The surprising announcement by the Indonesian government that it will cap the price of domestic coal at $70/t (basis 6,000 NAR) is a sign of the issues and contradictions that the coal and wider energy markets will increasingly face in the decades to come.
Indonesia’s largest utility, PLN, was surprised (as were many market participants) by the strength of the recovery in coal prices in 2017. Until now, Indonesian power generators have bought domestic coal based on the so-called HBA index, which comprises a basket of two Indonesian FOB indices and two Australian FOB Newcastle indices. The great volatility and bigger increase in FOB Newcastle prices exacerbated PLN’s problems, pushing the HBA index above $100/t in January 2018. This is well above the $60-$70/t reportedly budgeted by the utility for its coal procurement.
Power prices are fixed by the government in Indonesia, which is keen to ensure that electricity supply is accessible and affordable for the population. Indeed 10% of the population still has no access at all to electricity and the average power consumption per capita is one of the lowest in South East Asia at just 935KWh per capita per annum. Inevitably, this price cap has put PLN’s operating margins under increasing pressure, as input prices rose.
To remedy to the situation, the Indonesian government has made the surprise announcement that all domestic coal sold to the country’s utilities under the Domestic Market Obligation will be capped from now on at $70/t. This was even supposed to be backdated to cover sales from 1st January 2018, but it seems the new regulation will start from mid-March.
The consequences of such a move are still difficult to assess. Indonesian mines are obliged to set aside part of their production exclusively for domestic consumption, under the Domestic Market Obligation. We can only speculate that mines will try to minimise sales to the domestic market and maximise sales to the export market, which is currently paying much higher prices.
Admittedly, their ability to do so will be limited by the fact that some mines can only sell to the domestic market, due to their location or the quality of their coal.
As we emphasized in recent editions of our Long Term Price Forecast, which included special sections on Indonesia (November 2017) and South Africa (April 2017), increasing competition for coal supply between international and domestic buyers will become a very serious issue for most exporting countries. This has been made even more acute due to a chronic lack of investment in coal mining worldwide.
In other words, although many politicians want to phase out coal as quickly as possible, the reality on the ground is very different. A potential transition to a world without coal will take much longer than generally anticipated and will be very chaotic.
The current events in Indonesia, which stems ultimately from growing global demand for affordable electricity, could just be an early glimpse of things to come over the next 30 years, or even longer.
Founder and Director, Perret Associates Ltd