Supply and Demand for Coal

Question: Discuss about theSupply and Demand for Coal. Answer: Introduction References to demand and supply are a commonplace among economists. In definition, demand and supply refer to the ability/willingness of consumers and sellers to buy/sell a particular product. The market always settles at a point where supply and demand are in balance (no shortage, no surplus). A fall in demand leads to a drop in price, while a rise of the same results to an increase in price, ceteris paribus (Bade Parkin, 2011). Unlike demand, supply and price move in the opposite direction. An increase (decrease) in supply leads to a decrease (increase) in price, holding all the other factors constant. A good example of forces of demand and supply in play is the recent reduction in coal prices. Reasons for the Falling Coal Prices The decline can be attributed to the slowdown in global buying from China, India, and the USA, which have, until recently, been strong pillars of demand. We have seen the inventories of thermal coal (the type of coal used to power plants) reach a record high, leading to a soar in domestic production in a period of slowing demand. For instance, in 2015, the global supply of coal exceeded global demand by 30 million tons, in comparison to 9 million tons in 2014. Chinas slowing demand for coal has been a predominant factor driving the global prices down. China is the worlds leading coal consumer and has been responsible for more than 80% growth in global coal usage since 2000. The fuel use in the country declined in 2014 and 2015, marking its first time drop in two consecutive years since 1982. In part, the shrinking demand can be attributed to the countrys plan and pledge to cut down green gas emissions by 2030, to which coal contributes significantly. The ruling party put measures to reduce coal consumption, including the decision to close down mega coal-fired stations across the country. China has in decades, experienced slowest economic growth, translating to less demand for raw materials and other essential commodities such as coal. The state also enacted measures such as import reduction and quality restriction to protect domestic suppliers from the dropping coal prices. This, together with the countrys gradual shift from power hungry industries to service and consumption driven economy has put a pessimistic slant on the global coal demand and price predictions. The sharp decline in coal consumption in the US, the second largest coal consumer, has been attributed to legislations targeting carbon emission such as the Clean Power Plan in 2014, (Reuters India, 2016), as well as the decline in gas prices. Almost all the coal in the US is used to generate power. Hydraulic fracturing has made it possible for producers to access gas trapped in shale formations, resulting in a dramatic increase in gas supply, and a consequent reduction in gas prices (Forbes.com, 2016). Since natural gas and coal are substitutes in electrical generation, many utilities have now switched to the cheaper natural gas, and this has contributed to declining demand for coal. India, the worlds third-largest coal consumer, is implementing policies to increase domestic coal production and reduce coal importation. More than 67% of Indias total energy consumption comes from coal. After years of rising imports, Indias coal minister has pledged to make the country coal self-sufficient, and the plans are underway to cease all coal imports by 2017. India is also recognizing the benefits of phasing out the use of fossil fuels such as coal in favor for renewable (Reuters India, 2016), From the supply side, the problem witnessed in the coal industry is in part due to the unwillingness of few coal companies to cut down production, despite running losses due to intentions of bigger miners to force the smaller, weaker, and less efficient players to shut down. Some Aussie miners have been trying to make up for the price drop with higher export volumes. Export capacity in major coal exporting countries such as Indonesia and Australia has improved due to infrastructural development, and this has boosted coal supply in the global seaborne market. Economic Impact of Reduction in Coal Prices The falling prices have affected the economies of coal importers, exporters, and the countries with an enormous domestic production of coal but with a huge domestic demand of the commodity such as the US. For importing countries such as India and Japan, the recent slump in prices means that the consumers are spending less on coal and more on domestically produced commodities. India, as one of the most sensitive economies to energy prices, has its inflation- a long time problem- on a steady decline. Economists are of the view that, if the trend continues, the Reserve Bank of India may decide to cut the interest rates, which will help to boost other sectors such as manufacturing. The declining price has affected coal exporting countries in a variety of ways. Coal companies pay royalties to the government, which is typically either, a flat rate per ton or percentage of the market value. Along with economic input from jobs and projects, the budgets of state governments have been bolstered by royalties they receive from coal companies. The actual profitability of coal, together with other resource sectors affects the federal budget in a big way. During a boom, coal companies have higher earnings, and this translates to increased corporate taxes. There is also a multiplier effect as complementary sectors benefit from the boom, resulting in more federal taxes and increased employment levels (Jacobsen and Parker, 2013). Also, there are additional staffs that are on higher salaries, which contribute to more income revenues to the national budget and increased spending to the wider economy. The opposite is true during bust cycles. Coal is Australias second biggest export. It accounts for 10 percent of all exports (ABC Rural, 2016). The decline in coal prices has such consequences that it could end Australias more than 22- year stint of unbroken economic growth. As the value of this export takes a dive, we expect a fall in disposable income per person, a slump in terms of trade, and a consequent depreciation of the Australian dollar. The coal industry in the US is also in shambles. According to the labor department, the industry has lost hundreds of thousands of workers since 2011. Large companies such as BP, Chevron, and Shell, have continued to lay a significant number of their employees. On the national level, the situation has been mitigated by increased investments in green energy. Affected Industries Industries affected by declining coal price include the coal industry, railroad, power generation, as well as steel and construction industries. The decline has knocked down the shares of many coal mining companies, and this has seen many financiers exit the sector. There have been cutbacks, though they have not been enough to mop out the rising supply. For instance, in December 2015, Glencore Plc, the worlds largest coal exporter halted production for three weeks in 13 mining operations in Australia. This took a toll on the companys revenues. Coal companies have been closing down at an alarming rate. More than 200 coal power plants have closed down in the US alone In January 2016, Arch Company, the second largest coal company in North America, became the first in 2016 to file for bankruptcy protection (International Banker, 2016). The situation is so much worse that during the past half-decade, public coal producers in the US alone lost 99 percent of their value. A decline in coal shipment has yielded a blow to the freight railroad industry. Railroads require steady investments to maintain their competitiveness and are very vulnerable to internal and external shocks. Given the earnings of railroad operators mainly come from coal, the recent reduction in price saw a decline in their profits. As a result, Union Pacific Corp (UNP), and Norfolk Southern Corporation (NSC) reported a 10% reduction in their revenues (NASDAQ.com, 2015). While there may be some positive correlations between electricity prices and declining coal prices, this does not easily translate into an increasing demand for electricity. Power plants are increasingly switching to natural gas due to cost and efficiency issues because producers have to wade through multifaceted environmental limitations put in place to curb the use of coal. The decline in the international price of coking coal is expected to benefit steel producers. However, overproduction of steel in Asia has flooded the market with cheap stee (EUROFER: Chinese steel imports confuse buyers in Europe as Chinese steel producers exploit the export tax regime, 2015). There has also been an increased focus on using aluminum for automobiles due to stringent regulation pertaining emission and efficiency issues. Almost half of the worlds steel is utilized in the construction industry. Construction sector in China (the biggest in the world) is on the decline due to high debt, insufficient returns, and excess housing supply. All in all, the steel producers may benefit from falling coal prices in the short run, but the long-term demand is stacked against them. Conclusion The price of coal has substantially declined in recent years. It has reduced the company profits, increased unemployment, and has reduced the pace of growth in government revenue and household income among coal exporting countries such as Australia. This has restrained non-mining business investment. However, some coal importing economies such as India have benefited from the reduction in coal price, as well as some industries such as energy, steel, and construction. References ABC Rural. (2016). Low resource commodity prices factored into federal budget. [online] Available at: https://www.abc.net.au/news/2016-04-29/low-commodity-prices-factored-into-budget/7362958. [Accessed 8 Sep. 2016]. Bade, R. and Parkin, M. (2011). Foundations of economics. Boston: Pearson Addison-Wesley. Eurofer: Chinese steel imports confuse buyers in Europe as Chinese steel producers exploit the export tax regime. (2015). Steel Construction, 8(1), pp.71-71. Forbes.com. (2016). Forbes Welcome. [online] Available at: https://www.forbes.com/sites/jeffmcmahon/2013/04/23/4-reasons-coal-declines-even-as-natural-gas-prices-rise-eia/#5fe01df75b01 [Accessed 7 Sep. 2016]. International Banker. (2016). The Decline in the US Coal Industry. [online] Available at: https://internationalbanker.com/brokerage/decline-us-coal-indus. [Accessed 8 Sep. 2016]. Jacobsen, G. and Parker, D. (2013). The Economic Aftermath of Resource Booms: Evidence from Boomtowns in the American West*. [online] Economic Journal, forthcoming. Available at: https://pages.uoregon.edu/gdjaco/Booms.pdf [Accessed 8 Sep. 2016]. NASDAQ.com. (2015). Railroads: Low Coal Demand, Oil Price Slump Play Spoiler. [online] Available at: https://www.nasdaq.com/article/railroads-low-coal-demand-oil-price-slump-play-spoiler-cm556707#ixzz4JZwKk0mX. [Accessed 7 Sep. 2016]. Reuters India. (2016). Thermal Coal-Asian coal prices lifted by tightening markets in China, India. [online] Available at: https://in.reuters.com/article/markets-coal-physical-idINL3N0YP2XO20150603 [Accessed 7 Sep. 2016].