As US Producers Pull The Plug Will Coal Prices Go Up?

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-Australia still pushing out coal
-Coking Coal price reaching a low
-Upside likely to be modest
 

By Eva Brocklehurst

To Morgan Stanley the pain for metallurgical (coking) coal producers is starting to show. Metallurgical coal prices received a boost mid April when a major US producer trimmed output, citing poor prices. The dominos are falling as several producers shut down mines (one filing for bankruptcy). This should underpin pricing, in the broker's view, as the threshold for producer tolerance has clearly been reached.

UBS observes James River Coal's filing of Chapter 11 provisions in April was a watershed for North America's metallurgical coal industry. This triggered a range of production cuts among several producers that together promise to remove up to 14mtpa of mixed product supply. Such is the case that this could switch UBS analysts' current forecast trade surplus to a deficit and create upside risk for prices. UBS has been expecting production cuts in the US for some time, as these producers are among the highest cost coking coal sources in international trade. The miners have resisted cuts for some time as support from the domestic debt market and rail services has preserved the trade.

To put the US cuts in perspective, UBS forecasts a 0.6% fall in 2014's global trade demand, to 322mt, with a 15mt fall in China's imports from the record high of 75mt in 2013, as domestic supply displaces imports. This will offset a 10mt lift in Indian imports to almost 50mt. For 2014 international trade supply the broker expects a 1.5% lift to 330mt – revealing a shallow surplus of 8.4mt. This includes a reduction of 9mt from the US, as Canada's trade holds.

Flagship prices of the global metallurgical coal trade are Queensland's low volatile hard coking coals (HCC) and the June quarter contract price is US$120/t FOB. So, will the price move up? If all US supply were to be cut from international trade – an unlikely scenario according to UBS – then the price would just move to the next marginal cost block – equating to US$125/t FOB Australia. So production cuts create upside risk but actual price hikes face several short-term constraints, in UBS' view. One is the ongoing rapid supply growth at BHP Billiton ((BHP)) -managed Queensland mines and robust supply growth in China's domestic industry. Another is seasonal abatement in Asian steel production after the region's May holidays. UBS expects any short-term recovery in the price will only be a small positive earnings driver for BHP, Rio Tinto ((RIO)) Anglo American, Peabody and Whitehaven Coal ((WHC)).

Macquarie estimates the North American production cuts total around 11mtpa and also thinks spot price risk is starting to skew to the upside. The analysts suspect further cuts are required to fully re-balance the seaborne market. The market has not seen a sustained deficit for some years and Macquarie observes the March settlement of Queensland HCC was the lowest quarterly settlement on record. The broker suspected this would trigger the reaction from North America's producers. Macquarie estimates that the US curtailments – consisting of either a complete halt to mining or the sale of cross-over coals into the US thermal market is the situation the other major international producers, namely Australia, were hoping for, as they push tonnage into an oversupplied market.

Another aspect behind the metallurgical coal price weakness is the absence of China. Macquarie concurs with UBS in that, as China is a marginal producer globally, it is able to absorb the market surplus by displacing domestic output and this usually clears the seaborne market. This situation is reversed now and China's absence from the buy side of the seaborne market over the last three months means the market clearing spot price has been pushed lower. Has the price reached a nadir? Macquarie suspects so. International coal prices are at a substantial discount to Chinese HCC and the usual de-stocking that comes after January has slowed substantially. Also, Macquarie's surveys suggest mills are planning to increase purchases going forward.

How long will it take for coking coal prices to recover and how high can they go? Macquarie also thinks the upside remains modest. The reasons are that demand ex China has exceeded expectations and metallurgical coal import growth has exceeded pig iron production growth, although South Korea and Europe have made a strong recovery. This situation the broker thinks is unsustainable.

Moreover, semi-soft sales into the thermal market in the US, and by Australian producers into the seaborne market, are a stabilising factor but it won't take much of an improvement in the metallurgical coal price to reverse this trend. Thirdly, some of the mine closures in the US are not permanent and material can return when the market recovers. The level at which these producers return is likely to define the cap on medium-term price pricing – around US$150-160/t on an HCC adjusted basis, in Macquarie's view. How long it takes to get there is the big question, given the continuing ramp up and productivity gains in Australia and a lingering reluctance in the US for permanent large shutdowns.

One misconception that Macquarie wants to dismiss is that the tight US domestic thermal coal market will result in weaker US thermal coal exports. What happens is that marginal metallurgical coals are the first to be directed into the thermal market. The broker maintains that almost all exported US east coast thermal tonnage is the result of prior contracts, as spot market prices into Europe are not economic below US$85-90/t and the current spot is US$76/t.
 

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