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Can Killing This Black Market Save Coal?

Indonesia is among the largest coal exporters in the world. However, it has historically been plagued by illegal exports. This exacerbates the global coal glut and reduces tax rolls. The country is taking steps to solve that problem.

Right in the thick of things
Located above Australia, Indonesia is centrally located to supply growing Asian nations with raw materials. That has been a boon to the country's economy in recent years. However, as a collection of islands, keeping track of everything that goes on can be difficult.

Source: Sean Baker, via Wikimedia Commons)

That's why illegal exports are such an issue. The government has attempted to regulate this problem in the past, but recently appears to be taking a different approach. It's planning to build 14 coal terminals across two key islands so it has boots on the ground and, thus, a bigger hand in what goes in and out of the country.

The Energy Ministry's Coal Director, Edi Prasodjo, explained to industry watcher Platts that his country was on pace to produce around 425 million tonnes of coal this year. However, with an estimated 50 million tonnes of coal exported illegally, the problem becomes clear. Indonesia is potentially producing 10% more coal than its official numbers indicate, and it's missing out on tax revenues.

Why you should care
Growing demand in China and India, among other Asian nations, will be the driving force in global coal demand. Because of its location, Indonesia has a shipping advantage. That's true even when compared to southern neighbor Australia. So, if Indonesia can reduce the illegal exports, everyone wins since those volumes will have to be made up from legal sources. It gives Indonesia and Aussie miners like BHP Billiton (NYSE: BHP  ) a chance to increase "on the books" Asian exports.

On the thermal coal side of its business, BHP makes specific reference to a more than doubling of Indonesia's exports over the past five years as a driving force for thermal coal prices falling from $130 a tonne in 2011 to a recent level of $75 a tonne. The price drop has essentially forced austerity on miners throughout the industry.

BHP, for example, has plans to reduce its capital spending by 25% this year. It's also working to get more efficient. To that end, in the first half of its fiscal year (years end June) BHP was able to increase its truck utilization by 8%. All of this helps to keep BHP in the game and earning a profit. That said, falling commodity prices have reduced the company's operating margin from nearly 45% to just under 30% in three years. Earnings have tumbled, too.

(Source: U.S. National Archives)

Getting out of the market
While thermal coal isn't the biggest culprit behind BHP's problems (iron ore is), it certainly isn't helping. Less lucky has been Vale (NYSE: VALE  ) . The company recently shuttered its Integra Coal Mine in Australia because "the operation is not economically feasible under current market conditions."

Vale's Integra produced about 4.5 million tonnes of thermal and steel making coal in 2013. It's not rocket science to figure out that Indonesia's swift production increase helped put a damper on Vale's profits and it had no choice but to shut down a money-losing operation. That said, if Indonesia can stop the 50 million tonne black market in its backyard, Integra might be able to come back on line—after all it represents less than 10% of Indonesia's illegal exports.

No cure-all
Building new ports in Indonesia won't happen overnight, nor is it an instant cure for what ails the global thermal coal market. However, if the country can get a handle on the illegal exports, the ports could be an important step toward getting supply and demand back in balance. That would be good news for miners with Australian operations like BHP and Vale. Indonesia may not be on your radar today, but this nation is worth watching because it has an outsized impact on the global thermal coal market.

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Reuben Brewer

Reuben Gregg Brewer believes dividends are a window into a company's soul. He tries to invest in good souls.

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