Commodities | Nov 03 2006
By Chris Shaw
When Gloucester Coal (GCL) reported some exploration success likely to be enough to allow the company to increase production by as much as 40% by 2009 its shares naturally moved higher, but such stock specific news disguises what appears to be a more difficult outlook for the coal sector generally.
Wesfarmers (WES) management touched on the issue when confirming at their recent annual general meeting earnings this year were likely to be lower given lower coal division earnings, though the company pointed out as negotiations for the upcoming Japanese financial year have not yet started it is too early to get a feel for how prices might settle.
Deutsche Bank is firmly of the view the direction of prices will be down, as it notes recent spot contracts have been settled at prices below this year’s contract prices.
It puts much of this down to the Chinese, as figures showing a decline in imports of more than 42% for the year to date suggest greater self-sufficiency in terms of metallurgical coal needs. This is impacting most on Australia and Canada, as of the reduction in imports of 2.5 million tonnes this year 88% has come out of the export figures of these two countries.
It is also having an impact in other markets, as with Chinese domestic production increasing it is looking to export excess production, which is putting renewed pressure on markets such as India as the additional supply is reducing market tightness and so relaxing the upward pressure on prices.
UBS notes supply is also increasing generally as three significant new mines will come on stream in the lead-up to the contract negotiating period, the broker suggesting these new producers are likely to be more interested in locking in contract volumes at the expense of prices.
Last month ABARE (the Australian Bureau of Agriculture and Resource Economics) forecast coal prices would move slowly lower over the rest of this year before falling further next year, though it noted the price weakness would not be as a result of lower demand.
It expects thermal coal trade will increase by around 5% this year to 601m tonnes, with a further 3% increase in 2007 to 619m tonnes. Supply then is clearly the issue, the group expecting increased production from major producers such as Indonesia, Australia, South Africa and Colombia to offset any upward pressure on spot prices.
Some attempts are being made to address this, as US producers have recently announced production cuts of around 35 million tonnes out of total output of around 1.1 billion tonnes last year, but such cuts are unlikely to affect the current supply issues.
As a result, the group expects prices next year will fall below current levels of US$52.50 per tonne for PCI coal. UBS’s forecasts are not far away from this, the broker recently cutting its PCI coal forecasts for the next two years to US$55.00 per tonne from US$65.00 previously.
GSJB Were also expects prices to move lower, particularly for non-premium coals given the re-classifying of coal grades. Deutsche also sees this as a key risk for the sector, noting there remains potential for further re-classification of grades following the re-introduction of a standard grade this year.
The broker notes this was most painful for the PCI and semi-soft producers rather than the hard coking coal producers, but it sees equal risk in terms of the outlook this year. This reflects changes to blends being used in furnaces, as more high grade coal is being used.
Leading into the price negotiating period the broker is forecasting prices of US$94 per tonne for premium hard coking coal and US$85 per tonne for standard grades for Japan’s FY07.