Mongolia is a small country rich in natural resources. When it comes to
coal, the country is ranked fairly high among coal producers, with estimated
coal deposits of up to 152 billion tonnes. Coking coal accounts for about 35
percent of the country”s coal deposits.
Three years ago, China became a net coking coal importer and currently
imports around 45 million metric tonnes of coking coal per year. The
substantial increase in China”s steel production has stoked the Middle
Kingdom”s demand for this vital raw material.
As the chart below indicates, China”s steel production reached around 700
million tonnes last year. Even if China”s economy slows this year, its total
steel production should remain near this level. That means China will remain a
net importer of coking coal, especially since its domestic resources are
insufficient to meet demand.
Mongolia has been a major beneficiary of China”s demand for raw materials.
And in the case of coking coal, it has even been able to challenge the mighty
Australians. Just two years ago, for example, Mongolia had a 20 percent share
of the Chinese coking coal market, but now it controls 40 percent and rising.
Within the next couple of years, Mongolia could eventually enjoy close to a
60 percent share of the Chinese coking coal market.
There are three reasons for Mongolia”s rapid growth in market share. First,
Mongolia enjoys proximity as the closest producer of coking coal to China.
Second, it produces coal that is of high quality. Finally, Mongolian coal is
substantially cheaper-by USD50 to USD60-than Australia”s
coal supply.
Mongolia only began to dominate the market within the past several years
because the country”s lack of infrastructure had been holding it back. And
until recently, Mongolian companies were selling raw coal instead of washed
coal.
But companies are now washing their coal, which has improved its quality and
enabled them to command higher prices. Furthermore, the government has
incentivized this industry”s transformation by demanding lower royalties from
washed coal versus raw coal.
Mongolia has a flat 5 percent royalty rate and a surtax royalty rate. The
latter ranges from 1 percent to 5 percent for raw coal, and from 1 percent to 3
percent for washed coal. Beyond that, all “processed mineral
products,” such as washed coal, pay no value added tax.
Still, the country”s lack of infrastructure is an ongoing concern for
exporters. Currently, all Mongolian coal is exported to China on a road system
that”s often unpaved and literally comprised of tracks that vehicles have
previously worn into well-traversed terrain. As such, transportation is
extremely expensive, dangerous and slow.
This reality will not change overnight. In fact, the Mongolia Railway
Authority”s plan to build a rail system that links the country”s mines with
Russia and China has been stymied by bureaucratic delays and difficulty
securing financing. The 1,200 mile rail system is projected to cost around USD5
billion. As Mongolian coal is sold net of transportation costs, the rail system
will have a major impact on the profitability of Mongolia”s coal stocks once it”s
finally built.
Mongolian Mining Corp (MOGLF.PK)
is my favorite way to gain exposure to this market. Indeed, the company is the
largest producer of coking coal in Mongolia. Its main operation comprises
open-pit mining of coking coal at the Ukhaa Khudag deposit located within the
Tavan Tolgoi (TT) coal formation in South Gobi. The TT coal formation is one of
the few largely unexploited sources of high-quality coking coal in the world
and the closest premium hard coking coal resource to China.
In an effort to improve its coal”s quality, Mongolian Mining Corp (MMC) has invested in building a
coal handling and preparation plant (CHPP) that will allow it to process the
coal on site.
Upon completion, the CHPP will have the capacity to wash 15 million tons of
coal per year in all three of its modules. Since last June, the first 5 million
ton module has been operational and the other two should be ready in the next
year.
Although the company”s primary market is China, MMC has also been working
toward building the necessary transportation infrastructure in order to reach
other markets too. Given that MMC is one of the lowest-cost coal producers in
the world at around USD36 per ton, a reduction in transportation costs will be a
further enhancement to its already high margins of 30 percent.
The company”s coal has quality characteristics such as a high crucible
swelling number of 8.5, low sulfur of 0.6 percent, and ash content of 9.1
percent. MMC is constantly making improvements to its end product, so the
company will be able to gradually command higher prices as it achieves broader
distribution.
In the next four years, MMC expects to more than double its raw coal
production from 7 million tons last year to more than 15 million tons.
By Yiannis G. Mostrous, an associate editor of Personal Finance
Source: http://seekingalpha.com