Coal Keeps the Home Fires Burning, at a Price

James O'Connell, Managing Editor, Platts International Coal

The wild ride of 2007 coal and freight prices doesn't show any signs of abating as 2008 nears, leaving consumers coping with historic high costsexcept in the US.

THE UNPRECEDENTED GAINS IN BOTH thermal and coking coal prices, major structural changes in the ebb and flow of supply and demand, particularly in China, and the emergence of Indonesia as the largest exporter of seaborne thermal coal have ensured coal a place in the commodity spotlight in 2008. Coal has become cheaper in Europe and Australia as the US dollar, in which international trade is denominated, took a beating from their currencies during 2007.

The European market has seen prices shift above $110/mt delivered into northwest Europe (CIF ARA) this fall, from $66.50/mt in January, while customers in China are negotiating with producers as far away as Colombia to guarantee not only the last few tons to keep plants running but even medium-term contracts.

Infrastructure and transportation issues continue to arise. Australia's port of Newcastle saw long queues rebuilt, hitting 79 ships in July. Deep in the 2007 fourth quarter, despite reduction efforts, the queue was still hovering around the 40-vessel mark and expected to persist into 2008. A rail wagon shortage in Russia constrained deliveries into Europe and showed no sign of resolution.

The year brought fresh intensity to the scramble for coal reserves, especially in Australia, Africa and Indonesia, with India-, Japan- and China-based power companies leading the charge. That search is expected to gain momentum in 2008.

China's Increasing Appetite

Swiss investment bank UBS said in April, "The inability of the world's largest thermal coal consumers, China and the US, to supply requirements from domestic sources is expected to keep markets tight over the next several years."

The general expectation for the Asia-Pacific annual thermal contract negotiations for 2007 deliveries was a roll-over of terms and conditions; this will almost certainly not be the case in 2008. The current fiscal year contract was settled some $3 higher than in FY-06; FY-08 contracts between Chinese or Japanese consumers and Australian producers are expected closer to $68/mt or even $70/mta near 25% increase.

China's exports have been declining since 2002-03, but the market was taken somewhat by surprise with how swiftly China turned into a net importer.

In the first eight months of 2007, China's coal production totaled 1.47 billion mt, an 11.2% increase from 2006. Official figures show that in August alone, China mined 194 million mt of crude coal, up 8.2% year-on-year. Despite that increase, China's coal imports through August totaled 34.99 million mt, up 51.7% from 2006. But its exports were 33.53 million mt in the period, down 19.8%. What might have been shaken off as a first-quarter anomaly now shows China's shift to a net importer, with a net import balance of 1.46 million mt.

UBS said the shift is not only "occurring much faster than anticipated" but, with China expected to build 300 new gigawatts of generating capacity, much of it coal-fired, "the demand environment for thermal coal continues to look very strong." UBS expects coal to fuel 75% of new generation from now to 2020; capacity is targetted to rise 155% in 2006-20. Coal now provides about 78% of China's electricity.

In October, Iceland's Kaupthing Bank said China would need to import between 150 and 230 million mt of coal by 2010. In the medium to long term, China will look toamong othersMongolia, while in the short term, Indonesia and Australia remain its supply focus.

1. ARA, Richards Bay Coal, 2005-2007

Indonesia's Supply Issues

Dan Brebner, executive director of commodity research at UBS, said the levels of Chinese exports and Asian demand in 2006 "surprised everybody." He said, "Indonesian exports were the key reason we did not see high prices that year. The Chinese have gone from being a very significant net exporter and in 2006 this started to decline dramatically. We didn't really see this hit prices due to the response of supply out of Indonesia."

Indonesian exports to Europe have grown sharply over the last five years and, according to Platts estimates, are on track to far exceed 20 million mt this year. And traders suggest that European utilities' appetites for bituminous coal will continue to grow.

Drax Power, owner of Europe's largest coal-fired plant, announced plans in April to ramp up consumption of Indonesian coal to 1 million mt in 2008 from a standing start of zero in 2007. Indonesian exports to Europe hit 19.6 million mt in 2006 from 9.9 million mt in 2003.

India's overall coal imports from Indonesia rose by 16% for the first four months of calendar 2007, after posting a gain of 15% for the fiscal year through March 2007. India's imports reached an all-time high of 48 million mt last fiscal year, up from 31.2 million mt the previous year, according to official figures, and domestic production is already 31 million mt short of government targets in the first five months of this year. Traders are turning to Indonesia for the shortfall.

Indonesia's export market has seen amazing annual growth since 2000. Before then, exports ran about 60-70 million mt/year. An increase to 88 million mt in 2003 made everyone sit up as did overall production increases of 25%. In 2004, exports rose by 17% to more than 100 million mt, and in 2005, by 22% rise to 125 million mt.

Indonesia has earmarked coal as its major source of future domestic electricity, and embarked on an ambitious crash program to add 10,000 megawatts by 2009, a target most experts do not expect the country to meet.

Indonesia's domestic consumption of coal in 1995 was 8.9 million mt. By 2005, it had jumped more than 450% to 41.3 million mt. Consumption is forecast to hit 94 million mt by 2010 under the crash program. In order for Indonesia to fulfill this increasing appetite and to continue as a main global exporter, Jeffery Mulyono, chairman of the Indonesian Coal Mining Association, has said annual production will be raised to 264 million mt.

Indonesia's crash program is expected to utilize low-quality coals of which reserves are quite plentiful, but analysts suggest that even utilizing those coals could quickly slow export growth.

Asian electricity generators are venturing to Australia, Africa and Indonesia to invest in coal mines. One major 2007 investment was India's Tata Power buying a 30% stake in Bumi Resources, which controls Indonesia's Kaltim Prima and Arutmin mines. A key provision guaranteed Tata 10 million mt of coal for 12 years. This growing desire to lock in tonnage suggests Asian utilities' degree of concern about supply security and price.

2. Platts Newcastle CIM, 2005-2007

US: A Port in a Storm

In 2007 the US coal market has been immune to the supply/demand problems of the rest of the globe. Geographic isolation, high stocks, and controlled domestic production have ensured prices have not spiked. Analyst Paul Hannon, in Fortis' North American Energy Monthly, suggested 2008 will bring few surprises.

"I suspect that coal prices in 2008 will not be substantially different to those we are now seeing," he said. "I would think they'll stay steady or possibly ease off on the back of increasing capacity at mines and growing stockpiles." In the US in July, stockpiles were 25% higher than July 2006. By the end of August, US coal prices and production had fallen, a situation Hannon said reflected power plant stockpiles.

Hannon did note that "a cold winter could see some of that slack eaten away." Fortis estimated that US coal production will fall 2.9% this year and recover by 1.4% in 2008, with most of the increase continuing to come from western states.

Hannon expects spot prices for Powder River Basin 8,800 Btu/lb low-sulfur coal to hover around $10/st ($11/mt) in 2008, and Central Appalachian coal of 12,500 Btu/lb, around $45/st ($49.60/mt).

US government figures in September showed US exports to Europe growing 15% to 11.4 million st from 9.9 million st in 2006. But with US-Europe ocean freight rates nearing $50/mt, the issue for US producers is whether there's profit in increasing output to ship into the world market, even with European prices over $100/mt.

3. US NYMEX Lookalike, 2005-2007

Ports and Freight

The spike in freight rates that has marked the last half of 2007 is expected to continue into 2008. The shipping industry is delaying planned scrapping in order to cash in on demand that in October pushed rates on the Richards Bay-to-Rotterdam steam coal route above $50/mt for the first time ever. While many new dry bulk freighters were ordered after the last freight spike in 2004, "the majority of the new builds are only reaching the market in 2009 and 2010, so the market will be tight for 2008," one shipping expert said.

The late 2007 market frenzy was led by China's rush to re-stock its iron ore supplies ahead of biennial contract negotiations, broker sources said. One noted that low ore stocks mean "it will be more difficult to get cheaper iron ore" in the next contract.

The freight rate surge also coincided with a seasonal dip in Indian iron ore supplies as monsoons interrupted shipping. The calendar 2008 swaps rose by 35% in the six weeks from early September. Adding to the tight supply of ships is Australia's port congestion. But traders say rates so far above historic averages are not sustainable and could fall abruptly.

And Australia does not have a monopoly on infrastructure ills. Through 2007, the Russian railway experienced a severe shortage of coal transport cars, whichcoupled with a spike in domestic demand due to dry weather and consequent low hydro reservestranslated into lower-than-anticipated volumes of coal coming into Europe. Rail operator RZD reduced shipments of coal through Ukraine to the Black Sea by 50% throughout September.

The planned merger of Gazprom and Russia's largest coal producer, SUEK, is intended to reduce Russian coal exports and use the supplies for domestic power production so more gas is freed for profitable export, officials have said. But they add that, if European or Asian coal prices go high enough, Russia will take advantage of export opportunities.

Coking Coal and Steel

The coking coal sector has not been immune to the price run-up, showing continued strength in a tight and demand-driven market, as world demand for steel continues unabated, led by China's building boom. Most coal of the quality needed for coking purposes is sold on annual contracts, and fourth quarter 2007 price quotes affirm the widely held view that 2008 will see notably higher contract prices for coking coal of all specifications.

The most significant change has come in US coking coal prices, which saw coal with high impurities (high-volatile) specification price quotes gain tens of dollars during the third quarter. The $135-145/mt price for American low-volatile coal equaled that of hard coking coal out of Australia's Queensland, in part due to lower activity out of congestion-marred Queensland leading to increased world buying interest in the US product. The situation has been compounded by the transport limitations affecting Russia's metallurgical coal miners.

Australian government think tank ABARE predicted contract prices for metallurgical coal for fiscal 2008 will rise because of strong global demand and difficulties resulting from congestion in Australian supply chains. A fall 2007 note from Credit Suisse forecasts that 2008-2010 Russian coking coal prices will be 35% higher than previously thought, with Russian domestic coking coal prices rising 10-15% in 2008 from 2007.

In September, Macquarie changed its 2008 hard coking coal price forecast to $125/mt from $120/mt, or a 27% rise year-on-year. In early October, UBS updated its 2008 coking coal price to $130/mt from its July forecast of $115/mt.

For thermal coal, UBS has maintained its 2008 thermal coal estimates at $70/mt FOB Newcastle, the level around which negotiations between Japanese utilities and Australian producers are evolving. In mid-October Macquarie amended its forecasts for 2008 contract steam coal prices, and is suggesting a near 15% rise in FOB Newcastle to $70/mt, instead of its earlier 3.6%. It made similar revisions for prices out to 2011.