Coal – can it warm a cool economy?

Along with last year’s headline hitting iron-ore increases, its little sister, coal, also had its time in the spotlight.

Because it takes almost two thirds of a tonne of coking coal to make one tonne of steel, last year’s frantic scramble to secure supplies gave many ports good reason to invest in extra capacity – until the economic slide hit steel, iron and coal together.

But does this mean that ports should back away from dedicated coal-handling schemes?

It is true that coking coal has lost ground, and demand for thermal coal (used for power generation) has recently slowed in a number of Asian countries including China, India and Japan. China, which last year was looking to become a net importer, rather than exporter of coal, has found the tables have once again turned and it now has a surplus to sell.

All this led coal producer Mechel to withdraw a preferred share issue that could have raised more than $2.5bn and last month said it would “significantly” reduce a $5.5bn five-year capital spending plan – which could impact on its port operations at Kambarka and Port Posiet.

Posiet, in Russia’s far East (on the Sea of Japan near the Chinese border), gives the company easy access to Pacific Rim coal customers and provides a delivery terminal for the coal mined by the companies subsidiaries in eastern Siberia. At present it has approximately 2.5m tonnes of annual cargo-handling capacity and 170,000-180,000 tonnes of warehousing capacity (depending on coal type).

Seizing the opportunity for expansion, the port recently started a $120m programme (including the building of a new berthing wall) to allow an increase in the size of vessels to be serviced from 25,000 tonne carriers up to panamax size vessels with a displacement of 60,000 tonnes. Posiet also has projects in place to expand annual capacity to 7m-9m tonnes by 2010. This includes installation of specialised high-performance coal handling equipment and the construction of additional warehouses to take as much as 300,000 tonnes of coal, split into four different grades.

But, although partially attributed to growing expenses, the port’s earnings were down a telling 20% by the third quarter of 2008 and it is possible that some of the shine may have come off the expansion plans.

However, general market movements may be a little more complicated than this picture suggests.

For a start, the fortunes of thermal coal and coking coal are still rather different because higher grade coking coal – used for steel – is more of a high hitting export market, dominated by Australian producers who together have a two-third market share. But thermal coal has slowly and steadily been gaining in market share for several years now, especially as places like Mauritius, tired of the price volatility of oil, is changing over its power generation from oil to coal.

Despite – and maybe because of – the more even distribution of thermal coal, it could eventually reach a broader and possibly steadier market, as Barry Stokes of Clarksons suggests. In the UK at least, “all the major ports are bringing in coal for power station use. These have a really steady commitment and have to be fed on a regular basis,” he says. Though historically, thermal coal trade has been located in two main ‘basins’ – Pacific and Atlantic, with the drop in freight charges Mr Stokes tells Port Strategy that the Port of Liverpool is seeing coal brought in “from wherever it can… Indonesia, Russia – worldwide – no restrictions, all that matters is who is selling the cheapest”.

Based on this it seems that the shipping of thermal coal could open the way forward for the badly hit dry-bulk sector, as China, India and South-East Asia’s power-generation drives start up again, resulting in investment returning to both coal and coal-handling when the markets stabilise – although ‘when’ might be still be some time away.

Which brings us back to Mechel, and Port Posiet, which is well placed to help grow Mechel away from its stagnating Russian-Ukranian base by supplying a range of Asian clients.

However, it hasn’t gone unnoticed by the Russian government that Posiet is also positioned to help the moribund Russian economy break into trade with Korea. Recently, president Vladimir Putin met with Lee Myung-bak, president of Korea to talk about building a Russian port for Korea’s exclusive use – citing Posiet as being in the right place with good deep water access.

How the Russian government (not traditionally the lightest of authorities) will treat Mechel, who are already in place in Posiet and whether the deal will help or hinder the flow of coal – is a moot point, because it was only last autumn that President Putin publicly criticised the company for its coke pricing policy, resulting in the company haemorrhaging investors. But then again, one of the cooperative efforts agreed upon by the two countries is a railroad project linking the Korean Peninsula with Russia, which has to help things along.

And so some market analysts have said that while coal is suffering from the presently depressed commodities and power markets, once the developing economies start whittling away their stockpiles, things should start picking up again.

On the other hand Kevin Dougherty, co-manager of the Pharos Russia Fund, doesn’t expect an upswing in the short term, and the implication for all investments, including coal handling ones, would seem to be ‘batten down the hatches and hang on to your hats’.

He points out that Russian coal exports decreased dramatically by 31.2% year-on-year in October. And by the end of last year, China – the main driver behind coal and steel exports for so long – dropped its export figures below 10% for the first time since 2001.

To add to the woes for port and other infrastructure companies is that payments along the supply chain have broken down, explains Mr Dougherty. “For example, coal company Raspadskaya reported that they have only received payment for 20% of their October sales.”

This means another burden for both logistics and commodities companies – already suffering under collapsed prices. “Many projects are going to be slowed down or put on hold,” adds Mr Dougherty. “So, as for new projects, anything that was discussed even up to this last October is now questionable… Yes, I think coal will eventually recover since it is a cyclical industry and demand will pick up. But demand will not pick up anytime soon.”

He adds: “The Asian market is still a major strategic priority for Russian companies, and in the long term these development plans will go forward because that is where the future growth lies. But many of these projects will probably be delayed at least until the early phase of this crisis is past.”

Peter Morgan of consultancy firm Lithgow is even more blunt about the immediate future. “I don’t want to invest in anything in the moment except a mattress with a secure zip,” he says.