What’s in Store for Indonesia’s Coal Market?Partner and Head of Energy Practice at Oliver Wyman, Singapore Principal in the Energy Practice at Oliver Wyman, Singapore
The 2013 commodity slump led to the start of turmoil in the coal industry globally. The industry reacted by reducing operating costs, enhancing production to stabilize revenues and reducing investments to preserve cash.
Following the slump, market liquidity has recovered and is deepening in Asia for commodities. The thermal coal market is moving from a semiliquid to a liquid market with increased ability to buy and sell spot. However, trade volumes hinge on the direction climate policy takes and the penetration and success of the clean agenda. Thermal coal is increasingly being replaced by cleaner sources, and it is increasingly faced with pressure from different quarters. For instance, some of the world’s largest insurers, including Zurich, AXA, Allianz, Munich Re, Generali and Swiss Re, have all introduced changes or restrictions around the type of coal-fired power generation assets that they can insure. The pressure on offtake is likely to continue in the future and will likely result in a market of oversupply.
Recent Indonesian regulations on price caps and domestic market obligation requirements will impact coal mining companies. In our view, coal miners could face a revenue decline of 5-15 percent compared to 2017 and a margin erosion of 2-5 percent owing to these developments. In this constrained market, it is now even more important than ever to be operationally and commercially effective.
Levers To Maximize Value Extraction
As the macro market matures, coal companies need to focus on and extract new pockets of value. It is imperative for Indonesian coal miners to examine four dimensions for strategic response: Production scale and value-chain footprint; cost and operational effectiveness; commercial maturity; and business diversification.
Production scale and value-chain footprint
While Indonesian players have grown their businesses over the past few years, they are still medium-sized compared to global leaders. Indonesian company growth observed in the past 4-5 years is largely due to footprint expansion via brownfield and inorganic expansions.
Indonesian coal firms need to determine what their potential acquisition targets are wherein they can create value and whether they are ready with the systems and processes required to identify, acquire and integrate targets in a time-bound fashion.
We believe Indonesian producers need to manage their business portfolio of assets with different positions on the cost curve. The current rise in prices may provide an opportunity for miners to rationalize their portfolios through the divestment of assets with structural cost limitations, such as high strip ratios and complex logistics.
Indonesian companies could further strengthen their position through enhanced participation along the value chain, such as insourcing logistics, which can enhance the margins and lead to lower earnings volatility.
Cost and operational effectiveness
Although most Indonesian companies have focused on cash cost reduction, greater improvements are required to keep pace with global coal producers. According to Oliver Wyman analysis, over the past three years, Indonesian coal companies have reduced cost of production by 5-10 percent, while global peers have reduced costs by 15-25 percent. Global coal companies have more effectively leveraged digitization and artificial intelligence to enhance efficiency in operations and their supply chains than their Indonesian counterparts.
Major global players are aiming for fully integrated, highly automated operations by 2025, using IoT sensors, autonomous vehicles/equipment, and AI. It is imperative for Indonesian coal producers to also leverage developments in AI and digital to build sustainable competitive advantage, but they need to determine how they can optimize operational expenses.
While Indonesian coal producers have traditionally focused on being wholesale suppliers of coal, a few have tried to maximize value by optimizing marketing and logistics. Advanced logistics capabilities, storage and stockpile management and owning/leasing long-term freight for general cargo activities can help create additional value. In addition, creating systemic flexibilities, such as those of source location and optionality, to trade beyond their own production volumes can enhance overall profitability.
Indonesian companies need to build analytical capabilities to move from being pure play wholesale suppliers to asset-backed traders. To do so, they need to establish what the ideal commercial model for them is and whether the choice of the commercial model is aligned with their risk appetite; how they can build and optimize a portfolio of long and short positions; and whether they have a deep understanding of the value in securing access to key logistics infrastructure.
Another option for Indonesian coal producers is to diversify operations to de-risk their business. Given the excess capacity in the coal market and relative uncertainty of demand for Indonesian coal among key export markets of India and China, coal producers could consider investing in downstream opportunities. For example, Indonesia’s 35 GW power growth program provides companies with opportunities to partner with the likes of power producers, Indonesian family-owned businesses that want to enter the power sector, or, potentially, industrial parks that want to secure coal supply, among others. Additionally, the recovery in crude prices provides an interesting opportunity to re-evaluate the coal-to-chemicals play, which refers to the opportunity to convert coal to commodity chemicals. While this was not attractive when crude oil prices were low, it makes sense to re-evaluate the business case now as it is cheaper to get chemicals from coal as opposed to from crude oil. In addition, fiscal incentives for petrochemical investments by the Indonesian government provide a further boost to the economic case for a shift from coal to chemicals.
But, to diversify effectively, Indonesian coal companies need to understand how downstream integration can help diversify their business risk and who the ideal partners for them are as they look to go downstream into power or chemicals.
By focusing on these four aspects of their business, Indonesian coal producers will be able to grow revenues and enhance profitability—we believe that over the next five years, revenue could be enhanced by 10-20 percent, and margins by 25-50 percent. While this analysis is based on Indonesian coal mining companies and their prospects, it is also applicable to most other coal mining companies in the Asia-Pacific. In this rapidly changing environment, it is imperative for the industry to take steps in order to remain competitive and even viable.