The factors weighing on demand and prices in 2015 look set to continue this year. There seems little chance of a major restructuring of Chinese manufacturing or mining industries in the near term and it is difficult to see where this demand gap will be filled.
Production costs fall, prices to follow
The drop in demand for internationally traded coal has exacerbated overcapacity in the sector, resulting in nearly continual price declines over the last four years. Production costs also declined over this period, as producers took action to lower costs by reducing headcount, rationalising high cost production and improving productivity. Combined with the drop in oil prices, lowering diesel prices and weaker producer currencies, costs have been driven down.
Accelerated bankruptcies, restructures and closures in 2015 look like a sign of things to come this year. With falling coal prices adding further pressure to cashflow and balance sheets, it is likely we'll see more distressed sales in 2016, particularly from bankruptcy proceedings and debt restructuring.
We expect these adverse market conditions to provide an uplift to M&A activity, with additional activity likely to come from diversified mining majors which are re-prioritising assets, commodity exposure and allocating capital where expected returns are greatest. The number of willing buyers will again be key if sellers are to find counterparties in deals.
Further divestment activity likely
We expect to see further divestment activity from majors, especially in Australia, with over US$10 billion of assets potentially up for sale. Anglo American has reinforced its drive to sell non-core assets unless they can operate in the first quartile or are moving to a first quartile position. Rio Tinto's remaining Hunter Valley assets could also attract bids this year with a number of parties working through data rooms in the second half of last year.
Whilst many market participants will be glad to see the back of 2015, most of the problems afflicting the coal trade will persist through 2016. Chronic excess steel, coke and coal capacity, weak economic growth, continued US$ strength, and subdued oil and gas prices will keep a lid on coal prices this year. The supply correction began in earnest last year but will remain insufficient to bring either the thermal or metallurgical trade back to balance, meaning another year of low prices.
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