Indonesia’s coal producers are being buffeted from all sides at present, and not just by the global decline in coal prices. Low freight rates have diminished their shipping advantage to key Asian markets vis-à-vis more distant thermal coal suppliers in Australia and the Americas, while regulatory uncertainty and political risk are making long-term balance sheet forecasts difficult.

Indonesia’s coal giants saw margins deteriorate almost across the board in the first half of 2013 as the drop in coal prices hurt bottom lines and Chinese demand for power production was hit by slowing industrial output. This saw prices at discharge ports in China drop to four year lows earlier this year as domestic suppliers slashed prices in a bid to gain market share.

Although the competitiveness of Indonesian coal — not least against US exporters which have been finding some joy on the periphery of Asian markets — has been aided by the rupiah’s rapid depreciation against the US dollar, the Australian dollar has also weakened considerably, allowing Australian producers to lower prices and hold back production cutbacks.

Some Indonesian producers offset lower profits per tonne of output by boosting sales in the first half of the year. Bumi Resources and State-owned Bukit Asam, for example, both increased sales by some 20% in the first six months of 2013 but saw the price received per tonne decline by around a fifth compared to a year earlier.

The net effect of these efforts to prop up revenue streams by boosting production was a 21% year-on-year increase in exports from Indonesia in the first five months of 2013 when volumes shipped reached 164mt (million tonnes), according to the latest figures available from Indonesia’s Trade Ministry.

Some analysts expect weakening Chinese demand and excess coal supply to further dampen the pricing outlook for miners for at least the rest of 2013. China imported 187mt of coal in the first seven months of the year, up around 12% year-on-year. However, this was far below the growth of almost 30% racked up in 2012 versus 2011 and import demand has been slowing as the year has progressed. Indeed, in June total imports fell 22% compared to May and almost 20% compared to June 2012. With domestic producers continuing to cut prices, slower growth rates for imports are expected to continue for at least the remaining months of 2013.

As well as facing global headwinds, Indonesia’s coal sector is also battling a number of home grown challenges — corruption is endemic and there continues to be a lack of co-ordination between mining operations and forestry regulations, and between central and provincial governments. The endless wave of draft regulations emanating from Indonesia’s legislators is also frightening away investors and coal buyers, unfortunately just as Indonesia needs them most as the economy takes a turn for the worse.

With elections scheduled for next year and foreign capital an easy target, the government of President Susilo Bambang Yudhoyono is currently threatening to increase royalties payable on some mining permits next year. Other legislative proposals that could impact the coal sector include a threatened export

tax, a further tightening of rules governing foreign ownership of mining rights and land, and a requirement that minerals be processed before export. In coal’s case the latter would mean upgrading low rank coals before export, a major problem given that upgrading technology on a mass a scale is unproven, that about 90% of Indonesia’s coal output is classed as low to medium rank, according to figures from the Ministry of Energy and Mineral Resources.

“The perception of the investment climate in the Indonesian mining sector is deteriorating, mainly

due to uncertainties in regulatory activity, said pwc analyst Sacha Winzenried, at this year’s Coaltrans Asia exhibition and conference in Bali, Indonesia.

Macquarie Capital Securities analyst Riaz Hyder believes the pricing and regulatory challenges facing Indonesia’s miners will see some smaller producers drop out of the market, offsetting increases in production by larger suppliers which will more easily be able to generate supply chain cost savings to retain competitiveness.

“While coal prices have now fallen below the crucial cost support level of $80–85 per tonne, we are still yet to see any material supply cuts on the seaborne market,” he explained. “The Indonesian coal industry can be divided into the large producers — mostly still profitable — and smaller producers which are finding it difficult to break even, with thinner margins historically and less efficient supply chains given a basic ‘truck- and-shovel’ approach is typically employed.

“We continue to believe the Indonesian government would be in favour of consolidation to preserve Indonesia’s coal assets long term for domestic consumption while also helping to firm pricing. Moreover, the 2014 election we suspect is an important part of the proposed regulatory changes.”

Hyder said one factor constraining an upside to coal pricing remains the ability of closed mines in Indonesia and elsewhere to resume operations if pricing improves, but he forecast that pricing would stabilize in the medium and long term. “We are encouraged by the lack of investment in new capacity from a pricing perspective,” he added.

And there are other positives for Indonesia’s miners to cling onto. Despite sufferings its own economic travails, the demand outlook from India remains positive, with imports jumping over 50% year-on-year in June and surging to 76mt over the first half of the year, up 28% compared to a year earlier.

Another bonus for Indonesia suppliers was their exclusion from a new 3% tax on low rank thermal coal imports to China which came into force on 31 August this year. A free trade agreement between China and the Association of Southeast Asian Nations (ASEAN) means Indonesia is exempt from the tax which will impact Australian, Russian and Mongolian rivals.

“There is continued interest in the country’s geological prospectivity, but investors will need certainty on investment terms and the regulatory framework,” said Winzenried. “The long-term success of the Indonesian mining sector will be driven by an improved investment climate in order to attract the funds needed — whether from domestic or global sources — for a sustainable industry, in times of both low and high commodity prices.” Michael King