Coal news and updates

Miners brace for fall in ore, coal prices as volatility set to return

THE normally volatile iron ore market has been eerily stable at an elevated level for the past six months, but a break appears imminent with prices set to drop below the $US130-a-tonne mark.

The fall may be accompanied by the resumption of volatility in the market. The price has been trading within a tight range covering not much more than $US5 since August, while price swings of $US20 and more within a month or two have been common in the past.

Share prices of the big three miners, BHP Billiton, Rio Tinto and Fortescue Metals, have all been under pressure over the past week as investors brace for a market slide, with Fortescue shedding 9 per cent.

The fate of the iron ore and coal markets will have a big influence on Australia's economic performance over the year ahead, shaping national income growth and the government's budget outcome. They account for almost half Australia's export revenue between them.

The long-term outlook must be for a return to earth for iron ore prices, which still deliver gross profit margins to Australia's miners of 100 and 200 per cent, but prices may be firmer for longer than markets expect. The market forces are different for iron ore and coal.

China has the largest iron ore industry in the world, but still depends upon seaborne trade for 70 per cent of supplies to its steel mills, with the lion's share provided by just four companies  from Australia and Brazil. China has long railed against what it sees as a monopolised market. The suppliers do have some discipline, but China's real beef has been that it does not control the market.

In coal, where China is self-sufficient for as much as 90 per cent of its coal supplies, it has much greater leverage over the price. ANZ commodities analyst Mark Pervan says this is not enough to stop prices soaring when, as in 2011, floods in Queensland halt shipments. Australia provides 55 per cent of the seaborne coking coal.

Whereas iron ore suppliers are able to cut back output when market conditions soften, the multitude of coalminers are under much greater pressure to keep operating at full tilt regardless. Unlike the iron ore miners, they do not control their rail and port facilities and are commonly locked into take-or-pay contracts with these suppliers. They are operating with thin margins anyway.

Coking coal prices have fallen from $US152 to $US134 since early last month as the Chinese steel mills seek to push the impact of softening steel prices back on to their suppliers. Coking coal prices have fallen by 60 per cent from the peaks of two years ago, while thermal coal prices have also come back sharply.

The strength of iron ore prices in the latter half of 2013 was a surprise to the iron ore companies as much as to investors and the government. China's steel output traditionally softens towards the end of the year, while Australia's supplies to the market were rising by about 40 million tonnes, or double the historic rate of growth.

Pervan says the market strength and the lack of volatility was entirely due to Chinese mills and traders rebuilding their stocks. Volatility was suppressed by traders entering the market every time the price dipped. But, as the chart shows, stocks are now back to average levels. The price got to within a whisker of $US140 four weeks ago, but was down to $US131 by the end of last week.

China's steel prices are falling, having come down by about 7 per cent since late December, and mills are trying to push this back on to their suppliers by stopping their accumulation of stocks.

However, the short-term pressure around Chinese New Year, which begins at the end of this month, does not mean that the end to the super-profits of the iron ore miners is nigh. It is possible that Chinese demand will remain stronger and the build-up of fresh supply will be slower than currently expected.

Some of the nervousness around Australia's economic outlook turns on predictions of a slowdown in China. The authorities have set a target GDP growth of 7.5 per cent, which represents a marginal reduction from 2013's estimated 7.7 per cent. Analyst concerns centre on efforts to control local government debt, which will dictate tighter monetary policy and limits on government spending. This could have deeper impact on growth than the government expects.

There are also lingering concerns about financial stability. The explosive growth of credit in response to the 2008-09 financial crisis has left a trail of non-performing debt that has yet to be brought to book. The relatively unregulated "shadow" banking sector acted as a multiplier to that credit surge. Spikes in short-term cash rates late last year highlighted the vulnerability of China's financial system.

However, just when these issues might come to a head is beyond the realm of forecasts.

The moderation of China's growth has so far been remarkably smooth.

Last year's slowdown still brought growth in steel production of 11.7 per cent. Although the government would like to see growth being driven more by consumption and less by investment (and hence less steel consumption), this is not yet occurring. It is possible that the year ahead will bring similar rises in steel output.

Supplies are also expected to rise strongly. Pervan estimates that Australian iron ore miners will ship about 625 million tonnes of ore this year, which would be 40 million tonnes more than in 2013. The Bureau of Resources and Energy Economics is tipping a much larger increase of 128 million tonnes with shipments of 709 million tonnes this year. Pervan says increases in mine capacity are not being matched by rail and port capacity and says expansions will be slower to come on stream than expected.

There will be little additional supply from Brazil this year, with currency and credit conditions having interrupted expansion plans. Pervan says the real key to prices will be what happens to the high-cost Chinese production. Over 2013, China lifted its own output by 3 per cent. When the Chinese start cutting their own production, shutting their highest-cost mines, prices will start to move decisively lower.

In the meantime, Pervan forecasts a price fall of about 8 per cent this year to about $US124 a tonne, although he cautions this is an average that could be accompanied by some much deeper dips. Even with its forecast massive rise in shipments, BREE expects the average price would still be $US119 a tonne.

Source: The Australian