Impact of China Coal Restrictions Questioned

Who to believe? The traders and analysts who say China's new regulations on coal quality is a body blow to Australian exports, or the companies and their association who say the impact will be insignificant.

In this case, it seems far more likely that the impact will be minimal, but not non-existent, as the new rules will lead to changes in the composition of coal China imports.

A far bigger impact may come from the curbs on transporting low-quality domestic coal, which may actually boost imports.

In theory, the Chinese ban from the start of 2015 on coal imports above certain ash and sulphur contents appears to favour Indonesia, the world's biggest shipper of thermal coal, over Australia, the world's top exporter of metallurgical coal and number two for thermal coal.

China's new rules aren't uniform across the country, but for exporters, the most relevant is the ban on using coal with ash content higher than 16 percent and sulphur of 1 percent for cities in the southern Pearl River Delta, the eastern Yangtze River Delta and three northern cities including Beijing, Tianjin and Hebei.

The southeastern cities are biggest users of imported coal, given their distance from the bulk of China's own coal output.

The fear for Australian exporters is that 80 percent of the 54 million tonnes of thermal coal it exported to China in 2013 exceeded the new ash limit, according to consultants Wood Mackenzie.

That sounds dire, but isn't an accurate reflection of the real situation for Australian coal exporters.

Research by Morgan Stanley (MS) shows that 32.3 million tonnes of Australian thermal coal output has an ash content of great than 16 percent, while less than 10 million tonnes had sulphur of more than 1 percent.

Australia exported about 192 million tonnes of thermal coal in the 2013-14 fiscal year ended June, according to the government forecaster.

It's also possible that much of the tonnage that doesn't meet the ash requirement could be washed to make it compliant, although this would boost the cost and it remains to be seen whether Chinese buyers would be prepared to pay extra.

But even if the higher ash coal is excluded from going to China, it is still clear that Australian could easily maintain current volumes of exports to China.

What is likely is that higher ash coal will have to be offered at a discount to other buyers, such as utilities in Southeast Asia, India and North Asian countries.

Similarly, lower ash coal may command a premium, but overall the impact on Australian exports may be muted.

"There is nothing in the information which suggests that Australian coal exporters will be disadvantaged and we are confident that we can meet the proposed specifications," Greg Evans, the executive director of the Minerals Council of Australia, said in a statement on Tuesday.

BHP Billiton (BHPLF), the world's largest mining company and a major exporter of Australian coal, said it expects no material impact on its business.

ADVANTAGE INDONESIA?

The conventional wisdom is also that the new Chinese rules will favour Indonesian exports, given that almost all of its coal meets the ash and sulphur requirements.

However, there may be some impact from the new rule that sets the minimum energy requirement for coal that is transported more than 600 kilometres from the receiving port at 3,940 kilocalories per kilogram.

Much of the Indonesian fuel is below this at around 3,700 kcal/kg, meaning these imports would have to be used close to the ports they are shipped to, which may be a limiting factor.

The other factor that the market may not be paying due attention to is that the restriction on calorific value also applies to domestic output.

Coal with a heating value of less than 3,940 kcal/kg, ash content of more than 40 percent and sulphur of 3 percent, cannot be moved more than 600 kilometres from the production site.

This may well act as a brake on Chinese coal output, especially in the southeast regions as the fuel mined there tends to be of higher ash and sulphur content, with the better quality coal coming from the north and northwestern provinces.

If the aim of the new Chinese rules is to improve air quality, then limiting the domestic mining industry would be far more effective than restricting imports, which only make up about 7 percent of the country's total consumption.

Also, allowing the continued use of lower calorific Indonesian coal but banning higher value Australian or South African supplies may not result in much reduction in pollution, given that a typical power plant will use as much as 40 percent more coal if its uses 3,700 kcal/kg fuel instead of 5,500-6,000 kcal/kg.

Ultimately, what is of far more concern for coal exporters is the health of China's economy, and thus electricity demand, and moves to increase the use of cleaner fuels such as natural gas, nuclear and renewables.

These factors will have a far greater impact than the changes to coal quality regulations.

By Clyde Russell