Regional coal Heading into perfect thermal storm? Macquarie Research,

Visit http://indiaer.blogspot.com/ for complete details 􀂄 􀂄


Regional coal
Heading into perfect thermal storm?
Event
􀂃 Newcastle coal prices have surged by 15% from its low in mid-August to
about US$101.5/t currently. This is in line with our positive outlook on coal
driven by a seasonally stronger demand period from the Northern Hemisphere
and reduction in hydro capacity in China. Further, there are increasing risk of
supply disruption in major producing countries (e.g. Indonesian and Australia),
which will also tighten the supply-demand balance in the short term. This
predicates our positive view on the regional thermal coal sector, especially
Asean coal names given its high leverage to the global coal price.
Impact
􀂃 Entering into seasonally higher demand period. We believe that shortterm
coal demand will be partially driven by the recovery in demand in the
Northern Hemisphere as it enters into winter period. Historically, we have also
seen Chinese hydro generation (+/-20% of Chinese power generation)
decrease by about 40–50% QoQ in Q4.
􀂃 Chinese imports up 14% MoM in September, which is reinforced by our
channel checks with coal traders that China import demand is increasing
(especially for off-spec coal -both Indonesian sub-bituminous and Queensland
coal). This is also supported by the pickup in the Chinese coal price (driven by
power stations stocking up ahead of winter period).
􀂃 Supply disruption leading to tighter market. We expect Indonesian coal
supply will remain tight following nine months’ worth of rain (which has caused
producers to cut the 2010 target by 5–10%). This is especially as we enter the
wet season in Q4 and pre-stripping work has not hit budgets YTD. We have
also seen evidence of disruption coming out from Australia; including Xstrata
having recently suspended some deliveries from the Rollestone mine in
Queensland (with other producers seemingly having a similar problem). Our
channel checks also suggest that some coal traders have a short position in
Q4 deliveries and need to find coal to avoid liquidation damages.
􀂃 Potential for spot price to trade above our US$105/t coal price forecast.
Given the potential for a tightening supply and demand balance (we forecast
roughly an 11mt deficit in 2011), we believe that any supply disruption could
lead to large spike in coal price (ie, the spot price to trade above our US$105/t
coal price forecast). As a sensitivity analysis, for every US$1/t change in the
benchmark coal price assumption, we could see roughly 2–3% swing in
earnings.
Outlook
􀂃 We therefore reiterate our Overweight view on the regional coal sector with
Asean coal names as our preference given the high global price exposure and
relatively strong production growth profile. Our preferred picks in the sector
are Adaro, ITMG and SAR. We also find the Asean coal sector still relatively
attractively valued at 10.6x 2011E PER vs the historical average of 12–13x.
􀂃 Further, given we think that sentiment towards the sector will remain relatively
positive, we believe that the Chinese coal stocks will also benefit. Within China,
we believe that Yanzhou Coal has the largest global coal price exposure.
However, we also like China Coal given its strong production growth profile and
China Shenhua given it has been lagging the other coal names.