The Financial Crisis and its Impact to Indonesian Thermal Coal Market Rezki Syahrir 52471-1 The Financial Crisis, a Brief Description Began in 2007, the United States was undergoing a financial crisis, which appears to be bottoming out, although unemployment continues to increase. Numerous small banks and households still face huge problems in restoring their balance sheets, and unemployment has combined with sub-prime loans to keep home foreclosures at a high rate. The U.S. economy shrank by 1.0% in the second quarter, much less than the 6.4% decline in the first quarter. Inventory reduction has been a drag on growth, but foreign trade has been a large plus. Revised data show a real GDP decline of 3.9% over the past four quarters, the steepest peak-to trough decline in postwar history (Nanto, 2009). Evidence of the financial crisis consists of the following: First, several major financial institutions have failed. Second, various stock markets have fallen dramatically, especially in the week after the bailout plan was passed. Third, spreads on a variety of different types of loans over comparable U.S. Treasury securities have widened dramatically (Chari et al, 2008) .This crisis was spreading all over the world in months. Jickling (2008) states that there is no precise definition of “financial crisis,” but a common view is that disruptions in financial markets rise to the level of a crisis when the flow of credit to households and businesses is constrained and the real economy of goods and services is adversely affected. Another explanation of financial crisis is that we have to go back hundreds of years, is that they are caused by excesses—frequently monetary excesses—which lead to a boom and an inevitable bust. In the recent crisis, we had a housing boom and bust, which in turn led to financial turmoil in the United States and other countries (Taylor, 2008). The Financial Crisis Impact to Asian Countries Many Asian economies have been through wrenching financial crises in the past 10-15 years. Even though most observers say the region’s economic fundamentals have improved greatly in the past decade. For instance, an illustration that Asian policy changes in recent years—including Japan’s slow but comprehensive banking reforms, Korea’s opening of its financial markets, China’s dramatic economic transformation, and the enormous buildup of sovereign reserves across the region. Nevertheless, this contemporary condition not fully insulated Asian economies from global contagion (Nanto, 2009). Source: International Monetary Fund. World Economic Outlook, October, 2009. Figure 1. Asian Current Account Balance are Mostly Healthy Furthermore, Keat (2009) states that the unexpected speed and force of the global financial crisis impacted Asian economies through both the trade and financial channels, reflecting the region’s deep economic integration with the rest of the world. This effectively put to rest earlier notions that Asia had become “decoupled” from developments in the US. In the early months of the crisis, Asian nations did not have to deal with outright bankruptcies or rescues of major financial institutions, as Western governments did. With only a few exceptions— most notably in South Korea—leverage within Asian financial systems was comparatively low and bank balance sheets were comparatively healthy at the outset of the crisis. Moreover, what was about Indonesia? Like the others countries in the Asian, Indonesia was unavoidable to be predisposed by this crisis. Financial crisis impact transform to Indonesia through two channel basically, i.e. financial channel and trade channel or macroeconomics channel. However, the most significant impact of this financial crisis to Indonesia through trade channel or macroeconomics channel instead of financial channel. Nevertheless, Citrin (2008) states that Indonesia is reasonably well positioned to withstand moderate slowdowns in the Western economies. Its strengths include strong domestic demand, greater financial integration with other Asian countries, and expanding trade with regional partners. Its challenges involve rising inflation, burdensome energy subsidies and sagging consumer confidence. How the Financial Crisis Impact the Coal Market? To analyze how the financial crisis impact the coal market, we first elaborate the model of energy market, since coal is one of energy source. Labys (1999) had developed a Competitive Market Model, as a part of Economic Market or Industry Models. It is the most basic type of model from which econometric and other mineral or energy modeling methodologies. This model explained that demand as being dependent of prices, economic activity, price of one or more substitutes and possible technological influences. Even though its application to energy markets have not been extensive because of the difficulties of dealing with regulatory policy and non-competitive influences on market behavior, Verleger (1982, 1993) has shown that it can be applied to explain disruptive shortages (Labys, 1999). Because of it is a temporarily characteristic, financial crisis, which is knocking the world economic over, can be categorized as disruptive shortage. In figure 2, financial crisis is possibly recognized as “external influence of demand”, and then since it can reducing the purchasing power of consumers, then it potential to diminish the coal demand as well. It is, more less has impact to the world coal trading. For instance, the IMF recently projected growth in world trade volumes of just 4.1 percent in 2009, down from 9.3 percent as recently as 2006, even though this fall in export volume growth is projected to be greater for advanced economies than for developing economies (Lin, 2008). Technology Substitutes External Influence on Demand Demand Inventories Prices External Influence on Supply Supply Resources Capacity Figure 2. Basic Econometric Commodity Model Indonesian Thermal Coal Profile Resources As released by Indonesian Ministry of Energy and Mineral Resources in 2008, Indonesia contains of 104.74 billion tons of (thermal) coal, which is spreading almost all over the country, and even though most concentrated in Borneo (51.92 billion tons) and Sumatera (52.44 million tons) (figure 3). These resources consist of 1% in very high quality, 13 % in high quality, 62% in medium quality, and 24 % in low quality coal. Source: Ministry of Energy and Mineral Resources of Indonesia Figure 3. Indonesian Coal Resources Production Indonesian coal production tends to increase amazingly year-by-year (figure 4). In 2000, Indonesia produced 77,014,956 tons of thermal coal, and in 2007 increase to 216,930,000 tons, or almost three times bigger. In 2007, Indonesia was the seventh largest coal producer in the world, by 4.2% of the whole world contribution. Most of Indonesian coal production dominated by Coal Contract of Work holders, private companies of which have signed contract of work with central government for coal exploitation, and the rest produced by state own company and small scale companies. Source: Ministry of Energy and Mineral Resources of Indonesia, data processed Figure 4. Indonesian Coal Production 2000-2007 Market According to Indonesian law of mining1, the mine companies have their rights to sell their production, either domestic or export, or both of them, regarding to their own policy. Figure 5 shows that about 70% of Indonesian coal production exported every year. Source: Source : Directorate General of Mineral, Coal and Geothermal Figure 5. Indonesian Coal Market 2000-2007 Some factors had been generating this great amount of export, for instance, first, the price for exporting coal is higher than domestic does, and it means that exporting coal is more attractive for mine companies than to put it on the domestic market. Second, some of these companies are the sister company of another company overseas, for instance steel factory or power plant. Due to this, they had been set-up to supply their sister’s need for fuel. Third, it is related to the domestic infrastructures. Domestic infrastructures are able to absorb for very limited coal consumption only, not in a large amount. Indonesia’s infrastructures are still relying on its natural gas and oil production as fuel for power plant or any others factories. For instance in 2007, from total amount of fuel consumption, Indonesia was using natural gas and oil around 69%, compared with 27% of coal. In 2007, Indonesia 1 Law No 11, 1967 about Mining Policy. In 2010, this Law will be effectively replaced by Law No 4 2009, about Mineral and Coal Mining, which Indonesian government will determined the domestic coal market obligation (DMO) for all of coal mine companies. However, in 2010 each coal mine company has to fulfill this DMO to be allowed to make export. was the first largest thermal coal exporter in the world, with 171 million tons in total export volume. Table 1. Indonesian Coal Export by Destination Year Japan Taiwan Other Europe Pacific Others Total Asian 2000 13.177,44 13.519,59 19.819,47 8.861,56 1.876,11 1.206,32 58.460,49 2001 15.216,26 11.506,81 20.440,57 10.226,65 2.160,83 5.729,97 65.281,09 2002 16.529,76 13.099,99 30.605,89 9.294,60 2.555,17 1.450,95 73.536,35 2003 17.992,18 14.144,14 34.021,52 12.786,77 3.118,10 3.617,91 85.680,62 2004 19.013,41 16.677,88 34.686,66 11.987,43 3.583,98 7.809,44 93.758,81 2005 24.237,43 14.524,21 41.393,85 14.824,32 3.927,70 11.882,19 110.789,70 2006 23.128,07 17.070,46 49.589,54 21.004,55 5.263,14 27.577,11 143.632,86 Source : Directorate General of Mineral, Coal and Geothermal Source: Ministry of Energy and Mineral Resources of Indonesia, data processed Figure 6. Indonesian Coal Export by Destination Japan, Taiwan, and other Asian Countries are the larger destination for coal exporting. In 2006, these countries were being destinations for 8,978,807 ton of Indonesian coal, or 62.5% of Indonesian coal exported (table 1 and figure 6). The Financial Crisis Impact to Indonesian Thermal Coal Market As we have pointed out, that the financial crisis undeniably reducing the purchasing power of consumers, then it be able to diminish the coal demand as well. However, to analyze the impact of financial crisis to Indonesian thermal coal market, then we begin analyze the market destination of its. Combining figure 5, figure 6, and table 1, we now know that exporting coal to Japan, Taiwan, and other Asian countries is the most significant factor, which possibly influence of Indonesian thermal coal market. Surprisingly, figure 7 shows that Indonesian coal export tends to increase to these countries from 2007 to 2008 in general, the beginning period of financial crisis. Source: Ministry of Energy and Mineral Resources of Indonesia, data processed Figure 7. Indonesian Coal Export to Asian Countries Moreover, we discover indifferent phenomena when we look at Indonesian thermal coal market to Europe, Pacific and others countries (figure 8). In 2008, Indonesian thermal coal export to these countries tends to decrease, lower than 2006, a year before financial crisis arise. Nevertheless, it was not extremely deescalate, still remain higher than 2005, two years before financial crisis. Source: Ministry of Energy and Mineral Resources of Indonesia, data processed Figure 8. Indonesian Coal Export to Europe, Pacific, and Others Countries In order to understand the impact of this financial crisis to Indonesian thermal coal market as whole, we then complete our study by analyzing the domestic market of its. As we found in figure 9, domestic consumption of thermal coal in Indonesia tends to increase yearly, even during the financial crisis period. The development of power plants in the last several years being allegedly generate purchasing power of domestic coal consumers looks superior or uninfluenced by this financial crisis at all. Source: Ministry of Energy and Mineral Resources of Indonesia, data processed Figure 9. Indonesian Coal for Domestic Market Summing Up That the world is undertaken financial crisis now is undeniable, as we have pointed it out along with its evidences. However, the financial crisis impact is indifferent in countries and products. In case of Indonesian thermal coal market, we found that the financial crisis impact is almost negligible. Shown in figure 10, Indonesian thermal coal production and market are looking secure, had no significantly shock, and even tend to escalate during this financial crisis period. Note: data for 2009 up to September. Source: Figure 10. Indonesian Coal Production and Market Furthermore, some explanations can be described. First, United States and European countries, which are extremely suffering by financial crisis, are not the main destinations of Indonesian coal export. The main destinations are Japan, Taiwan, and other Asian countries, of which slightly stronger in economic to face this crisis. Second, even though the Japan, Taiwan, and other Asian countries undergoing delineation in economic growth, the most of coal imported from Indonesia is used in coal- fired power generations. Assumed the demand of electricity generated the power plants remaining constant during the financial crisis period, hence the demand of coal was relatively stable. Third, the average of profit rate of Indonesian mining companies is relatively high compares with the average mining companies in the world (figure 11). In the last ten years, the average profit rates of Indonesian mining companies nearly two times bigger than Australia’s. However, when the coal price went down due to financial crisis, Indonesian coal mining companies still can put their product on market. Average Profit Rate of Indonesian Mining Average Profit Rate of Indonesian mining Companies and the Global Companies Companies and Australia *) Aggregated results of 40 of the largest mining co. ROCE = Return on Capital Employment Source: PricewaterhouseCoopers, 2006 in Miranti 2008 Fugure 10. Average Profit Rate Mining Companies in Indonesia, Australia, and the Global Companies, and Australia Fourth, the coal trading system between producer and consumer tends to sign a long contract term. This contract can be used to hedge risk (Dahl, 2004). Terms contracts have been useful to investors in both power stations and coal mines as instrument assuring, respectively, fuel supply continuity at defined cost, and a guaranteed revenue steam adequate to serve debt and equity finance (Austen, 2008). The escalation of coal demand had forced the consumers, most of which are industrial users, to save their supply, preventing the lack of coal, through a long-term contract system, also called derivative contract. In the other hand, this long-term contract trading system, or a derivative contract helps the coal producers to save their market as well. The explicit purpose of derivative contracts if to keep plants running. These industrial users drive the market value of convenience yield. Factories seek to minimize their cost of production by avoiding the cost of shutting down and restarting factory due to high price or lack of available supply (Pilipovic, 1998). However, in some cases, the consumers postpone their coal demand as force majeure, but this is a temporarily postpone only, not a cancellation of demand. Furthermore, the rest of coal demand postponed possibly to be rappel to the following term. Nevertheless, this is not significantly influence the Indonesian thermal coal market as whole. Reference Books Austen, Dick. (2008). Trend in Coal Contracting and Pricing, and Likely Consequences for Coal Price Volatility, Coal Use and Coal Supply. In Priddle (Ed). The Future Role of Coal Market, Supply and the Environment. Paris: International Energy Agency. Dahl, Carol. (2004). International Energy Markets, Understanding Pricing, Policies, and Profits. Oklahoma: Penn Well Corporation. Labys, Walter. (1999). Modeling Mineral and Energy Markets. Massachusetts: Kluwer Academic Publisher. Pilipovic, Dragana. (1998). Energy Risk, Valuing and Managing Energy Derivatives. New York: McGraw-Hill Companies, Inc. Articles Chari , et al. (2008, October). Facts and Myths about the Financial Crisis of 2008. Working Paper, Federal Reserve Bank of Minneapolis Research Department. Retrieved from www.minneapolisfed.org/research/WP/WP666.pdf Cirtin, Daniel. (2008, April 30). The Impact on Indonesia of the Current Financial Crisis in the US. International Monetary Fund Washington DC: USINDO. Retrieved from http://www.usindo.org/publications/briefs/2008/Dan_Citrin_Brief_04-30-2008.pdf Jickling, Mark. (2008, March 21). Averting Financial Crisis. Congressional Research Service Report for Congress. Retrieved from fpc.state.gov/documents/organization/103688.pdf Miranti, Ermina (2008). Prospek Industri Batubara di Indonesia, Retrieved from http://www.bni.co.id/Portals/0/Document/coaldes2008.pdf Nanto, Dick. (2009, October 2). The Global Financial Crisis: Analysis and Policy Implications. Congressional Research Service. Retrieved from www.fas.org/sgp/crs/misc/RL34742.pdf Taylor, John B. (2008). The Financial Crisis and the Policy Responses: An Empirical Analysis of What Went Wrong. Retrieved from www.stanford.edu/~johntayl/FCPR.pdf Websites http://www.bi.go.id/web/id/Publikasi/Kebijakan+Moneter/Outlook+Ekonomi+Indonesia/oei_0 109.htm. 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