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Case Study

Case Study

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Published by Abhishek Tripathi

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Published by: Abhishek Tripathi on Jun 20, 2012
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09/25/2014

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CASE STUDY
JAPAN
There are no price controls on coal in Japan. All fuels and energy services are subject to ageneral consumption tax (akin to a value-added tax) at a flat rate of 5% (4% national, and 1%prefectural), as well as excise and other taxes at different rates according to the fuel.A coal tax is levied on all final sales of coal.With respect to
international market, a “benchmark pricing”, typically a negotiated price
between Japanese steel mills and Australian producer for coking coal or between Japaneseelectric utilities and Australian producers for steam coal, prevails as a reference price ininternational market. However with the development of spot market, where coal price tendsto be much lower recently, a benchmark pricing system is beginning to be influenced by spotmarket pricing, because buyers need toprocure coal at lower price in the face of deregulationof electricity market or international competition.
PRICE SETTING MECHANISMS: DOMESTIC COAL PRICING
Prices of coal products consist of various elements, such as:
 
Mine mouth costs: labour cost, production cost, royalty and capital cost;
 
Transportation costs: rail cost;
 
Port costs;
 
 
Retail profit margins;
 
Taxes and leviesDomestic coal price is determined without government intervention.The reason for setting a ceiling price is because of social consideration as to provideelectricity at a low price to help lower income groups, while governments heavily subsidizecoal producers to meet the difference between producer profit margin and ceiling price.
PRICE SETTING MECHANISMS : INTERNATIONAL COAL PRICING
There are two broad ways of setting international coal prices in Japan: long-term contractpricing and spot pricing. There are, however, many variances.
CHINA
China's coal consumption peak season typically starts before the Chinese New Year.Coupled with the unusual snowstorm in southern provinces this year, coal prices in
 
China shot up furiously within a short period of time at the beginning of 2008.In the transit hub of Qinhuangdao, major coal prices reached a record high in January2008, up more than 20% from just a month ago, and such increases are on top of thecontinued uptrend in coal prices since 2004. Coal is the most important energy source inChina, accounting for 70% of the national energy consumption.
"Tight balance" between supply and demand
 The coal price trend in China is closely related to its price forming mechanism. And thereform progress in China's coal pricing mechanism in recent year has shown a cleartendency towards marketization.In the era of planned economy, coal prices were uniformly set by the government. In1993, China started to relax sale prices for coal products other than thermal coal, which
 
accounted for 50% of total coal consumption in China, so thermal coal price was stillunder a dual pricing mechanism of "planned coal" and "market coal". In late 2004, thegovernment announced the "Coal-Electricity Price Linking Mechanism", which allowsperiodic electricity price increases once thermal coal price increases 5% or more in thepast 6 months, and the thermal coal price in turn can be determined by negotiation
 
between coal sellers and buyers in the market. For various reasons, thermal coal pricefailed to become marketised initially, but the price differentials under the dual pricingmechanism began to converge. In 2007, the 50-year-old system of governmentorganising annual coal order meeting among coal producers, transporters and userswas finally removed, and now suppliers and buyers are starting to independently
 
negotiate prices based on market circumstances, under the government's macro controlframework.Against such a backdrop, the relationship between supply and demand has now becomethe major factor in determining coal prices. From a consumption mix perspective, theelectricity, metallurgical, chemical and construction materials industries, whichcollectively account for 70% of total coal consumption, are the main users of coal inChina. In the first three quarters of 2007, outputs from China's coal-fired power, coke,raw steel and cement industries had grown 16.7%, 19.4%, 17.6% and 15% respectivelyover previous comparable period, far exceeding raw coal output growth of 11% from thesame period. On one hand, the demand for coal had been increasing significantly. Onthe other hand, the government were mandating the closure of small and medium coalmines and limiting the capacity expansion of coal mines, thus reducing coal supplygrowth. And the railway transportation in China has long been a bottleneck for coal. As aresult of all these factors, demand and supply of coal in China has been in a "tightbalance" situation for years.Coal prices in China started to decline in 1997 and reached a bottom in 2001. Theproblem of coal shortage started to surface in 2004. Although coal producers had been
 
expanding their production in the following years, with 8.2% increase in output in 2007alone, the supply shortage nevertheless failed to alleviate. Therefore, coal producers inChina have made a windfall profit in recent years, thanks to the ever-rising coal prices.Experts predicted that national raw coal output in 2008 would be similar to the level in2007, with about 2.73 billion tons of production, against an expected demand of 2.728billion tons. Although there may be tightness in certain regions and coal products,China's coal market as a whole is expected to reach equilibrium this year, with coalprices maintaining at a high level.
"Full-cost" reflecting resources scarcity
 Not only coal prices in China reflects demand and supply interaction, they are alsostarting to reflect the associated resources scarcity and environmental costs. Therefore,the crystallisation of regulatory costs is another important reason for the ever-rising coalprices in China.Previously, most coal mining rights in China could be acquired with little compensation,and costs of safety, environment and rehabilitation had not been included in the normalcosting of coal. This not only failed to reflect the true value of resources, but also led to
 
uncompensated resources consumption and unrecovered environmental damage. Formany state-owned coal companies, they also had to face legacy issues such asrebuilding exhausted coalmines and staff re-employment difficulties.

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