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How to secure your coal supply

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World Coal,

Whether the coal market is booming or softening, coal contracts underpin much of the world’s supply of electricity, and long-term coal agreements are not going away. In his latest report for the IEA Clean Coal Centre, Coal contracts and long-term supplies, Paul Baruya examines long-term fuel supply contracts, where they are used and the features that make them attractive to many utilities.

Regardless of the uncertainty of the current coal market, contracts still form an essential basis of every trade deal. In 2014, the National Development and Reform Commission (NDRC) of China published guidelines for coal miners and utilities to agree medium- to long-term contracts. This would replace the traditional process of annual negotiation and agreement of one year contracts. Such a change could instigate a major shift in coal buying in the world’s largest coal market. This is in stark contrast to OECD Europe where hard coal purchases for UK and German utilities are agreed almost entirely on a spot basis.

However, a number of countries and companies use long-term contracts to varying degrees, including: Czech Republic, India, Indonesia, Japan, Korea, Malaysia, South Africa, and the US. Independent power developers cannot secure finance without securing both long-term power purchase agreements and similar arrangements for coal supply contracts. These latter contracts could be an essential component to the expansion of electricity supplies in many industrialising economies seeking least cost and reliable electricity. Minemouth power plants may not require the same level of contractual sophistication and detail in their supply agreements due to the short supply chain. Where longer distances are involved, an intermediary with expertise in haulage and handling may be included in the contract along with a greater degree of quality checks and auditing to ensure the delivery is prompt and to the prescribed standard.

Term agreements have many advantages compared to spot purchases, especially for power plants operating under baseload. Probably the primary reasons for adopting long-term agreements are certainties in the required volume of coal of the right quality, and better predictability in the price, whether it is geared to a fixed or a variable formula. Long-term planning becomes easier and allows producers (and end users) to plan mine advancements and investments and enhancements in equipment, methods and land planning. It also provides an incentive to explore future blocks of resources when long-term volumes are coupled with long-term prices. While the agreement secures tonnage over the long-term, variations on a monthly or quarterly basis are inevitable. Despite the apparent locked-in nature of a long-term agreement, flexibility in these contracts can be put in place to enable the buyer to take more tonnage in some periods and perhaps less in others. Pricing is an essential aspect of any coal contract. Market conditions can alter prices every hour but long-term contracts stabilise prices, albeit with varying degrees of fluctuation depending on the price formula. For most term contracts, price renegotiation can occur annually or every three years, which reduces the need to repeat the tendering process, but ensures that both parties are aware of current market conditions and so steers them to cost competitiveness.

Long-term agreements can lead to strategic business interests and cooperation to suit both buyer and seller. Both parties can benefit if one owns part or all of the other’s assets. Sellers can also enter into strategic long-term contracts with rail and port to ensure a continuity and robust supply chain for many years, offering buyers confidence that the producer has access to sufficient capacity to deliver the coal when needed.

While price, volume and quality are the main criteria for any agreement, a number of assurances must be made by both parties, which will fall under the terms and conditions of most contracts. The timeliness of delivery, payment and communication between parties is usually stipulated. Other ancillary services and requirements, such as sampling and auditing volumes throughout the supply chain, will be common for international shipments and must all be considered when drafting contracts. So, under certain circumstances long-term contracts serve as a useful and often indispensable instrument for coal procurement for some buyers. Flexibility can be built in, in terms of volume, price and quality, while providing greater confidence in the long-term operation of both new and existing power plants.

This report introduces the reader to the basic structure and terms for fuel commodity agreements and provides examples of contracts, their variations, as well as possible disputes and remedies.

Paul Baruya’s latest report for the IEA Clean Coal Centre: Coal contracts and long-term supplies. Edited by Harleigh Hobbs

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