FOCUS: Coking coal prices rally on supply jitters, healthy demand

Seaborne coking coal prices rose to their highest in over two months last week - on Monday June 11, Metal Bulletin’s fob Australia Premium Hard Coking Coal Index was 35% higher than where it was a year earlier - with supply concerns emerging as a key factor affecting the outlook for the market.

Changes made by Queensland’s rail freight operator Aurizon to its operational and maintenance practices have been flagged by the market as a major cause for uncertainties over supply in the coming months.

While Aurizon had highlighted these changes as early as February this year, concerns have been magnified recently because of rising expectations that coal throughput on the main Goonyella rail line in Queensland, Australia, may be affected in the near term.

Metal Bulletin looks into the impact this has on the seaborne coking coal market.

Revenue cap
The change in Aurizon’s operational and maintenance practices relates to the Queensland Competition Authority’s draft decision of an “Access Undertaking” that proposes a maximum allowable revenue of A$3.893 billion ($2.975 billion) for Aurizon over the 2017-2021 period - A$1 billion below the projected revenue proposed by the rail freight operator.

The Access Undertaking is a rule book that governs the Central Queensland Coal Network that is updated every four years with input from stakeholders across the coal industry.

The Queensland Competition Authority is a government-appointed regulator and its role, in its own words, is to “ensure monopoly businesses operating in Queensland, particularly in the provision of key infrastructure, do not abuse their market power through unfair pricing or restrictive access arrangements.”

Aurizon is Australia’s largest rail freight operator and the Central Queensland Coal Network that it operates accounts for the bulk of Australia’s coking coal exports because it connects Queensland’s mines to the ports. Queensland exported some 151 million tonnes of coking coal in 2017.

Aurizon has said that competition authority’s proposed maximum allowable revenue “does not promote the economically efficient operation of, use of and investment in, the [Central Queensland Coal Network]; nor does it appropriately recognize the operational and other risks associated with the [network], in particular, exposure to international demand and coal prices.”

The draft decision also includes a proposal by the authority calling for the reduction of A$104 million in maintenance allowance for the rail freight operator.

While the final decision on this maintenance allowance as well as the maximum allowable revenue is still pending, Aurizon has already started implementing changes to its operating practices on grounds that the final decision will be applied retrospectively from July 1.

Aurizon’s changes

According to Aurizon, in order to meet the Queensland Competition Authority’s requirement of earning A$1 billion less in revenue over the 2017-2021 period, it would need to reduce the coal throughput on its rail network by up to 20 million tonnes per year.

The estimated split of this reduction across the Central Queensland Coal Network’s four rail corridors is: Goonyella, by up to 10 million tonnes per year; Blackwater, up to 8 million tpy; Moura, up to 1.5 million tpy; and Newlands, up to 0.3 million tpy.

In February this year, miner Wesfarmers had warned that rail availability “in particular” would be a factor affecting the sales volume from its Curragh coal mine in Australia in the second half of its financial year ending June 30.

Lower allocation of track availability on the Blackwater line in Queensland had resulted in a drop of second-tier spot tonnages, market participants said earlier this year.

But the market only started taking greater notice of the potential impact of Aurizon’s decision to lower throughput in recent weeks when expectations emerged over train cancellations on the Goonyella line.

Goonyella connects Queensland’s Dalrymple Bay, Hay Point and Abbot Point terminals to coal mines operated by the BHP Mitsubishi Alliance (BMA), Glencore and Peabody, among others.

“This was always going to happen but the market ignored it when only the Blackwater line was affected. With ballast cleaning moving to the Goonyella line, the market started to take notice,” a miner source said.

Another miner source pointed out that the Goonyella line typically operated at capacity, which means any cancellation on that system cannot be made up for later.

“This was apparent, for example, during Cyclone Debbie last year when supply bottlenecks spilled over to the entire year due to the suspension of operations on the Goonyella line in April,” he added.

The first miner source said that routes were “being closed around maintenance schedules and the time taken for maintenance works has also increased, and that is creating throughput bottlenecks.”

But a third miner source admitted that it was not clear what Aurizon’s 20 million tonnes of throughput cut per year would actually amount to.

“Does it mean nominal capacity or does it mean loss of contracted volumes?” he said.

What can buyers do?
A buyer source said that while any disruptions to Australian supply remained the single most important supply-side factor affecting the seaborne coking coal market, end-users are better prepared to deal with them now, having made efforts to diversify the sources of their raw material needs since last year.

“The availability of cargoes from North America, for example, has been rising since last year so there are options for end-users in case a major Australian supply disruption occurs,” a buyer source in India said.

Another buyer source in the South Asian country said that he and a number of his peers were treating the Aurizon issue like a weather event.

“It is highly unpredictable and we will deal with it when the situation materializes. At the moment, our term contracts are being serviced and we are able to buy spot cargoes from traders so there is little more to do in terms of strategizing for the potential loss,” he said.

Japanese steelmakers that procure a significant proportion of their seaborne coking coal from Australia have asked the Queensland government to resolve the issue as soon as possible.

“It is true that suppliers are being conservative on July and August tonnage estimates amid the uncertainties surrounding rail capacity, but they will prioritize term shipments and those should not be affected,” a buyer source in Japan said.

Apart from being the largest coking coal supplier in the world, Australia also has qualitative and geographical advantages over competing producers such as North America and Mozambique, which makes it hard for end-users to substitute Australian volumes.

“We are limited by the technical capabilities of the blast furnace and cannot change our coal blend easily, though the frequent interruptions to Australian supply is encouraging us to ramp-up alternative supply in our portfolio,” the source in Japan added.

Another buyer source in Southeast Asia whose exposure to the spot market is limited says that the mill he works for is planning to try out coal from North America this year amid its push to ramp up its steel output.

“Australia has had a lot of supply issues recently and while it is true that quality and freight remain challenges for us if we procure cargoes from other countries, we are keen to give it a try, especially since we are increasing our downstream output,” the source said.

Meanwhile, a buyer source in north Asia said that while his suppliers have confirmed that they would meet all their contractual obligations, rising spot prices in recent weeks might affect their quarterly negotiations.

“Term contracts are ultimately agreed based on spot indices or negotiated with a reference to spot indices during the negotiations. The current rally in seaborne prices may influence our negotiations for the July-September period,” he added.

Interestingly, it was the disruption to Australian supply last year that led to a change in the quarterly pricing mechanism for contract cargoes between Japanese steelmakers and miners – the two sides adopted a formula that involves pricing their quarterly volumes on the average of a basket of indices that track spot prices.

Incidentally, Metal Bulletin has a set of indices that track fixed-price transactions in the spot market. Any spot supply tightness typically results in higher transaction prices, which in turn drive these indices higher.

Metal Bulletin’s fob Australia Premium Hard Coking Coal Index has already gained 4.5% so far this month amid robust buying activity among traders and Chinese end-users.

The transaction-based methodology of Metal Bulletin’s indices minimizes the influence of “sentiment” in the calculation of the final numbers, with confirmed trades being assigned the highest tonnage weighting during the calculation process; non-transactional data is assigned the minimum tonnage weighting.

One of the seller sources also pointed out other factors lending support to the recent price gains, such as the strength in the downstream Chinese market and Indian restocking demand ahead of the peak monsoon season over the July-August period.

Additional factors
In China, a government clampdown on pollution, which has significantly restricted coke production, has resulted in a price rally for the steelmaking raw material. Metallurgical coke prices in China have risen by 550 yuan ($86) per tonne since May.

This has in turn led to prices for domestic coking coal in the country rising as well, a situation that has made Chinese buyers more willing to pay more for cargoes in the seaborne market

Metal Bulletin’s assessment of domestic prices for coking coal in China stood at 1,360-1,800 yuan per tonne per tonne last Friday, unchanged since May 18. This is just 150-210 yuan per tonne below February’s multi-year high of 1,570-1,950 yuan per tonne.

“Top-quality materials have room for further rise as domestic supply is tight, especially for low-ash and low-sulfur materials,” a buyer source said last Friday.

A Chinese trader source said that long vessel queues at Queensland’s ports, fewer offers in the spot market and the willingness among buyers in China to accept higher-priced imports were all contributing to the rise in seaborne transaction prices.

“There were some weather-related disruptions as well this year so it is really difficult to say that the rail capacity issue is the only factor behind the recent rally in prices,” one of the seller sources said.

A Chinese coke producer source meanwhile said that prices of the steelmaking raw material might retreat by the end of the month once restrictions imposed by the government to cut pollution are eased.

“There is definitely appetite among Chinese buyers, even at the current seaborne price levels of around $200 per tonne cfr China, but we have decided to hold off from buying in the spot market to gauge if the rally holds steam,” he added.

A third Indian buyer source added that while there was some appetite for spot cargoes in the South Asian country, the approaching monsoon will soon wipe that demand out.

Looking ahead

Aurizon has so far not indicated any changes to its guidance of a reduction of 20 million tonnes per year of coal throughput, though the competition authority is consulting with stakeholders on the rail freight operator’s maintenance allowance and practices.

Signs of a resolution came to the fore earlier this month, however.

Responding to the Queensland Competition Authority’s consultation paper, the Queensland Resources Council said on June 1 that “that there is a A$73-million difference between the direct maintenance cost allowance sought by Aurizon and that which was considered prudent by the [competition authority] in its draft decision.”

The council added that subject to further information provided by Aurizon, it would be supportive of an increase in the rail freight operator’s maintenance allowance.

On the same day, the Queensland Resources Council said that “Aurizon should cooperate with the Queensland Competition Authority, immediately resume its normal maintenance program on the Central Queensland Coal Network and end the coal export impasse it started.”

Market participants have also said that a lot is at stake for Aurizon, Queensland’s miners and the consumers of Australian coking coal should the state’s coking coal exports drop. Monetary loss will be instrumental in determining a resolution, they said.

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