China-Australia tiff to hit dry bulk demand

The Chinese government has prohibited the import of Australian coal, which will be detrimental for dry bulk vessels as Chinese importers will shift from Australia to Indonesia and Mongolia, resulting in a decline in average haulage length and a loss in shipping demand.

China-Australia coal tussle
Deteriorating relations between Australia and China are now a major threat to the dry bulk market, which is already severely constrained by the ongoing pandemic. As per media reports, the Chinese government is prohibiting the discharge of coal cargoes sourced from Australia. Although the government is yet to confirm officially, it will, if true, be a severe blow to any prospects for a recovery in the dry bulk market. About 93 million tonnes of coal is moved annually on the Australia-China route, accounting for about 2% of total dry bulk seaborne trade. However, the ban’s impact on the dry bulk market will differ for coking and non-coking coal imports, as analysed below.

Impact on China’s non-coking coal trade
Finding an alternative for Australian non-coking coal should not be a daunting task for China because Australia is not currently a dominant supplier. China sourced just 21% of non-coking coal from Australia against 61% from Indonesia during January-August 2020. Due to the low global demand for coal amid the ongoing pandemic, Indonesian miners will most likely fill the Australian void in China’s non-coking coal imports. The distance between Indonesia and China is almost half the distance between Australia and China, implying that the tonne-mile demand will shrink by 50%, even if China’s non-coking coal imports remain intact.

Moreover, weakening demand for imported coal in China will also reduce the burden of replacing Australian coal. During January-August, China imported 148 million tonnes of non-coking coal – a decline of 16.5 million tonnes over the same period in 2019. In addition, the Chinese government is encouraging the use of domestic coal and clamping down on the use of coal in electricity generation, reducing the requirement for imported coal.

Impact on China’s coking coal trade
Contrary to non-coking coal, finding an alternative for Australian coking coal will not be easy in the short term (over the next 3-4 quarters).

Australia is a dominant source for coking coal to China, accounting for 62% of the latter’s coking coal imports during January-August 2020. Due to China’s rising crude steel production, its dependency on imports will remain high even though the government is encouraging domestic coal use.

Although Mongolia is a major supplier of coking coal to China, it cannot fully replace Australian coking coal in the Chinese market in the next-3-4 quarters. Therefore, if the government imposes a ban, China’s overall coking coal imports will slump over the next one year, hurting dry bulk vessel demand.

However, in the medium term, Mongolia will meet the requirement of Chinese steel mills. Mongolia is laying down 415 kilometres of railway network from Tavan Tolgoi coal mine to the Zuunbayan China-Mongolia border, which is likely to beoperational by the end of 2021. The railway network will have an annual capacity of 30 million tonnes, more than 70% of Australia-China coking coal trade in 2019. Since trade between Mongolia and China is over land, any shift in China’s imports away from Australia to Mongolia will be a complete loss of shipping demand.

Ban spells trouble for Australian coal
For Australia inding an alternative destination will be a difficult task for its miners. Other major destinations for Australia’s non-coking coal are Japan, South Korea and Taiwan which have a combined share of 62% in Australia’s non-coking coal exports. As all these countries are either witnessing a decline or marginal growth in non-coking coal consumption, the scope for export growth to other these destinations is limited.

The remainder of Australia’s non-coking coal exports go l to India and Southeast Asia, and the growth prospects in these markets are also limited. Demand for coal is weak in India due to the pandemic, and the Indian government is determined to reduce import dependency by substituting non-coking coal imports with domestic coal. Moreover, the rise in exports to Southeast Asia will also be moderate due to their overall low import volume.

In conclusion, the imposition of the ban on Australian coal will significantly impact the dry bulk market. Seaborne trade of coking coal will decline because of China’s inability to find an alternative for Australian coking coal in the short term and an increase in land-based imports from Mongolia in the medium-term. Effectively, it will wipe out about 120 billion tonne miles of coking coal trade annually. Similarly, suppose China replaces Australian non-coking coal with Indonesian supply. In that case, dry-bulk demand will decline by more than 80 billion tonne-miles even if import volume remains intact at the 2019 level. Overall, the ban will squeeze about 200 billion tonne-miles annually, equivalent to 1.0% of dry bulk tonne-mile demand in 2019. Although it is only a 1% fall in overall dry bulk demand, the impact on the bigger bulk carriers such as Cape size and Panamaxes will be more profound.
Source: Drewry