Coal news and updates

Thermal coal stands as a leading indicator to equities

The economic slowdown in China is real, and the recent fall in thermal coal prices has shown this. Platts assessed the European CIF ARA Cal-16 contract at $51.30/mt Monday, down $2.35 on a week earlier and the lowest for a year-ahead contract since Platts began forward thermal coal assessments in 2007.

*The thermal coal market foreboded the recent collapse in the equities market, which further exacerbated the weakness in the product.

*Physical thermal coal prices reacted in line with the slowdown in the real economy, that later was reflected in non-commodity financial markets.

*While risk continues to be weighted to the downside in coal, the market is likely to grind lower as the cost of extraction gradually reduces with weakening crude and producing-nation currencies, against a backdrop of weak global demand. Delivered European prices have the potential to reach approximately $40/mt in the medium term (6 months). The market is likely to layer off short positions during the period of decline, and as it approaches the floor, there is a high chance volatility will subside.

*The risk to the upside on the back end of the CIF ARA curve comes primarily from shocks to oil prices and macro developments that can set off short-covering rallies on the back end, giving opportunities for selling timespreads where appropriate on the curve.

Chinese thermal coal imports have been slowing sharply, indicating weakness in power generation and in turn power demand in the industrial sector. Equity markets picked up the signals when official industrial production data was released, but the signs were obvious before. Utilities have seen a decline in demand from the export-driven manufacturing sector, and as a result have needed to build thinner forward coal books. The extent of the drop in the raw material demand was made public, yet the signal it gave out regarding the health of the economy appears to have been underestimated.

Devaluation in the currency market would eventually have helped exporters, but instead, the selloff in equities that ensued reflected global sentiment in relation to Chinese growth numbers over the real material impact the currency revision was intended to have. Sentiment-driven selloffs usually lead to increased volatility as they tend to be short-lived until asset classes come to terms with the new, "real" Chinese economic numbers.

The interest rate cut in China -- yet another tool the government is using to stimulate growth -- may help industries in the short term, and the government has enough headroom to further cuts. Furthermore, government has enough headroom to additional cuts which could stem losses in the coal complex. As seen today, this will ameliorate sentiment in the international market, but for coal imports in China (that have dropped 40% year on year) to rebound to even last year's level, far more than 25 basis points would have to be shaved off the headline rate.

Weakening of emerging markets currencies against the US dollar may put pressure on dollar denominated thermal coal imports, as seen with India and some Southeast Asian countries. As a consequence, deferral of long term fixed-price physical supply deals until currency crosses stabilize may become increasingly important, which can intensify the bear run in the Asian thermal markets, especially with Indian bids backing off as traders attempt to pick the bottom. The recent low experienced in the South African Richards Bay 6,000 kcal/kg NAR market attests to this trend.

Meanwhile, weakness in currencies of key exporting nations including Colombia, South Africa, Indonesia and Australia is likely to lower the cost of production domestically, thereby potentially accentuating the oversupply in the market. This is likely to cause a downward spiral in prices, until a floor is reached.

The elusive "floor" has been a subject of debate as the market consistently broke almost every estimate on the street, as prices grinded lower. What we do know is that from current levels, there is a declining marginal impact of every unit of weakening in exchange rates on the cost of production. Operating margins can be cushioned only so much by declines in the currency value and in oil prices, as we move towards the intrinsic value of the commodity and plus its most "basic" extraction and freight costs.

As mentioned in the "UK Power Pilot," The Colombian producers can push their marginal cost of production to the low $30s/mt on an FOB basis, adding freight to which can set the delivered price into Europe at close to the low $40s/mt. At this price, the Russian exporters will likely start struggling to push more spot tons into Europe unless, based on historical correlations, the Rouble weakens by at least 10% against the US dollar and Brent crude trades down to the high $30s/bl. It is noteworthy that in many cases, over 50% of the delivered cost of Russian coal is attributable to oil prices.

Meanwhile, as the coal market has built more shorts over time and as the grind lower continues, it may require either a fundamental jolt at best or an excuse at least to enter into a short-covering mode. The susceptibility increases as prices decline slowly, approaching the floor.

source: http://www.platts.com