Inexpensive low-grade Indonesian coal, the linchpin of numerous independent power projects in India, is slated to become a rarer commodity. A combination of government regulations, rising domestic and regional demand, along with possible sectoral challenges, will support higher prices for Indonesian coal going ahead.
As the world’s largest thermal coal exporter, Indonesia is looking to gain from the country’s booming coal industry and Jakarta has already brought in measures that will swell its coffers through higher taxes and bigger royalty payments. This includes the introduction of the pricing benchmark last year that is linked to four other major coal indexes.
All existing supply agreements with Indonesian mining firms will have to be brought in line with this new benchmark by September this year, a move that has prompted the Association of Power Producers — representing 13 Indian independent power developers — to seek higher tariffs for upcoming projects. The Association has claimed that projects of about 13,000 Mega Watt (MW) in total be affected by this regulation.
“The new regulations (or pricing system) will allow the Indonesian government to get the right amount of royalty , and the taxable revenues from the sector will also move up to the correct levels. It will also stop the practice of transfer pricing. The government has put in a strong framework,” said Rudi Vann, an analyst at Wood Mackenzie.
But this is unlikely to be the last move in Indonesia’s efforts to develop its mining industry. It is understood that the government is currently in the process of drafting a new regulation that could ban the export of low-grade coal by 2014. This is likely to apply to coal below 5100 kilocalories (kcal) in value.
While an existing law states that the country’s mining industry needs to move towards value-added exports, it is “quite unclear as to what this means for the coal sector,” said Supriatna Suhala, executive director of the Indonesian Coal Mining Association, which represents over 90 miners. Of Indonesia’s total coal reserves of 21 billion tonnes, 20.22 per cent is low-rank coal, 66.39 per cent is of medium-rank, 12.43 per cent of high-rank and only 0.96 per cent of very high-rank, according to the country’s ministry of energy and mineral resources.
Low-quality coal ranging between 4800-5800 kcal forms a large chunk of Indonesian exports, and it is unclear whether the coal benefication technology that the government regulation requires is available with the country’s coal industry.
Although the Association is opposed to the proposed ban, Suhala said that it will at least try and ensure existing investors in the sector are protected. “We don’t know about the new comers but it will definitely hurt the investors who have signed contracts and invested in mines and infrastructure. We will try and protect existing investors,” he said. Major Indian investors in Indonesia’s coal sector include Tata Power, which has a 30 per cent stake in two of the largest mines in the country, and the Adani Group, which has planned investments of over $1 billion in mining-related infrastructure.
“There has been no significant improvement in infrastructure. It remains under-invested in,” said Andreas Bokkenheuser , an analyst at UBS, underlining a major risk that the country’s coal sector will face as it cranks up production.
“The low hanging fruits, in terms of the reserves near the coast and ports, have been developed. Now miners will have to move further inland and substantial infrastructure creation will be required. There is also the issue of equipment and manpower availability. These production targets are aggressive,” head of a local lender, who did not want to named, with interests in the sector said.
There are also concerns over pre-production procedures. Analysts have flagged forestry and mining permits, as well as increased cost of land acquisition, as risks for the sector.
With Domestic Market Obligation (DMO) rules now in place, Indonesian miners are only permitted to export a part of their production after domestic requirements have been met. At the same time, domestic demand is likely to increase as government pushes for the completion of 10,000 MW of power projects, which will be 100 per cent coal-fired.
Unless production is able to sustain its current growth trajectory, exports could be impacted, especially that of low-grade coal to India which will also power Indonesian generation facilities.
Regional demand for Indonesian coal remains strong. Apart from the usual demand drivers, such as China, India and Japan, newer importers are also emerging. For instance, after meeting half of China’s coal import requirement less than four years ago, Vietnam last month received its first shipment of Indonesian coal and is expected to become a net importer , UBS said in a report.
Moreover, infrastructure bottlenecks in South Africa, the world’s fifth largest coal importer, could provide additional support for Indonesian coal as exports from Africa could dwindle. “A decade-old failure to build infrastructure necessary to ensure sufficient coal supply to both national and foreign buyers, will now result in exports being redirected into the domestic market. Australian and Indonesian coal producers are the primary beneficiaries, ” the report added.
For India, the situation will be aggravated by stagnation in domestic production even as demand has increased. With up to 100,000 MW of capacity addition likely in the 12 th plan period starting next year, more coal-based projects may need to scout overseas for fuel.
“Three-five years back, domestic coal production was able to keep pace with the demand from power producers. However in 2010, domestic production has remained at a flat level, while there has been a sudden increase in demand from Indian power companies,” said Prakash Sharma of Wood Mackenzie.
With a substantial part of its imported coal requirement already coming from Indonesia, India’s appetite is expected to grow further. “India's coal imports from Indonesia are rising every year. In 2010, it overtook Japan to become the second largest importer of Indonesian coal after China. We expect India to become the biggest importer of Indonesian coal in 2012,” said Sharma. "Given the long-term demand fundamentals, current high coal price scenario may continue to squeeze margins (of Indian power producers),” he added. This may well be the end of the road for cheap Indonesian coal.