Recent commentary on the Australian coal industry has focused on domestic issues such as the Mineral Resources Rent Tax, the Carbon Tax and the conflict between mining and agricultural lands.
However, little focus has been given to one matter with the potential to have the single biggest impact on the Australian coal sector.
We have already begun to witness Indian investment into the Australian thermal coal sector, including Adani's acquisition of the Carmichael coal project in mid 2010, Lanco Infratech's acquisition of Griffin Coal later that same year and, most recently, GVK's acquisition of Hancock Coal and the massive Alpha, Alpha West and Kevin's Corner coal projects.
In our view this is just the beginning, with the demand for Australian thermal coal to fuel power stations in India set to increase significantly.
POWER, POWER AND MORE POWER
Currently, India has about 170,000 MWs of installed electricity generation capacity, which is insufficient to meet existing demand. Loadshedding and blackouts are common in most Indian cities.
Electricity is essential to India's long term growth and the Indian Government's 'power for all' policy recognises this. Under the policy the Government is committed to ensuring there is sufficient electricity to meet existing demand and the future demand of a rising middle class and industrialisation. Delivering on this policy is no small feat.
According to official estimates India will require 160,000MWs of new generation capacity over the next 10 years. This represents almost a doubling of India's current generation capacity from 170,000 MW to 330,000 MW – growth equivalent to the construction of 114 new coal fired power stations the size of Tarong Power Station (one of the largest power stations in Queensland).
While not all of the new generation capacity will be coal fired, it is likely that the vast majority will be.
Predictions are that in 5 years time India will require about 1 billion tonnes of coal every year for power generation.
Despite having one of the world's largest reserves of coal, policy disputes and limited investment in technologies and mines has limited effective exploitation of India's reserves. In 2011, coal production increased just 1% while power generation capacity grew at 11%.
Even if India increases domestic coal production from its current level of 550 million tonnes per annum (Mtpa) to 700 Mtpa, there will still be a shortfall of some 300 Mtpa. Some commentators suggest that the shortfall will in fact be closer to 500 Mtpa. Whatever the deficit, it will need to be met by imported coal.
IMPACTS ON AUSTRALIA
The consistent message from Indian companies is that access to coal offtake alone is not sufficient , as it leaves them exposed to volatile market prices.
Instead, taking an equity position in foreign coal mines is the preferred model to hedge against movements in the coal prices, and in effect get access to coal at the cost of production.
Australia is not the only potential source of imported coal for India. Indian companies are also actively looking at opportunities in Indonesia and the emerging coal provinces in southern Africa.
Despite claims about Australia's increased sovereign risk perception among foreign investors, recent moves in Indonesia pose an even greater concern for Indian investors.
In mid 2011 Indonesia imposed a new coal pricing requirement which saw coal prices double in late 2011. In early 2012 a new requirement was introduced which forces foreigners to sell down their interests in projects over time to a minority stake. Most recently the Indonesian Government is seeking to re-open existing mining concessions to make various changes, such as reducing the term or area of mining licences, or increasing the royalties payable to the Indonesian government.
THE IMPENDING AVALANCHE
In response to the urgent requirements for new electricity generation capacity, a large number of Indian companies proposed to build new coal fired generation plants and entered into power purchase agreements (PPAs) with the Indian government to underpin the development. Under these PPAs the price for electricity is locked in.
The price for electricity under these PPAs was set on the assumption that cheap domestic coal would be available from Coal India (the Indian state owned coal company)which is required to sell coal at a 70% discount to market prices. However, significant shortfalls in domestic production mean that for many generators there is simply not enough domestic coal available.
The shortfall could be made up by importing coal. However, the FOB cost of production of coal from Australian coal projects for example, when added to the shipping cost, means that in many cases power projects underpinned by these PPAs are no longer economically viable.
The Indian government recognises this is a significant issue. Accordingly, some commentators expect that in the near future the Indian government will allow the electricity prices payable under the PPAs to be increased.
If and when this happens, electricity generation project proponents will be looking for coal investment opportunities. And so might begin the great Indian coal rush.
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