February 26,2010

China's Appetite for Overseas Coal Roaring in the Year of Tiger

By CSC staff, Shanghai

Entering the Year of Tiger, enterprises in the world's largest coal producer,

China, are more and more seeking overseas coal. The unexpectedly massive onslaught of snow and ice in the country's northern reaches has caused coal shortages in the southeast and is strengthening the determination of Chinese firms to go after overseas resources. As transportation from inland mines to the southeast coastal areas is also seriously short and coal prices are higher in domestic than in international markets, in the next few years economically developed areas in southeast China will be increasingly importing their coal.


On January 12, the Metallurgical Corporation of China (MCC) announced that it will take a 5% stake for US$200 million in Resourcehouse, Ltd., the parent company of China FirstPty, Ltd., and get the general contract management of EPC, a ChinaFirst coal project in Queensland.


On February 6, Resourcehouse, owned by Australia's fifth wealthiest businessman Clive Palmer, announced that it had signed a coal trading contract worth US$60 billion with China Power International Development (CPI). The Australians say it is the country's "largest export contract in its history."


In January, Yanzhou Coal Mining (YCM) acquired 100% of Australia Felix Resources (Felix) for US$3.2 billion (about AU$3.33 billion), the largest Chinese acquisition in Australia and one of the top ten M&A cases in Australia in 2009.


Wang Xin, vice-chairman and general manager of Yanzhou Mining Group (YCM), is extremely optimistic about the prospects of Felix, saying, "Felix's coal output is expected to reach 15 million tons in 2010, which will substantially increase the total coal output of our company." Felix's 2012 coal output is expected to reach 24 million tons, equivalent to 2/3 of YCM's, with profits expected to total up to 4 billion yuan.

Chinese enterprises' M&A activity in coal involve the five populated continents outside
Europe. Shenhua Group has acquired rights of exploration to Australia's Watermark site and six pieces of agricultural land with coal resources in the northwestern New South Wales. A surface coal mine with an annual output of 1.5 million tons in Indonesia is already in operation. MCC has stakes in Australia's Waratah Coal as well as Resourcehouse. Baosteel has acquired the Australian firm Aquila. CIC has invested $1.9 billion in the largest coal supplier in Indonesia PT. Bumi Resources Tbk, its largest investment in 2009. CIC has also invested Canadian firm SouthGobi Energy Resource.

China's coal consumption accounts for 36.9% of the world's total, and demand is growing. Its southeastern coastal areas are gathering areas for coal imports. At the high end, prices for international supplies have been lower than for domestic coal. While it is easy to buy a good domestic coal mine with $3.2 billion, choosing to acquire Felix, say, makes sense because Felix has coal mines already in profitable operation. In China, the operation of a coal mine is limited by a variety of factors, such as the uncertainty of profits, even if the mine is in operation, due to capricious local policies, not to mention unlooked for intervention from Beijing. By contrast, Australia's coal mine investment environment is in accordance with its legal system, and normal market operations and profits can be expected.


In recent years, negotiations between China's coal and electric power suppliers have been deadlocked. Power firms have been buying coal large-scale from overseas sources in response to rising domestic prices. In July 2009, coal imports reached 13.88 million tons, three times over the same period last year.


On January 9, 2009, the domestic railway line for coal owned by Shenhua Group began construction and is expected to be in operation by the end of 2011. The Tolgoi coal mine in Mongolia is the northern terminal, with 6.5 billion tons of coal reserves, the world's largest untapped coking coal deposit. Shenhua has begun negotiations with Mongolia on the development of its mineral resources.


At the beginning of last year, MCC contacted Waratah Coal to negotiate a possible stake in the enterprise. In the same year, China Investment Corporation (CIC), China's sovereign wealth fund, began to study investment in Indonesia's coal enterprise, PT. Bumi Resources Tbk.


CIC's investment approach is different from MCC's.


Last May, MCC inserted US$3.1 billion into Waratah Coal's $5.15 billion pool to finance a coal and port project. The investment of MCC accounted for 60% and MCC promised to introduce other Chinese investors to stake $515 million in this project. In return, MCC obtained the contracting right to shoulder the debt risk for Waratah Coal and can purchase 30 million tons of coal from the project per year. 


On February 3, MCC announced its acquisition of a 5% stake of Resourcehouse. Shen Heting, president of MCC, says that the company may get a project contract of $7 billion and may purchase 30 million tons of coal.


CIC's investment has been rapid. Following the investment of $500 million in SouthGobi, CIC put $1.9 billion into PT. Bumi Resources Tbk, an important provider for China's coal imports. "We will use the CIC funds to invest in railway construction along the Sino-Mongolian border," Alexander Molyneux, president of SouthGobi Energy Resource, says, adding that the company's coal mine, Ovoot Tolgoi, is only 45 km from the Sino-Mongolian border, with coal reserves of about 114 million tons.


As they journey abroad, Chinese companies are getting smarter. China's current M&A strategies draw on Japan's experience. Investment entities are necessary to reduce risks brought about by price fluctuation, and long-term contracts are established to avoid price fluctuations and lock risks.


China's National Administration of Coal Geology General Prospecting Institute announced in early February that the company will set up a joint venture with China-Africa Development Fund to explore and invest in Africa's coal resources. 60% of Africa's coal is concentrated in South Africa.


In July, 2009, China Huaneng Group announced it will bid for a 51% stake of Indonesia's fifth-largest coal company PT. Berau Coal. Before this announcement, Huaneng had acquired a 25.5% stake in Australia's Monto Coal Project for AU$29.423 million, with coal reserves of about 500 million tons.


Huaneng has 15 power plants along China's river and coastal areas. If the imports are more than 10 million tons per year, it will account for 20%-25% of the amount of coal consumption in these power plants. It is very difficult to obtain high-quality coal resources in domestic areas, so international acquisition or shareholding is the better choice.


Chinese enterprises get a lot of support from financial regulatory authorities and banks as they go abroad. The Ministry of Commerce, National Development and Reform Commission, and the State Administration of Foreign Exchange focus on supervision and support of Chinese enterprises' overseas investment and M&A activity.


YCM's acquisition of Felix was an artful use of the country's foreign exchange policy, adopting an "internal security" approach, referring to YCM's guarantees to commercial banks, with foreign branches of China's commercial banks providing loans to Yancoal Australia (a YCM subsidiary), so that YCM had no need to use its own cash. More important, the domestic one-year lending rate is 5.3% to 5.4%, while it is less than 1.98% in Australia.


Wang Xin says Felix was delisted after the acquisition. In the second half year, the company will go public again. After re-listing, the bank loans will be largely repaid through the refinancing.


With China's rapid economic rebound, the consumption of iron and steel, cement, electricity and other raw materials is rapidly increasing, significantly boosting the demand for coal. It is expected that in 2010 China's coal demand is about 3.1 billion tons. Shenhua has suspended coal export since December.

The h
undreds of millions of tons of coal transportation in China each year put enormous pressure on railway transportation and is a great drag on social resources. The pattern of coal imports in the southern areas will help the transformation of "south import and north export." Early in January, executives from the National Energy Board convened a meeting attended by five power companies and related electricity association. The focus of this meeting was to set the use of imported coal as alternative in the period of shortage of domestic coal supply to ease the overall tense situation.


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