INDO coal: more downside seen in near term; Buy on weakness - don't chase the rally! - BoA Merrill Lynch

I recently spoke with my industry contacts. Driven by the Japan tsunami, things are not looking too good in the near term as we have previously expected.

1. There is an estimated demand drop from Japan of around 15mn t. From power plants impacted, demand could likely fall up to 18mnt, while only 2 JPUs in the east can add demand up to 3mn t. Nobody seem to know the extend of the damage.

2. Korea stockpile is relatively full, even before the tsunami.

3. Apparently some of TNB power plants are down up to April. We estimate its coal demand is cut by 29% till then.

4. Qinhuangdao port is relatively full, at 7.5mn t and pricing arbitrage is closed.

5. If there is a lot of bituminous coal around at a cheaper price, demand for sub-bituminous coal (Indo coal) will likely fall as well:
* Korea, who has been consuming more of 5000s kcal, will likely switch back to 6000s kcal/bituminous coal.
* Market for 4000s kcal are primarily China and India...China not buying at current price, India better off buying 3600kcal we think.
* 3600kcal is now priced at US$35/t, vs. 4200kcal at US$48-54/t coal. If India can get the bituminous coal cheaply, they most likely going to blend it with a much lower CV coal.
* Bhatia bribery court case could slow India's demand in near-term. Bhatia and Adani contribute 70% of India's import.
* Freight rate is rising about US$5/t because of higher fuel price :>key for sub-bit coal. We already see 4200kcal coal falling US$10/t in the last month.

6. Don't worry about DMO. It's more attractive to sell domestic. 5200kcal coal is now sold about US$10/t lower than export (the disc has narrowed) while 4200kcal coal is priced higher than domestic! Domestic uses previous months benchmark.

7. The only potential good things are the bad weather in Indonesia is continuing and Queensland is yet to fully recover.