China, India Demand Cushions Prices

Matthew Boyle, Australia-Pacific Editor, Platts Global Coal

Despite the hopes of coal consumers, coal prices didn't plummet in 2006 as demand stayed firm. China and India's growing economies, coupled with solid suppy-demand fundamentals in North America and Europe—and highly volatile prices for alternatives—will likely keep physical coal prices from wide swings in the coming year.

AT THE START OF 2006, INTERNATIONAL COAL consumers were predicting big price reductions when they negotiated annual contracts, coming off the record coal prices achieved in 2004 and early 2005. Some Asia-Pacific utilities were talking about coal below $40/mt after being forced to accept 2005 contracts well above $50/mt; steelmakers were looking for big scale-backs from the $125/mt many paid for metallurgical coal.

But the late 2005 price drops bounced back and those hoped-for decreases didn't materialize, as indeed major coal producers had warned they wouldn't. The fundamentals stayed sufficiently in balance, with new capacity coming on line but demand strong, so that declines plateaued and reversed. Contract reductions were modest. As long as major coal-consuming economies like China, Japan, and the U.S. continue strong, big price declines in international trade don't look likely in 2007 either.

For the U.S. market, prices did slowly drop over 2006 with its mild winter and summer weather, and the question for 2007 will be producer discipline: can the big miners stick to production cutbacks announced in fall 2006?

Coal supply has been increasing globally, fueled by the record profits and expansion projects by producers to meet the strong demand, but more increases have come in the Asia-Pacific region than in the Atlantic market. A string of port, freight and infrastructure projects across the globe, completed or nearly completed during 2006, has helped maintain global thermal and metallurgical coal supply-demand fundamentals.

In steam coal there is close to balance as 2007 nears, with a small oversupply globally. Indonesia, particularly, has ramped up production and exports, followed by Australia. Russia and China could become bigger exporters than they are, but are satisfying hefty domestic demand. Lower demand in Russia would mean more exports, and lower prices, in Europe. More exports from China historically depress prices globally.

But supplies are tight in the Atlantic. Demand has been strong, particularly in 2006 with high natural gas prices. South African supplies are very tight, with rail transport problems to port limiting shipments. Russian producers also face rail car shortages, and rising production costs mean they won't offer into Europe without higher prices. Polish supplies are decreasing. That has kept the market for coal delivered into Europe above $60/mt, and even justified imports from Australia as consumers and investors become more sophisticated in hedging their coal and freight forward deals.

Metallurgical coal, on the other hand, is globally tipped towards undersupply—but plenty of new mines are being brought into production, so that's not likely to last. Moreover, softening of demand for steel is putting downward pressure on prices. But there are differences among regions and coal qualities. PCI seems to be abundant and falling in price. Hard coking coal and the small anthracite markets are seeing tighter supply and therefore higher priced—semi-soft appears balanced.

Factors stemming the forecasted falls in coal prices in 2006 were port and rail infrastructure constraints, strong oil prices, and the omnipresent shortage of labor and tires for coal mining machinery. These factors will continue in play for the global industry for 2007.

The fall in freight rates during the middle of 2006 saw Australian coal producers seize the opportunity to resume steam coal exports to Europe for the first time since 2004, concluding long-term contractual business with Atlantic market participants for around 10 million mt/year beginning in 2007. Australian producers have been looking to conclude long-term agreements at the lower freight rates, and then re-let the cargo space if they do not require it.

Rates for all sizes of freight have fallen in 2006 due to increases in fleet sizes, with new bottoms ordered in the 2004 squeeze period beginning to enter service. Freight rates fell as expected during the northern summer, but the speed of the fall caught many by surprise. The industry is divided over whether dry bulk freight rates will increase marginally on current levels, or will surge on the back of strong demand towards the 2004 records. Capesize rates for the Richards Bay to Rotterdam route, which stood at $25/mt in early 2005, were slightly above the $17.50/mt for calendar 2007 by early October.

Spot prices in Europe fluctuated wildly during 2006. Volatility in gas, power and freight prices saw cargoes delivered into northwest Europe (or CIF ARA) reach as high as $72 per metric ton in August 2006, before falling below $65/mt a few weeks later.

Australian coal benchmarked from Newcastle has traded around the $50/mt level for most of 2006, while Indonesian and Chinese coal has been offered at higher-than-average price levels: in the mid-$40s/mt for Indonesian coal to around the $55/mt level for Chinese export-grade thermal coal.

China has continued its role as one of the main drivers of coal demand—a situation replicated in the oil, metals and other commodity markets—as the country seeks to increase its electricity and steel production. According to the National Development and Reform Commission, China accounted for 26% of the world output of steel and 47% of cement production in 2005, while Chinese crude steel production for the January to September 2006 period has also increased 18.4% on year to 308.44 million mt. Chinese electricity generation is 70% coal-fired.

Chinese imports of thermal and metallurgical coal continued to hit new highs, despite rising domestic inventory levels. The economy bureau and policy research center for the Chinese Communist Party's Central Committee said China's domestic consumption of coal in 2006 is expected to be 2.17 billion mt, up a relatively modest 110 million mt (or 5%) from the previous year. Chinese coal stocks reached 152 million mt by the end of June 2006, 31.77 million mt higher than in June 2005 and the highest inventory on record since 1999.

Domestic quality thermal coal from Shanxi province, around 5,800 kcal/kg, was priced in October at RMB 400-430/mt ($50-$53.80/mt) Free-on-Truck at Qinhuangdao, China's largest coal port. It is expected quality thermal coal prices will increase further in 2007 on the back of strong consumer demand. Inferior thermal coal, around 4,000-5,000 kcal/kg, has been quoted at RMB 280-350/mt ($35-$43.80/mt) FOT Qinhuangdao, and market observers say prices in 2007 are believed likely to remain steady at current levels.

Chinese export prices increased in 2006 after the Chinese government removed the Value Added Tax rebate of 8% on coal exports. Chinese thermal coal export prices climbed to around the $55/mt FOB Qinhuangdao in October, while Chinese export coking coal prices hit the $85-90/mt level. As Chinese producers continue to tap the export markets to supplement domestic sales, prices are seen likely to remain firm heading into 2007.

In 2006, the almost clockwork system of annual contractual deals between producers and consumers in the Pacific and coking coal markets ran aground. Traditionally, met coal prices established a benchmark in talks between Australian producers and Japanese steel mills. This price, within limits, was replicated around the world. Similarly, steam coal deals were sealed first between Australia and Japan, and provided a benchmark in other Asian regions.

In late 2005, a dip in the market had consumers expecting lower contract prices, but the dip proved short-lived. By spring 2006, there were only marginal decreases in Japanese fiscal year 2006 metallurgical coal prices, from about $125/mt to around the $115/mt level for hard coking coal. Steam coal prices rolled over or slightly increased on year above the $52-54/mt level. Japanese fiscal 2006 prices were concluded at $52.50/mt. Producers were unwilling to let coal prices fall too quickly, and made aggressive contractual offers. They even proved willing to leave the negotiation table if their prices were not accepted.

This optimism on prices was characteristic of a number of Australian coal producers, who remained adamant that prices for all types of coal should be higher than current market levels. The past couple of years have been good to coal producers, particularly those in Australia, with record profits reaped on the back of higher selling prices. A knock-on effect of this has triggered consolidation within the industry, by companies either looking to increase their production base, such as U.S. producer Peabody Energy taking over Australia's Excel Coal in October 2006, trying to reduce their production costs (the failed NEMI-Western Canadian Coal merger) or trying to secure coal supply (numerous Indian coal producers seeking equity stakes in Australian and New Zealand coal mines and producers).

Indian coal consumers have been forced in many areas to rely on imported coal, as their own coal reserves are often undeveloped, poorly managed, or have a higher ash content. The Indian government has also set aggressive targets for steel and electricity production. India wants its annual steel output to climb to more than 160 million mt by 2020, while power generating capacity—using a mix of hydro, fossil, nuclear and non-conventional energy sources—is to increase to 400,000 MW by 2030 from the existing 130,000 MW. Clearly, Indian consumer demand will become even more important to the global coal markets.

Russian coal has been taking a swing role in Europe, with more supply entering the market when European prices spike above Russian domestic ones, and that pattern is expected to continue in 2007.

In the U.S. and Canada, increases in production costs, for fuel and materials like steel and tires, are likely to limit downside pressure on prices. Rail freight problems contributed to a mid-winter 2006 spike in Powder River Basin (PRB) coal prices, with the 8800 Btu/lb coal exceeding $20/st and the 8400, $16/st, before easing back to more normal levels over the spring and summer. The 8800 coal was settling around $10/st late in 2006 and the 8400, around $8. Rail limitations in the West are easing and, on the upside, everything that can be shipped can be sold. PRB prices are forecast to continue soft in 2007.

Closely watched Central Appalachian prices for NYMEX look-alike and rail coals slid during the year, from the $50-60/st range (sometimes exceeding $60) to the $40-$50 range. The U.S. spot market continued to be relatively small, with many major producers selling out their year's production one and even two years in advance.

Eastern U.S. mines, especially in Central Appalachia, are facing higher costs because easily accessible seams have been mined, and they now face more difficult geologic conditions. They also confront continuing labor challenges and more costly safety requirements, in addition to rising equipment and fuels costs, along with the slumping sales price of coal.

The margins are being squeezed so that small companies are finding it tough to make enough money to stay in business. All of those factors are also being felt by the bigger companies, and this fall, four of the top five producers lowered their production guidance.

Analysts have applauded the production reductions, saying they bring discipline to the market, rebalancing supply and demand by reducing an oversupply of coal and thereby nudging prices upward.

Nuclear power as an alternative to coal-fired power plants continues to gather steam amongst developed nations. Even Australia—traditionally opposed to nuclear power—is reconsidering, including mulling a plant in the heart of New South Wales coal country, the Hunter Valley. China and India have extensive official programs for nuclear expansion, and European countries and the U.S. are also taking a new look at nuclear power.

But nuclear units take a decade to plan and build, and even nuclear advocates say predicted demand is so high that all energy sources are needed. The available short-term choices for baseload power continue to be coal and natural gas, of which coal continues to be cheaper. Soaring demand in China and India, together with solid supply-demand fundamentals elsewhere in Asia and in Europe and North America, bode well for the global coal markets for 2007.