Will China's dirty coal ban hurt Australian miners?

Some media are suggesting that a move by China to ban the use of dirtier forms of coal will hurt Australian coal exports – but the opposite could be true.

Green groups would be leaping for joy at some of the stories in today’s newspapers suggesting Australian coal exporters will be “hit hard” by China’s move to ban “dirty” coal imports. Yet in reality this move by the Chinese Government could possibly help Australian producers, at least in the short to medium term.

Nonetheless, in the longer term it shows the Chinese Government is serious about improving air quality – and this will ultimately benefit natural gas, renewables and nuclear power.

But firstly it’s important to recognise this latest initiative is not aimed at banning coal per se but, rather, coal which is high in impurities known to contribute to higher levels of smog-related emissions that cause a range of cardio-respiratory health problems (nothing to do with CO2 emissions, which drive global warming). The restrictions focus on ash and sulphur content of the coal as well as the energy content.

The restrictions applied vary in stringency, depending on geography. Details of the restrictions prepared by Citi Research are detailed in the table below (note that Australia does not export lignite, or brown, coal. The least stringent apply across the entire country and would not affect a single major Australian thermal coal exporter, all of whom would comfortably comply. However, it is the most stringent – which apply to the major economic zones of Beijing, Hubei, Tianjin, the Yangtze River Delta and the Pearl River Delta – which are of the greatest relevance. These areas are on or close to the coast and, therefore, are the most prospective for Australian seaborne exported coal.

Graph for Will China's dirty coal ban hurt Australian miners?

As shown in the table at the bottom, the sulphur restriction (denoted as 'TS') would only be an issue for two mines – Yanzhou’s Duralie mine and Glencore-Xstrata’s Ulan mine. The ash requirements, however, represent a greater challenge. But there are several things that need to be kept in mind before declaring this as a problem for Australian coal:

1) The importance of the highly restricted region as a buyer of Australia’s non-compliant coal, and ease to which this coal could be transferred into other markets.

2) Ash content can be lowered via further washing, although at a cost.

3) The extent to which non-Australian suppliers may encounter greater difficulties meeting the restrictions.

In relation to the first point, only 10 per cent of Australian coal exports go to China, and the highly restricted region represents 42 per cent of Chinese thermal coal imports further softening the blow. This means the amount of production likely to be affected is low.

Morgan Stanley observes:

“... up to 39 per cent of Australian exports are potentially impacted, but only a portion of this actually goes to China. We have made a cursory review of the ASX miners under coverage and determine no, to low, earnings impacts are implied.”

But, in addition, once you take into account point-three you realise that these restrictions are a far greater challenge for Chinese suppliers than they are for Australian coal producers. This might mean this is, in fact, an opportunity for Australian coal producers.

Citi Research commodity analyst Ivan Szpakowski notes that these regulations are likely to be challenging for a number of Chinese coal producers to meet, thereby restricting domestic supply. He notes, “most imports from these countries [Australian and Russia] will remain unaffected, and as there should be a greater impact on Chinese supply, global balances should not be seriously affected".

Indeed Szapowski expects the restrictions will increase prices in China and thus this could be beneficial, overall, for Australian coal producers.

Thinking longer term, such restrictions signal a willingness of the Chinese leadership to take a hit on energy prices in order to address air pollution. With every step that the Chinese Government tightens pollution controls over coal it is narrowing the cost-gap with alternatives. This is not so good news for Australian coal producers.

Figure 1: Coal quality characteristics of selected Australian thermal coal mines with sulphur >0.6 per cent (click to enlarge)

Source: Morgan Stanley (NOTE: Total Australian thermal coal exports in 2013-14 were 192 million tonnes)

China tends to be a heavy user of coal in circumstances which would be unacceptable, for air quality reasons, in most developed nations. There is only so far you can go in improving the air quality of emissions from coal by reducing its impurities and applying pollution-control equipment. Eventually this gets to a level of expense that you are better off switching to natural gas for direct-heat purposes, or even renewables or nuclear for power generation.