Cement: Coal shoulder

A significant mark down in coal being loaded at the Richards Bay Coal Terminal in South Africa would have importers pleased. Since its peak last year, average monthly coal price has dropped 68 percent. Here in-country manufacturers of cement—specially those located close to the port can now meet their coal procurement requirements from shipments coming via sea at much cheaper rates than last year, specially since import restrictions in the country are also easing. Those away from the port—northern cement manufacturers—also have some good news. Afghanistan which had earlier began to raise its premium on coal sales seeing international coal prices peaking and Pakistani LC restrictions prolonging their stay has now slashed duties and royalties on its exports. This is likely in anticipation of potentially losing a lucrative market to international coal.

They want to keep their Pakistani cement customers coming as its easy cash in the pocket, no complicated international trade involved. It’s happy days for cement manufacturers all around as coal costs plunge and their own pricing power in the domestic market persists (Aug to Aug, cement prices are up 32 percent on weekly average). Is there a catch? Do Pakistani cement manufacturers even need all that coal?

Historic trends suggests when domestic demand is slow, cement manufacturers increase their share of export. While they don’t fetch as high a price in exporting markets as they would in domestic markets due to competition, they still benefit as they are able to offload excess commodity and cover their fixed costs. They are able to maintain capacity utilization. But if exports are not performing either, when capacity utilization does drop, prices in the domestic market for whatever demand exists start to decline too. FY23 was different. A quick glance at data (see graph) would suggest the relationship between capacity utilization and prices no longer holding true. Despite capacity utilization dropping—in Jul-23, it was 49 percent, lowest in over a decade—prices have continued to be raised.

But demand is not expected to recover over the next few months. Whilst analysts are predicting a downward pressure on cement prices as capacity utilization declines and coal inventories pile up, BR Research would disagree. There is no reason for peak prices to breath their last, simply because a decline in price will not suddenly create additional demand in the market. Even though, demand is certainly down due to reduced purchasing power and debilitating inflation, higher taxes and so on., we all know the tale. The cost of cement is certainly a substantial component of the total cost of construction but the price of one product would not determine the large investment required to kickstart a construction project or change the feasibility of an existing stalled one. Roughly, the cost of cement is about 10-12 percent of the total grey construction cost (for the construction of a house) and about 7 percent of the total construction cost including finishing. A quick calculation suggests if today the price of cement declines by Rs40 per bag—down 12 percent from current levels—which by the way sounds quite outlandish right now, the share of cement in total construction would still remain at 7 percent, and fall slightly below 12 percent to 11 percent of grey construction.

The point is simple and it is this. There could be latent demand for cement—desire of consumers to purchase cement but not having the purchasing power to do so—but transforming it to real demand would not be possible entirely just by manufacturers reducing their own prices. There is a reason why capacity utilization has slowly slid to its all time low and prices have persisted at their all times high. Declining cement prices may not persuade greater buying, though a substantial decline may lead to hoarding for future. It may not come to that.