Winsway Coking Coal Holdings Ltd (1733:HK)
US$500,000,000 8.5% Senior Notes due 2016
11 October 2011
Joint Bookrunners and Joint Lead Managers
Use of Proceeds
Winsway Coking Coal Holdings Limited (“Winsway” or “the Company”) is a leading supplier of imported coking coal into China, and one of the single largest off-takers of Mongolian coal into China (measured by volumes purchased). The Company’s core business includes the procurement, transportation, storage, processing and marketing of coking coal, predominantly servicing the domestic steel sector.
Its clients include the Baogang Group, Hebei Steel, Tangshan Jiahua Coal Chemical and Risun Coke. It is also the provider of a variety of associated services to its suppliers and clients, including logistic parks, coal processing plants and infrastructural (road and railway transportation) capabilities. In 2010, Winsway procured 67.7% of the raw coking coal available from Mongolia (equivalent to 6.5 million tons), of which 4.7 million tons was sold as cleaned coking coal and the rest lost in the cleaning process
Water risk disclosure minimal given amount of water used
Water is used at every stage of the mining process: from cooling equipment and separating waste from valuable minerals through to the control of the amount of dust on-site.
The processing of raw coal is a heavy user of water resources, and in mining-rich areas there is often an over-consumption of local water resources. Roughly 80-170 litres of water are used per metric ton of coal that is washed.
As mining operations often cannot be re-located, it makes better business sense to manage the limited water resources available. An additional stress may be the limited water infrastructure, coupled with less stringent water quality regulations – as water becomes a scarcer resource, it will become increasingly more expensive for Winsway to continue to operate with the same degree of profitability as it has in recent years.
Although water risk is acknowledged by Winsway in passing (see below) as having a potential impact on the costs associated with its processing of raw coal, the Company does not seem aware of the true impact water scarcity may have on its future profitability.
Risk Factors in the Offering Document:
“Any shortages or disruption in electricity or water or gasoline supply could lead to lengthy production shutdowns and increased costs related to recommencement of operations, which could have a material adverse effect on our business, financial condition or results of operations. Any significant increase in electricity, water and gasoline prices will increase our production costs and may adversely affect our results of operations if we are not able to pass the increased costs on to our customers.”
No reference is made to the development and integration of water management systems into the production process.
Water tariff hikes could increase costs
Whilst the price of water for industrial use in China has been rising, it is still not as high as elsewhere in the world (see Water Price Hike). Further increases are imminent and will likely have a significant impact on the operating expenditure, (see opinion here and interview here on pricing) of not only Winsway’s current processing business, but also that of the mining ventures it is currently exploring. How Winsway will address this increase in costs is presently unclear as it will in its own words “not be able to pass the increased costs onto [its] customers”.
Winsway’s location issues
Winsway’s current operations are situated in Urad Zhongqi, Jining and Bayuquan (in Inner Mongolia, Shandong and Liaoning provinces, respectively), and it is one of the few companies to have substantial logistic and transportation investments at two tier-one Sino-Mongolian crossings (Ceke and Gants Mod). Shandong and Liaoning provinces are amongst the Dry 11 with water resources similar to Oman and Syria.
Inner Mongolia on the other hand is water stressed, with renewable water resources of 1,564m3 per person per year (see Who’s Running Dry). Moreover, Shandong and Inner Mongolia rely heavily on groundwater sources and are showing signs of Groundwater Depletion. Mining will only serve to hasten excessive groundwater exploitation and increase pressure on the region’s water resources.
According to Winsway, they process 6.5 million tonnes of raw coal. Given the 80 – 170 litres of water used for washing, the amount of water they use is estimated at 520-1,105 million litres of water per annum.
As it is, the government has acknowledged that Inner Mongolia is currently suffering from drought1, with 580,000 people affected. Going forward, climate change will only further exacerbates water scarcity with more frequent instances of droughts and flooding.
Potential pitfalls: another Zijin, more protests, new government policies?
It is a well-recognised fact that China’s surging economic growth is outpacing its freshwater supply and that companies are known to cut corners in order to keep up with demand.
In July 2010, Zijin Mining Group (“Zijin”) was forced to shut down its copper plant in Shangang, Fujian province after a 2.4 million gallon toxic spill contaminated the Ting River, killing 2000 metric tons of fish – enough to feed 72,000 residents for an entire year. When the news first broke, the first question investors asked themselves was “Is this relevant?”– as with most mining plays, Zijin’s stock price was cyclical and affected by various factors apart from the environment. However, the swift detention of three members of management and the announcement by the local government of its intent to pursue legal redress against the company brought the matter home: no longer could investors turn a blind eye to the low-cost and old mining methods utilized by Zijin. The company that was once lauded by Forbes as a candidate for its Fab 50 List of Asia’s top private companies was now the subject of regulatory investigation and was fined RMB30 million for the pollution.
The water-resource issue has been recognized by the Chinese government. In February 2012, the State Council issued a new water management decree with a stark warning that “water usage had surpassed what [China’s] natural resources can bear”.
In addition to heightened government scrutiny, as industrialization continues and groundwater sources diminish, companies are likely to face increasing pressure from local residents who may question the priority given to industrial use of water versus water for personal consumption. Instances of civil unrest as a result of concerns on water use are not unusual in China. In the last decade, such instances have included the storming on an industrial park in Zhejiang in 2005 where water contamination from 13 chemical plants were linked to an increase in birth defects and a series of crop failures and between 2007 – 2010, a subsidiary of KO YO Agrotech (Group) was placed on the Sichuan province watchlist due to claims of polluting a river, exceeding wastewater discharge standards and discharging untreated industrial wastewater, receiving widespread media coverage and complaints from the local populace.
Stakeholder engagement: request for more disclosure and analysis
When considering investments in companies involved in the mining sector in China, the risks associated with water availability, consumption and access, and the means of mitigating and managing such risks, should be examined more closely. As water resources become scarcer in the mineral-rich regions of the north, the competition for water supply will increase and the industry will find itself in a position of having to “pay to play”.
Investors have an important role in the management of water resources: by engaging with corporates and through encouragement and support of best practices, investors and corporations can work together towards mitigating water risk in the future.
Click here for more on the coal industry and what it means for energy security – would a fundamental shift be required?