China Troubles Impact Coal Prices

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"Chinese companies are encouraged to own their coal mines—to limit rising coal prices."

What we took away from the recent Coaltrans Asia conference in Bali was that long-term prospects of coal remain buoyant, driven by worldwide energy demands. However, in the short- to midterm, prices will remain unexciting. We shared the view of the consensus that prices will remain between US$80 and $100 per ton (our assumptions is $90/ton) in the near- to midterm. We have therefore cut our rating on the coal sector from "overweight" to "neutral."

The prices are going to remain unexciting in the near term due to the China bubble, the Chinese government's cap on power prices and their encouragement of vertical integration and the European crisis.

China's economy is dependent more on investment and exports than on domestic consumption. The slowdown in the U.S. and Europe will impact China's exports, therefore slowing down its economy.

Lower levels of investment and domestic consumption also mean a slowdown in the manufacturing sector; thus, power plants; coal requirements will decline.

If the China property bubble bursts, property prices will plummet. Fewer properties will be built, which will lead to lower steel and coking coal consumption. This will limit the upside of coking coal prices. Chinese government regulates the power sector in China. Coal markets are liberalized while electricity prices are still tightly capped to stem inflation and maintain "social stability." The power-price cap will create losses for power companies if coal prices rise significantly. If international coal prices rise, China will use more domestic coal and import less, thus limiting coal's upside internationally as China is a net importer of coal. The country is also encouraging vertical integration of power companies. Companies are encouraged to own their own coal mines—to limit rising coal prices.

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