Coal Glut Foils Price Rally With Miners Tied to Exports: Energy

Apr 23, 2014 2:47 pm ET

(Energy column news alert: SALT NRGI <GO>)

April 23 (Bloomberg) -- Australian mining companies are prolonging a supply glut that’s driven coal prices to a four- year low because of freight contracts that make it cheaper to ship at a loss than to cut output.

Shipments of thermal coal from the second-biggest exporting nation will expand the most of any country this year, according to Morgan Stanley. The bank cut its 2014 price forecast by 9 percent to $77 a metric ton earlier this month, estimating global supply will outstrip demand by 4 percent. Prices averaged $77.24 so far this year, according to globalCOAL data.

Miners are tied to port and rail contracts that oblige them to pay transport fees even if they don’t ship any coal. The slump in prices means as much as two fifths of shipments lose money, Morgan Stanley said in an April 8 report. Standard Bank Group Ltd., Credit Suisse Group AG and Goldman Sachs Group Inc. also cut coal-price estimates in the past several weeks.

“It’s a trade-off between making small losses in the current market of somewhere between $5 and $10 a ton and maybe larger losses if they shut completely,” said Mark Pervan, the Melbourne-based head of commodity research at Australia & New Zealand Banking Group Ltd. “There is a lot of high-cost capacity in Australia not prepared to shut down and that’s prolonging the return to recovery.”

Price Slide

Spot thermal coal at Newcastle port in Australia, an Asian benchmark, fell to $72.98 in March, the lowest since October 2009, according to data from globalCOAL, a London-based data provider and trading platform. Prices for the fuel burned by power plants were at $73.80 in the week ended April 18, after averaging $85.27 last year. The cost of coking coal, used in steelmaking, has dropped 16 percent this year, according to Energy Publishing Inc.

Utilities in Japan agreed to an annual price of $81.80 last month, the cheapest supplies from Australia in five years. About 13 percent of global thermal-coal exports are unprofitable at that level, compared with 25 percent at $73 in the spot market, according to Morgan Stanley. Asian steelmakers are paying a record low for a quarter’s supply of hard coking coal.

“For thermal, there is no obvious short-term catalyst to see prices higher,” said Daniel Morgan, a Sydney-based analyst at UBS who estimates $70 may be the tipping point at which mining companies’ losses on sales exceed those on freight deals. “It’s not a demand problem, just lots of supply.”

Freight Fees

The freight agreements, known as take-or-pay contracts, helped finance at least A$6.1 billion ($5.7 billion) in port and rail developments on the east coast during the past seven years as producers sought to increase supply to Asia. The Wiggins Island export facility in Queensland and a third terminal at Newcastle have been funded under the deals.

The long-term freight contracts were spurred by the need to ensure volumes for infrastructure investments that can last a quarter century, according to Aurizon Holdings Ltd., Australia’s largest hauler of coal. The agreements helped attract funding, the Brisbane-based company wrote in an e-mail April 15.

The take-or-pay agreements are hindering unprofitable mines from cutting output, Goldman Sachs analysts said in a March 30 report. Long-term supply contracts are also shielding some mines from the slump in spot prices, the analysts said.

China Imports

Prices may rebound after dropping to a level that makes it cheaper for China to import than buy domestic output, according to Goldman Sachs. Prices are “unsustainable” and will likely return to levels sufficient to cover some of the highest mining costs by the end of the year, the bank says.

Some miners are starting to reduce supply. Glencore Xstrata Plc, based in Baar, Switzerland, said last month it would stop production from its Ravensworth mine in Australia. Walter Energy Inc., based in Birmingham, Alabama, said last week it will immediately idle output at its Wolverine mine and suspend its Brule project by July. Both are in Canada.

The price drop is “squeezing everyone’s margins,” Dean Dalla Valle, the president of BHP Billiton Ltd.’s coal unit, told reporters in Sydney on April 4. Australia & New Zealand Banking Group says about 100 million tons of thermal output needs to be cut to balance the market, equal to about 11 percent of seaborne trade, while Goldman Sachs says 7 million tons of coking production should be trimmed, or about 2.4 percent of seaborne volumes.

Excess Capacity

Australian thermal coal shipments are projected to climb 3.7 percent to 195 million tons this year, the nation’s Bureau of Resources and Energy Economics said in its March quarter report. Take-or-pay contracts discourage output cuts and may sustain or even boost current output levels, the bureau said.

Globally traded thermal coal demand will increase 3 percent this year to 987 million tons, compared with growth of 7 percent last year, UBS said in an April 9 report. Supply will increase 4 percent to 999 million tons, creating a surplus of 12 million, according to the bank’s estimates.

Rio Tinto Group, based in London, raised its forecast for thermal coal output this year to 16.7 million tons on April 15, from a previous prediction of 16.5 million. BHP Billiton increased its production estimate the next day for the coking variety by 2.5 million to 43.5 million during the year ended June 30.

Shares of BHP Billiton, the world’s biggest exporter of metallurgical coal, rose 0.5 percent to A$38.20 in Sydney today. Rio Tinto slid 0.1 percent to A$62.79.

‘Bright Spot’

“Pricing is not great,” Ivan Glasenberg, the chief executive officer of Glencore, said on a conference call last month. “There are companies under water.”

Standard Bank cut its Newcastle forecast by 6.9 percent percent to $76 a ton, it said in a report e-mailed April 15, while Credit Suisse Group AG reduced its prediction by 6 percent to $80 on March 31. Goldman Sachs lowered its thermal-coal price by 7 percent to $77 on April 15 and its projection for the hard coking type by 8 percent to $124.

“It’s tough right now and it’s not going to get much better,” said Pervan of ANZ. “The bright spot is that it won’t get much worse.”

--With assistance from Naomi Christie in London.