the rise of low-cost competition from countries once regarded as high-cost producers.

“Now, the US and Canada, which were formerly high cost producers compared to Australia, have emerged as aggressive cost competitors,” he said.

As if that warning was not enough to shake confidence in coal there were last week’s other signals that pointed to the thermal coal price not recovering any time soon as supplies flood the market.

In the US, President Obama launched his latest attack on carbon dioxide emissions which has been labelled a “war on coal”. He says not, but it is hard to escape the fact that everything proposed will cut coal demand in its most important market, electricity generation.

In Australia, one of its more interesting mining promoters, Peter Bond, glibly announced that he was no longer buying coal assets. Instead, the Linc Energy boss said, he was interested in selling the coal assets he already had.

“We are focussing on selling our coal assets,” he told the Australian Financial Review. “We’re not building a coal company”

The same might be said of Rio Tinto, which is already a major coal producer but is certainly not in the business of building more capacity. There are reports circulating that it is looking to sell its ill-fated Mozambique operations, which have been hit by transport issues and, more recently, by threats of terrorist activity.

So, how bad is the supply situation? Pretty bad, actually, which is why the outlook is for more cost cutting, expansion deferrals, development delays and job losses.

According to one survey of the industry, thermal coal has just endured its biggest quarterly price decline of the past 12 months with forecasts pointing to the price stuck between the tramlines of $US80-and-$US90 a tonne for the rest of 2013.

The problem is that an extra 30 million tonnes of thermal material is expected to hit the world market this year, just as demand dries up.

Bank of America analyst Peter O’Connor told Bloomberg that the coal industry was being “crippled by over-supply” and that even lower prices might be necessary to force production cuts.

The problem, which really is the elephant in the room, is the issue of who cuts first and deepest.

An analyst at Asian investment firm Maybank put it succinctly when he called the problem “a lack of producer discipline”, which is code for no-one being prepared to sacrifice market share even if they are producing at a loss.

In time, the problem will fix itself because investors and bankers will not support a loss making business forever.

Until that supply response comes, and high-cost coal is forced out of the market, it seems miners will be locked in a game of chicken with everyone waiting for the other man to blink.

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