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Energy | Indonesia’s Coal Industry: Full Steam Ahead

After being hit hard in recent years following the fall in global commodity prices, coal has experienced a significant price increase since the first quarter of 2017. Many analysts predict that the upward trend will continue throughout the course of 2017. Caution beyond that point should however be taken as various factors contributing to coal’s price recovery can be limited to the short term only, such as production cuts in China and increased demand in India.

Indonesia’s Coal Industry: Full Steam Ahead
The days of high coal prices due to peak Chinese demand that saw the springing up of small scale coal operations and opportunistic diversification into coal by established companies is unlikely to be repeated after having had their fingers burnt

On the rise again

After dropping to below $50 USD in 2016, coal prices have steadily rebounded back to the 2013 level of above $90 USD per tonne. Since the beginning of 2017, the prices have soared by 24.21% (See Indonesia’s Coal Mining Sector: A Silver Lining Behind Dark Clouds).

There are many factors contributing to this price increase; from the closure of hundreds of coal mines in China due to a surge in mining accidents, to increased demand in the US and India, as well as reduced coal supply from Australia.

The Chinese government decided to cut back its mining activities from 330 days to 276 days during the year to reduce work-related accidents which had increased in frequency and severity. Furthermore, since 2016, Beijing has also placed moratorium on the creation of new coal mines for three years and has plans to close 4,300 small and inefficient coal mines (See What China’s Slowdown Means for Indonesia: A Trade Perspective).

Meanwhile, the United States and India have seen a rise in demand for coal. US President Donald Trump’s (See The US Presidential Elections and What it Means for Indonesia) decision to pull out of the Paris Climate Change Treaty and rescind on commitments to greenhouse gas emissions set by former President Barack Obama is predicted to cause a hike in US coal production and demand by 31% until the end of the year.

The US Energy Information Administration (EIA) projects that coal-fired power plants will account for 31.3% of electricity generation in the US; slightly above natural gas with 31%. Meanwhile, coal demand in India remains high due to industrial development.

Mr Paulus Warsono Broto
Dewata Group
Mr Paulus Warsono Broto
Coal Mining & Concessions
Given that most of the newly built coal power plants in markets such as India are likely to remain in operation for at least thirty to forty years, I expect that the coal industry in Indonesia will continue to grow as a result of being one of the primary sources of thermal coal
See Interview

In Indonesia’s domestic market, coal remains in high demand as the state-owned electricity firm (PLN) allocated 55.6% of its energy mix in 2017 to coal-fired power plants (See Investment in Indonesia’s Electricity Sector; Sparks of Life). This is higher than that of natural gas with 17%, LNG at 8%, hydro at 6.4% in addition to geothermal which accounted for 4.6% (See Overview of Renewable Energy in Indonesia: Progress, Albeit Slow).

This is behind why the Ministry of Energy and Mineral Resources (EMR) has revised up the coal production target in 2017 by 13.8% from 413 million tonnes to 470 tonnes based on the evaluation results of the work plan and budget (WP&B) of coal mining companies. Until the end of August 2017, coal production realisation in Indonesia reached 62% or 294.5 million tonnes. Meanwhile, the domestic market obligation (DMO) until the end of August only reached 30.8 million tonnes or 29% of its target of 107.9 million tonnes.

Dark clouds remain

Short-term Effects

Despite coal’s price recovery and the increase in demand, dark clouds remain over Indonesian coal mining companies. Many analysts predict that the price recovery will not last long as it is not supported by sustainable underlying factors.

The short-term nature of these factors is underlined by coal production in China and Australia; two of the biggest coal producing countries. Once back to their normal production levels, coal supply will return to its previous volume and so the price will follow. The same holds true if the concern over environmental issues, especially climate change, in coal consuming countries is being raised high on the agenda again. This will reduce coal consumption, which will eventually drive down its price.

Proposed Price Cap

On the other hand, coal mining companies in Indonesia can not expect much from the domestic market either because the largest coal buyer in the country, PLN, has proposed to the Indonesian government that it set special DMO prices for the state electricity firm. The proposed price is the production cost plus 15% - 25% margin which is expected to make the price more efficient as it will eliminate fluctuations in the coal price.

At the other end of the spectrum, however, coal industry players in Indonesia expressed their concern that the price cap will prevent them from maximising their profits when prices are soaring. In order to maintain profitability, coal companies need to diversify their business interests, including developing their own coal-fired power plants or switch their production to export when their contract expires.

Nevertheless, many argue that the policy is a win-win solution. Coal producers will benefit as they will have guaranteed, long-term coal sale and purchase contracts from PLN. This will act as an incentive when the price is low. Others, however, are pessimistic that the Indonesian government will grant PLN’s request as the average selling price will be reduced by 20% - 30% and thus the royalties earned by the government will tumble.

Increased DMO

Aside from the price, PLN has also asked the government to increase the DMO for coal. Currently, only around 20% of Indonesia’s national coal production from 46 coal contracts of work (PKP2B) holders are set aside for the domestic market, while the remaining 80% are exported. In 2017, DMO for coal production was set at 107.9 million tonnes, or increased by 19.22% from the DMO realisation in 2016 of 90.5 million tonnes.

Earlier this year, the Indonesian government regulated the electricity tariff of coal-fired power plants through Regulation of EMR Minister No. 19/2017 on Coal Utilisation for Power Plant and the Purchase of Excess Power. The regulation caps the price of electricity sold by coal-fired power plants, including mine-mouth power plants.

Tax Issues

Further issues faced by Indonesian coal companies are the the high proportion of coal mining business permit (IUP) holders that have not obtained a clear and clean (CnC) status (See Applying for a Mining License in Indonesia). According to the EMR Ministry, only 2,441 out of 3,873 coal IUP holders have received CnC status.

Meanwhile, the remaining 1,432 companies have not obtained the CnC status for various reasons such as having difficulty in paying tax arrears, legality issues, land permits overlapping with other IUP holders, unpaid royalty payments, and failing to make a deposit into the reclamation-guarantee fund. Up to September 2017, the Indonesian government has revoked 171 coal IUPs, including 152 in Jambi, 17 in South Sumatra, and 2 in West Kalimantan.

For 2018, the government has proposed setting the PNBP target for the coal sector in the draft 2018 state budget at 16.78 trillion IDR. The figure is lower than that set in the draft 2017 state budget of 17.9 trillion IDR.

Still Unattractive to the Banking Industry

Despite soaring coal prices, the banking industry in Indonesia is still reluctant to extend credit to coal miners and mining companies in general. As of July 2017, bank lending to coal companies was down 14.69% yoy with an NPL rate of 7.49%. In general, bank credit to the mining sector only grew 1.21% yoy with an NPL rate of 7.49%. In addition, the proportion of mining-related credit to total credit is only 2.72% (See: Indonesia’s Banking Sector; Under Pressure But Staying Strong).

Indonesia’s banking sector still considers mining as a high-risk industry which is prone to price fluctuations. This approach has been reinforced by the decision of the Indonesia Stock Exchange (IDX) to delist PT Berau Coal Energy Tbk (BRAU) from its index. IDX considered the company as having a condition or event that adversely and significantly affected its business continuity; both financially and legally.

Upward trend expected to continue

Despite these difficulties, all in all, the Indonesian coal sector still offers attractive prospects; at least for the upcoming two decades. In the domestic market, Indonesia has undertaken a 35 GW power project where coal-fired power plants will account for 60% of its total output, or 20 GW.

This will create demand for 160 - 170 million tonnes of coal per year starting in 2019. Beyond that, coal is still expected to account for 50.4% of the country’s energy mix by 2025 and remains the most dominant energy source for domestic power plants until 2035.

The current price recovery will also have a positive impact on the mining support services industry. In Indonesia 80% of coal mining activities, especially exploration and transportation, are carried out by contractors. When coal prices arelow, the fees received by mining contractors for production, overburden removal and transportation activities are reduced by 5% - 10%. Now is therefore the ideal time for mining support services companies to negotiate a better fee.

On the external side, China and India are forecasted to help sustain global demand for coal until 2035, which is expected to grow by 1.1% per year. The demand for coal in India and China is predicted to account for 64% of total global demand by that year.

Besides the two aforementioned countries, Vietnam is quickly becoming one of largest importers of Indonesian coal. Indonesia and Vietnam have signed a coal sale and purchase agreement which is in place until 2022. The country is currently developing coal-fired power plants and up to April 2017, had imported 4.6 million tonnes of coal from Indonesia and Australia. Vietnam’s coal demand until 2020 is predicted to reach 50 million tonnes and will increase to 80 million tonnes by 2030.

Another potential export market for Indonesian coal is South Korea. PT. Bara Tabang, a subsidiary of PT Bayan Resources Tbk, will supply 10 million metric tonnes of coal for six years to Korea Midland Power Co. Ltd starting in October 2017.

Many analysts predict that the bullish trend in coal prices will be maintained throughout the winter until January 2018. Coal prices are expected to increase to $98 USD per metric tonne or even pass the $100 mark per metric tonne to $105 – 110 USD per metric tonne by the end of 2017.

Some analysts also forecast that the positive sentiment in coal prices will lead to a consolidation in the industry, whereby large-scale coal companies with greater financial capability will acquire small-scale ones in order to increase their reserves so as to meet growing demand. This has already been demonstrated by the acqusitions made by several big coal companies such as PT Bukit Asam Tbk (PTBA), PT Indika Energy Tbk (INDY), PT Golden Energy Mines Tbk (GEMS), and PT Intra Asia Indonesia.

Indika Energy recently acquired 40% and 5% shares of Samtan Co. Ltd. and PT Muji Inti Utama in PT Kideco Jaya Agung worth $677.5 million USD which will boost the company’s stake in Kideco to 91%. GEMS has also been actively eyeing new mines and plans to acquire four mining companies in 2017. The process of acquiring two coal mines has been completed, while the remaining two mines are still in the due dilligence phase.

The same holds true for Bukit Asam which plans to acquire several mines this year. The company which will supply coal to PT Chandra Asri Petrochemical Tbk’s new plant, which is currently still undertaking the due dilligence process to increase its mining assets.

Meanwhile, Intra Asia Indonesia, a subsidiary of Intra Asia Trading Pte Ltd, plans to acquire three IUPs in Kalimantan in 2017 to expand its portfolio. Currently, the company owns three exploration IUPs with estimated coal resources of 35 million tonnes. The company needs more reserves as it plans to export 3 to 5 million tonnes of coal to Vietnam in 2018.

The planned movements by major coal companies show that dynamism is returning to Indonesia’s coal sector after a long slumber. While demand from key markets such as China, India and Vietnam, in addition to the domestic Indonesian market should maintain sustainable demand to keep prices up; the past volatility has likely put off a lot of small scale coal mine owners. Therefore, we can expect further consolidation to take place amidst a steadying of coal prices. However, the days of high coal prices due to peak Chinese demand that saw the rise of small scale coal operations and opportunistic diversification into coal by established companies is unlikely to be repeated after having had their fingers burnt.

Global Business Guide Indonesia - 2017

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