China-Australia Trade Conflict Reshuffles Global Coal Markets

By Andrew Blumenfeld, IHS Markit

The trade dispute between Australia and China looms large over the seaborne coal trade. It has affected shipping routes and thoroughly thrown sales planning into a vortex. The oft-asked question is: “When will it end?” Unless one is a well-placed government official in either China or Australia, there is no answer. However, given these disputes usually come to a resolution over time, the question to be asked is: “What will change once détente is reached?”

Origin of the Dispute and How We Got Here
Australia and China were working well together. In June 2015, the two countries signed the China–Australia Free Trade Agreement (ChAFTA). This concluded roughly 10 years of negotiations and streamlined trade between the two countries for multiple products and services.

The ChAFTA allowed for 95 percent of Australian exports to China to be tariff free. Further, there would be easier access for Australia’s services and investments as well as dispute mechanisms. Australia would also allow up to 5,000 Chinese nationals and tourists to visit Australia annually.

Coal trade from Australia to China flourished. In 2015, Australia exported 71.4 million tonnes to China which grew to 92.7 million tonnes in 2019, the last full year prior to the disagreement. But technology advancements and emerging fears about the rapid pace of Chinese involvement in Australia began to take hold.

The first signs of stress emerged in 2018 following Australia’s questioning and then rejecting Huawei’s 5G telecommunications equipment. Australia and other countries, including Canada and the U.S., had suspicions about the Chinese technology company. With concerns about the risk of security threats if Huawei’s telecommunications equipment were to be embedded in their networks, Australia was one of the countries to initiate a ban on Huawei’s equipment.

Australia further infuriated China when it began questioning the events in Hong Kong and, by extension, what appeared to be military installations in the South China Sea and stepped-up rhetoric regarding the future of Taiwan. Again, this was not isolated to Australia as other nations also raised complaints about Chinese activities. China claimed no wrongdoing, countering that it was acting within its jurisdiction and was looking to quell what it considered encroachment on its region of influence.

China then leaked “14 Grievances”, a dossier designed to outline China’s position and build pressure on the Australian government to change their positions. The dossier stated Australia was interfering and was violating prior agreements. The list of grievances included Australia’s call for an independent investigation into the origins of the COVID-19 virus, the spread of disinformation about Chinese intent and the cancellation of numerous Chinese projects. The rhetoric has not subsided, and from all appearances, neither side is backing down.

Australia Needs China?
China represents the largest export market for Australia, accounting for a third of Australia’s total goods and services exported in 2019. However, China is not reliant on Australia for its exports, as exports to the U.S., Japan, South Korea and even the Netherlands exceed Australia as a destination for Chinese goods and services. This asymmetric relationship creates near-term problems for certain Australian goods including many agricultural products and wine. However, its primary exports, including iron ore and natural gas, are unaffected thus far.

The lopsided trade relationship leaves Australia with few retaliatory options. Outside of registering complaints with the World Trade Organization, there is little to be done other than seek new customers for affected products. Further, given that China produces half of the world’s steel, restricting iron ore exports would affect Australia’s economy more than China’s.

Australia has been relatively successful in pursuing new markets for some but not all the products that have been detoured from China. Offsetting much of the economic pain for Australia has been global growth as economies reopen from the pandemic. Higher prices have meant some lost trade volume, but realizations are higher and as a result, the Australian economy has not meaningfully suffered. Strong growth in iron ore exports and pricing as well as coal exports to other markets have, for all practical purposes, offset the economic losses in Australia.

Coal Seeks New Ports
Australia has been successful selling most of its displaced coal to India, Japan, South Korea and other Asian countries. Europeans had also been buying this coal, but higher freight rates and the increased price of Australian coal have made that option less competitive. Fundamentally, it has been the outsized improvement in demand and the sluggish supply response that has moved prices higher, and this has helped Australia.

According to IHS Markit’s Commodities at Sea, there were no Australian coal shipments to mainland China in June 2021, compared with 11.9 million tonnes shipped in June 2020. However, despite the collapse in Australian coal exports to China, Australian coal exports worldwide in June 2021 were at 32.9 million tonnes, down just 2.4 percent compared to 2020.

The reshuffling of global shipping patterns creates its own set of stresses, including the impacts of longer distances. Coal and other affected bulk commodities are tying up vessels longer and with global demand for all goods booming, freight rates have reached decade highs.

The absence of Australian coal in China has opened that market to replacement coal from other countries, including the U.S. According to Commodities at Sea, U.S. coal exports to China have been increasing, lured by premium prices.

Indonesia, the largest exporter of seaborne thermal coal, has seen strong Chinese buying in 2021. This is expected to continue, but Indonesia has an increasing domestic requirement and cannot fully displace Australian coal. Thermal exports from Colombia and Canada to China have increased as have those from Russia, but this has not been ratable. For U.S. thermal exporters, the primary effect has been a reshuffling of destination markets where U.S. coal fills a void. U.S. sales of thermal coal exports are likely to increase, especially from the West Coast, albeit in small volumes given export-port constraints.

The longer the Australia-China dispute remains, the more U.S. metallurgical coal will likely find its way to China as a necessary backfill for the Australian product. What is not clear is how the apparent differences in coal quality will be accommodated by the Chinese steel industry. Low-volatile U.S. metallurgical coal provides a relatively straightforward substitute. However, introducing more high-volatile coal from the U.S. will take some time, similar to the acceptance history of this coal in other Asian markets. But given China’s appetite and blending capabilities, it really is a matter of when, not if.

The trade dispute has created considerable market inefficiencies. China is making accommodations in its steel industry by trying to curb production, but that also has its consequences for a country that has a continuous need for housing, transportation and durable goods. Further, the high cost of the raw materials is likely to put a squeeze on manufacturers and consumers, which has the potential to create internal problems. A resolution would seem probable, but this is politics and “rational” market behavior probably takes a back seat.

Australia will lean heavier on its other multilateral trade agreements to assist in the reworking of its international trade. This would include many ASEAN countries, Japan, Canada and Mexico. Australia’s proximity to many emerging markets, including Southeast Asia and India, would provide diversification that would probably remain in place once there is a resolution to the China dispute. Australia will look to exploit growing steel demand in these emerging markets with its high-quality metallurgical coal.

The duration of the trade dispute is unknown, and it could expand given mounting concerns regarding China’s actions in Southeast Asia. Australia was singled out, in large part, because of the asymmetric trade relationship, but that does not preclude this dispute from spreading. Actions by the past and present U.S. administrations have raised the stakes and geopolitical tensions are on the rise. Escalation is a major concern for the international coal trade as well as for other commodities.

For international coal producers, once a resolution is reached between Australia and China, more disruption will occur as traditional trade patterns reemerge. However, it is likely that Australia will seek to retain much of the diversity it has gained. Therefore, China will likely remain a viable destination market for U.S. coal in the future. But there is a “price” to diversity. As seen in the past, the fortitude of both buyer and seller is subject to the basics of economics, and without a clear policy mandating diversity, the likelihood of returning to old ways is high.

Andrew Blumenfeld is data analytics director at IHS Markit.