For the third time in less than ten years, seaborne premium metallurgical coal (ex. Queensland) has barrelled through US$300. The quarterly benchmark for metallurgical coal was settled at US$84 for April – June 2016, US$92.50 for July – September 2016, US$200 for October – December 2016 and could very well manage a +US$300 settlement for January – March 2017. This run-up is the primary reason for thermal coal (ex. Newcastle) coming within cents of US$110, as exporters redirect thermal coal and constrained resources to capture the upswing in the metallurgical coal market.
This news should be sufficient to grab your attention; however, there is much more to the story. In the previous two run-ups (2008 and 2011), Australia – the biggest seaborne metallurgical coal player – experienced weather events of epic proportion, which severely disrupted the supply chain. Furthermore, global steel prices (hot-rolled coils) were robustly above US$600/t, enabling the steel mills to pass along the higher raw material costs. Lastly, the AUS$ was close to parity with the US$ during the last two run-ups, which muted the upside for the Australian exporters.
This rally has been radically different. Aside from a few minor operational problems at some mines in Australia, we have not had any supply disruptions resembling another ‘Big Wet’. In fact, we are only now beginning to enter Australia’s wet season. Global steel prices have inched higher, but might not even reach US$500 due to the fact that global steel mill utilisation rates remain in the low 70s. The AUS$ has defied the conventional wisdom that professes higher metallurgical coal prices always coincide with a strengthening AUS$. In fact, while the latest run-up (US$315) falls short of the record US$375 level reached in 2008, it surpasses that record when denominated in AUS$ (AUS$420 at US$0.75 vs AUS$408 at US$0.92).
To truly understand the current rally, I suggest you read, ‘Are You Ready for an Abrupt Shift in the Coal Sector?’, which I published on my website in June. In short, a myriad of inputs have been in play since the market dropped below US$150 three years ago: a suspension of expansion CAPEX; mine closures and cutbacks; surviving mines operating at maximum output; high-grading reserves at opencast coal operations; a less-diversified seaborne buyer, who is more dependent on Australia; China’s serious efforts to curb surplus production that was on the verge of creating a credit crisis; etc.
Without some additional supply and/or demand inputs, I believe this rally has peaked. While I expect metallurgical and thermal coal prices to retrace significantly by 1H17, I do not expect a reversal to the low levels experienced during 1H16. One extremely important caveat: we are only now entering Australia’s wet season. I agree with many observers that believe the probability of another Big Wet is remote. However, I also believe they are missing the point. A Big Wet is not needed to bring this rally into overtime. In fact a normal ‘wet season’ might suffice. Australia’s ‘dry season’ was unusually wet. The environmental authorities restrict the amount of dewatering activities that each surface operation can perform. From my discussions with exporters, I am hearing opinions that the wet ‘dry season’ has pushed many operations close to the maximum allowed by their respective mining permits and a normal ‘wet season’ might hamper production. As we have already witnessed in the past few months, a calamitous disruption in supply is not necessary to sustain high prices.
There are many factors that argue for the rally’s end. Vale’s metallurgical coal operations in Mozambique continue to ramp-up with the completion of the Nacala export terminal. Other operations in Mozambique are being brought back into production. Many opencast operations in Mongolia were on ‘hot idle’ waiting for coal prices to recover. The idled mines in Canada formerly owned by Walter Energy are in the process of being resuscitated. China continues to export steel and coke at a strong clip. Additionally, if China believes it has gone too far in dealing with surplus coal production, it might reverse course in order to lower its domestic coal prices, which would decrease coal imports.
From my perspective, the risk for consumers of a full-blown, sustainable metallurgical coal rally is very real, but would require a ramp-up in global economic growth, particularly in China, and the global steel mill utilisation rates climbing to the 80s. This would allow the new production from the above-mentioned countries to be absorbed and the market would be sustained for 3 – 5 years, which would be necessary to bring on significant greenfield production. To counter this risk, it would behove the seaborne buyer to lock-in metallurgical coal prices at levels that give miners a fair return on capital with some left over to invest into future production.
About the author
Steve Doyle has over 30 years experience in the coal trading business, founding Doyle Trading Consultants in 2002. He is now President of BtuBaron LLC.
This article first appeared in World Coal December 2016. To read this and much more, register to receive a copy here.
Read the article online at: https://www.worldcoal.com/special-reports/08122016/the-btubarons-half-time-report/