BHP Billiton bets on rising South African coal demand

South African freight transport company Transnet and the South African coal unit of miner BHP Billiton have signed a 10-year ‘take-or-pay’ rail contract for export coal, Transnet said.

However, market participants described the contract, which is worth about R2.4bn ($169m) per year and R24bn over the 10 year period, as a “bet” on growth in the South African coal market. The take-or-pay contract is based on the expectation that demand will be there, participants said.

“This contract is basically BHP taking a bet on the Asian market. This has Indonesia and India written all over it,” an analyst said. “India is a good bet. It is a potential big market for South Africa. People are optimistic about India.”

China, Japan, Pakistan and Indonesia are also likely to take some of the tonnes, while and excess can be sold into Europe, if needed.

Some analysts pointed out that the ‘take or pay’ contract could result in BHP having less room to manoeuvre when supply and demand are not balanced, which would mean that BHP would likely export, even in an oversupplied market. However, even though it might be currently uncompetitive for miners to ram up output, in the longer term it could prove a sound decision particularly as coal demand in India, South Africa’s main importer, is expected to grow.

“We expect India to become the biggest coal importer in the coming years, therefore South African miners would be first in line to benefit,” said Diana Bacila, analyst at Norwegian energy market analysts Nena AG.

Australian lessons

Take-or-pay rail contracts were a large contributor to oversupply, and consequent falling prices, in the Australian market. In 2013 Australian coal producers responded to falling market prices by increasing their production in order to minimise the cost of tonnes produced. In practice, this may mean shifting production to coal seams where extraction is easier and faster as well as taking advantage of the booked rail capacity.

“There is a big difference between Australia and South Africa when it comes to the take-or-pay. Australian miners were developing mines and there was no railway built to ship their coal for the respective areas. And now, after so many investments in both mining sites and railway capacity they ended up struggling with oversupply,” Diana Bacila added.

South Africa is completely different because all miners rely on Transnet to export their coal, Bacila pointed out. They could use trucks and road transport but no other railway. Stacy Irish