Metallurgical coal miners maintain regional pricing despite China’s ascendancy
By Julien Hall in Singapore
June 20, 2013 -
Despite the specter of oversupply and a near-continual drop in spot prices in the last two and half years, producers of metallurgical coal have retained the ability to achieve a premium in certain regions when selling spot cargoes.
Together with a general lack of spot liquidity ex-China, this regional pricing is undermining efforts to measure a consistent FOB Australia price, while at the same time growing China imports are creating an ever stronger alternative hub for price discovery.
In the spot market, China has been able to buy at the cheapest price in recent years, while the rest of north Asia, India and Europe typically pay between $2-7/mt higher.
As an example, out of nine spot hard coking coal deals into India, Europe and Asia (ex-China) in May and June 2013, Australian and Canadian miners achieved on average a premium of $5.8/mt compared to cargoes sold to China.
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These premia are highly inconsistent, however, with some buyers managing to negotiate “China + $1/mt,” while some only got “China +$12/mt.”
To explain this phenomenon, miners would point to the fact that they have to sell cheaper to China, where they must compete with domestic producers.
China is the world’s largest producer and consumer of met coal. Steelmakers in other regions, meanwhile, are more dependent on seaborne imports, and thus have a weaker hand in negotiations.
Perhaps also explaining the premium, Australian and Canadian coals have become embedded in the coke blends of global steelmakers, while the Chinese are simply price-sensitive, occasional swing buyers.
Seaborne exporters tend to tread with care and avoid offering discounted spot cargoes in regions where they have long-term contract customers.
Traders say that doing so would run the risk of undermining long-term contracts which, since the start of 2013, have been on average $9/mt above spot.
Another factor explaining this ex-China premium is that met coal has in the past been rather opaque and “the market” has traditionally taken its cue from term settlements, in the absence of published spot prices which emerged around 2010. This phenomenon continues in places, and some steel mill procurement managers still refer to the quarterly Asian benchmark or BHP Billiton-Mitsubishi Alliance’s monthly term prices when buying spot.
Other sources have pointed out that regional price differences could have to do with steelmakers’ different evaluation of coals, and could reflect a willingness to pay more for coals which are more critical to their blends.
Another theory is that non-Chinese buyers tend to insist on stricter quality-related penalties in spot contracts, giving the sellers a form of hidden optionality allowing them to offer more competitive prices in China. It is unclear, however, if such factors can explain such large price differences.
In any event, market forces alone have been unable to iron out these regional price differences because when miners sell on an FOB Australia basis to traders, they will typically impose geographic constraints on where the cargoes should go.
Such geographic limitations are not enforceable through contracts, but are often set in gentlemen’s agreements, with the understanding that traders delivering in a “forbidden region” may fall out of favor with the producer.
“The miners have term agreements in places like Japan, Korea, Taiwan and India. They’d be unhappy if we sold spot to them,” an Australian trader explained.
He added that regional pricing was “policed more tightly in a tight market.”
The gap between spot and term metallurgical coal prices has also led to some usually very discreet “backdoor” term agreements, where a miner and a steelmaker agree to make a parallel long-term deal facilitated by a trader at a price below the headline benchmark but higher than spot.
In such deals, all parties benefit somehow as the miner will be able to sell additional volume at a price higher than the spot market, the mill will be able to reliably procure its favored brand of coal at below the usual term price, while the trader will take a cut.
Several such deals are in place for Japanese steelmakers procuring Australian hard coking coal.
Additionally, one-off spot deals are occasionally agreed into Europe or elsewhere in line with China prices, but on condition of absolute discretion, and often via traders.
Bipolar market: CFR China pricing on the rise
Meanwhile, seaborne exporters have been growing increasingly reliant on China, which produces close to half of the world’s steel, and has displayed the ability to absorb vast volumes of met coal – at the right price.
Chinese imports have surged from 6.9 million mt in 2008 to 54 million mt in 2012, matching Japanese imports for the first time.
The country is on track to be the world’s largest metallurgical coal importer in 2013.
So far this year, China has accounted for 69% of spot hard coking coal deals observed by Platts in Asia Pacific, and an even larger proportion when including softer coking and PCI coals. From January to May 2013, Platts has observed over 17 million mt of spot trade in Asia.
With the country’s status on the rise, some Australian or north American met coal miners have been setting up offices in China, or hiring China-focused marketing managers.
Others are increasingly looking to formalize their sales into China by setting up long-term contracts.
“We’re negotiating long-term contracts in China,” a marketing executive at an Australian mining company said Tuesday.
The contracts will be on a CFR basis, enabling the miner to gain a freight advantage by selling in large Capesize vessels, while pricing would be agreed bilaterally for each cargo.
The company has been reliant on China for a couple of years, but the long-term agreements would enable the miner’s products to be formally part of Chinese steelmakers’ blends, he added.
Asked if he feared losing value compared to higher-priced contracts into other regions such as Japan, he said: “If you’ve sold everything you can to Japan, there’s no loss selling [cheaper] to China.”
Despite this, a significant part of China’s seaborne met coal imports remain spot transactions.
These are either done directly from miners to steelmakers or through traders.
Highlighting the depth and fragmentation of the Chinese coke and steel industry, met coal trading chains can involve two or three traders, often including one international trading company, and one or two Chinese firms.
Contrasting with regionally fragmented FOB Australia trade, Chinese imports tend to be priced extremely consistently, as Australian, Canadian and Indonesian miners compete for business on a delivered basis.
This competitive and highly liquid CFR China trade flow has enabled the collection of very consistent data relating to spreads between brands of coal over the last two or three years, thanks to which it is possible to evaluate the spot value of a specific brand of hard coking coal on a given day to a level of precision of just $2/mt.
Such precise observation has been far more challenging on an FOB Australia basis, where pricing is muddied by a lack of liquidity and regional differences.
China’s impact on global prices
China’s rising relevance in metallurgical coal means that the commodity’s seaborne market is increasingly bipolar, with CFR China trade playing an ever more critical role, though it has yet to eclipse the established FOB Australia marker.
Australian (and Canadian) HCC export prices are increasingly tied to CFR China prices “netted back,” as scarcer and less consistent ex-China FOB Australia spot trades struggle to maintain their relevance in the face of abundant transactions priced to compete on a delivered-to-China basis.
“It is logical that China should determine Australian export prices. We have seen this happen for a long time already,” a European steelmaking procurement manager said last week, explaining that China had indirectly been affecting global prices in recent years.
A US mining executive said on June 5 that, even in the Atlantic basin, metallurgical coal prices could potentially be set by China in the medium term.
The future of met coal pricing in the region depends on the strength of the European economy, he said.
If Europe weakens further, China will have a greater role in setting global prices.
“Within two years, CFR China equivalent prices will set global prices,” the Australian miner agreed. “This is the market that will suck all the extra coal.”
He explained that Australian miners would refuse to sell cheaper elsewhere than to China, while on the flip side, buyers would increasingly insist on paying no more than China.
Potentially confirming this trend is already starting to take place, a Russian miner also said in early June that his European customers were already asking him to sell coal at a price matching his CFR China opportunity cost.
Such pricing is akin to what happens in iron ore, where CFR China pricing determines what global steelmakers pay for the raw material.
For example, in long-term contracts between Brazil and Europe, CFR China iron ore prices are netted back to FOB Brazil, and then netted forward to CFR Europe.
If the predictions above come true, such a system could yet emerge for met coal.
Rigid quarterly contracts create gaps with spot prices