China Poised to Pounce on U.S. Coal Suppliers

by Jason Simpkins

The recent buyout of Alpha Natural Resources Inc. (ANR) by Cleveland Cliffs Inc. (CLF) could ignite more than $50 billion worth of M&A deals in the U.S. coal industry over the next few years as Mainland China rushes to solve a major energy shortfall.

"In the next 12 months there will be an unprecedented amount of both domestic and cross-border mergers and acquisitions," Wilbur Ross, chairman of International Coal Group Inc. (ICO), told Bloomberg News. "U.S. reserves are undervalued relative to those in the rest of the world."

Ross, the billionaire investor who helped consolidate the U.S. coal and steel industries, considers this the start of a round of mergers that will prove Cleveland-Cliffs prescient in its Alpha bid.

The top eight U.S. coal producers, which are worth more than $50 billion, are possible takeover targets for a country desperate for resources. And compared with China, American coal companies are bargains.

China Shenhua Energy Co., Asia’s biggest coal company is valued at $15.52 for every ton of coal it holds, compared to $2.11 a ton for Peabody Energy Corp. (BTU), and $1.76 for International Coal, Bloomberg reported.

At a point when the U.S. economy is slowing under the weight of a growing financial crisis and spiking food-and-energy prices, escalating growth in the developing economies around the world has ignited a bull market for coal that analysts believe could last for at least 10 years.

And that’s going to lead to a major shift in the ownership of coal-related assets.

Enter the Red Dragon: China’s Coal Crisis

China, home to 1.3 billion people and the world’s fastest-growing economy, counts upon coal for 80% of its energy needs. Indeed, it’s the world’s largest coal producer, as well as its largest consumer. Coal demand in China jumped nearly 9% last year - meaning the Eastern power now accounts for a full quarter of the world’s annual coal consumption. So it’s no surprise at all that the growing global discrepancy between supply and demand is most acute in China.

Vic Svec, a senior executive at Peabody Energy, the world’s largest private-sector coal producer, referred to China’s ability to influence the price of commodities as a "butterfly effect."  In other words, "demand from Beijing can ripple back to Queensland, Australia, or Gillette, Wyoming," Svec told The Wall Street Journal.

Svec’s right. Five years ago, China exported 83 million metric tons more coal than it imported. But last year, the nation’s surplus dropped to a meager 2 million metric tons. That means more than 80 million metric tons of coal (about 12% of the internationally traded market) has been taken out of global circulation.

That’s a big reason why the highly coveted low-sulfur coal from the Powder River Basin in Wyoming and Montana has climbed from less than $10 a ton last year, to nearly $15 a ton - a price gain of 50%. And why thermal coal prices at Australia’s Newcastle port, a benchmark for the Asian market, have more than doubled this year.

Ironically, the high prices and demand China helped create, have left the country on the brink of a potentially disastrous energy shortfall. Overseas coal has simply become too expensive for China to import.

The Asian nation imported just 21.55 million metric tons of coal in the first six months of this year, down 20.4% from the same period last year, according to China’s customs bureau.

Now, the county is suffering through its worst power shortage in decades because of soaring demand and inadequate supplies.

Nearly half of China’s provinces have started to ration electricity. Last month, the government raised electricity tariffs by 5% but prices are still 30% lower than current coal prices would imply, according to BNP Paribas SA (BNPQY.PK) estimates. And that has forced many smaller energy producers out of business.

The government in Beijing tried to deal with the matter by imposing price controls on electricity that make it impossible for energy suppliers to raise their prices, even as they pay more for natural resources that have skyrocketed in price. But that measure is driving smaller producers out of business.

"Large state-owned power companies have no choice but to keep operating and we have seen strong power generation growth from them so far this year despite the high coal prices," Daisy Zhang, an analyst with BNP Paribas in Shanghai, told the Financial Times. "But smaller power plants have been shutting down because the more they operate, the more [money] they lose."

Figures from the China Electricity Council for the first five months of this year show that out of a total of 4,800 power plants, 1,800 suffered net losses over the period. The overwhelming majority of the losers were fueled by coal.

The government has also capped the price of coal but that hasn’t alleviated the pressure on energy suppliers either.

"If a coal company wants to raise prices it just issues a notice and that’s it. There’s no way [to refuse] even if you don’t agree," one coal purchaser with a power plant told the Shanghai Securities News last week.

The newspaper also cited industry officials as saying that coal companies have been refusing to honor contracts, thereby forcing power firms to buy from the spot market, where prices are considerably higher.

While previously around 80% of contracts were honored, the figure has dropped to 60%, the Shanghai Securities News said.

Another problem is the growing number of coal exports. Beijing has capped the price of coal sold in its home market, but global prices continue to rise, which makes exporting coal far more profitable. The difference between domestic and global coal prices was about $54.70 per metric ton in the week ended on July 4, China Business News reported.

China exported 25.49 million metric tons of coal in that time, a 10.2% increase from the year prior. In fact, China’s coal exports soared 83.5% year-over-year in June to 6.99 million metric tons, the highest monthly total since March 2005, even as the nation suffered through a shortage of the fuel that has resulted in blackouts across the country and a multitude of energy providers being shut down.

While many in the industry anticipate Beijing will raise energy tariffs further after the Olympic games, few believe that will be enough. It seems apparent that the solution for China’s coal crisis is to get more coal, and many believe it will through cross-border acquisitions.

China Ready to Pounce on U.S. Coal Suppliers

The total volume of mergers and acquisitions (M&A) dropped by 36% in the first half of 2008, the slowest start since 2005, according to Dealogic. But while deal volume in the United States tumbled 40%, transaction volumes jumped 5% in Asia.

The pickup in Asian transactions is largely attributable to Chinese companies, which announced plans to buy a combined $42 billion in foreign assets. That’s more than five times the amount Chinese companies spent on M&A in 2007, according to Dealogic. It’s also equivalent to the combined volume of all the foreign takeovers by Chinese companies from 2000 to 2006.

Also, while deal volume was down in most every sector, takeovers of energy and mining companies shot up 33% in the first six months of 2008. And that is only a small indication of things to come.

The recent buyout of Alpha Natural Resources Inc. by Cleveland Cliffs Inc. could pave the way for more than $50 billion worth of M&A activity in the U.S. coal industry over the next few years, Bloomberg News reported.

"People will look back on this as the first major U.S. event, not as overpriced," International Coal’s Ross said.

Another factor to consider is the weakness of the dollar, which makes U.S. assets even more affordable for foreign companies.

Cross border activity represented 40% of the $1.6 trillion in first-half deals and, according to Thomson Financial, "was aided by emerging economies with cash to spend and favorable exchange rates in the U.S."

Chinese interests have already displayed an aptitude in acquiring resources vital to their growth. This was evidenced earlier this month, when Sinosteel won its hostile bid for Midwest Corp. Ltd., an Australian iron ore producer. Iron ore, the other key ingredient in steel production, has more than doubled in price over the past year.

Also, in February, Aluminum Corp. of China (ACH) teamed up with Alcoa Inc. (AA) to buy a 12% stake in Rio Tinto PLC (RTP), hoping to thwart an unsolicited takeover from BHP Billiton Ltd. (BHP) that would have give the Australian powerhouse control over a third of the world’s iron ore.

So far, all but one of the 10 unsolicited hostile bids launched by Chinese firms on foreign targets since 2005 have focused on natural resources, according to The New York Times.

"Working on China-related deals two or three years ago, I once gave a presentation to an interest group in which I said Chinese investors did not yet have the appetite for hostile takeovers," a Chinese lawyer working for an international law firm told China Economic Review. "But I am sure we will see a lot of more of these over the coming months and years. Chinese investors are increasingly sophisticated."

The attorney went on to say that he was currently working on two commodities-related investments by Chinese firms in Australia - one of which could well end with an aggressive takeover bid.

Original post

Comments

[investor88]

Informative article with useful figures. Interesting observation that analysts believe bull market in coal can last another 10 years; longer term holders of battered leading coal stocks can breathe easier. Based on coal price/ton, Peabody and International Coal represent good value.

[fxtrader07]

sorry to spoil the party but there are more attractive takeover targets in Asia for China when it comes to coal.. transportation will also be easier and over shorter distances from, say indomesia, than from the us. still there will be also takeovers in the usa, but wilbur ross might be a tad too u.s. fixated in his view (apart from talking his own book)

[PastTense]

The obvious question about coal is whether or not the world is serious about doing something about global warming. If the world is serious about global warming it will switch away from coal to nuclear, wind, solar and other renewable energy sources.

[friedrich engels]

i think you overestimate the coveting of prb coal. it is low sulphur but is lower in btu production than is needed for thermal use. re: asian buyout v n. american buyout: china is having trouble buying midwest coal in australia and in my opinion there's a bit of xenophobia as regards china's buying out their mines and mills. if they buy here which i'm not so sure will happen they'll pay a huge premium as coal, esp met coal, is off the charts. one issue on their not buying u.s. mines is the distance to ship the coal the cost of which is not conducive to profits.

[flow5]

the democrats in Colo are keeping us from mining the coal and drilling

[pachanguero]

Shut up about the anti USA scam called Global warming. You are just sheep.

No... on secound thought keep yapping as I make a ton of money on coal as I have for two years.

The more fools like you bellow your religion of earth worship the more you kill your own position.

LOL....

[dman90012]

Global warming is a hoax according to NASA's own data. Global temperature trends have remained flat if not lower over the last 10 years. Global warming is an attempt by governments to increase regulation over private companies and also to fatten Al Gore's pockets.

[jimmy46]

1 congress won't let china buy america's energy companys

2 powder basin coal is low thermal and not worth shipping around the world

3 eastern coal would really have a long boat ride to china

4 ANR has met coal, a completely different story, and the stock
isn't acting like the deal will go thru anyway

[coopnorth]

let the price run up.
if there is one thing we (US) has, that's coal.
free market--sell to the highest bidder.

[Emerson]

Would anyone like to hazard a guess as to which ones are worth buying now? Thanks

[Chubbs]

Ten years of increasingly intense coal burning will poison the atmosphere. Everyone, enjoy your coal profits. No problem there.

[ChipSeal]

When faced with the prospect of load shedding or a degree or two hotter in a hundred years from now, global warming will no longer be a concern.


On Jul 21 09:09 AM PastTense wrote:

> The obvious question about coal is whether or not the world is serious
> about doing something about global warming. If the world is serious
> about global warming it will switch away from coal to nuclear, wind,
> solar and other renewable energy sources.

[HarryHope]

"Overseas coal has simply become too expensive for China to import.
China exported 25.49 million metric tons of coal in that time, a 10.2% increase from the year prior. In fact, China’s coal exports soared 83.5% year-over-year in June to 6.99 million metric tons, the highest monthly total since March 2005, even as the nation suffered through a shortage of the fuel that has resulted in blackouts across the country and a multitude of energy providers being shut down."

Why would China be buying US coal if its too expensive to import. And if China was exporting coal while short internally, wouldn't China first cut off exports? Article seems to contradict itself while spouting off lots of quasi-relevant numbers.

[iThinkBig]

Been saying this a lot of the last year: We create energy independence so we can ship more raw commodities to the rest of the globe. Cheaper energy here means we can ship it cost effectively to there. There are so many angles of win-win it is this ignorant House (yes, I admit, I am a DEM hater, there I finally said it) that refuses to consider it may not be 1998 anymore and our integrated world moves in five year cycles whereas it used to work in 20. Lack of research kills and the government with the SAIC has no excuse for it...

[nonethewiser]

ithinkbig,

If U're a dem hater, then u must really be a fool, for the neocon Republicrooks have got us where we are now vis a vis foreign wars, Israeli-philes threats against Iran driving the price of oil past $100/barrel, the deregulation of the investment banks and their theivery on the loans whose complexity even Mr. Buffet's can't understand...and don't forget the tax-cut and spend double deficits.

A HUGE DEPRESSION is coming and you're none-the-wiser with the Dem-hating talk. Not a fan of their economics myself, but I rather go with a quasi-peace party than a war-loving, nation-building, deficit-spending party ANYTIME.

Holding my nose and voting for Obama '08

[sdcougar]

For those still in the dark about the falsity of the Global Warming claims, see this report by ABC's John Stossle (sp?)

www.youtube.com/watch?...

also see Daily Tech, "...The American Physical Society, an organization representing nearly 50,000 physicists, has reversed its stance on climate change and is now proclaiming that many of its members disbelieve in human-induced global warming. The APS is also sponsoring public debate on the validity of global warming science. The leadership of the society had previously called the evidence for global warming "incontrovertible...