Commodities | Oct 14 2014
-Where is the floor in thermal prices?
-Will China extend tariffs to iron ore?
-Downside risk for Aust volumes
-Coking coal market also weak
By Eva Brocklehurst
Thermal coal prices are depressed. Very depressed. Deutsche Bank believes the price will test US$60/t over the next three to six months. The Chinese domestic price now strongly influences the seaborne price and, as China seeks to impose import tariffs, this will add further downside pressure. Nevertheless, the broker maintains weakness among producer currencies – such as the Australian dollar – are the bigger threat. Once these two negatives filter through Deutsche Bank believes a floor to seaborne prices will be found, and a break below US$60/t should instigate the necessary production cuts. At that point it will be the better time to entertain investment in thermal coal equities again, in the broker's opinion.
Even before the tariffs were mooted, Chinese coal demand and strong domestic supply growth had affected the seaborne market and Deutsche Bank suspects Chinese demand is unlikely to change in the near term. Therefore, the last thing any coal producer would have asked for was an import tariff. Now they have them. Deutsche Bank considers the relative winners are Indonesian producers, by virtue of a trade agreement with China, while the tariffs are to the detriment of Australian, Canadian and Russian producers.
The broker expects a further US$5/t downside risk in thermal coal pricing and as margins are already narrow this means a further 100mt of production is at risk. This should be enough to trigger supplier discipline and stabilise prices. Cost cutting and weakening producer currencies have led to a fall in margin costs and this has also pressured the price. The broker calculates the impact from the Chinese import tariff is around US$2/t while the impact from the weaker currencies against the US dollar is likely to be US$3/t.
Reports suggest the import tariffs will be 6% for thermal coal and 3% for metallurgical (coking) coal, with 5% for "other" coals. Citi notes previous tariffs at similar rate were phased out in 2005-7 and the tariffs are a main negative for North American coal producers. The broker believes, all else being equal, the tariff should initially lower Chinese demand for imports. The question Citi asks is, if the tariff does not achieve the intended goal of protecting local producers and raising domestic prices what extra measures will be forthcoming? It also raises the question of whether China would extend tariffs to iron ore, as many domestic producers are also suffering from multi-year lows in pricing and are calling for a reduction in high cost supply to make room for imports of new lower-cost production from Australia.
The news was more bearish than UBS expected for thermal coal, having forecast that China would impose a 3% tariff. Production cuts announced in early August were modestly bullish for Chinese domestic coal prices but UBS suspects this may not translate to seaborne markets because of other policy changes. Firstly there is a central directive to curb imports and, secondly, minimum coal quality specifications, which will impact some seaborne coals. The most bullish aspect UBS can find from the news is that Indonesia's new trade policy, which requires all coal exporters to have an export licence from October 1, has not yet caught up with all exporters and this may lead to a short term disruption and reduction in volume from the world's largest thermal coal exporter.
The degree to which the seaborne coal price is impacted – and recovers – depends on the pace of demand growth in China's economy. Commonwealth Bank analysts note power demand and, hence, thermal coal demand have slowed recently. If this continues, the new import tariffs are not necessarily guaranteed to drive domestic prices higher and therefore improve the financial viability of the Chinese coal mining sector. Australia exported 25% of its thermal and coking coal to China in the year to August and, should all these coals attract new tariffs, CBA analysts envisage downside risk for Australian coal export volumes and prices. The analysts estimate 31mt of Australian coal exports would become cash-flow negative with the tariff, and 30mt of this is thermal coal.
Macquarie estimates that the coking coal market, despite a number of capacity cuts, is still oversupplied. Rebalancing is a slow process and the broker expects that, despite a weaker Australia dollar, underlying fundamentals are weak. Most of the pain of cutting production is being felt in North America, where producers are at a significant freight disadvantage shipping into Asia. Nonetheless, Australian mine ramp-ups outweigh the 6-7mtpa cut to production that has occurred. Longer term, for metallurgical coal, the story is more positive. Macquarie is not sure what price level will be needed to bring more supply into the market but suspects a contract price of US$155/t. In nominal terms the broker does not believe this will happen before 2017.
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