Australian coal: Stranded by the East?

A new report, by the University of Oxford, projects that Australian coal assets are doomed to become ‘stranded assets’ which “suffer from unanticipated or premature write-downs, or conversion to liabilities”, as a result of China’s new carbon conscious policies.

Coal, often referred to as the ‘backbone of the world’s energy mix’, is facing its moment of truth as the Intergovernmental Panel on Climate Change’s latest report “warns that much of the world’s fossil fuel reserves must stay in the ground to avoid catastrophic climate change”.

China, the world’s second largest economy and coal’s global price-setter, is currently undergoing an environmental wake-up call as it continues to take centre-stage for its tenacious energy appetite. The gravity of the situation has intensified the spotlight on the AU$100 billion worth of Australian coal mining projects currently locked the pipeline for the next fifteen years or more.

man bike(Doug Kanter for The New York Times)

The report by the University of Oxford’s Smith School of Enterprise and the Environment titled “The Stranded Down Under? Environment-related factors changing China’s demand for coal and what this means for Australian coal assets “, as part of its Stranded Assets Programme, highlights the array of risks already faced by the Australian coal industry which exported below AU$8billion coal to China in last financial year.

The industry’s business-as-usual approach and undervaluing of China’s environmental-related risks fails to take into account the shifts in Chinese coal consumption in the next twenty years.

Australian assets are expected become ‘stranded assets’; “suffer from unanticipated or premature write-downs, or conversion to liabilities”. Given the size of the Australian coal export industry, reported at a staggering AU$38.9 billion in the 2012/13 financial year; accounting for 16% of the value of Australian exports and 3.4% of GDP, any demand or price movements will be considerably felt.

The power of Stranded lies in its ability to demonstrate the ownership of risk by painting the network of relationships between Australia’s top ten coal mining projects, their parent companies and the corresponding stock exchanges. It observes that “the coal price required for many of these projects to be economic, is unlikely to be sustained given China’s changing demand for coal and how in particular (China) could be affected by environment-related factors”. If this fails to catch the attention of the coal industry, I don’t know what will.

Ownership of top 10 proposed coal mining projects by cost (and cost as a multiple of company revenue)

chart1(Stranded Down Under?, 2013)

As expected, the study’s release generated significant buzz with green blogs hastening to the ground-breaking study. Ben Caldecott, Director of Oxford University’s Stranded Assets Programme and author of the report, has just kicked-off the Stranded Down Under tour in March across Australian capital cities.

What are the environmental-related factors?

The study highlights the possibility of Chinese coal consumption falling from 70% of the electricity mix to 63% by 2020, reducing China’s total national coal consumption by approximately 5%. Domestic coal producers would naturally be prioritised, resulting in a disproportionate fall in imported coal.

The below environmental-related factors are to reduce Chinese coal consumption, below business-as-usual projections, as well as have a negative impact on the price of coal in the next twenty years. Bear in mind, twenty years is not a long time given coal mines like the Alpha Coal Project (yet to reach coal production stage) is expected to have a lifespan of thirty years.

1) China switching to ambitious targets in Energy Intensity and Efficiency

A shift in energy intensity and efficiency is expected to cause significant reduction in Chinese coal demand and coal price within ten years. Since 1990, China’s economy has become more energy-efficient with an expectation that energy intensity per unit of GDP will continue to decrease.

The Chinese government has set strict and ambitious targets which will result in a decline in coal’s share of the energy mix from 69% in 2011 to 65% in 2015. The 12th Five Year Plan on Energy Development aims to reduce energy intensity by 16%; the Chinese government has set a target of 4 billion TCE (tonnes of coal equivalent) on primary energy consumption (which equates to a strict energy use expansion of 3% a year); and also placed a coal use cap of 3.9 billion tonnes.

Stranded points out that energy inefficient coal-fired power stations were likely to be hit the hardest by these targets after low-hanging fruits were reaped. The 11th FYP had already shut down 85GW of inefficient coal-fired power plants, now the 12th FYP plans to shut down more small inefficient plants and enforce strict emissions standards on those remaining in operation.

2) Chinese Iron and Steel Sector becoming energy-efficient

The Chinese iron and steel sector (which utilises coal as the largest source of energy) has continued to undergo an evolution expected to significantly depress Chinese coal consumption and price in the next twenty years.

The “process of restructuring and optimisation, an increase in market openness leading to greater competition and the introduction of improved processes and equipment” has led to increased energy efficiency and decreased carbon intensity. As such, China is predicted to experience a 40% decrease in coal use per unit of output as early as 2015.

The 12th FYP encourages merges and acquisitions of small plants (which are inefficient and financially isolated from “research and development and technology upgrades”) via a target to increase the proportion of steel produced by the top ten steel producers, from 48% in 2010 to 60% in 2015.

There is also the vision to “promote the use of modern technology, energy efficiency and improved product quality” by encouraging firms to establish energy management centres and to recycle more than half of their waste heat by 2015.

3) Use of coal limited by Water Scarcity

Water scarcity is expected to place significant downward pressure on coal demand and price in the next twenty years. 2013 was the first year water quotas were issued for every province.

Water scarcity remains one of the biggest problems faced by China and its unquenchable thirst for urbanisation – with over 400 cities currently experiencing water shortages. According to Stranded, water withdrawal by the coal industry in China is expected to increase to 27% by 2020 (from 17% in 2011).

As a result, governments are likely to increase coal washing, as this improves the fossil fuel’s energy content and thermal properties; which would lead to an overall decrease in water use.

The increasingly sensitive issue of air pollution can also be tackled by using more washed coal. Energy security and water scarcity concerns will be addressed by implementing measures to increase power plant efficiency which would lead to reduced water and coal consumption.

4) Carbon Pricing and Emissions Trading Schemes

China has already implemented pilot provisional ETS in Shenzhen, Beijing, Shanghai, Guangdong, Tianjin and Chongqing, and plans to launch the national scheme by 2015 (according to the 12th FYP).

Bloomberg New Energy Finance estimates that “half of the abatement required to meet China’s emissions intensity targets will be driven by the ETS” alone. China’s carbon tax is definitely on the table but still in the research and trial phase.

5) China continues to lead in Non-Fossil Fuel Energy Investments

I believe Stranded may have been conservative in labelling non-fossil fuel energy as having only significant medium and long-term negative impacts on the price rather than consumption of coal. This is based on the finding that coal-fired power will continue to grow in absolute terms, but fall in its share of the electricity mix (from 70% in 2013 to 63% in 2020).

The fact remains that China’s exponential expansion of renewables is unlike anything seen before. US$67 billion in renewable energy investment was injected in 2012 alone; three times the level by Germany. China became the second largest wind energy producer in 2011 and added more solar capacity in one single year than any country in 2014 (12GW).

Furthermore, the 12th FYP and revised targets has set out to increase nuclear capacity to 40GW, hydropower to 120GW, wind power to 200GW and solar power to 50GW. Nuclear and hydropower aside, Stranded revealed the IEA predicts renewable energy to form 28% of China’s electricity generation by 2035.

6) The Chinese shale boom?

A subsidiary plan (to the 12th FYP) for shale gas was released in March 2012 containing targets for production by 2020; supported by numerous subsidies and preferential treatment policies.

Despite obstacles relating to geography, technology and infrastructure (compared to the shale boom in the U.S), analyses shows there will be moderate impact to coal demand in the medium term as the Chinese government moves to increase energy security and address air pollution concerns.

Interestingly, Environmental Concerns and Local Pollution, which often flood international headlines as the major causes of civil unrest in China, were only labelled to drive ‘slight’ reductions on coal consumption and ‘slightly’ negative impacts on coal price within the next twenty years.

The reaction to Stranded Down Under

In January this year, Coal Services Pty Ltd (a joint venture between the NSW Minerals Council and the CFMEU) responded with new figures showing a rise in NSW coal exports to China over the last financial year “by more than 30% to 31 million tonnes”. Thereby, defying the so-called ‘doomsayers’ predictions drawn by Stranded.

Though this result is testament to Australia’s competitive export market, it’s important to steer clear of tunnel vision. We need to be mindful when interpreting temporary uplifts; and not to blindside the long-term forecasts derived from holistic economic outlooks – one which takes into account of economic, social and environmental aspects.

Experts are already warning of a ‘carbon-bubble’ threatening to make 65% to 80% of currently listed fossil fuel reserves potentially redundant – reserves which simply cannot be burned if we are to comply with the restrictions set by the international ‘carbon budget’.

For China, many of these policies and targets driven by the environmental-related factors outlined in Stranded have long begun to dilute coal demand. It would not only be risky but simple short-sightedness and irresponsible to assume business-as-usual for coal in the new carbon conscious world.

By Ailin Sun

2 Comments Add yours

  1. Given the cross ownership outlined in the ownership diagram above, I wonder what the impact will be on the Australian economy? On potential perverse outcome would be that coal prices will drop even further locally. I wonder what that will do to our local energy industry?

    1. Ailin Sun says:

      Interesting questions Daniel!

      A drop in Chinese demand would definitely not be good for our export economy. The majority of Australian coal production is designed for the export market and this has been increasing exponentially. Whereas the proportion for domestic consumption is small and has remained at relatively the same level.

      A drop in prices could lead to a reining in of supply and shrink the industry. The local energy industry fell outside of my wider project brief but our domestic energy consumption levels would not be sufficient to match the gap left by the loss of China’s demand.

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