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Newcastle, Australia-based coal futures contracts introduced by three institutional players

Successful investing is anticipating the anticipations of others, according to the English economist, John Maynard Keynes.

However, not even Keynes could have anticipated the demand-driven factors that have propelled international coal prices to record highs over the last 18 months or foreseen the speed at which those prices would unwind.

"The Asian region is the engine of coal demand growth." -- Michael Dixon, AME Minerals Economics

The higher prices have been a boon for Asian producer countries like Indonesia which has overtaken Australia as the biggest exporter of thermal coal.

It has also focused attention on the Asia Pacific region where coal consumers for the most part are involved in annual negotiations which are centred around either a set price or at a premium/discount to a nominated benchmark.

The introduction of Newcastle, Australia-based futures contracts by not one but three institutional players will effect a significant change in the way business is concluded in Asia and the rest of the world.

For the most part in Asia, it is uncharted territory and as such brings fresh fears, information demands and, of course, the potential to make and lose large sums of money.

Attending a conference in Indonesia in 2007, an irate India-based producer stood up and declared that Asia did not need and did not want a futures market.

He accused speculators of driving coal prices to historic levels and rounded up his argument with "you cannot burn paper".

Despite the oxymoron, there are genuine fears that it will favour one side of the market rather than potentially be a benefit to everyone.

Other major issues include what it will bring to the industry, the impact it will have and whether there is any tangible difference between the contracts offered by the various competing entities.

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Based in Sydney, Michael Dixon, Executive General Manager with AME Minerals Economics, is ideally placed to see first hand how it will alter trading patterns.

He suggests it will be a positive development. "The Asian region is the engine of coal demand growth. Looking ahead, it'll be a welcome addition to the market. It will allow greater flexibility for producers and consumers to manage their supply, demand and prices."

Dixon also looked to quash fears of manipulation by any single market player.

"There is the potential for hedge funds and speculators to drive volatility in futures markets but eventually supply/demand fundamentals will win out over speculators because positions have to be covered one way or another," he said, noting that if the futures market grows and expands worries will dissipate.

"The other part of the answer is: if you're worried about the futures market, don't use it. If you're a producer or a consumer then you'll have contracts in place and you don't actually have to use the derivative market. It's an additional tool for these people," Dixon stated.

The main competitors in the market, as acknowledged by most participants, globalCOAL and the Australian Securities Exchange even agree on this point.

"There's been plenty of empirical work done on commodity markets worldwide especially with the run up in oil prices recently. The SEC in the US looked at that and concluded that speculators did not add volatility and were not necessarily behind the run up in the oil prices," said the London-based Eoghan Cunningham, CEO of globalCOAL. (Listen to podcast: Introduction of Newcastle, Australia-based coal futures contracts.)

"The futures market is set up so that sellers could sell when they wanted to sell and buyers buy when they wanted to buy not when the other side is ready. So you need the speculators, you need the day traders you need them to add liquidity to the market so that people with fundamental positions can trade when they want to trade and hedge when they want to hedge." Cunningham notes that evidence from other commodity markets indicates that because speculators bring liquidity they dampen volatility.

"I don't think futures will change the fundamentals of supply and demand and where the coal comes from but what it will do is ensure that players in that market can manage their risk, said ASX General Manager, Emerging Markets, Anthony Collins, suggesting that: "India will be a fairly minor player. I think the main action is really going to be Australian producers and Japanese power utilities or the trading houses that service them."

Next page: Disagreement on future contract specifics

Created: November 27, 2008

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