ELSEVIER PII:S0301-4215(97)00128-6

Energy Policy, Vol. 25, No. 12, pp. 1013-1025, 1997 © 1997 Published by Elsevier Science Ltd

Printed in Great Britain. All rights reserved 0301-4215/97 $17.00 + 0.00

Investment practices in Australian coal

The practice and profit of quasi-integration in the Australia-Japan coal trade

Peter Colley* National Industrial/Research Officer, Construction, Forestry, Mining and Energy Union, Sydney, Australia

The Austrafian coal industry has frequently been described us a perpetual case of 'profitless prosperity'. Industry literature on the subject usually sources this problem to government charges on the industry and to labour costs. However, these alleged problems do not appear to have dimims" hed the enthusiasm for new investment in the industry. This study argues that a more complete explanation must look at who is investing in the Australian coal industry, what the rationale for those investments is, how they are financed and what their specific profitability is. The particular examination made here is of the quasi-integration investment practices of Japanese trading, steel and power compani.~ easily the largest group of buyers in the international coal trade. The close co-operation between Japanese government and business in this strategic raw materials industry is documented, us are the methods of subsidised investment. An examination of the financial performance of these companies' Australian coal investments shows that the profitability of their investments is significantly below that of most other investors in Australian mining over a recent 5-year period. Taken together, there is significant support for the conclusion that a process of co-ordinated quasi-integration has taken place and that the principal aim of such investments has not been to make profits from coal-mining. These results should make other prospective inves- tors reconsider the benefits of quasi-integration, and should also be a public policy issue for Australian governments seeking to encourage the development of 'profitable prosperity' in the Australian coal industry. © 1997 Published by Elsevier Science Ltd. All rights reserved. Keywords: Coal; Investment; Profits

Introduction

The Australian coal industry has enjoyed phenomenal growth in output since the 1960s when a few major Japanese trading companies first became interested in the coking coal potential of Australia (Byrnes, 1994). Since that time, the fate of the Australian coal industry has been fundamentally intertwined with that of its biggest customers: the Japanese steel and power- generation companies. Even though Japanese dominance of Australian coal exports has declined somewhat in recent years as a result of rapid growth in coal demand from other Asian nations, these two groups of companies continue to be the largest purchasing bloc, especially so as their purchasing arrange- ments are tightly co-ordinated (Bowen and Gooday, 1993).

*Present address: CFMEU Mining and Energy Division, 3rd Floor, 361 Kent St, Sydney NSW 2000, Australia.

All forecasts for the international coal trade predict further major growth in this trade, and especially in the Asia-Pacific region. The Australian industry figures highly in these forecasts The lEA (1996) shows Australia as being likely to supply almost 50% of all capacity expansion required to meet rising demand through to about 2010 (see Table 1).

Yet despite this record of growth and further positive forecasts, the industry is plagued by low profitability. The term 'profitless prosperity' has virtually become a conventional way of describing the industry.1 Partial surveys of the industry's financial performance (see Figure 1) show average rates of return that are in most years consistently less than that of

~'Profitless prosperity' has been used so often in reference to the coal industry that it is difficult to trace the original source. Two recent manifestations include the Financial Times (UK) survey of the coal industry on 8 July 1996, and as the title of the 7th World Coal Outlook Conference at Macquarie University, Sydney in September 1994.

1013

1014 Investment practices in Australian coal." P Colley

Table 1 Possible additional export capacity from existing and new mines (millions of tonnes/year)

Firm existing Firm new Planned additions to Planned new Total existing

Australia 17.8 l 1.6 20.9 69. i 119.4 Canada 5.8 - - 1.7 1.0 8.5 Colombia 4.1 - - 23.0 5.3 32.4 Indonesia 1.1 - - 12.4 i 1.2 24.7 Mozambique - - - - - - 1.0 1.0 New Zealand - - - - 2.0 1.3 3.3 South Africa 6.6 3.6 3.6 5.0 18.8 United States 0.3 1.5 8.0 13.0 22.8 Venezuela 0.3 1.4 9.8 8.5 20.0 Vietnam 0.2 0.3 - - - - 0.5 Total 36.2 18.4 81.4 1 ! 5.4 25 ! .4

Source: lEA (1996), pI. 136.

25

20 "o o 15

~ 5

N -5

.o -10

-15 Z

[ ] NSW coal [ ] Aust. mining

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 10yr av.

Figure 1 Profitability of the NSW coal industry. Source: Coop- ers and Lybrand (1995)

other mining in Australia and often lower than that of Austral- ian industry as a whole. The NSW Coal Association has claimed that the 10-year average rate of return (measured as net profit as a percentage of shareholders' funds) is only 2% in nominal terms (i.e. not allowing for inflation). The standard reasons cited for this phenomenon are allegedly high govern- ment charges on the industry and high labour costs (eg ACA, 1994; Jacques, 1996).

However, if these were persistent features of the industry, then it would be expected that investment and growth in the industry would be curtailed; that investors would look elsewhere for projects not fettered by such burdens. Instead, the numbers of coal mining projects queued for start-up continues to be very impressive, as does the actual number of start-ups (lEA, 1996; BZW, 1993).

This study postulates that a more complete explanation for continued growth in the face of poor returns must involve an examination of who is investing in the industry and for what purpose. In doing so, it draws upon earlier argument (D'Cruz, 1983; Anderson, 1987) that the coal trade between Japanese industry and some of its major suppliers exhibits the characteristics of quasi-integration. That is, there are elements of vertical integration--the integrated ownership of various points of the production chain from raw material extraction to final point of sale of products--in the coal trade with Japan. These elements fall short of conventional vertical integration in that the degree of common ownership is less than a controlling interest. In the case that is the subject of this study, Japanese-based companies are a significant investor in the industry (13% in 1993--see Table 2) but are rarely the majority or controlling owner of Austral- ian coal mines.

This study seeks to describe and document both the quasi- integration that has occurred in the Australia-Japan coal trade and the co-ordinated activities amongst private companies and government that have facilitated it. In seek- ing to document the effect of that quasi-integration on profits from Australian coal mining, detailed analysis of virtually all Japanese coal investments in Australia is undertaken. It is shown that the profit performance of these investments has been poor and, by corollary, so has the performance of other equity partners in the same projects. This leads to a tentative conclusion that the process of quasi-integration and the co-ordinated strategy behind it have been a significant contributing factor to the poor profit performance of the Australian coal industry.

Table 2 Percentage of Australian coal production owned by foreign-based companies, 1992-1993

Country Production share ('000 tonnes)

NSW QLD Total

As a percentage of total coal produced in Australia

Japan 14,904 8398 23,302 13.1 Europe 16,626 11,968 28,594 16.1 USA 6559 11,772 18,331 10.2 Other Asia 1461 - - 1461 0.8 Total foreign ownership 39,550 32,138 71,688 40.3

Source: Joint Coal Board (1990) and Queensland Coal Board (1993) and updates received directly from JCB and QCB staff in mid-1994.

Investment practices in Australian coal." P Colley 1015

Preliminary issues Correct identification of the parties

Virtually implicit in the term 'the Australia-Japan coal trade' is the concept that the trade takes place not only between two sovereign entities, but also that between 'Australian' coal-producing companies and 'Japanese' coal-consuming companies. Other research by the author (Colley, 1995) demonstrates that this is not a sustainable proposition. Virtu- ally all the Japanese companies involved in the coal trade have not only almost exclusively Japanese shareholders but also a strong pattern of cross-shareholdings (Gerlach, 1989) that eliminate even the possibility of contestable ownership of the companies involved (Prowse, 1992). In direct contrast, the Australian coal industry exhibits a high degree of foreign ownership: approximately 40°/o in 1993. More importantly, although control of production is seemingly dominated by relatively few major companies, with the top four mine- managing companies accounting for 63% of exports (ACR, 1996), in reality ownership is far more diffuse with most minesites being subject to joint venture or similar agree- ments with foreign consumers. There is a significant degree of ownership volatility in the industry, with recent new entrants, and a high level of takeovers and acquisitions.

The distinction in the capital formation of the parties in the Australia-Japan coal trade is an important one. Firstly, it is possible for quasi-integration to occur in only one direc- tion. Japanese-based coal-consumers and traders are able to take minority equity or joint venture stakes in Australian coal mines but not vice versa. It is not possible for a company that is primarily a coal-producing company to undertake vertical integration in the trade in order to maximise overall returns.

Secondly, the international fragmentation and volatility of ownership of the Australian industry, relative to the tightly co-ordinated and very stable ownership of Japanese coal traders and consumers, is likely to lead to significant differ- ences in the degree of cohesion and even the goals of the two so-called 'parties' to the industry. Put simply, ownership of the coal industry in Australia is far too fragmented, diverse and subject to rapid change for there to be any coherent 'Australian' party to the trade.

Table 3 Excess capacity in seaborne hard coal 1984-1995 (millions of tonnes)

World supply World trade Excess capacity

1984 366 235 131 1985 393 273 120 1986 349 276 73 1987 350 283 67 1988 374 305 69 1989 393 320 73 1990 419 342 77 1991 465 358 107 1993 494 385 109 1994 491 423 81.3 1995 502 458 44

Source: IEA ( 1992)( 1995)(1996).

exports were around 136 million tonnes. This capacity utilisa- tion rate of 87% is relatively high by international standards, but not for an industry that is the leading global exporter and amongst the most competitive in the world. The capac- ity utilisation rate has been significantly less in many previ- ous years. With respect to future capacity, industry forecasts of supply and demand (e.g. Barlow, 1992) show that the Australian industry has the potential to readily add far more production capacity than potential demand could possibly require.

As Australia is the world's largest supplier, and has a large number of mines with similar positions at the lower end of the production cost supply curve, the implications for price levels are significant. Put simply, variations in Australian production capacity have a considerable impact on global coal prices. This contention is supported by the Australian Bureau of Agricultural and Resource Economics (ABARE), as is the effect on community returns:

The responsiveness of Australian production to changes in price has some important implications for coal marketing and coal industry policy.... As Australia is the world's largest exporter of coal and faces less than perfectly elastic demand conditions, any increased supply of coal from Australia may tend to weaken the world price ..... Not only is production affected but export revenue, mining industry returns, and State and Federal revenues from the coal industry are also affected

The problem of oversupply

A recurring feature of the global coal mining industry, includ- ing the Australian industry, has been the tendency for supply capacity to consistently exceed demand by a considerable margin. This has two consequences. Firstly, under-utilised investments represent an inefficient use of investment funds, entailing lower profits than would otherwise be the case. Secondly, over-investment in enterprises with high fixed operat- ing costs leads to 'destructive price competition' wherein individual producers will maintain production and supply rather than reducing it in response to the level of demand. Table 3 shows a commonly accepted measure of excess capac- ity in the global industry.

The lEA (1996) estimates Australian export supply capac- ity in 1995 at 156 million tonnes per annum, whereas actual

(Beck et al, 1991, p 8). The vulnerability of the industry to low prices once

additional capacity is committed is a function of the capital intensity of modern mining operations.

High capital intensity enables high productivity and low unit costs. However, it also means that a high proportion of production costs are fixed and sunk rather than variable-- the costs are incurred whether or not production occurs. Such mines have a very high incentive to maximise produc- tion almost regardless of the price received. 2 This has grave implications for an industry's capacity to vary supply in

2Anderson (1987) has presented the theoretical proofs of how capital intensive operations engage in destructive competition during periods of oversupply.

1016 Investment practices in Australian coal: P Colley

response to changing demand. It creates the situation where cut-throat competition amongst suppliers occurs, with the result that some very efficient producers may be forced out of production, not because they are inefficient or high cost, but simply because they do not have as much to lose as the more capital intensive (and more debt-encumbered) produc- ers. The argument, and its implication for price-bargaining, is summarised by Koerner (1992, p 12):

The evolution of production technology from labour- intensive small-scale underground mines to capital-intensive large-scale open-cut mines has changed the supply side econom- ics of the international coking coal trade and increased the market power of buyers in periods of supply overcapacity.

There are a number of other reasons put forward for the persistent existence of substantial global oversupply. The most obvious is the maintenance of uneconomic domestic industries for social or national security reasons (Steenblik and Wigley, 1990). Another is that the post-oil-shock move by major oil companies to diversify into coal led to over- investment and over-supply over the ensuing 15 years (Koerner et al, 1995).

Here, an additional argument is advanced: that the co-ordinated financing activities by Japanese coal consum- ers and traders has had a significant effect on Australian supply capacity and has thus affected the overall global supply situation and global coal prices. This activity has occurred because it is in the interests of Japanese coal- buyers to have persistent oversupply in the Australian industry in order to ensure intense price competition between Austral- ian sellers looking for high volume sales in order to service high fixed operating costs.

Investment practices

This study documents and analyses investment practices in the Australian coal industry that complement and reinforce trading practices that have been analysed elsewhere (Ander- son, 1987; Colley, 1995). These investment practices are a key means by which Japanese companies influence the terms of the Australia-Japan coal trade. What needs to be clarified is how those investment practices are part of the trading relationship.

The linking of investment and trade is hardly a novel concept; their capacity to be mutually supportive is well- recognised as the rationale for some businesses seeking vertically integrated operations. However, the Australian industry is not generally conceived as having the characteristics of a vertically integrated industry. This study contributes evidence that the use of investment practices on a co-ordinated basis by Japanese buyers and traders has led to the achievement of a regime that is similar in effect to that of a vertically integrated industry. However, it has been done without the capital expense or political risk associated with vertical integration.

There have been two major components to Japanese invest- ment practices in the Australian coal industry:

(1) The provision of concessional financing and deb t guarantees by public sector banks and development agencies in Japan; and

(2) the direction of investment funds into Australian min- ing on non-market criteria (i.e. not for profit on the investment itself).

The purpose of both has been to stimulate greater coal production, and production capacity, than would otherwise have occurred. This proposition is difficult to fully prove, as it involves establishing a causal link between the policy state- ments of government and particular financing and invest- ment decisions by business. However, there is some quite recent evidence that the Japanese Government has sought to stimulate Japanese private investment in the Australian coal industry for the express purpose of enlarging supply and thereby lowering coal prices:

The second problem is, as was pointed out in the process of making a supply forecast, that the demand and supply relation- ship in the international thermal c0al market will shift to a tight base. The price of thermal coal will rise. The relative price of thermal coal against that of oil in the year 2000 will approximate the worst period of the 1986 counter-oil shock: about 0.6. The price of thermal coal must be reduced, as must its relative price against oil and plans must be made to enlarge usage of thermal coal. For this, an enlargement of the thermal coal supply is needed. In Australia, which has the largest share of the thermal coal supply, interest rates are very expensive ...... To solve this problem, Japanese firms need not only assume ownership rights and interest in Australian coal mines, but also to invest and finance these via low interest loans from Japan....i. Through the dimensions of reduction of interest and refund duties and the enlargement of supply by the promotion of new development, the price of thermal coal will be stabilised at a lower price

3(NEDO, 1990, section 9.2; emphasis added) This degree of state/business co-ordination should not be

seen as surprising. As is repeatedly emphasised in the literature on Japanese trade, resource security is of paramount concern to business and government alike. That mutually shared goals should be achieved through co-operation rather than simply untrammelled competition is central to the way in which economic activity is organised in Japan. As the recently published Policy based finance: the experience o f post war Japan by the Japan Development Bank and the Japan Economic Research Institute (1994) makes clear, this is an approach that is entrenched in Japan and will remain, despite the preference of the OECD secretariat for competitive frameworks for industry development.

Provision of concessional financing and debt guarantees

Soft-financing, or loans that are made on less than com- mercial rates of interest or on other generous terms, act to facilitate new investments, or the continuance of current

3'Thermal coal' is another name used to describe steaming coal.

Investment practices in Australian coa# P Colley 1017

investments that are otherwise marginal or non-viable. They are a significant means by which over-supply can be created.

The common view of concessional financing is that it has been of benefit to the Australian economy--it has enabled the coal industry to enjoy massive growth in output. Smith (1982a)(1982b) goes so far as to argue that the extensive provision of soft finance by the Export-Import Bank of Japan might entitle Japanese buyers to concessionally priced coal, that is that the provision of a subsidy in investment could be repaid by a subsidised coal price.

It has been assumed that the provision of low-cost finance has enabled the industry to grow and then supply coal in a manner that increases the overall available surplus, and it is further assumed that this surplus is equitably distributed between producers and consumers. However, if the parties to the trade are not equal in their construction and co-ordination, then it follows that the surplus from the industry might not flow equitably but be appropriated by the more powerful party.

Sources of concessional finance

Concessional financing for coal mining began in the 1960s, but it was formalised in the 1970 MITI (Japanese Ministry of International Trade and Industry) White Paper that promulgated the 'Development-for-Import' or kaihatsuyunso policy. The core elements of the policy were:

• Japanese companies should place a larger reliance on direct investment in foreign ventures to augment the normal vehicle of contractual purchases;

• development projects should be carried out on a large scale to benefit from economies of scale;

• projects should dispersed in as many regions and in as many parts of those regions as possible; and

• local needs for improved infrastructure should be met as far as practical (Anderson, 1987).

The primary focus of the policy was to improve security of oil supplies, and by far the greatest effort went into oil projects in the Middle East and elsewhere. However, coal was also a significant component, with the goal of diversify- ing energy supplies, diversifying their sources and improving the security of supply.

Japanese business and the public sector share a fear of resource vulnerability that is hard for more resource-rich nations to understand:

Mineral resources are the lifeblood which sustains the life of the people and their industrial activity. Japan depends almost entirely on imports for its mineral resource requirements. What is more, deposits of mineral resources are concentrated in a few areas of the world... Owing to this peculiar set of circumstances, the availability of mineral resources could pose a short term sporadic threat or a protracted industrial menace to the economic security of Japan

[MITI White Papers 1981-1982, cited in Kolenda (1985), p 257].

The primary vehicles of participation by the Japanese state in the kaihatsu yunso policy have been the funds of the

Japan Development Bank, the Export-Import Bank and the Agency of Natural Resources and Energy in the Ministry of International Trade and Industry.

The Japanese state has access to substantial investment funds through its Fiscal Investment and Loan Program (FILP). The fund now has revenues equivalent to 8% of GDP and 50% of the Government budget (Japan Development Bank and the Japan Economic Research Institute, 1994). The core finance of the program arises from savings accounts and insurance schemes operated through post offices~ Direct access to voluntary savings, combined with a savings rate in Japan that is high relative to most OECD nations (OECD, 1995) has given the Japanese state investment funds on a scale that is inconceivable in most OECD nations. These concessional funds do not replace or dominate private capital; they are more often an adjunct to it that gives the latter a competitive advantage. FILP funds were equivalent to 13% of all loan funds in Japan in 1955 and 11.8% in 1990 (Japan Develop- ment Bank and the Japan Economic Research Institute, 1994).

The bulk of FILP funds goes to domestic programs--- infrastructure, housing, local government, small business, etc. However, a significant portion is allocated to international trade and investment. In 1990, the Japan Development Bank and the Export-Import Bank received just over 20% of all concessional finance, and the Export-Import Bank allocated 35% of its funds to overseas investments or import programs.

The total amount of funds allocated to subsidising overseas investments in 1990 was ¥1401.7 billion--about US$9.9 bil- lion at the then prevailing exchange rate. This is a substantial public sector commitment to assisting business in overseas ventures that is not related to any aid program. That assist- ance is provided because the overseas investments, where they fit within the development-for-import policy or similar program, are seen as being in the national interest.

The use of concessional credit in some foreign investment projects is regulated by the OECD (1996) through the 'Helsinki Arrangement', which seeks to prevent concessional financ- ing of projects that should compete commercially. However, the arrangement is targeted at tied aid projects---investments made in otherwise non-viable projects in developing countries with conditions attached to purchase of capital goods from the donor country or similar benefits. The Helsinki Arrange- ment does not appear to regulate the type of investments examined here, even though they affect the commercial viability of projects and distort the coal market.

There are further sources of funds from the Japanese public sector. MITI's Agency of Natural Resources and Energy administers a number of coal-related programs. Much of this budget is administered by the New Energy and Industrial Technology Development Organisation. NEDO operates as a subsidiary of MITI, and is funded by both MITI and the various steel mills and power utilities. It is a standard example of the way in which business and the state work together in Japan to achieve mutually shared goals.

NEDO works to facilitate the development of coal mines for the Japanese market in three ways:

1018 Investment practices in Australian coal." P Colley

• direct subsidies are given for geological surveys; • loans and subsidies are given for feasibility studies; and • the provision of debt guarantees for loans by the Export-

Import Bank or from commercial banks.

Under this last category, NEDO guarantees 50°/° of Export- Import bank loans and 100% of commercial bank loans. It charges a nominal fee of 0.4% of the guaranteed amount (NEDO, 1991, 1994).

In providing bank debt guarantees, NEDO is effectively removing all or most of a bank's risk exposure in such loans, with the effect of encouraging bank lending to mining projects of marginal or uncertain profitability. In some cases at least, NEDO does not seem to be genuinely shouldering risk. A new mine is at risk if it fails to win coal purchase contracts. However, as the following case demonstrates, new mines are often granted 5-year or longer contracts by the major buy- ers; favourable treatment that is not extended to other sup- pliers who have been reliable in the past.

NEDO's 1994 publicity material shows 19 coal projects that have received assistance, eight of which are in Australia. Two very recent Australian coal projects are shown as attract- ing NEDO support: North Goonyella and Ensham. North Goonyella is a project that received a 5-year coking coal contract at a time when most suppliers are on annual contracts (Tex, 1995).

In both cases, the mine operators are relatively new to the industry but have not faced the conventional barriers to entry of large scale industries. Ensham is owned and oper- ated by Idemitsu Kosan, a private Japanese oil company that first bought into the Australian coal industry in the last decade. North Goonyella is owned by White Industries Ltd and Sumitomo Coal Mining, with the former being the opera- tor. Both are also typical of the projects that the merchant bank BZW (1993) has referred to as being of dubious com- mercial merit. The Ensham project became embroiled in inter-company litigation under the Australian Trade Practices Act after Idemitsu Kosan pushed out its joint venture partners (including Rio Tinto Ltd--then RTZ-CRA) who did not consider the project to be commercially viable at the time (ATPR, 1992).

Implications of concessional finance

It is apparent that Japanese firms investing in Australia have access to government-assisted and co-ordinated finance that other companies do not, and these funds are not allocated primarily on the basis of the project's ability to make a profit, but rather on whether it fulfils Japanese national interest objectives. As the quote from NEDO demonstrates, the national interest is not only the enlargement of supply but the lowering of coal prices. It is in this light that Japanese investment in Australian coal mines of marginal profit- ability can be understood. It is impossible to prove collusion between NEDO in the provision of debt guarantees and the major steel mills in the awarding of long-term contracts. However, the latter are stakeholders in the former, and the former is an instrument of policy implementation for a policy goal that is shared by both state and business. It appears that

the goal is to stimulate supply with the intention of lowering resource prices whilst simultaneously improving security of supply. If this is so, then it is not a case of sharing the benefits of the trade between producers and consumers equitably.

However, the more common view is that the kaihatsu yunso policy has been beneficial to all parties and is, if anything, of greater benefit to the host nation. A typical example is Kolenda (1985). The rationale for this view is:

(1) that overseas investments by the Japanese state and busi- ness, done for resource security objectives, have substantial positive 'spin-off' benefits for the host nation in terms of industry development and export earnings; and

(2) that because Japanese participation is, in general, on a minority equity basis and through debt financing, control remains with local companies. Further, Japanese inves- tors have demonstrated a willingness to divest equity over reasonable periods of time.

Each point offers only a limited perspective. With regard to the first, the achievement of satisfactory 'spin offs' in the case of the Australian coal industry is questionable. Where new mines result in lesser capacity utilisation and reduced profits for the industry as a whole, there may not be a satisfac- tory return to investors and the community. The evidence of trends in profit rates do not signal clear national gains to the Australian community from concessional financing.

With regard to the second point, the initial and less important limitation is that it involves a very simplistic concept of control. Where the minority equity partner is also the conduit for cheap finance, and is the key to market access, the influence of the minor party is substantial. The influence does not need to be exercised in an overt manner; common sense sensitivity to the interests of the minority partner dictates the actions of the majority parties and mine manage- ment.

Secondly, and more importantly, direct majority owner- ship and/or direct control is not a necessary component of the strategy. It could even be argued to be an expensive component that would render the strategy less successful. If the goal is the enlargement of supply and the depression of prices rather than profit-making from mining, long-term or majority ownership is not necessary. The worst that can happen to a new mine if it becomes bankrupt is that owner- ship changes hands and debt is discarded; the mine will keep operating. 4

In the case of trading companies, a minority equity hold- ing often enables the company to market all or most of mines' output and thus attract a substantial revenue stream that is not contingent on the mines' profitability. Commis- sions on sales are in the order or US$1.20 per tonne and

4An interesting contemporary example of this were the mines of Clutha Ltd in NSW. Long-term debts combined with a few major technical problems forced the company into the hands of an external administra- tor in 1995. Most parts of the company's mines were eventually kept operating; the main issue in debate was how much of the accumulated debt the old owners passed on to the final purchasers (International Coal Report, 1995).

Investment practices in Australian coal." P Colley 1019

sometimes they are paid by both buyers and sellers (World Coal, 1994).

A small ownership stake in a mine held by coal buyers and trading companies is often enough to encourage other investors into the operation. More than a small investment would have no marginal benefit. Whereas for Japanese trad- ing companies, it is the access to sales and resulting commis- sions that provides the commercial rationale for participation in a group strategy, for coal buyers, it is the reduction in cost of key inputs that is the driving factor.

In summary, there is substantial evidence of the involve- ment of Japanese government agencies and public banks in the concessional financing of Japanese overseas investments. It is difficult to establish the exact volume or extent of such finance in the Australian coal industry, but there are clear examples of new mines that have benefited from its avail- ability. It is argued that these financing activities are consist- ent with an intention to stimulate over-supply in the industry in order to encourage destructive price competition. In such a context, the benefits to the host community of such financ- ing activities should be questioned.

In the next section, attention is turned to a detailed examina- tion of the scale and performance of Japanese equity participa- tion in the Australian industry to determine if it supports or contradicts this argument. It has been argued thus far that Japanese investments in the Australian coal industry have not had profits from coal mining as a primary objective but rather have been designed to stimulate supply and reduce prices. If the profit rates for such investments are low in comparison to other investments then that is further circumstantial evidence in support of the explanation proposed by this study.

Direction of investment funds into Australian mining

Yonezawa (1978) has argued that Japanese trading firms have pursued national interest objectives in the procurement of coal supplies even where such pursuit has cost them more than procurement on the basis of lowest price available. He says that there is little need for direct government interven- tion to secure such policy goals where they are implemented so willingly by business. This section lends support to this view by showing that Japanese equity investments in Austral- ian coal mining have not been based primarily on the profit- ability of the operation.

In this section, the results of detailed analysis of the financial performance of Japanese investments in the Austral- ian coal industry are documented. These results are measured against the performance of the parent companies, against the performance of other mining investments in Australia and against general Australian investment performance.

Methodology

Salient features of the methodology required for understand- ing the results are that:

• profitability has been measured as 'earnings before inter- est and tax as a return on total funds employed' (EBIT/ TFE) in order to measure the efficiency of the total investment in a manner not clouded by financing arrange- ments. Virtually all the investments are in the form of private unlisted companies, many of which have very high debt to equity ratios. In these situations, debt repay- ments are as much a form of profit on the investment as any dividends on shares.

• the investment results are from analysis of the five years 1990 to 1994 inclusive and cover 28 investments by 18 Japanese companies--representing virtually all such invest- ments in the Australian industry.

• the Japanese coal investments have been analysed as a group, and as a subset of more recent investments. 'JCI' represents all Japanese coal investments, whilst 'JC2' is the same group less the significant investment of Mitsubi- shi Development Ltd that was made in the 1960s and 1970s. Nippon Steel Australia Ltd has also been excluded from JC2 as coal mining is only a small part of its Austral- ian investments. The aim of this disaggregation is to help determine the performance of more recent coal invest- ments, which are identified as the JC2 group. It should be noted that the JC2 group, whilst representing more 'recent' (less than 20-year-old) investments, does not necessarily represent newer mines. Many of the JC2 investments are in existing, often old, mines. Therefore, the profit rates of the JC2 group are not significantly influenced by being mostly in new mines at an early stage of development.

• the results have been benchmarked against:

• general mining industry investment performance as measured by the Australian Mining Industry Council (1994) (AMIC--now the Minerals Council of Australia) in their annual Minerals Industry Survey;

• overall Australian industry investment performance as measured by the Australian Stock Exchange (1995a,b) (ASX) in its annual Financial and Profitability Study; and

• the performance of the Japanese parent companies as reported by the Nikkei database in Tokyo.

Results

The results in Figure 2 show that profit rates of Japanese investments in the Australian coal industry have been substantially below that of the broader Australian mining industry. The JC1 group has an average EBIT/TFE of just under 10%, and JC2, the subset of more recent investments, has an EBIT/TFE of around 6.5%. This contrasts poorly with the AMIC average of around 15%. It would appear that Japanese investors in the Australian coal industry are not investing in a manner similar to Australian and other foreign investors in the Australian mining industry.

The returns of the JC2 group were significantly lower than the ASX all company average (6.5% versus 9.5%). This suggests that recent Japanese investors have been embarking on investments that other investors in Australian industry do not consider satisfactory. However, the JC2 investments

1020 Investment practices in Australian coal. • P Colley

16

14

12

10

% 8

6

4

2

0

~ / / / / /

/ / / / / / / / / / / / / / / / / / / / / / / /

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J~anese Japanese Japanese AMIC ASX coal mining coal mining parent average Austrailian investments investments company companies

(1) (2) average average

Figure 2 Japanese coal investments in Australia vs. benchmarks. Average EBIT/TFE, 1990-1994

were equal, or superior to, the rates of return obtained by the parent companies on their home operations•

Figure 3 shows the average scales of investment in the various categories, and therefore provides a perspective on the effect of coal mining investments on the available funds of the parent companies. The average size of investments in the JC1 group is US$53m, representing just 0•43% of the average parent company funds of US$12,267m. However, the average investment is quite significant relative to the average size of mining investments in Australia. Investments in the JC1 group are equal to 17.5% of average company investment of US$303m and that of the JC2 group equals 12.1%o. This confirms the view that for most Japanese investors in the coal industry the amounts invested are fairly insignificant in comparison to the rest of their activi- ties, but are sufficient to markedly alter investment levels in the Australian industry• Therefore, what is being seen in the recent increase in the number of Japanese investors in the Australian coal industry is not a wave of substantial investment from the Japanese investors' point of view. They can be seen more readily as small strategic invest-

1ot)ooo

1 0 0 0 0 o

1ooo

.1 1oo

10

Figure 3

12,267

53 37

303

Japanese Japanese Japanese coal mining coal mining parent investments investments companies

(1) (2)

A M I C s u r v e y

Average funds employed y/e 1994 (US$m)

ments undertaken by a number of Japanese companies as part of a consensus view on managing capacity in the Australian industry,

Figures 4 and 5 show the performance of individual Japanese investments and corresponding parent companies. In Figure 4, it is evident that the profit performance of the Japanese parent companies is remarkably similar• Only one company out of 18 has an average profit rate of less than 4% pa, and only one exceeds 8%. By contrast, the profit perform- ance of Australian investments shown in Figure 5 seems to fluctuate substantially• The strongest performer is Nippon Steel Australia but, as mentioned previously, it is mostly not a coal investment• Most of the other strong performers represent investments that have been long standing (eg the Mitsui investment in BHP managed mines) or which are a stake in major coal operations• The JCD and EPDC invest- ments are in the large Rio Tinto-managed Blair Athol coal project, whilst UBE Industries, Nissho Iwai and Joban Kosan are all minority equity holders in the Coal and Allied opera- tions (another Rio Tinto subsidiary).

There are a large number of poorly performing invest- merits, and many of them are relatively recent.

Nippon

M/tsubishi Corp

Mitsubishi Materials

Japan Energy

Joban K ~ a n

Kanmnatsu

Kawasho

Marubeni

Mltsui & Co

Mitsui Matsuahlma

Mitsui Mining

N~.pp(m Oil

Niseho twai

Semttu~'~ Coal M ~ n g

Tsihelyo Koul~t~u

Tome't

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Ube IMus-mes

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i ~ i l ] i i i i i i i i ~ i i i ~ i l i l i l iiiiiiiiiiii!i!iiiiiiiiii]iiii~!]iiiill ]iI i!i!i!i!i!i!i!i!i!i!!ii]i!ii!!i!i!i!!i!!!i!!!iiiiiiiiii:

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Figure 4 Average profits (EBIT/TFE) of Japanese parent companies, 1990-1994

Investment practices in Australian coaL" P Colley 1021

N I ~ $~I A u ~

~ i ~ M i

DIa Coal l~alnl (Aust)

( A ~ i )

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Cl~lsea Coal.

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~ , , , m ~ A.,,. I!:i:i:i:i:'i:i:!:i Mitred Mining Aum-~ia

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Sumiwmo Cod Mining Aust.

r ~ , ~ ^ , , , ~ it'~i:!:~i~!~i Tom~ Cotp

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Ube Industries

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Figure 5 Average profit (EBIT/TFE) of Japanese coal mining investments, Australia, 1990-1994

A n a l y s i s

The data suggest that Japanese investments in the Australian coal mining industry are generally performing poorly in comparison to the investments made by others in the Austral- ian mining industry. More recent Japanese investments are performing poorly, even in comparison to investments made by all investors in all industries in Australia.

In the case of Australian mining investments, it should be noted that in 1994, the mineral commodities industry was

recovering from a period of depressed prices and profit- ability caused by the world recession and particularly by the entry of the nations of the former USSR into world markets. Therefore, the mining industry benchmark against which Japanese investment performance is being measured is a low one.

However, the conclusion that Japanese investments are performing very poorly in comparison to other investments must be tempered by the observation that the performance of the former is comparable to, or better than, that of their

1022 Investment practices in Australian coal." P Colley

parent companies. Profit rates in Japan have only recently recovered from recession in the early 1990s, which leads to the observation that the performance of Australian subsidiar- ies may be being compared to a period of unusually low profitability in Japan. However, as recessionary impacts have been felt in both Australia and Japan, this is not a ready explanation, though it cannot be totally discounted.

Komiya (1990), in his study of Japanese investment abroad, has claimed that most such investments have been poor performers and have been undertaken for reasons other than direct profits: to secure access to raw materials, access to markets for manufactured goods, or as a result of diplomatic concerns (e.g. to alleviate US concerns about imports). However, he states that one exception to this rule are mining investments in the Middle East and Oceania--that they have been relatively profitable. This seems to suggest two things. The first is that the acceptable rates of return for Japanese investors may be lower than for their Australian or other foreign counterparts in the Australian mining industry. Whereas the rates of return are lower than those achieved by other investors in the rest of the mining industry, they are comparable to the parent company rate of return. This recalls the statements of NEDO that the cost of finance is too high in Australia and that therefore there is a need for Japanese companies to make direct investments. The bank debt guarantees that NEDO offers act to lower the cost of finance and thereby improve profitability, as does the use of funds from the Export-Import Bank of Japan, which have a con- cessional rate of interest.

Stockbrokers Mclntosh Baring (1993) have raised the view that the real rates of return to the Japanese investors may be considerably higher than they are to the other inves- tors. That is, there may be profits made from investing in coal mines that are not disclosed (or required to be disclosed) in the financial reports of the Australian operations. Aside from the issue of commission on sales, the provision of debt finance may provide an opportunity for profit-making on interest rate differentials by the parent company. The analysis of the annual returns of the coal mining investments undertaken for this study showed many having loans from the parent body. These loans are generally shown as being at Australian market interest rates. In many cases, however, it is likely that the original source of the finance to the parent company is the Export-Import Bank, and such finance is being provided at concessional rates of interest. Even if the Export-Import Bank is not involved, funds raised in Japan generally have lower interest rates than funds raised in Australia. Therefore, the parent company may be able to make profits on its loans to its Australian investment as well as from sales commissions and any dividends.

However, cultural acceptance of lower profit rates may also be a reason why Japanese investors are able to view Australian investments in a better light than their Australian and other foreign counterparts. Crawford et al (1978) sug- gest that Japanese industry and government operate on a longer time frame and are geared towards long-term growth and productivity improvement rather than short run dividends.

The second observation that is suggested from Komiya's proposition is that it is curious that direct investment in the industry has remained constrained, even though it is reason- ably profitable from a Japanese perspective.

Japanese investment in the Australian coal industry has been increasing over the last 5 years, and is greater than at any previous time. This contradicts earlier predictions (eg Smith, 1978) that such investment would remain minor. Nevertheless, the volume of investment remains extremely small from the Japanese investors' viewpoint.

If the Australian investments are comparable to (or bet- ter performing than) parent operations, the level of invest- ment could be expected to be higher. There would seem to be good grounds for greater equity in the Australian industry.

However, this would be consistent with neither the kai- hatsu yunso (development for import) policy nor with diplomatic objectives. The issue of foreign investment in Australia has been politically sensitive (e.g. Pooley, 1985) and one oft-cited reason for Japanese investors generally maintaining only minority equity stakes has been to assuage such concerns (Kolenda, 1985).

Working within the constraints of concerns about foreign investment, it has nevertheless proved possible to facilitate quite large investments through the provision of minority equity positions. Other investors view the presence of a Japanese buyer or trader in the share registry of a company as something of a guarantee of coal sales; it is a direct link to the major market. Thus, for relatively small direct invest- ments, it has proved possible to trigger much larger invest- ments. Alternatively, in times of falling markets, the entry of a Japanese investor into the equity of a mine has been enough to keep banks supporting an operation that would otherwise close.

The rationale for these investments to which the analysis is directed is that stated by NEDO and MITI: the achieve- ment of resource security and low resource prices for Japanese industry. The price of coal can constitute 30% of the operating and capital costs of a power station. In the case of steel-making, iron ore and coal are central cost elements of the manufacturing process. The FOB (Free On Board--price at port of departure from country of origin) contract price of Australian coal to Japan has fallen by almost 80% in real Yen terms in the decade to 1994 (see Figure 6). Whilst some of the decline is attributable to the appreciation of the Yen over this period, the decline in real Australian dollar terms has also been substantial (see Figure 7).

If Japanese investments have been occurring in the Austral- ian coal industry as part of the kaihatsu yunso policy (and there seems consensus amongst commentators that it is) and the goal of that policy is as stated by NEDO-- to stabilise coal prices at lower levels than would otherwise be the case-- then the current levels of investment in Australian coal by Japanese steel, power and trading companies would seem to have been critical to that objective.

The increase in the amount and number of investments in the Australian coal mining industry, whilst significant from

Investment practices in Australian coaL" P Colley 1023

20000

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Figure 6 FOB coal contract prices in 1990 Yen. Source: Austral- ian Coal Report

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Figure 7 FOB coal contract prices in 1989-1990 Australian dollars. Source: Australian Coal Report

an Australian perspective, has represented a relatively inconsequential part of the economic activities of the parent companies. However, the number of investments, undertaken by an increasing number of companies that are all either traders or consumers of coal, suggests that the investment practice is the result of an agreed view.

Conclusion

The persistence of oversupply is a critical factor in increasing the market power of buyers and reducing the bargaining power of sellers. Financing and investment practices by Japanese coal consumers and traders in the Australian coal industry appear to have been primarily designed to stimulate supply to the point where oversupply is a factor affecting coal prices.

This study has documented and analysed two major types of investment practices by Japanese coal consumers and traders in the Australian coal industry. They are the use of concessional finance and debt guarantees supplied by Japanese

government agencies, and the taking up of minority equity stakes in the Australian industry. The major role of conces- sional finance in both domestic industry development and in foreign investment has been described and has been analysed in the context of Japanese trade and industry policy, particularly the development-for-import policy.

An associated issue of Japanese investment practices is the performance of Japanese equity investments in the Austral- ian industry. The volume and number of these investments have increased in recent years, but remain a minority of equity in the industry, and an extremely small component of the available funds of the parent companies.

The performance of those investments has been very poor from the perspective of Australian mining industry invest- ments as a whole. This suggests that such investment is undertaken for reasons other than the direct profits derived from owning mines.

However, the profits have been satisfactory in comparison to the profit rates of the parent companies. This leads to a conclusion that might best be put as an extension of that reached by David Anderson. In his major study of coking coal procurement practices, Anderson (1987) reached the conclusion that the trading practices examined had simultane- ously resulted in improved security of supply and reduced prices, when conventional theory would normally have expected a premium to have been paid for diversified sup- plies. Anderson did not examine the profitability of invest- ments in any detail, though it was assumed that the high- price coking coal mines developed by the Japanese Steel Mills in Canada in the late 1970s were loss-makers.

The results of this study seem to indicate that mining investments undertaken by Japanese investors for the purpose of achieving resource security and lower prices have been commercially viable in their own right from a Japanese perspec- tive, though not from an Australian perspective.

The pattern of such investments suggests that their primary rationale has been to act in a complementary manner to the trading practices described by Anderson in order to ensure resource security and stable low prices.

This pattern, in conjunction with a profit performance that is satisfactory from a Japanese viewpoint, suggests that the kaihatsu yunso strategy has been a triple success: it has achieved resource security, it has obtained lower coal prices, and it has provided a source of profitable investment income. The role of the sogo shosha (large Japanese trading companies) who are not coal-consumers themselves has been crucial. They are both the dominant investor in the industry and the facilitators of the trade. Their access to concessional and/or low-interest finance is one of the driving mechanisms of Japanese participation in the Australian coal industry.

The kaihatsu yunso strategy and its triple success imply a level of manipulation of the Australia-Japan coal trade that is much more complex than is suggested by earlier studies of the trade (e.g. Smith, 1982a). s Whereas a 6'/0 rate of return

5A critique of Smith's bilateral monopoly model is the subject of separate research by the author.

1024 Investment practices in Australian coal: P Colley

may be considered acceptable to Japanese investors, for Austral- ian Governments and the community, it may not be. A nominal rate of return of 6% (little more than 3% in real terms with current inflation rates) may be judged as not producing the economic rents and public revenues of which the industry is capable.

The possibility of a strategic trade approach having a significant adverse impact on the economic rents of one of Australia's major export industries should be a major concern for public policy in Australia because of its implication for losses in community returns. Lower rates of profits than would otherwise occur entail pressure on royalty rates and on the level of government charges on the industry (eg rail and port charges). Revenue from corporate income tax must also be affected.

It is possible that this problem, which seems to have escaped public policy attention in Australia, may finally be dawning on some of the other investors in the industry. In Rio Tinto's recent major investment in Australian coal, the takeover of Coal and Allied Ltd in 1993, the company tried to buy out the minority Japanese investors Ube Industries, Nissho Iwai and Joban Kosan. Despite a very attractive share price offer that saw almost all other shares sold to Rio Tinto, the Japanese companies showed no intention of sell- ing. It would appear that the retention of a minority stake in some of the largest coal mines in New South Wales had wider strategic concerns that outweighed simple considera- tions of return on investment.

The research presented here indicates that other investors in the Australian coal industry, of whatever nationality, who are seeking to make profits primarily from mining itself should seriously quest ion the benefits of the quasi- integration investment practices of coal-consumers and traders.

Acknowledgements

The supervision of Dr Dick Bryan and the comments of Ian Graham on earlier versions of this work are gratefully acknowledged.

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