Metallurgical Coal Markets: A Volatile Price Ride
By Jim Truman, Wood Mackenzie
2016 was a year of enormous volatility in metallurgical coal markets and many uncertainties remain for 2017. Spot prices for Australian low‐volatile coal started out 2016 in the doldrums, averaging below US$80/t and by mid‐November, ascended to nearly US$315/t … only to later fall to US$150/t. We will endeavour here to describe the factors that led to such dramatic movements and lessons for future expectations in the market.
Much work is done by analysts looking at the fundamentals of supply and demand to forecast trends, but the largest recent drivers of metallurgical coal price movements have been what are known as “black swans” – somewhat unpredictable shocks to the system. Extreme weather conditions have flooded mining pits, damaged transportation routes and interrupted loading activities at ports. Underground mines encountered unexpected difficult conditions that led to temporary outages and force majeure notices to customers. And a new factor appeared: the Chinese government imposing restrictions to the number of working days for domestic mines in an attempt to harness excess capacity.
Although these supply shocks cause major movements in prices and global seaborne demand, the examination of fundamentals provides a base level that the market should be drawn to approach. Similarly, in times of tight supply and skyrocketing prices, producers are drawn to bring on more production to capture strong profits. For these companies, a determination must be made as to the duration of the high prices and whether the environment is right to justify capital outlays for new mines and equipment or just a temptation that will shortly fade away.
The largest of these shocks over the past ten years have been caused by heavy rains in the Queensland mining region. The eastern portion of Australia typically experiences a wet season between December and March. Occasionally, these are more intense than usual, due to patterns of temperature changes in the Pacific Ocean. In 2008, heavy flooding in Queensland tightened supply by 15 Mt and drove annual contract prices from US$98/t in 2007 to US$300/t for 2008.
Flooding in 2010‐11, proved to be worse than in 2008, taking at least 25 Mt out of the market and pushing the Q1 2011 contract price to US$330/t. At that time, the US coal industry, which is the classic swing supplier to the seaborne market, was able to respond quickly. Shipments from the US to Asia increased from about 5 Mt in 2010 to 18 Mt in 2011 to make up for lost supply from Australia.
PRICE DECREASE AND MINE CLOSURES 2011 TO EARLY 2016
As the Australian pits dried and production resumed, prices fell back to pre‐flood levels and then continued to decline as miners in Queensland pushed output in order to lower costs and win back market share. These efforts were assisted by a weakening of the Australian dollar to the US dollar. As a result, between 2012 and 2016 costs fell by nearly 50% and price dipped to below US$80/t. By early 2016, about 20 Mt of high‐cost production had been shuttered and the market was in better balance on volume.
CHINA ADDS WORKDAY LIMITS AND AUSTRALIAN MINES EXPERIENCE OUTAGES
Then in April 2016, China imposed a 276 day‐per‐year work restriction on their mines to combat overcapacity. As a result, total Chinese production, met and thermal, during the first seven months of 2016 was down about 10%. This move caused the spot market up to climb to about US$100/t.
But, the big driver came in mid‐July and early August, when a number of heavy storms hit northern China and damaged the highway network and railroads. The resulting domestic supply shortage translated to more demand from the seaborne market.
In addition to the closures necessary to generally balance the market, a number of Australian producers were having their own mining issues. Then, the Grasstree and Appin longwall mines declared force majeure. Together these two operations account for about 10 Mtpa of production, a loss approaching the magnitude during the Queensland floods. Many of the US producers, who came to the rescue when Asian steelmakers needed replacement coal in 2011, were sold out for 2016. So, spot prices increased rapidly to about US$315/t in November 2016.
SUPPLY RETURNS TO NORMAL
By late November both the Appin and Grasstree mines returned to production. Also easing the market tightness, in mid‐November China relaxed its work rule policy to allow mines with good safety records to produce 330 days per year through mid‐March 2017. With the large Australian mines back and China’s domestic mines at more normal levels, the price began to fall. By mid‐February, the low‐volatile price was cut in half to about US$150/t.
WHAT DOES THE REMAINDER OF 2017 HOLD FOR PRODUCERS
With prices still substantially above the averages for the past few years, coal producers are examining ways to increase output. BHP is looking to increase output by 2.0 Mt in H1 (implying 4.0 Mt for the year) and Anglo American plans about 2.5 Mt additional output from its Grosvenor mine. In Mozambique, Vale is pushing to export about 4.0 Mt more coal in 2017 than it did in 2016. These changes alone could add over 10.5 Mt to the global seaborne supply.
In addition to those changes, which would more than cover our expectation for demand growth, North American producers are nearly all engaged in expansions by working more shifts each day, working more days per week and in some cases opening new mines. Canada will see both the Brule and Wolverine mines return, as well as Donkin in Nova Scotia. In the US, all longwalls in Alabama are increasing output. Ramaco has re‐opened the Elk Creek complex and plans to open Berwind this year. Nearly all other producers have plans for some level of expansion to capture some business. We estimate over 15 Mtpa of announced potential expanded output for 2017.
Wood Mackenzie believes that the market will be awash with available coal over the course of 2017, pushing prices down. As a result, not all of the announced production expansions are likely to come to fruition, only those positioned with the best cost structures and the ability to capture some of the modestly expanding demand.
Volatility will remain. The Chinese government’s decision on whether to restrict domestic production is a new feature of the marketplace and will continue to add volatility to prices and volume requirements for imports. We expect their 276 day work rule will be reinstated for Q2 2017, but many mines will be exempt, having annual contracts with steel mills. Still, the seaborne market should be better poised to handle spikes in demand, with more supply at hand, than it was in 2016.