FOCUS: Chinese policy not sole factor affecting seaborne coking coal prices

While 2016 and 2017 each had a single, clear factor that drove up seaborne coking coal prices, this was a key feature that was missing last year, when the market continued to strengthen regardless.

And if the first few months of 2019 are anything to go by, the seaborne coking coal market might have just reached a new level of complexity.

When China decided to tackle overcapacity in its coal sector in 2016, it sent prices for seaborne coking coal to record highs of above $300 per tonne fob Australia. That year was seen as a turning point for the market, and prices have not fallen below $139 per tonne fob Australia since.

The following year, a major cyclone that hit Queensland state - Australia’s major coal-producing region - sent prices surging close to the record highs of 2016.

Although 2018 did not experience such dramatic increases, prices on average continued to strengthen due to steady demand for the steelmaking raw material compounded by supply bottlenecks affecting the seaborne market.

The Fastmarkets MB fob Australia Premium Hard Coking Coal Index averaged $206.62 per tonne last year, up 10.3% from 2017’s $187.28 per tonne. In comparison, the index averaged $142.44 per tonne in 2016.

The index’s average for the last quarter of 2018 was even higher, at $220.79 per tonne.

But in the first three months of this year, prices fell amid uncertainties surrounding China’s import policies.

The Fastmarkets MB fob Australia Premium Hard Coking Coal Index averaged $206.33 per tonne in the January-March period, down by about 10% year on year. The cfr China index averaged $205.28 per tonne, down 6% year on year.

The decreases came despite China’s coking coal imports surging by about 35% on the year during the quarter to 16.42 million tonnes.

Market sources have attributed the import surge to Chinese buyers increasing their procurement rates in the first quarter, having exhausted their quota for last year well ahead of the year-end. Additionally, imports from Mongolia also increased significantly.

China imported 3.51 million tonnes of coking coal from Mongolia in the first two months of 2019, up 44% on the year, according to Chinese customs data.

China’s import restrictions
While the buying restrictions in the final three months of last year came in the form of buyers having exhausted their annual import quotas, fresh hurdles targeting Australian coal emerged this year.

Neither countries has officially confirmed these restrictions, which entail an extended customs clearance process, among other things.

China is Australia’s largest trade partner, and accounted for 22% of Australia’s earnings from coking coal exports last year, according to a report published by the Australian government earlier last month.

Many market participants believe that tensions between Australia and China are behind the latest unofficial restrictions.

This would not be the first time that geopolitical issues have had such an effect.

Last year, the country put coal on a list of commodities that incur a 25% import tariff as a retaliatory measure to tariffs that the United States announced for some Chinese commodities.

China imported around 2.6 million tonnes of US metallurgical coal in 2017, but last year, volumes dropped 23% to 2 million tonnes, according to data tracked by Fastmarkets MB.

Should US-China tensions ease, market participants are expecting Beijing to stop taxing US coal imports, but this remains conjecture at this stage in the absence of anything official.

But even under normal circumstances, China does not import that much coal from the US due to its quality and logistical considerations. Any recovery in US supply to China is unlikely to make up for the latter’s need for coal that is on par with Australian materials.

China bought around 30 million tonnes of Australian coking coal last year, which accounted for nearly half of its overall import volume, according to data tracked by Fastmarkets MB. For this reason, any restriction by China on Australian imports is significant not just for Chinese buyers but the wider seaborne market.

Some market participants expect Chinese buyers’ “inability” to procure Australian coking coal to weigh on prices.

Several buyer sources in China have indicated that they have reduced their long-term contracted volumes with Australian producers this year amid uncertainties over Chinese policy.

And if sellers have more cargoes to offer on a spot basis, this could put pressure on prices, market sources pointed out.

But this does not necessarily mean that buyers’ overall import volumes will be lower than last year’s. While China’s restrictive policy is being adhered to by state-owned companies, privately owned ones have managed to get around it, according to Chinese and Australia sources.

Interestingly, last year’s average price increase also came amid lower imports by China, the world’s biggest buyer of seaborne coking coal. The country imported 65 million tonnes last year, down 6% year on year, according to data published by the Australian government.

As such, it would be simplistic to say that Chinese import restrictions will only weigh on prices for seaborne coking coal.

There is also the matter of quality when it comes to seaborne supply.

In the absence of suitable alternatives in China’s domestic market, Chinese steelmakers are unlikely to cut their imports of premium low-vol coking coal import from Australia.

According to Fastmarkets MB data, such materials accounted for nearly 80% of all transactions concluded in the spot market on a fixed price basis in the first quarter of this year, up from around 55% in the same period last year.

China accounted for the bulk of the spot market trades in both periods.

While government policy in China may partly determine Chinese buyers’ procurement strategy this year, there are also other considerations.

Other factors
The price gap between seaborne coking coal and domestic materials in China often determine the procurement strategies of Chinese buyers of the steelmaking raw material.

Prices for domestic materials are often dictated by the level of safety and environmental scrutiny on the mining sector as well as weather-related factors that typically come into play during winter.

The flow of Mongolian coal into China also affects the domestic market, with the landlocked country selling almost all of its exports to Chinese buyers.

Term contract prices for domestic materials in China have stayed stable since the start of the year. Shanxi Coking Coal Group - the country’s biggest producer - has not making any price adjustments despite the lowering of China’s value-added tax to 13% from 16% on April 1.

Sources say the stable domestic prices have sustained interest among Chinese buyers for seaborne cargoes in recent weeks.

Another variable to consider when projecting demand for coking coal in China is coke margins, according to Alona Yunda, a senior analyst at Fastmarkets MB’s research division.

Historical data suggests that wider coke margins often encourage integrated steelmakers to buy metallurgical coal and produce their own coke, rather than purchasing the latter.

Wider coke margins also prompt merchant coke producers in China to produce more to capitalize.

Therefore, when coke margins widen, coking coal imports tend to rise as well.

Coke margins in China fell to historical lows in the first quarter of this year, but have started to widen since the second half of April.

Fastmarkets MB estimates that the margin in China’s domestic coke market fell to a year’s low of $39 per tonne in the first quarter. In the first week of April, the margin hit a low of $21 per tonne.

Levels below $40 per tonne are deemed as unsustainable.

Margins have started to bounce back, however. They widened to $32 per tonne in the week ended April 19.

This growth will likely boost coking coal imports further, unless restrictions at Chinese ports are sustained or tightened.

In the longer term, China’s environmental policy may also have a greater impact on its coking coal consumption in line with Chinese steelmaker’s preference for higher-grade iron ore, which cuts their need for coke in the operation of their blast furnaces.

Environmental considerations could also change the structure of the country’s coke industry in the coming years, with small coke ovens expected to give way to larger, greener operations on the coastal regions.

Both these factors are expected to facilitate China’s uptake of high-quality coking coal - which is mostly sourced from Australia - to produce premium coke, make blast furnaces more efficient and reduce emissions in the steelmaking process.

One other factor to consider over the longer term is the potential displacement of iron ore by ferrous scrap as a steelmaking raw material and its impact on coke consumption.

According to Fastmarkets MB’s research analysts, the gap between steel and iron production has in fact narrowed in China so far this year, which leaves less room for the use of ferrous scrap in the steelmaking process.

The iron-to-steel production ratio rose to 84% in the January-March period of this year, up from a cumulative ratio of 83% in the whole of 2018.

With regard to the future of ferrous scrap as the principal raw material in the steelmaking process in China, and the extent to which it can displace iron ore, several uncertainties remain at this stage, such as its cost effectiveness and the technical limitations for its consumption in basic oxygen furnaces.

Supply response
Uncertainties surrounding Chinese policy notwithstanding, there is no denying that the metallurgical coal market is one that runs on a tight rope.

This is largely due to a tight supply-demand balance, with emerging economies such as India and countries in Southeast Asia driving global steel production growth amid limited investment in greenfield coking coal projects in the last few years.

US coal producer Arch Coal said earlier this year that the seaborne coking coal market would require the installation of 10 million tons of new mine capacity annually - or a total of more than 75 million tons between now and 2025 - to meet steelmakers’ growing appetite for coking coal.

This assumption is based on demand for seaborne coking coal rising by 1.5% per year, and an annual depletion rate of 2% for existing mines.

In the wake of 2017’s supply disruptions caused by severe weather in Queensland, Australia, many buyers are increasingly making resource diversification - either by increasing their intake of non-Australian coal or looking for opportunities to invest in mines - an important consideration.

“Buyers have taken note of the problems regarding the reliability of Australian supply following the weather-related and other issues in recent years and have become more receptive of coal supply from North America,” a buyer source in India said.

“US suppliers have made particular inroads into the Indian market in recent years and their coal is giving Australian materials competition,” he added.

US metallurgical coal exports to India stood at 5.1 million tonnes last year, up 44% year on year. In the same period, India’s intake of Australian met coal rose by 12% to around 30 million tonnes.

US met coal exports have hovered around 50-55 million tonnes over the past few years. While they rose last year to 55 million tonnes, they are slated to return close to the 50-million-tonnes mark this year once prices retreat and with investment in new projects remaining at a minimum.

The high cost of production in the country and the volatility of seaborne coking coal prices amid the current health of the global steel industry are deterrents for investors to commit to funds.

Canada faces the same situation, with met coal exports staying around 30 million tonnes over the past five years, based on data published by the Australian government.

Top Canadian producer Teck Resources said earlier this year that the value of its existing steelmaking coal assets was likely to increase because capital markets were rationing capital to coal, which, although is directed at thermal coal, also affects steelmaking coal as well.

New projects have cropped up recently and some are on the anvil, though most of them are still located in Australia. But those catering to the premium hard coking coal segment remain scant.

“While the current price levels for coking coal are above the incentive prices for a number of projects, the truth is that greenfield projects do not crop up overnight,” a marketing manager at a trading firm said.

“Most of the supply response we have seen has been on bringing back projects that were in care and maintenance or previously idled mines such as those in Canada,” he added.

Looking ahead
As with most commodities, China and its policies will continue to have a significant role in shaping the global coking coal market in the years to come, though India is swiftly rising in stature as a key buyer of the steelmaking raw material.

A consolidation of the Indian steel industry and buyers’ eagerness to establish stable supply channels are also likely to shift miners’ focus to this growing market in the years to come, especially amid falling shipments to China.

Sophie Zhao in Shanghai contributed to this article.

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