Most of the inputs into China’s economic model these days involve subtraction – slower economic growth, lower demand for commodities, a reduced focus on exports. But look closely, and there are still numerous additions—including some substantial ones—to the mix. China’s state-owned electrical utilities are set to spend some 350 billion Yuan ($56 billion) on grid improvements in 2015, part of an eight-year plan intended to steer pollution away from coastal population centers. For international coal exporters, it’s nothing short of a sea change – and not a positive one.
The express purpose of the infrastructure upgrade is to correct a geographic mismatch. Chinese manufacturing hubs such as Shenzhen and Guangzhou are on the country’s east coast, perfectly placed for easy shipping, while most of its coal mines are in the west and northwest. But even if the coal were burned in the west and northwest, there were no transmission lines to carry electricity over long distances without significant losses. Instead, domestic coal has been transported east over rail lines and by sea. But in recent years, opportunistic foreign coal producers have also brought seaborne imports into the country, with Chinese traders snapping them up when the price is lower than domestic coal. In total, imported coal makes up about 200 million tonnes of the 4 billion tonnes burned in China each year.
As for that imported coal, it has been burned almost as soon as it’s entered the country – on the power-hungry eastern seaboard. Domestic coal, too, is largely shipped in and burned locally. The problem with that is that the region isn’t simply home to the bulk of China’s manufacturing — it’s also home to most of its people. Authorities see the haze that blankets Beijing and other cities as an increasingly untenable and potentially destabilizing problem. The solution: building 27 ultra-high voltage (UHV) transmission lines to connect the mines in the northwest and the power-hungry cities on the coast. Burn the coal in Inner Mongolia and Shanxi, use the power in Shanghai.
Eight UHV lines are already up and running. The longest spans some 2,100 kilometers from Hami, in the Mongolian border province of Xinjiang, to Zhengzhou, an eastern city that houses, among other things, a Foxconn plant that played a key role in producing the iPhone 6. Five additional transmission lines are under construction, and Credit Suisse analysts expect work on eight more to begin in 2015.
The shift couldn’t come at a worse time for those supplying coal to the country. China’s appetite for coal was already waning, with total demand up just 0.6 percent in 2014 compared to 16.5 percent in 2011. More importantly, demand actually fell by 6 percent in 2014 in the coastal region, and is expected to keep shrinking for the next six years. Additional railroad lines have also made it easier to move domestic coal from west to east, reducing the country’s demand for imports even further. Net imports of thermal coal fell 13 percent in 2014, from 244 million tonnes to 213 million tonnes. Credit Suisse expects net imports of just 92 million tonnes in 2020 – a 62 percent reduction in less than a decade. All told, coal’s share of China’s energy supply is expected to drop from 76 percent in 2014 to 69 percent in 2020.
The Chinese government also introduced tariffs on and hiked quality requirements for imported coal late last year. Add that to shrinking demand, and tens of millions of tonnes in surpluses are expected to flood the global coal market over the next few years, driving prices lower. While thermal coal averaged $71 per tonne in 2014, Credit Suisse’s commodities analysts expect it to stay below $60 for the next three years. “The depressing conclusion for coal producers is that flat output is not sufficiently disciplined – more needs to be done to curtail production,” the analysts write.
So who’s going to blink first? Given the strong dollar, Credit Suisse says U.S. producers will likely exit the market first. But there will be no market for any expanded capacity by major producers for years to come. Mining conglomerate Glencore shut down Australian production for three weeks in December, but other Aussie producers haven’t followed suit, in large part because they’re locked into multi-year contracts with domestic railroads and ports that require payments whether they ship anything or not. A weakened Australian dollar has also made it easier for the second-largest exporter to keep mines running. Russia, the third-largest exporter, “could well be a sticky producer that refuses to scale back output,” thanks to the weak ruble, says Credit Suisse.
But the order in which individual countries cut back won’t really matter in the end. Eventually, all coal producers – even those in low-cost Indonesia, the largest exporter to China – will be forced to shrink production. The coal industry is about to take a trip back to the B.C. era – before China, that is.