Using our analysis of cost and coal quality across individual mines, we assess how new regulations will impact one of China's key suppliers
China's National Development and Reform Commission (NDRC) recently announced the extension of existing coal quality requirements - maximum 16% ash and 1% sulphur - to the Pearl and Yangzte River Deltas.
There is much uncertainty regarding how the guidelines will be implemented. However, assuming the guidelines are rolled out on 1 January 2015 and apply to all coal consumed in these areas, how will key thermal coal exporters be affected?
We believe the impact on imported coal will generally be positive since it tends to have a lower ash and sulphur content than domestic supply. In fact, Indonesia stands to benefit from the ban due to the quality of its current exports to China.
Yet not all imported coal would satisfy the new limits, including 80% of Australian exports to China.
High ash coal from Australian mines is simply coal that bypasses the coal processing plant, or is washed and/or blended to a higher ash specification. Quality restrictions will therefore not rule out continued Australian exports on ash grounds as this coal could be processed to meet Chinese requirements.
The sulphur restriction will also not prove to be a significant obstacle for Australian producers as all but one high-ash coal producing asset has a sulphur content of less than 1%.
However, processing the coal to meet ash quality restrictions will come at a price. Lower ash products have a higher processing cost and there will be an associated reduction in yield as less marketable output will be produced.
The overall cost impact will vary between assets, however we estimate an average cost increase of approximately A$16/t, with a minimum of A$1/tonne and a maximum of A$27/tonne.
These figures do not include any additional costs related to lower yields which will result in reduced throughput on rail and port infrastructure capacity.
As Australian coal producers generally operate under fixed price 'take or pay' contractual arrangements, this could result in increased unit costs of between A$2 and A$3 per tonne.
Assuming a total average cost increase of A$18 per tonne, this would equate to an increase of approximately A$16 per tonne once adjusting for the high energy content of the lower ash product.
So while Australian exports wouldn't be precluded on a quality basis, they are likely to be impacted by economics.
The key will be whether consumers in China are willing to pay more for lower ash, but higher energy, thermal coal from Australia in comparison to imports from Indonesia.
The impact on Australia of Chinese coal quality restrictions [Subscription required]
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