China’s coal conundrum

China remains the world’s largest coal consumer and biggest emitter of greenhouse gasses. But Beijing is no longer turning a blind eye to this, and has set tough quotas in order to slash coal overcapacity by 500 Mt over the next couple of years. Severe smog has blanketed much of China this winter. The growing discontent with the levels of air pollution has started to push Beijing to address its reliance on the fossil fuel.

As in other major economies, China is addressing its coal use. However, for Beijing, the policy is less to align with climate change obligations, and more a bid to curb the pollution that is choking its major cities and raising disquiet among its citizens. Air pollution has become a social, economic and political hot potato for the ruling Communist Party. Opening parliament in early March, Premier Li Keqiang pledged: “We will make our skies blue again.”

China’s authorities have decided to tackle pollution by cutting coal and steel capacity. In March, the National Development and Reform Commission said it aims to cut coal production by more than 150 Mt and steel capacity by 50 Mt this year, as part of a plan to reduce 800 Mt of coal and 150 Mt of steel capacity by 2020. The move by the world’s number one importer of coal is set to shape seaborne exports of the fossil fuel and increase the need for coal imports to replace lost domestic capacity.

More not less

China’s coal imports have already been rising, increasing by 25% in 2016 to 256 Mt, as the country’s power and industrial sectors turned to foreign sources in response to Beijing’s moves to reduce overcapacity in the domestic coal sector. In December, coal imports rose by 50% from the same period a year earlier to 27 Mt. China’s efforts to mop up overcapacity in both its power and coal production sectors have triggered a rally for both domestic and international coal prices.

Demand for seaborne coal from China’s power and industrial sectors have been on the rise as the government commands its domestic miners to reduce operations as part of this broader effort to curtail industrial overcapacity. China’s coal imports are expected to continue this growth in 2017, as the production cuts have created a supply shortfall, with analysts not expecting Beijing to ease up on its recent drive to address overcapacity across industry.

However, delays in processing imports could further constrain supply and send domestic prices higher. In March, international traders were reporting delays of weeks to clear cargoes through customs in China, due to tougher inspections for sulphur and mercury content at ports. The agency responsible for monitory coal imports, the Administration of Quality Supervision, Inspection and Quarantine, last year rejected 1.5 Mt of imported coal, less than 1% of the country’s total coal imports.

Import paradox

Indonesia has been the leading beneficiary of this switch to coal imports, enjoying a 38% surge in imports of its cargoes by China in 2016. Paradoxically, the impetus for this growth in demand for coal imports has been, in part, a response to pollution from the use of coal in China’s power plants and mills. Also, much of the Indonesian product coming into China’s bulk terminals is low-grade coal, which is often blended with domestic supplies.

These shifts in policy are set to be a boon for Australian miners and exporters, with their higher-grade coal. Moreover, China’s ban on imports from North Korea (see box story), as part of international efforts to contain the isolated state’s nuclear weapons programme, is set to further benefit exporters of coal to China. With the government committed to reducing domestic production, Chinese coal is  unlikely to replace the 22.5 Mt imported from North Korea in 2015. (North Korea’s anthracite coal is mainly used in steel making and ceramics). 

Cutting steel mill capacity is also set to put a rein on coking coal and iron ore imports through the country’s bulk terminals. However, in 2016, capacity cuts did not lower output from China’s steelmakers, but kept production levels from growing much beyond 800 Mtpa. Steel capacity cuts were focused on older and inefficient mills. China’s steel makers actually increased production slightly last year by 1.2% to 808 Mt, which resulted in an increase in iron ore imports, as many domestic mines have remained closed due to low prices in recent years.

China crisis?

China’s drive to tackle overcapacity policy has a direct impact on world markets, both in terms of price and the level of coal imports handled by its bulk terminals. Mining curbs introduced by China last April spurred the price of thermal coal to more than double to US$110/t. Amid the shortage among international suppliers, power companies in Asia had to import more coal. Coking coal for steelmaking also spiked to more than US$300/t, one of the strongest commodity rallies in 2016.

Beijing’s moves last year were widely seen as an attempt to bolster prices, so that China’s struggling state coal miners could service loans. However, Beijing miscalculated the number of private miners that had left the market. Investors, quick to exploit the situation, made profits by driving up the future prices of coal. Beijing had to respond to the surge in prices by relaxing its controls, with Australian exporters among those that gained most from the domestic supply deficit.

The Chinese government’s move to cut domestic coal production is likely to result in the country’s power stations, steel mills and other industrial users turning further to seaborne imports to secure supplies. Moreover, these imports are likely to be more competitive, as supply restrictions push up the price of domestic grades of coal. Imports of the fossil fuel were up by 25% in 2016 to 255.5 Mt, with China overtaking India last year to become the world’s number one importer.

Beijing’s coal policy will be a welcome short-term boon for international bulk shipping and coal exporters, as the industries face a rapid retreat from coal consumption elsewhere. But in the long run, China’s government is following other major economies and reducing its reliance on coal. Last year, the 13th Five-Year Plan stipulated that China would cap coal-fired power capacity to 1,100 GW, although this still amounts to a sizeable 16% increase on the current 920 GW capacity. However, coal power projects in the pipeline would have taken that figure to 1,250 GW.

By any measure, China’s overcapacity of coal-fired power plants is gargantuan. A total of 210 coal-fired plants, with a total capacity of 168 GW, were granted approval in 2015 alone, according to environmental pressure group Greenpeace. With the overcapacity understood to have reached around 20%, the Chinese government last year started to address the issue and announced it would put a halt to the construction of coal-fired power stations.

Beijing’s move to target overcapacity among its domestic coal-fired power sector has been building up a head of steam over the last year. In March 2016, the central government ordered 15 provinces not to approve any more coal plants, and the following month raised the possibility that it would introduce what it dubbed as a “traffic light” system to constrain growth of coal power station approvals, with red, amber and green denoting banned, potential and goahead schemes. In October, it started to cancel projects that were under construction.

In January, China cancelled plans to build more than 100 coal-fired power plants as it looks to get a hold on spiralling investment in the sector and balance its reliance on coal-fired power. The National Energy Administration announced it had suspended coal-fired power plant projects, both planned and under-construction, axing 120 GW of capacity. Planners have suspended projects already under construction in 13 provinces, predominantly in China’s coal-rich north and west, with a total of 54 GW – more than the total capacity of Germany.

With more power plant construction projects likely to be axed this year, China could achieve its target of capping its coal-fired power generation capacity to 1,100 GW by 2020. However, this target at the end of the decade is still three times the coal-fired capacity of the US. With more coal-fired power plants than it needs, many of China’s coal-fired power stations are running at half of their capacity. Meanwhile, there has been a rapid shift to alternative fuel sources, such as renewables, including wind and solar, and nuclear.

But China’s state-owned power sector has political clout in Beijing circles. Grid operators still prefer coal generated power over other sources like wind and solar. Despite the scale of the proposed cuts, China continues to face huge overcapacity in its power sector. Moreover, local government officials in the provinces such as Inner Mongolia, Shanxi and Xinjiang will be resistant to the politically difficult move to make the job cuts, lose employment and cancel lucrative contracts.

Mine closures

In December, China’s National Development and Reform Commission (NDRC) said it would cut the capacity of its mines by 300 Mt, despite a recent increase in production and consumption of coal. The aim is to improve profit and increase efficiency. Beijing is targeting output of 3.9 Bt of coal in 2020, up from 3.75 Bt in 2015, according to the NDRC. China’s consumption of coal is set to rise to 4.1 Bt from 3.96 Bt over the five-year period. The NDRC wants to cut 800 Mt of obsolete coal capacity, and add around 500 Mt of upto-date capacity.

Government economic planners want to slash the number of smaller, inefficient mines, particularly in the northeast of the country. Instead, authorities are looking to promote more output from producers in the western regions, such as Inner Mongolia and Xinjiang. But steep rises in prices have already prompted the NDRC to relax controls that limit mine operations to 330 days a year from 276. About 800 mines are being allowed to increase their working days, a move that could increase effective production capacity by 300 Mtpa.

However, it will take time for the new stream of domestic supply to hit the market. In the meantime, Chinese demand accounts for around a fifth of the seaborne market, according to consultancy Wood Mackenzie. China’s thermal coal imports last year increased by 40 Mt, with major exporters including Australia, Colombia and Russia, while Indonesia offered a supply of lower-grade coal. International suppliers are looking to benefit from China’s need for coal. For now, imported coal will continue to feature heavily in bulk terminals across China.