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Outlook for metallurgical coal is steady

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World Coal,

Mike Elliott, EY Mining & Metals, explains why the global outlook for metallurgical coal is steady despite steel industry troubles.

Despite issues of overcapacity and significant cost pressures in the global steel industry, total global demand for steel continues to increase and demand for metallurgical coal follows with it. The current slight oversupply in the metallurgical coal market will thus be corrected in the near term, as demand increases and new production projects and expansions are delayed or cancelled. As a result, the demand for metallurgical coal in the medium term may even exceed current forecasts of steady growth.

The metallurgical coal sector
While the steel sector has a number of competitive issues to overcome, moderate growth in both the supply and demand of steel is still forecast. It is thus likely that demand for metallurgical coal will grow at a moderate rate.

However, the metallurgical coal market is also facing a low point in the market with some oversupply resulting in lower prices. Between June and August 2013, the Australian prime hard coking coal price fell to below US$ 140/t, the lowest since 2010. Strong new supply coming online from Australia and Indonesia is a key driver of the current low point in the market, with exports up 14% and 20%, respectively, for 2013 up until September. Many see this as the bottom of the market but prices have yet to make a strong sustained recovery.

In the face of lower coal prices, high cost producers and semi-soft product have been pushed out the market. Current production is largely coming from miners’ lowest cost mines to enable them to make good margins despite lower prices. There is little incentive in the sector at present to increase production, as it is likely to be at a higher cost and therefore lower margins.

As a result, new projects are being placed on hold until prices improve. This is in addition to the myriad of other challenges faced by miners to bring new projects onboard. Bulk mineral projects are difficult to bring online and fraught with problems, such as delays and cost blow-outs, financing issues, permitting, environmental regulations, infrastructure requirements, sovereign and political risk and execution challenges. Shareholder pressure has also recently been a factor in slowing investment in new projects. New project uncertainty is such that only 39 million t of the planned 156 million t of new metallurgical coal supply will make it onto the market by the end of 2017.

Increasing demand and trade in metallurgical coal
With lower prices, the removal of high-cost producers and the difficulties bringing supply online, the metallurgical coal market will return to balance over the medium to long term. This is particularly so when the forecasts for increases in imports over the next seven years are considered. There is an anticipated increase of around 33% – largely due to enormous demand from China and India.

Chinese metallurgical coal imports are forecast to increase at an average rate of 12%/year from 2012 to reach 80 million t by 2018. Growth in Chinese metallurgical coal imports is linked not only to the increase in steel production and demand discussed above, but also to current lower metallurgical coal prices, which are forcing a number of high-cost domestic producers to put operations on hold or shut down. As domestic resources are usually located some distance from mills and are of lower quality, steel mills tend to increase their imports when the seaborne prices decline.

In India, steelmakers meet 60 – 65% of their metallurgical coal requirements through imports. This is because domestic coal reserves have high ash content and are therefore not suitable for use in the steel industry. With strong growth likely in Indian steel production, metallurgical coal imports will grow in parallel. Consumption of metallurgical coal between 2013 and 2017 is set to increase by 30% to 59 million t of which almost 70% will be imports. The ban on iron ore mining imposed in India could possibly lead to even higher imports as steelmakers will be forced to use inferior grades of iron ore that need more coal to process it into steel.

In Brazil, it is expected that average growth in steel production will be around 3.3%/year and associated steel consumption at 2.6%/year to 2018. As a result, imports of metallurgical coal will increase over the same period – an average rate of 6%/year to reach 16 million t in 2018.

Demand for metallurgical coal in the EU will remain modest with flat steel production. Steel demand in the EU continued to contract in 2013 but there are signs of economic stabilisation. As a result, steel demand may start to increase during the course of 2014. Metallurgical coal production in the region is forecast to only increase by 1.9%/year over the outlook period to reach 49 million t in 2018.

In the US, metallurgical coal producers are seeing their profits diminish in the wake of weaker domestic steel demand and excess metallurgical coal on the market. It is likely that this will continue to be the case, as US exports expanded to fill the Australian supply gap during floods in Queensland. This supply is now back online and has grown. As it is more cost competitive, it is pushing higher-cost US metallurgical coal producers out of the market. The likely appreciation of the US dollar with the tapering of quantitative easing will also render US producers less cost-competitive.

Innovation in steel production methods
An area of challenge to the continued use of metallurgical coal is the increasing use of innovative technologies and methods to produce steel. As weak demand and lower prices for steel combined with higher raw material costs, steelmakers have been seeking ways to be increase their margins. Some of these methods include:

  • Increasing flexibility with coke blends: steelmakers are reducing productivity by running longer heat cycles using lower-quality high-volume metallurgical coals.
  • Using new, cleaner technologies, including direct reduced iron (DRI) or electronic arc furnaces (EAF), which use little or no metallurgical coal.
  • Increased use of pulverised coal or PCI. This is dependent on the price parity between metallurgical coal and PCI: during periods of higher hard coking coal prices more PCI is used as steelmakers cut costs.

The changing dynamics in the energy market have also impacted steelmakers. The emergence of cheap natural gas in the US has allowed a greater shift to DRI production: for example, Nucor’s new DRI unit in Louisiana is expected to have savings of US$ 10/t for its steel production at current gas prices.

Meanwhile, Africa has seen increased use of EAF as the cost for start-up is much lower and its scalability suits the environment. With access to cheap gas and stable electricity sources, there has also been significant uptake of EAF in the Middle East.

In line with policies and guidelines under the China’s 12th Five Year Plan, steelmakers have been encouraged to adopt new technologies to improve the efficiency of their new plants. Large Chinese players, such as Baosteel, are collaborating with global steelmakers, such as ArcelorMittal and Nippon Steel, to adopt the latest technologies and gain current technical expertise. For example, Chinese steelmakers are looking to adopt new technologies, such as Corex, Finex and ITmk3 to reduce the dependency on metallurgical coal for future projects.

However, despite increasing popularity of both DRI and EAF, it is unlikely that either will be a significant challenge to the blast furnaces as the main method of steel production.

A bright future
The result of these trends is that new metallurgical coal supply is unlikely to be sufficient and timely enough to meet future demand from the steel market. And that demand – even at a tepid rate – will be substantial enough to support a healthy metallurgical coal market. The risks are mostly to the upside: demand may increase at a faster rate than expected, while supply may be impacted either by project delays and/or cost blow-outs. This under/oversupply situation is expected to increase the volatility of metallurgical coal prices both on the upside and downside.

Most importantly, while China continues to increase its steel production by an average of 7%/year, the outlook for metallurgical coal will remain strong. Add to this the possibility of a brighter global economic outlook – such as developed countries emerging more strongly than expected from the current downturn – it is likely that demand for metallurgical coal will remain at least constant and possibly grow more strongly than expected.

The views expressed in this article are the views of the author not Ernst & Young. This article provides general information, does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Liability limited by a scheme approved under Professional Standards Legislation.

Written by Mike Elliott, EY Mining & Metals.

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