Coal's blind optimism fades, but industry must shrink to succeed: Russell

While analysts feel prices have bottomed out, a huge rally is still unlikely

Battered and beaten, the coal industry finally seems to be moving from blind optimism that things will somehow get better to a more realistic hope that it can survive, albeit in a smaller, less influential manner.

A common theme at coal conferences over the past few years is that prices have finally reached a bottom and that a recovery is just around the corner.

Given that global coal benchmarks are currently in their fourth consecutive year of declines, this has clearly been an optimistic view, based more on fervent hope than a sober analysis of the state of the industry.

But at the World Coal Leaders Network conference in Barcelona this week there appeared to be a greater acceptance of coal's diminishing role in power generation, the rising political and environmental obstacles the fuel faces and an acceptance that low prices are here to stay and the glory days ended in 2011.

There were even a few analysts and industry leaders prepared to say that prices have reached, or are very close to the bottom of the cycle, but these cautiously optimistic views came with enough caveats to ensure that 'bullish' still isn't a word used very much in the coal world.

The first, and possibly most significant caveat is that a bottom in prices doesn't imply that a rally is the next step.

The price of thermal coal at Australia's Newcastle Port has dropped this year, losing some 15% since the end of the first quarter to currently trade around $53 a tonne.

While this is a drop of about 60% from the post-2008 recession peak reached in February 2011, what is important is that Australian spot coal seems to be able to hold above the $50 a tonne level.

This matters because at that price level it's likely that current production rates will be maintained as miners have managed to cut costs, or have them cut for them by lower fuel prices and currency declines, to the extent that $50 leaves them with some profit margin.

But it's also important as prices around that level are still below what is needed to make new production viable, especially for major projects such as the $7 billion Carmichael coal mine in Queensland, being proposed by India's Adani.

While the project has passed what should be its final regulatory hurdle, it's still far from clear that it will go ahead, given the current low prices and increasing doubts as to whether India actually needs imported coal on a longer-term basis.

ASIA HOPE, ATLANTIC GLOOM

The second major caveat is that the coal world is becoming increasingly split between Asia, where there are perhaps a few positive signs, and the Atlantic basin, which remains mired in the doldrums.

The Barcelona conference, the 35th annual gathering of coal insiders, was notable for nobody expressing anything other than gloom about the outlook for Europe and the United States.

Cheap natural gas, policies that favour renewables and increasingly policies that make life harder for coal-fired generators mean that at best, seaborne coal demand in the Atlantic basin will remain flat, and even that is the optimistic view.

That means that any growth in seaborne demand is to be concentrated in Asia.

Given that both China and India are experiencing falling coal imports this year, is there any case for optimism with the world's two biggest importers uncertain?

There is no clear answer on that, as nobody is able to present something more concrete than guesswork on what may happen in China.

Coal imports rose a slight 1.6% on month in China in September, but are still down almost 30% in the first nine months of the year compared to last year.

India's imports have been dropping in recent months, with September showing a 27% drop from the year-earlier month, largely as a result of Coal India's success in boosting domestic output.

These figures wouldn't seem to support any optimistic view even in Asia, and in strict volume terms it's hard to mount a bullish case.

But throw coal quality into the mix and a different picture emerges, one where countries that produce better quality coal, such as Australia, South Africa and Colombia, can possibly increase their exports at the expense of countries that mine mainly low-rank coal, such as Indonesia.

The main loser from China's declining imports has been Indonesia, and this may be the case for India as well, as buyers seek higher quality coal for blending with lower quality domestic output.

The big unspoken at the Barcelona event is that coal as a global industry is shrinking, a trend that looks set to continue.

It's too early to write off coal completely, or even to say the industry is in its death throes.

Far from it, there remains cause for some optimism, especially in Asia where demand from traditional users like Japan and South Korea remains solid, and new consumers such as Malaysia and the Philippines build coal-fired power plants.

But the coal mining industry as it currently stands is more than likely adequate to meet any new demand, and may even have to shrink further in order to balance supply and demand and create room for prices to rise enough to ensure that new output can be brought online to replace existing mines as they reach the end of their lives.

It may be hard for the industry to swallow, but only by shrinking can it sustain and endure.