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Coal in decline as Chinese economy slows down

China pumps out machinery, mobile phones and smog, but it runs on coal. It is by far the largest burner of the black stuff so, when Chinese factories start slowing down, it is usually time to sell coal stocks.

A sharp economic reversal in China this year remains unlikely, but July data was strikingly weak after stellar second-quarter growth. That is bad news for coal firms everywhere, and especially for China’s state-owned behemoths like Yanzhou Coal, struggling with crushing debt burdens and fickle regulators. Yanzhou is roughly half-owned by the Shan-dong provincial government and its holding companies, but most of the big shareholders in Hong Kong are Western institutions.

The coal price rebound fuelled by Chinese stimulus this year has pushed Yanzhou’s stock up about 40 per cent and its first-half sales are up 82 per cent from a year earlier, but the firm hasn’t used the breathing space to pay off much of its borrowings. Debt still clocked in at a vertigo-inducing 156 per cent of equity in June.

Instead, Yanzhou is pursuing expensive acquisitions in Australia through its subsidiary Yancoal, which recently agreed to buy Rio Tinto’s Hunter Valley coal assets for $US2.69 billion ($3.37bn).

Cash-strapped Yancoal is issuing $US2.5bn in new equity to fin¬ance the deal over the objections of minority shareholders, with Yanzhou itself on the hook for up to $US1bn. Yanzhou also plans to boost capital expenditures by about 20 per cent in 2017.

None of this would matter that much if China’s economy was poised for another 12 months of above-trend growth. Unfortunately, it is increasingly clear that isn’t the case. Chinese policymakers are tightening credit gradually ahead of upcoming important Communist Party meeting and that is starting to affect investment and industrial output.

Chinese real estate investment, the biggest driver of global materials demand, including coal, grew at its slowest pace in over a year in July, and infrastructure investment ticked lower. Industrial output weakened across the board.

Two other bearish factors for coal and electricity demand are about to kick in. First, it has started raining again in southwest China. Dry weather has pushed hydropower utilisation down the most since 2012 and coal power plants’ run rates sharply higher. That dynamic is now moving into reverse as hydropower ramps up again.

Furthermore, plans to close more energy-intensive steel and aluminium plants in northern winter during the peak pollution season — on top of steel capacity cuts already enacted — could deal another blow to power demand.

Metal smelting alone accounts for about 20 per cent of power consumption in China.

Things are looking brighter for the global coal sector following the disastrous price crash of 2015 — including the US, where the sector is seeing a revival — but things are just about as good as they can possibly be right now. Next year will be tougher. Investors should take the opportunity to dig out their cash while the digging is good.
Source: Wall Street Journal

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