Euromoney reporter Kanika Saigal recently spent time in Indonesia on a fact-finding trip, and visited our mining operations in South Kalimantan as part of a focus on the coal and commodities sector. Here is her report, published in Euromoney’s October issue:
Kanika Saigal, Euromoney, Oct. 3, 2013 — As China’s appetite for commodities appears to be fading, demand for Indonesian coal could also fall, putting the export economy under stress. Mining company Adaro explains why the future is still bright.
The chartered flight from Banjarmasin to Warukin in South Kalimantan is a short, bumpy ride. Before the small plane takes off, earplugs are handed out to the passengers to block the noise screaming from the engine. But once airborne, it turns out nobody is bothered about the din. They are concentrating instead on the spectacular views.
South Kalimantan’s arable, green land has an unusual order to it. Some of it has been carefully sectioned into identical squares and used to grow oil palms. Small settlements can be seen close to cultivated land and there are reservoirs of all shapes and sizes dotted around. The most remarkable sight, however, is the vast opencast coal mine.
Tutupan mine is the second-largest opencast mine in Indonesia. It stretches 16 kilometres in length, is two and a half kilometres wide and a quarter of a kilometre deep. The black and grey lines across the edges of the mine are in stark contrast to the lush environment surrounding it. From the air, it looks as if little work is being carried out below. Only a few trucks can be seen navigating their way through the makeshift roads that meander to and from the mine. It stretches 16 kilometres in length, is two and a half kilometres wide and a quarter of a kilometre deep.
Closer inspection at ground level reveals that there are in fact hundreds of people working on site making sure that everything runs properly. Operations at Tutupan began in 1991 and coal extraction has grown at a steady pace since. Together with the smaller Wara mine, just a short 4×4 ride away from Tutupan, 47.2 million tonnes of coal was extracted in 2012, and production is planned to increase to around 53 million tonnes by year-end 2013. Potentially, work can go on for some time yet: the mine boasts coal resources as large as 2,521 million tonnes and economically viable reserves of 493 million tonnes.
Euromoney’s guide is Alastair Grant, an adviser for Adaro, the Indonesian mining company that owns the Tutupan and Wara mines. Originally from New Zealand, Grant has made a life for himself in Indonesia, settling in the country in the 1960s. He has been with Adaro since 1990 – just after the then Spanish-owned company was sold to a consortium of Indonesian and Australian companies. He is an Adaro institution. “I’m sorry if I talk too much,” he says in his soft Kiwi accent at the start of the trip. “I think people often get sick of hearing my voice.” Obviously passionate about the topic, Grant is full of facts and figures on the coal-mining industry in Indonesia and offers up a complete record of Adaro’s short history.
During Adaro’s exploration phase in the 1990s, Grant worked in a team of about five people from a modest house near the potential mine site. “We slept in the back of the building and would move to the front of the house each morning to work, or we would go over to the mine site to see what was happening,” says Grant. “It was very important for all of us to be close to the site and to the community.”
From such modest beginnings, the company has grown to be the second-largest coal mining company in Indonesia, with thousands of employees and additional investments in mines throughout the country, including a 10.2% stake in Bhakti Energi Persada in East Kalimantan and a joint venture with Australian mining company BHP Billiton in Central Kalimantan. Adaro’s client base spans the globe. “But the majority of our coal is sold to Asia, with the highest proportion to domestic buyers,” says Grant. “Last year, 23% of our total coal production was bought by Indonesia.”
But coal prices have been steadily dropping since the start of this year, and the sector’s strong performance has come under scrutiny. Thermal coal in the Australian port of Newcastle – a benchmark for the coal market in Asia – dropped 15% from $91.70 a tonne on January 4 to $78.30 on September 20. Since mid-2008, coal prices have dropped by half as economic growth in fuel-hungry India and China has slowed. Total sales for Adaro’s coal actually slipped from 50.8 million tonnes in 2011 to 48.6 million tonnes in 2012 because of turbulent market conditions.
Demand in China and changes in the country’s economic structure are some of the biggest influences on coal prices. “As the country moves away from an investment model of growth towards consumption – which is much less commodities based – China’s hunger for commodities will decrease. Structural factors indicate that this trend may well continue for some time,” says Prakriti Sofat, Asia economist at Barclays.
As a result, coal-mining projects in Indonesia have lost some of their sheen. “Indonesia’s terms of trade have been declining for the last 18 months, and the economy has been feeling this headwind for some time,” says Sofat. “Mining projects are becoming less and less attractive. General investment in the sector is decreasing.”
Moreover, the outlook for alternative, non-coal power-generation supply continues to surprise, explains Anthony Yuen, director of commodities research at Citi. “And if non-coal generation growth exceeds power demand growth, which is already slowing, use of coal is set to level out or even decline.” According to Yuen, optimistic long-dated coal prices might be unsupported: “Although lower prices may spur demand growth elsewhere, the demand slowdown in China should more than offset such gains.”
Even the idea that India, Asia’s second-largest energy consumer, could replace China as the driver of the commodity cycle has come under question as the depreciation of the rupee might have a longer-term impact on demand that has not yet fully come to the surface. Although coal imports to India have been relatively strong in the first half of this year, with July volumes already up 48% year on year, thermal coal imports to India will slow and average out at 35% growth for the entire year as a result of currency pressures, says Vipul Prasad, metal and mining analyst at Morgan Stanley.
Decreasing demand and oversupply are driving coal prices down. Some analysts argue that the commodities super-cycle is coming to an end. But while exploring Adaro’s operations on the island – equipped with hard hat and protective boots – Grant assures Euromoney that despite all the negative signs, demand for Indonesian coal is still strong; that Adaro will easily meet, if not exceed, its target for the end of the year; and that extraction will continue as long as the mine is economically feasible.
Back in Jakarta, in the comfort of Adaro’s head office, David Tendian, Adaro’s CFO, gives an interesting and lengthy history lesson on the commodity cycle. “It’s so important for people to understand the history behind the theory,” he says. In Tendian’s account of the commodities cycle, we have not yet reached the prolonged downturn in commodity prices – not in coal anyway.
“We are seeing a slight turnaround. Recent Chinese PMI [Purchasing Managers’ Index] data have been really encouraging, and the US and European economies are finally showing signs of positive growth. Commodity and coal prices will react to this. There is some light at the end of the tunnel.” More importantly, Tendian is a firm believer that Asian growth on a broader level will ensure strong demand for Indonesian coal. “Indonesian thermal coal is suited to power plants and electricity generation. And if we look at the power-plant situation in developing countries, including those in Asia Pacific, there is a great shortage of power,” he explains.
Tendian recalls the blackouts that hit India last summer, leaving nearly 700 million people without power. On July 30 2012, 20 of India’s 28 states were hit by power cuts, including New Delhi, when three of the country’s five electricity grids failed, bringing into question whether or not India could cope with the country’s increasing appetite for energy. “Trains stopped running, roads were jammed, and hospitals didn’t have any working equipment. It was a major political catastrophe, and the government can’t let this happen again. I even remember when I was holding a meeting in this very office and the power went out. It showed how constrained the power supply in Indonesia is. When a capital city in Asia can’t cope with power needs, there is a bit of an issue.”
Tendian continues: “We recently met with one of our buyers from South Korea. We discussed how that due to the recent heat wave, South Korea’s power generation is running at a critical level. Power supplies were completely drained, and they know that they need build more power plants to accommodate power needs. This particular client will need an additional 30 million tonnes in the next three years.”
At the beginning of the year, South Korea granted approval to four private companies, including Samsung C&T, to build eight coal-fired power plants in total. The plants are to be built by 2027, and combined will generate 8,000 megawatts.
“We met with another client in Malaysia. We discussed how, in the next three to five years, Malaysia will need 20 million tonnes of additional coal to fuel their growth,” says Tendian. “Even in China, regardless of the slowdown, a new power plant is built each year roughly equivalent in size to one UK power plant. That’s a lot of energy that they’re going to need.”
Elsewhere in Asia, governments are preparing to fulfil growing power requirements. In Taiwan, the Taichung power plant is the largest coal-fired power station, generating 5,780 megawatts, and is working at full steam. Developing countries including Vietnam and Myanmar will also increase their appetite for coal in the coming years.
“At the current coal price, there has been no new investment in coal mining; in fact people are cutting down,” says Tendian. “So actually, the supply side is correcting itself to match demand but not as fast as maybe it should be. There is still a slight oversupply, But when some of these new power plants are up and running they will need to feed themselves with coal for the next 25 years or more. Coal consumption will increase, and supply will match demand again. In about a year and a half to two years the price will start to go up. This is when power plants under construction will be finally up and running. At the moment, there is a mismatch between power-plant creation and coal supply, but this will soon correct itself.”
Developments in renewable energy and sustainability have encouraged some consumers to rethink their strategy surrounding the use of cheaper fossil fuels. But developing countries looking for cheap and accessible energy will continue to see the benefits of affordable coal from Indonesia to fuel their economic growth. “I don’t think environmental issues will play a big role in energy consumption for at least the next five years,” says Serene Shang Yi Lim, commodities research analyst at Standard Chartered.
And there are certain environmental advantages to buying coal from Indonesia, says Grant. Adaro coal from Tutupan and Wara is of a different quality to that from places such as Australia and South Africa. It’s low in ash, nitrogen and sulphur, making emissions much cleaner. “The product is much more environmentally friendly than that from lots of other places,” says Grant. “And because of its low ash content, erosion and wear on equipment is limited, keeping maintenance costs to a minimum.”
That said, the coal is higher in moisture and has a lower calorific value at between 4,100 and 5,100 kilocalories per kilogram. Compared with Newcastle coal, which has a calorific content of 6,000, Adaro coal produces less energy per unit. “There never used to be a market for this type of coal,” says Grant. “Because of its low calorific content, lots of power plants weren’t set up to use this type of coal and they didn’t think it would be worth it to them to use it. Over time, we have actually created a thriving market for this type of coal.”
As part of Adaro’s marketing strategy, the company has trademarked its coal with the catchy – if slightly oxymoronic – title Envirocoal. “Envirocoal is actually one of the cleanest fossil fuels in the world, and this is a major attraction to using our coal,” boasts Grant.
Indeed, one of the main pull factors of Envirocoal is that because of its low calorific content, the coal is cheaper. According to Standard Chartered, while the price for Newcastle coal on September 20 was $78.30 a tonne, Indonesian coal was $59.05. Power utilities in countries such as India have even been specifically developed to use this type of low-sulphur, low-ash and low-calorific-content coal. Mundra Ultra Mega Power Project, owned by Tata Power in India, was designed to burn this sub-bituminous coal. Adani Power, another thermal power producer, worked off a similar model. “New power utilities in places including Malaysia and the Philippines will also be made to process Indonesian coal because it is suited to their needs,” says Lim.
Adaro, and some other Indonesian mining companies, are also able to maintain relatively healthy margins despite the lower cost of the coal because extraction and transportation is relatively cheap. “Investment costs for open-pit mines are some of the cheapest because it’s relatively easy to develop them,” says Ferry Wong, head of equity research at Citi in Indonesia. “And because Indonesia is an archipelago, most coal deposits can quickly and easily be transported by sea to their intended destination – one of the cheapest ways to transport any type of goods.”
For Adaro, a mixture of flat-bottomed barges, floating cranes, loading facilities and transfer units can get 185,000 tonnes of coal from site to sea in 24 hours. “Our main competition comes from Australia, but we are the cheapest. Australia has to transport coal by train before getting to the sea, [a route that] is controlled by the Australian government and is much more expensive,” says Tendian. “In this environment, we have the advantage.”
It has not been all smooth sailing for Adaro. Although the regional autonomy law that divested power from Jakarta to local level led to wider economic development outside the capital, more bureaucracy and higher levels of confusion were also added to the mix.
“In order to get anything passed, we usually have to face different regional governments, and often the processes are not streamlined,” says Tendian. “For example, when it comes to land ownership, we need to buy the land from locals; to do this you need the title deed, but the locals don’t have one. At the most they have a piece of paper that they’ve gotten from who-knows-where that actually conflicts with another person who also claims to be the owner of the same land. It’s difficult to know who to go to to get these issues resolved.”
Adaro has had to adapt sharply as Indonesia has transformed from a dictatorship to democracy. “To a certain extent, it was easier back then to develop resources because democracy wasn’t an obstacle. The unintended consequences of democracy and the lengthy process it takes to start working means that the next tonnage of resources that can be exploited in Indonesia will be a lot more difficult to come by,” says Tendian. “The supply of all commodities in the long run, especially out of Indonesia, could become a lot more difficult.”