Fitch: Indonesia coal output cap to hurt miners reliant on volume growth

(Singapore-20 February 2014) -- Fitch Ratings says that the credit profiles of mining sub-contractors and miners highly reliant on increasing volumes to support high debt servicing will be most affected if Indonesia strictly implements limits on thermal coal production. The Indonesian Ministry of Energy and Mineral Resources announced its plans to cap Indonesia's total coal output at 397m metric tonnes in 2014 - 6% lower than the 421m tonnes produced in 2013 - in an attempt to ensure Indonesia's long-term energy security and also on the expectation that a lower output may result in higher prices for its coal exports.

The announcement comes amidst some of the larger Indonesian miners announcing 2014 production targets that are up to 10% higher than their production in 2013. Mining companies have been seeking to increase production to partly compensate for substantially reduced dollar margins per tonne of coal following a steep decline in international seaborne thermal coal prices, especially those companies burdened with high debt levels and weak liquidity. For example, PT Bumi Resources Tbk expects to increase production from 74m tonnes in 2012 to about 100m tonnes in 2015.

Fitch understands that the higher production budgets of these miners have yet to be approved by the Ministry of Energy and Mineral Resources. Production caps are not new to Indonesia, although they have not been strictly applied before. How effectively the production caps are implemented, however, remains to be seen. The monitoring and control of production of those miners operating under coal contracts of work (CCOW), which are issued by the federal government, would be easier than that of mines operating under Mining Business Licences (IUPs), which are mostly issued by provincial governments. Indonesia's six largest miners account for about 50% of Indonesia's total coal production. Mines operating under CCOW concessions account for almost 80% of current production.

Fitch does not expect a 5%-10% production cut from 2013 levels to materially impact the credit profiles of miners with low financial leverage, such as PT Adaro Indonesia (BB+/Stable), PT Indo Tambangraya Mehgah Tbk, PT Harum Energy Tbk and PT Kideco Jaya Agung. Also, the operating cash generation of Indonesian coal miners is more sensitive to declines in prices than volumes due to a large variable cost structure. Moreover, the impact of lower output would be partly mitigated if the reduction in coal exports from Indonesia helps support seaborne coal prices. Fitch expects Asian coal markets to remain well supplied and any reduction of coal exports from Indonesia is likely to have only a very limited impact on coal prices, although it may alleviate any further downside pressure on prices. The 24m tonne reduction in production amounts to about 3% of global seaborne thermal coal volumes.

Fitch also says that the proposed production cap will negatively impact the business volumes of mining sub-contractors. An industry-wide coal production cap implemented during a weak price environment would likely lead some coal miners to continue mining at lower strip ratios (in areas that require less removal of overburden) for an extended period to enhance profitability. Apart from the decline in business volumes, the generally fixed prices per unit of overburden/coal extracted and their high operating leverage would render these companies more vulnerable to a reduction in coal volumes than the miners themselves. Over 70% of Indonesian coal mining and overburden removal volumes are done through sub-contracted miners. (ends)