Financial Crisis and Indonesian Coal Market_paper by jonathan_nicho


									   The Financial Crisis and its Impact to Indonesian Thermal Coal Market

                                        Rezki Syahrir

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

          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).

            Influence on                             Demand

                              Inventories                                  Prices

         Influence on                                  Supply

         Resources                                    Capacity

                           Figure 2. Basic Econometric Commodity Model

Indonesian Thermal Coal Profile


       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


       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

         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

  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

                           Table 1. Indonesian Coal Export by Destination
          Year     Japan       Taiwan       Other       Europe       Pacific    Others           Total

       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.
                           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

          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.
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