Too much stimulus. Too little demand. A suspension of reason. Structural change. These are the elements of a coal market that finds its supply completely disconnected from demand. What lessons can coal producers learn from this? Hard experience has taught us that:
- Very high coal prices bring about increased investment, oversupply and decline in demand, all of which are price-correcting, structural and cyclical mechanisms
- Producers should limit debt, protect cash and invest conservatively, especially when prices and demand expectations are high
And, of course, something we’ve known all along but frequently choose to ignore:
- If it looks too good to be true, it probably is!
Events in China have reinforced these lessons. There, easy credit and massive stimulus led to capacity expansion that continued in the face of the 2008 global economic crisis. But global demand for Chinese products weakened as the crisis worsened. Competition for market eventually drove marginal producers to price coal at variable cost levels and many operators became, and remain, cash negative. Still, producers pressed on, aided by infrastructure development that streamlined delivery and lowered costs. Yet demand stubbornly failed to recover. Things got worse.
Why did producers persist? Because China’s managed, coal-primed economy growing at 7% a year proved irresistible to market-hungry global coal companies. It’s now obvious that China’s economy will slow and decouple from energy consumption, with a dramatic impact on seaborne thermal coal trade. But this knowledge arrived too late to slow a multi-country coal production expansion fed by easy credit that bet decoupling in China was a distant, not immediate, reality.
Instead, Chinese stimulus and official forecasts of high growth encouraged capital inflow even following the global recession. China’s heated expansion demanded coal. Speculative coal price increases followed that were caused in part:
- some 30 years of coal underinvestment in many regions of the world
- a more or less 30-year decline in the US dollar (except from 1995-2000 and since 2012)
- the development of traded coal commodities markets albeit with significant illiquidity
- post-recession stimulus and a significant injection of money
- fears of inflation.
Now the bubble has burst. The consequences of global miscalculation are being borne by all producers. Countries exporting raw materials are suffering through a period of colossal overcapacity. A soft currency “war” is underway in which export-led economies seek to lower their production costs by allowing their currencies to weaken as prices continue to fall. The dollar has strengthened in this environment making most US coal exporters uncompetitive. Since the overcapacity extends to manufacturing as well, the strong dollar is leading to the possibility of tariff wars, which will have knock-on effects on the raw material trade. Overcapacity anywhere leads to trade friction everywhere.
Thermal coal markets have historically been cyclical, but an end to today’s unhealthy markets requires structural, not cyclical, change. Excess capacity must be wrung from the system, but this has been excruciatingly slow to develop.
We can blame China for today’s poor thermal coal markets all we want, and be only partly right. Past experience tells us more. As the Walt Kelly cartoon had it, the truth is: we have met the real enemy, and he is us.