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Iron-ore and coal prices go separate ways

Mining Firms Nurse a Hangover as Volumes Exceed Demand

Prices of the key ingredients in steel production—iron ore and coking coal—are moving along sharply different paths, as mining companies resist cutting coal output despite the market being awash with the raw material.

While iron-ore prices have risen 22% since May, coking coal is still searching for a rebound. Coking-coal prices are off more than 4% over the same period.

For steelmakers that endured falling profits when commodity prices ran hot two years ago, the price split is good news as each ton of steel requires about 1.5 tons of iron ore and 600 kilograms of coking coal. China is on course for another year of record steel production, with supply directed to the construction of high-rise apartment buildings, the manufacture of luxury cars and other uses.

But mining companies that placed bold bets on coking coal by investing billions of dollars to build new mines or expand existing pits in countries from Australia to Colombia are nursing a hangover as demand struggles to keep pace with the extra volumes traded globally.

"There is simply too much coal on the market," the International Energy Agency said in a report this week.

According to IEA Executive Director Maria van der Hoeven, this isn't likely to change any time soon. In a speech in Paris on Monday, she said as much as 500,000 tons of annual coal-production capacity could be added every day for the next six years unless mining companies opt for cutbacks. The estimate includes both coking coal and thermal coal used in electricity generation.

Shipments of steelmaking coal from Australia—the world's biggest exporter of the commodity—are forecast by the government to rise to 178 million tons in 2015 from 145 million tons last year. Most of these cargoes head to China, which accounts for 60% of global demand.

Among the biggest contributors of new supply is likely to be a joint venture between BHP Billiton BHP.AU +2.49% and Japan's Mitsubishi Corp. 8058.TO +0.21% , which expects to start production at its US$3.74 billion Caval Ridge mine in Queensland state next year. That investment was approved in November 2011, when coking-coal prices were nearly double current levels.

The benchmark price for Australian hard coking coal fell to a four-month low of $121.10 a ton, more than 20% lower than the start of the year.

"Demand has in fact been strong, but it has been overwhelmed by supply," said Tom Price, a Sydney-based commodities analyst at UBS.

In contrast, global iron-ore exporters are struggling to increase output in areas other than Australia's remote Pilbara region, supporting prices of that commodity. The spot price of iron ore climbed to nearly $140 a ton earlier this month, a four-month high, according to the Steel Index, a data provider. Prices have since eased a bit, to $134.30 a ton, but remain well above the consensus forecasts of analysts at the start of this year.

Shipments from India, which was the world's third-largest iron-ore exporter until two years ago, have virtually dried up because of court-imposed mining restrictions. Exports from South Africa and Canada have stagnated as reserves are depleted, while Brazil isn't likely to contribute much in the way of new exports until Anglo American AAL.LN -0.27% PLC's delayed $8.8 billion Brazilian Minas Rio project starts up toward the end of next year.

At the same time, steel mills in North Asia have been rebuilding iron-ore stocks before sea routes start to ice over in winter.

One option for coal miners is to scale back production to ease the supply glut, but that isn't always easy to do.

In Australia, many miners are locked into so-called take or pay contracts with rail and port operators. Coal producers agreed to long-term deals to lock in space at export terminals when the coal industry was booming, but it means they would now need to pay for access even if they were to cut production.

According to Justin Smirk, a Sydney-based analyst at Westpac, WBC.AU +1.93% about 20% of all seaborne coal sales are being made at a loss.

"The recent fall in Australian prices suggests we need to see a further rebalancing in metallurgical-coal supply before prices can recover in any meaningful way," he said.

BHP Chief Executive Andrew Mackenzie said Chinese production has also been surprisingly strong this year, capping any recovery by coking-coal prices.

Many analysts don't expect coking-coal prices to rebound for at least another 12 months, amid continuing supply concerns. RBC Capital Markets expects coking-coal prices to average $154 a ton in 2014, down from $159 a ton forecast for this year.

Instead, they see more chance that iron-ore prices will come down more sharply. RBC predicts an 11% fall in iron-ore prices next year, as new supply from Anglo American's Minas Rio project and mines owned by Fortescue Metals Group Ltd. FMG.AU +2.32% is added to the market. UBS is even more bearish, predicting iron ore will fall below $100 in the second half of 2014.


Source: The Wall Street Journal