2015 was another tough year for both the thermal and metallurgical coal markets, and looking ahead analysts are not expecting any dramatic improvements in 2016.

Demand is set to rise further in India, but with climate change concerns on the rise and both met and thermal coal still in oversupply, it may still take a few years for the markets to rebalance.

The Investing News Network (INN) got in touch with Andy Roberts, research director for global thermal coal at Wood Mackenzie, and Jim Truman, the firm’s research director for global metallurgical coal, for an in-depth look at the coal outlook for 2016. Here’s what they had to say.

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INN: What are your initial thoughts for the thermal and met coal markets in 2016? 

WM: Without a doubt, Asian growth in thermal demand is stalling at a time when capacity is abundant. A rebound in the near term is highly unlikely. There is little doubt that overcapacity will continue for some time. For how long depends on many factors, the sum of which will determine whether producers act to close operations or muscle through the soft market.

Key among these factors will be foreign exchange rates. If the dollar strengthens, perhaps on an increase in interest rates by the US Federal Reserve, then the potential to shelter more margins in the form of lower costs might yet exist, and that could encourage producers to continue to avoid shuttering mines. But if the dollar weakens, non-US producers may be forced into rationalizing production. Other factors influencing costs also should be watched, oil prices in particular.

In China, while low domestic coal prices might allow China to institute some desired power market reform, prices have fallen so low that domestic coal producers are in disarray. The government has intervened to protect the coal market because coal, despite planned reductions in consumption, will remain essential to China’s long-term energy security.

Coal’s long-term importance in China has encouraged policies meant to modernize coal production and eliminate bottlenecks between producers and consumers. The result of these policies has been an ongoing massive expansion in infrastructure, including at railroads that deliver most of the coal in China.

Still, the immediate problem continues to be domestic Chinese coal oversupply — infrastructure improvement will provide only limited additional opportunity in 2016. Greater exports may eventually be part of the oversupply solution, but not so much in 2016.

Yet even as the oversupply problem is eventually solved, new policy measures, including those designed to combat air pollution, accelerate the development of clean energy sources, advance the pilot carbon trading schemes and reform the coal resource tax, will continue to slow coal consumption growth. A peak in coal demand is coming. Thus, as domestic coal delivery potential also improves, Chinese coal imports, once predicted to grow substantially, have now fallen from 208 million tonnes per year in 2014 to about 145 million tonnes in 2015. We forecast them to hover between 135 and 145 million tonnes beyond the end of this decade before they recover.

The positive news for seaborne thermal coal markets is India, where Prime Minister Modi has been successful in reinvigorating the economy. Progress is certainly being made, though the challenges are enormous. Interestingly, the stated government goal is the elimination of imports on the back of enormous production potential at Coal India (NSE:COALINDIA). In our opinion, this goal will be unmet for a combination of reasons, including the poor quality of the domestic resource and its unsuitability to some of the newer Indian power plants, the expected delivered cost advantage of seaborne coal on a quality-adjusted basis, the inability to evacuate and deliver sufficient domestic Indian coal using existing infrastructure and the inability to upgrade that infrastructure in time to meet the growing demand. The result will be growing demand for seaborne imports by India — not sufficient to counter the loss of market in China, but enough to make some difference.

INN: Any concerns about the thermal and met coal markets?

WM: An increasing number of financial entities are backing away from coal industry investment as attitudes shift to using more renewable energy, given concerns about the impacts of coal consumption on climate change. Metallurgical coal has fewer substitutes available, so in that sense a certain level of demand will be maintained.

Coal industry financing requirements are low in this weak market, but eventually demand will absorb excess capacity and the need for capital will grow. Access to debt markets will then be required, but there are likely to be far fewer options available at that time, and borrowing costs will probably be higher.

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INN: Are there any factors that investors should keep their eyes on in the new year?

WM: Investors are keen to time the market — to buy low and to sell high. No one wants to overpay for assets. The state of the current market leaves absolutely no doubt that there will be distressed properties available in 2016 and beyond at what might seem like bargain prices. But investors will need to assess whether the cost of those properties is truly low enough to justify any investment.

Key to recognizing the value of those properties is understanding the transition in place in the coal industry. The traditional boom/bust commodity cycle for thermal coal is being transformed by concern over climate change. The coal industry value proposition has been permanently altered.

The thermal coal industry is entering a long-term harvest mode. Coal will remain an important energy source for decades, but there is little doubt that preference for non-coal energy sources will lessen demand for coal over time. In the past, even marginal producers were profitable in market upswings. In the future, profitability will be increasingly restricted to low-cost producers. Investors will need to exercise great care in ensuring that the properties they invest in are on the low end of not just the FOB supply curve, but the delivered supply curve as well. There will be a premium on careful, market-oriented due diligence.

INN: What are some companies to watch in the thermal and met coal spaces in 2016?

In the US, all eyes will be on large producers Arch Coal (NYSE:ACI) and Peabody Energy (NYSE:BTU) as they navigate through these difficult times, work to deleverage their balance sheets and attempt to steer clear of restructuring. Much will depend on the attitude of senior debt holders in these highly leveraged companies. The timing of debt repayment obligations will matter; the nearer the obligation, the more serious the problem, since market prices are unlikely to rise much in the near term and producer net income will remain slim.

In Australia, the strong US dollar will protect some margins, but there is little more to warrant excitement. Both equity and debt markets will challenge junior miners as they seek to generate enough cash to keep operations going. These cash risks may require some form of consolidation — or disinvestment.

In China, the government will likely continue to support the miners in an ad hoc manner, though their problems will continue. Chinese domestic oversupply will continue, even as small miners exit the business and consolidation occurs. In Indonesia, low-rank thermal coal producers will face the prospect of a decline in market in China.

Major mining companies may look to shed assets as equity value comes under pressure. It’s all about debt at the moment. There is no joy in being over leveraged in a market as soft as this one.

Securities Disclosure: I, Teresa Matich, hold no direct investment interest in any company mentioned in this article.

Editorial Disclosure: The Investing News Network does not guarantee the accuracy or thoroughness of the information reported in the interviews it conducts. The opinions expressed in these interviews do not reflect the opinions of the Investing News Network and do not constitute investment advice. All readers are encouraged to perform their own due diligence.

Related reading: 

Coal in 2015: Another Tough Year

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