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A protracted, La Nina-related wet season cut Indonesia’s thermal coal exports (the country is the world’s largest exporter) by 15 percent in 2010 (though the overall industry’s capex was up 18% yoy, suggesting the potential for increased volume capacity), hurt output in other key producing regions such as Queensland, South Africa and Colombia and will give miners “the upper hand over the utilities in the next round of annual contracts negotiations,” as many analysts predict rising thermal coal prices against the backdrop of tightening supplies coupled with feverish and price-sticky demand from developing countries.  In India and China, for instance, roughly 67% of primary energy used comes from coal (versus a developed country average of 20%).  Indonesia is a bit more oil-intensive (at a tremendous subsidized cost) though the idea going ahead, per Bukit Asam, is to “burn more [coal] to make up for falling crude oil production from aging fields.”  Taken together this points to a quick study of the Indonesian coal sector.  ITMG, for one, looks cheap.  It trades at a multiple of 10x versus the sector average of 14x and per J.P. Morgan analysts will be least affected by the state possibly implementing a price cap on domestic sales and/or the ministry level’s recent announcement of a potential export ban of coal with a calorific value (CV) less than 5,600kcal by 2014, given ITMG’s high-CV coal (6,200kcal/kg) and low-volume government sales (5% of sales).  Moreover, per CIMB, “the company is strongly geared to price upside as a substantial portion of its volume (75%) is still exposed to index and spot prices.”  On that note,  the overall sector is priced “implying unrealistically low (thermal) coal prices of US$75-85/ton” whereas the FT writes that even conservative traders put impending contracts at about $130.

From this month’s Business Diary Botswana:

Back in late July Bloomberg noted that Botswana, the world’s biggest diamond producer by value and volume, was set to produce 24 million carats of gems in 2010, 36 percent more than last year, as demand recovered following the global recession.  Some analysts pointed to the industry’s rapid contraction of output in the face of perceived demand destruction as the root cause underlying the quick turnabout—at the crisis’ peak, for instance, Debswana, the 50/50 joint venture between the government of Botswana and De Beers Group, and then-producer of approximately 33.6 million carats of precious stones per year, said that it would reduce production and reallocate resources accordingly.  “The increasing supply shortages forecast for the next decade, coupled with increase in consumer demand, will support industry growth in the long term and enable the diamond industry to bounce back from the short term impact in the global recession,” the company announced in late 2008, though as market value across basically all asset classes sagged in unison worldwide, its fingers were no doubt crossed.  Many analysts now maintain, however, that dour predictions surrounding luxury sales were always somewhat exaggerated: what the industry lost to the U.S. turned out to be offset by the rise and relative stickiness of Russian, Chinese and Indian demand, they say. Moreover, this ‘new normal’ in regards to buying habits—a phrase describing the paradigm shift in growth rates and consumption away from developed and towards developing markets put forth by Mohamed El-Erian, CEO and co-CIO of PIMCO, the world’s largest bond investor—is likely to persist going forward, a chief reason why so many industry insiders remained bullish even as prices plummeted.  De Beers forecasts that the U.S., which accounted for about half of global diamond consumption pre-crisis (with China and India hovering around 6-7 percent), will fall to 30-35 percent by 2016, while China and India each grow to roughly 16 percent.  This shift will translate into overall, annual global jewelry sales growth of 4-5 per cent between now and 2020, according to Freddy J. Hanard, CEO of the Antwerp World Diamond Centre (AWDC), a promoter of Belgium’s diamond industry. 

Such upbeat forecasts are certainly reassuring to Botswana’s diamond industry, which began in 1967, the year after Botswana broke away from Britain, upon the discovery of what is still considered one of the world’s largest diamond mines in Orapa, a then-desolate area some 250 miles from Gaborone.  It’s also somewhat reassuring to officials startled by this month’s declaration by the IMF that plans to fully balance the country’s deficit (affected in part by falling diamond exports) by 2012-13 were “ambitious.”  That said, the indisputable catalyst for Botswana’s economic growth and transformation since its independence (average annual growth rate of 9 percent from 1966-2004) is still the same fuel underpinning its relatively high standard of living and political, social and economic stability across the continent today.  In fact, per the Boston Consulting Group’s “African Challengers” research note from June, Botswana was chosen as one of eight “African Lions” (a la the four Asian Tigers—Hong Kong, Singapore, South Korea and Taiwan—all of whom high realized high growth and rapid industrialization between the early 1960s and 1990s) based on a variety socioeconomic factors, but namely GDP per capita rates which as of 2008 exceeded those of any of the BRICs.  Yet in Botswana’s case, the sustainability of the accolade may be of more concern than with any of its peers: diamonds currently contribute 50 percent of public revenue, 33 percent of gross domestic product and 70 percent of foreign exchange earnings.  And despite persisting rhetoric from government officials insisting that, in the face of various expert opinions that the country’s diamond reserves will be depleted in roughly 20 years and that the economy must therefore diversify away from gems and towards sectors such as mining, tourism, agricultural and even offshore financial services, Botswana remains disproportionately dependent on the precious stones.  To that end, the IMF’s recent projection that overall GDP growth will reach 8.4 percent in 2010 is explicitly a function of “the rebound in diamond production” and the overall mining sector’s 16.8 percent y-o-y rebound. 

One notable source of potential revenue going forward that, until the past few years, has largely been underdeveloped and overlooked is coal mining , as well as the comparatively environmentally friendly production and use of coal-bed methane (CBM)—a naturally occurring methane gas trapped inside coal that once was considered a dangerous hazard.  Admittedly, given that Botswana currently imports 80 percent of its 550 MW power demand, with the majority coming from South Africa—which is dealing with its own shortages and will stop supplying its neighbours by 2012—the matter touches as much on security and sovereignty as it does budgetary concerns.  Yet there are roughly 200 billion metric tons of coal reserves (largely located in the eastern Kalahari Karoo Basin, an extension of South Africa’s Waterberg Coal Basin), that theoretically could be a vital source of internal power generating capacity, according to the Ministry of Minerals, Energy and Water Resources, as well as help reduce the country’s dependence on imported power and also be transported for sale not only to South Africa, where Eskom, the government-run utility, still faces a coal shortage due to an inability to meet demand with domestic output—but to an export terminal on Namibia’s Atlantic coast, where ocean-going vessels could be loaded quickly.  Until recently, though, the problem has centered on transportation, and at least one analyst (who asked for anonymity) blames the lack of capital stock squarely on the state.  “The problem is that Botswana and its coal resources are landlocked.  There is no easy way to transport these resources to ports for exports as the country does not yet have adequate infrastructure, and building such infrastructure is associated with great expenses,” he wrote. 

But that lack of investment may be a thing of the past, per the Southern Times, which reported in late September that “both Namibia and Botswana are in the midst of courting private companies to build the envisaged Trans-Kalahari Railway line stretching from Mmamabula coal deposits in Botswana’s hinterland to Namibia’s deep water port of Walvis Bay.”  Ultimately, proponents say, Botswana coal could be marketed internationally, across Europe, China and India.  To date, four private companies have been actively exploring eastern Botswana’s coalfields, including CIC Energy, Kalahari Energy, Aviva, and Saber Energy, part of the Tau Capital group that owns CIC Energy, while a fifth, Australian-listed Earth Heat Resources, will soon join the fray.  The companies will be engaged in projects, per a report, “ranging from coal mining, coal to hydrocarbons, a coal-fired power station, CBM production, a CBM-fired power station and the various fuel [spin-off] industries.”  Moreover, the government seems keen on attracting further investors, revising  its Mines and Minerals Act of 1999 that, while continuing to vest all mineral rights in the State, introduces a new retention license which gives it an option to acquire up to a 15% interest in new ventures on commercial terms, thus abolishing its free equity participation, which previously meant that, for significant minerals operations, it would tend to exercise a legal right to acquire an equity interest of 15% to 25% without compensation. 

Finally, the CBM market in particular seems to be drawing a growing contingent of advocates, though its commercial uses is less clear.  “Research [has] demonstrated that capturing methane and harnessing it into a productive energy source has the ability to dramatically decrease the detrimental effects on the environment.  It has been proven that burnt or used CBM is twenty two times less detrimental to the environment than when it is left to escape un-burnt.  It also has twenty one times greater heat trapping value when released into the atmosphere than carbon dioxide.  Based on its environmental footprint it is clear that every opportunity should be taken to remove CBM from the atmosphere and one of the best ways to do this is to use it in energy production,” wrote Megan Rodgers of Bowman Gilfillan, a Johannesburg and Cape Town-based law firm.  That said, China’s CBM experience—involving convoluted access for suppliers to the pipeline network, and the necessity of subsidies—leaves question marks on the industry’s future feasibility.  Such concerns aside, however, Botswana’s energy and diversification push seem on the right track, another step away from diamond dependence.

Last August The Economist published an interesting piece on Africa’s population transition; while still an outlier compared with the developing world, the continent’s total fertility rate, which was over six in 1990 compared with two in East Asia, is expected by the U.N. to halve in sub-Saharan Africa by 2030 and then fall below 2.5 by 2050.  The article poses the question whether or not Africa will be able to capitalize on what it labels the “demographic dividend”:

As societies grow richer, and start to move from high fertility to low, the size of their working-age population increases. The effect is a mechanical one: they have fewer children; the grandparents’ generation has already died off; so they have disproportionately large numbers of working-age adults. According to a study by the Harvard Initiative for Global Health, the share of the working-age population will rise in 27 of 32 African countries between 2005 and 2015.

The result is a “demographic dividend”, which can be cashed in to produce a virtuous cycle of growth. A fast-growing, economically active population provides the initial impetus to industrial production; then a supply of new workers coming from villages can, if handled properly, enable a country to become more productive. China and East Asia are the models. On some calculations, demography accounted for about a third of East Asia’s phenomenal growth over the past 30 years.

One nation explicitly predicted to benefit from said dividend is Mozambique, a country still suffering the effects of a brutal civil war following its independence from Portugal in 1975.  Yet per last week’s Economist, much has changed since the peace deal officially ending the carnage:

At the end of the civil war in 1992, Mozambique was arguably the world’s poorest country. Its transport, education and health systems were in ruins. Many Mozambicans with marketable skills had fled. But now its economy is one of the fastest-growing in the world. In the past 15 years it has swelled by an average of 8% a year, dipping slightly to 6% during last year’s global meltdown, with nearly 7% expected this year, well above the 4% the World Bank forecast for southern Africa as a whole.

After South Africa, which imports electricity from the continent’s most powerful hydroelectric plant, China and India continue to be the country’s biggest foreign investors, keen to feed their voracious resource appetites and specifically their supplies of quality, coking coal (although India is one of the world’s biggest producers of coal, it produces only limited quantities of the coking coal needed by its steel plants).  In late June, China announced that it had agreed to invest $1bn in a coal project in Mozambique’s Tete province, and India sent yet another trade delegation two weeks ago to “consolidate friendly relations between the two countries.”

Coking coal could indeed be a feather in Mozambique’s macro cap, though the extent to which the country can profit from an expected continual surge in demand will be dependent on improved infrastructure, noted a recent research piece from MF Global which concluded that the coking coal market had better long-term fundamentals than the iron ore market, and furthermore that Mozambique and Mongolia have the potential to be “potential game changers” on the supply side – but only from 2015 and “conditional on infrastructure”.  At present however, it noted, Mozambique suffered “severe limitations on its rail and port infrastructure.”  While critics of the BRICs’ resource romp in Africa contend that the rents gained from commodity-rich governments are often inadequate and/or squandered by opaque political elite decision making, one byproduct of foreign investment is generally an immediate upgrade in infrastructure.  And if coking coal can be the impetus for the above-related demographic dividend to take shape, then the commodity loss can indeed be seen as pie-expanding instead of zero-sum.

Per The Economist, Indonesia is likely to remain at “the heart of an Asian coal boom” given the fact that: (i) the quality of its coal is second to none and is thus eagerly sought even by net exporters such as China; and (ii) for coastal power stations in China, India, Japan and South Korea, “it is often cheaper to import coal by sea from Indonesia than from mines in the interior.” While not environmentally optimal, coal remains plentiful and cheap, two fundamental facets behind the International Energy Agency’s (IAEA) conclusion in November that global demand for coal will increase by 1.9%/year until 2015, placing its growth among fossil fuels second only to natural gas. And absent any kind of universally enforceable carbon tax, UBS analysts note, exports to China and India will see the largest percentage increases.

Moreover, the near-term cash flows of at least some firms may also have an implicit sovereign guarantee given their explicit value, which also provides them with an alternative source of financing. For example, Bumi Resources, Indonesia’s publicly listed and biggest miner by production, became the country’s fourth dollar denominated debt issuer this year when it sold $1.9 billion worth of debt at 12% in September to China’s CIC sovereign wealth fund, which the firm used to pare debt and boost investments. And last month, Bumi announced it would seek to raise $300 million from the sale of seven-year convertible bonds at 12%. A month earlier, Adaro Indonesia, the country’s second biggest producer which, along with Bumi, says it will double capacity by 2012, issued $800m in senior notes at an annual yield of 7.625% (two points lower than when it went to the market in 2004) and maturing in 2019. Interestingly, three-quarters of demand came from U.S. and European investors. And before Adaro, Indo Integrated Energy II, a unit of PT Indika Energy, sold $230 million of seven-years at 9.75%, while PT Bukit Makmur Mandiri Utama, the country’s second biggest coal contractor, offered 11.75% for $600 million of bonds maturing in four and five years.

Analysts at the time of Adaro’s issuance noted that most Indonesian miners would need to give between 9-10% on their coupons, meaning Bumi’s 12% on its upcoming seven years seems particularly high, particularly given the notes’ possible conversion to equity and CIC’s vested interest in the firm. Per Edwin Sinaga, president director of PT Finacorporindo Nusa, a Jakarta-based brokerage firm, “Bumi was forced to offer a relatively high interest rate because investors were aware of its high level of debt.” Other analysts have questioned whether Bumi has the assets remaining to properly secure further debt. Markets reacted poorly to the announcement of further debt, and Bumi remains below its 52-week high established in September. Going forward, it will be interesting to see if the market is properly pricing Bumi’s questionable capital structure.

PT Adaro Energy, Indonesia’s no. 2 coal miner (behind PT Bumi Resources Tbk, which by contrast will send 8 million tons to China this year), stated recently that it had already contracted much of its increase sales to China of 3.5 million tons in 2009–up from roughly 2 million tons last year–while reiterating that Chinese demand for overseas thermal coal would remain “robust”.  China imported over 11.5 million tons of Indonesian coal last year–more than a quarter of its total.  Australian coal prices on the globalCOAL Newcastle index, a benchmark for Asia, ended Friday at $74.31/ton, while port coal prices at China’s top coal port Qinhuangdao remain around $92 a ton.  “As long as there is a difference between domestic and import prices, China will still be buying coal from overseas,” commented Apimuk Taifayongvichit, chief marketing and logistics planner at PT Indo Tambangraya Megah, the Indonesian unit of Thai Banpu, which noted this week that it is looking to acquire a mine in Indonesia’s Kalimantan region in order to boost production.

Indonesia is the world’s second biggest coal exporter after Australia, but has been hit hard in 2009 by falling export volumes and prices and declining domestic demand.  While the government projected earlier this year that domestic consumption would rise by nearly 30%, excess coal supplies mean that most companies will struggle to realize profit growth this year, according to Sylvia Darmaji, a mining sector analyst at PT Ciptadana Securities.  Yet Adaro’s marketing director, Alastair Grant, vehemently disagrees, stating that the firm will likely see double-digit growth in both revenue and net profit this year on the back of increased foreign demand, which comprises over 70% of its sales.

Finally, forward thinkers may want to keep an eye on political developments in Australia.  The Economist notes this week that coal industry executives there complain that Prime Minister Kevin Rudd’s promise of a carbon-emissions trading scheme would likely mean that Indonesia would be able to undercut Australia in global markets.

Analysts estimate that Botswana has roughly 200 billion tons of undeveloped coal that it must make viable as its diamond resources continue to decline. The bulk of the coal is located in eastern Botswana’s Kalahari Karoo Basin, an extension of South Africa’s Waterberg Coal Basin. At present, four private companies are engaged in the eastern Botswana coalfield, including CIC Energy/International Power Ltd, Kalahari Energy, Aviva/NEMI, and Saber Energy, part of the Tau Capital group that owns CIC Energy. Their projects include coal mining, coal to hydrocarbons, a coal-fired power station to Coal Bed Methane (CBM) production, and a CBM-fired power station and the various fuel industries spinning of from coal, its associated minerals and by-products of its extraction.

The potential economic byproduct and windfall that could be realized across the state from a coal boom is laid out nicely in Mmegi:

Most of the projects underway in the eastern Botswana coalfield are expected to enter commercial production after 2012. Analysts believe this places their developers in the enviable position of sidestepping the adverse effects of the prevailing global recession. For instance, it is expected that some project costs could decline for these developers because prices of steel and other materials have generally declined . . . Botswana’s new eastern economic belt is expected to transform rural villages like Mmashoro, Mmamabula itself and a whole lot of others into growth zones leading to a rise in land values and the establishment or upgrading of basic services such as schools, post offices, health care facilities and policing. It is expected that these villages, some of which will have to be electrified as a by-product of the heavy industry coming to their region, will also see the arrival of services such as banking, insurance and telecommunications.

However, some practical constraints may impede the timeframe. Botswana’s most recent budget saw it relax its fiscal belt and adopt deficit spending, but were its spending provisions adequate?

At present, one of the biggest challenges for the development of the economic belt is lack of infrastructure. Many of these developments are taking place away from major roads, railways and power lines, hiking costs for the many players involved. Kalahari Energy Chairman, Jim Best, has explained the challenge thus: “Part of the problem has been the infrastructure. There’s potential for exports from this area, but this cannot happen without infrastructure. We are lobbying government for infrastructure to make exports possible.”

JGW

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