insight MAY 201314

METALLURGICAL COAL

Often in the shadow of its higher-profi le cousin iron ore, the metallurgical coal market is undergoing a quiet revolution.

Decades-old habits are giving way to new thinking in a range of arenas, as signifi cant volatility and a push by miners to adopt shorter-term pricing has

forced the market to pay ever more attention to pricing mechanisms and coal-blending techniques.

Iron ore quickly made the leap to spot price-based contracts from annual fi xed prices, helping nurture a swaps and options market with rising volumes accounting for around a fi fth of physical trade.

Th e met coal market is taking a cue from iron ore, but developing at its own pace and its own terms. Th e complexity of the product’s selection – and use in sensitive coke ovens – is proving this is one commodity for which it’s diffi cult to standardize pricing.

Pricing in the event of carryover tons – when miners and buyers cannot perform the volumes agreed each period – along with volatile steel demand and regular weather disruptions has the industry happy to fi nd a medium between all contracts referencing spot prices and annual fi xed pricing.

Risk management and fi nancial regulations are helping drive the market toward adopting spot prices.

QUIET RIOT IN THE

METALLURGICALCOAL MARKET

JULIEN HALLTeam Leader

HECTOR FORSTERTeam Leader

Courtesy: iStockphoto.com

15MAY 2013 insight

METALLURGICAL COAL

Volatility drives pricing innovationMetallurgical coal prices used to be set once a year in protracted negotiations between Australia’s leading miners with Japan and South Korea’s large steel mills. Conversations often centered on likely changes in supply and demand in the coming year, and included a recap of the past year, resulting in a price both parties felt was acceptable.

Th is status quo was shattered in April 2010 as the world’s largest exporter, BHP Billiton-Mitsubishi Alliance, introduced quarterly pricing to its global customers in an eff ort to better refl ect shorter-term market fl uctuations. Other major miners immediately followed suit.

A year later, BMA went one step further, bringing in monthly prices for the majority of its international buyers. BHP Billiton’s move was unsurprising, being in line with outgoing CEO Marius Kloppers’ aim to achieve the “price of day” for all its commodities.

Other major met coal producers, devoid of such guiding principles, did not follow. By sticking with the quarterly mechanism, they boosted market share from mills happier to use longer fi xed-prices than the monthly price terms on off er from BMA.

In the US, miners were able to off er customers a range of pricing terms, using fl exibility as a way to win customers amid a surge in export volumes since 2011. By providing annual, six-month, quarterly and “prompt” monthly pricing alongside spot and tender-based off ers, market share in countries such as Brazil and China grew at the expense of Australian and Canadian suppliers.

Alpha Natural Resources, the biggest US coking coal exporter, said last year that as early as April 20, 2012, 78% of expected met coal shipment volumes for 2012 of 22 million short tons had already been priced. As of January 25, 2013, 47% of shipments Alpha anticipated for 2013 had already been priced.

Perhaps typically symptomatic of a market in transition, the resulting state of play globally is a patchwork of pricing mechanisms, with quarterly the most common system, seen side-by-side with monthly, annual and spot index-linked pricing.

Further complicating the picture, an increased number of spot index-linked trades are taking place globally. Th e main proponent has been BMA, which has sold “fl oating” spot cargoes priced against spot indices as well as

PRICING MECHANISMS

Selling to Pricing basis

BHP Billiton-Mitsubishi Alliance

Large Asian steelmakers50% Quarterly,

50% Monthly

Other steelmakers globally Monthly

Spot buyersFlat price, fl oating

price basis index

Asia-Pacifi c: Anglo American, Teck Coal,

Peabody, Xstrata, Rio Tinto, Jellinbah,

Wesfarmers, Vale

Global steelmakers Quarterly

Spot buyers Flat price

Xstrata, Rio Tinto Semi-soft term buyers Semi-annual

Major miners and traders, US:Global steelmakers

Quarterly,

Semi-annual,

Annual, Monthly

Spot buyers Flat price

Asmin Koalindo Tuhup (Indonesia),

Raspadskaya (Russia), Colombian miners

Term buyersFlat price, fl oating

price basis index

Spot buyersFlat price, fl oating

price basis index■ term

■ spot

Source: Platts

►

insight MAY 201316

METALLURGICAL COAL

similarly-priced long-term contracts with one or more European steelmakers.

Such deals have also been observed in a wide range of met coal producing regions, including Colombia, Indonesia, Australia, Russia and Mozambique, mostly between miners and traders. Occasionally between steelmaker and steel user, or between coke maker and user, the use of the coking coal indexes in contracts is seen.

Love me, tenderAnother sign of a maturing, increasingly transparent market is the recent emergence of spot tenders by miners. Here again, BMA led the way, fl oating two spot tenders for its fl agship hard coking coal and PCI brands in late January 2013. Vale followed suit in early March 2013, fl oating a tender for its Carborough Downs HCC. Mid-sized miner Yancoal has also been a proponent of tenders throughout 2012 for its coking coal and PCI, though the company tends to restrict access to a handful of prefered traders.

While these tenders are something of a novelty in met coal, in the iron ore market they have acted as a key contributor to increased transparency for over two years.

Buyers in Turkey, Egypt, India and Brazil have actively held tenders for coking coals and coke, as they seek the lowest prices from suppliers competing on off ers and several get enough interest to hold rounds.

Miners agree to disagreeSo why has met coal’s gradual pricing evolution been slower than iron ore’s almost instantaneous jettisoning of the decades-old annual benchmark negotiation system in 2010?

Besides the fact that metallurgical coal is generally a more complex commodity with more diverse global trade fl ows, one key reason stands out: a lack of consensus among major miners regarding their preferred pricing mechanism.

In addition, China, the biggest spot buyer, is far more self-suffi cient in met coal and has landlocked neighbor Mongolia to thank for plentiful supplies. Th is helps it act much more as a swing buyer of premium seaborne grades compared to iron ore, where it is more active on a far grander purchasing scale.

As it stands, Anglo American, Teck Coal, Peabody, Xstrata and Rio Tinto appear to continue to support quarterly pricing, a system which many steelmakers globally also prefer, citing improved cost visibility.

Lacking BHP’s doctrinal emphasis on market pricing, these miners will be likely to evaluate new pricing systems mostly on their ability to boost balance sheets. And crucially, as spot prices have been on a near-continual decline for two years and mostly below term prices, any shorter-term pricing (spot-linked or monthly) would have yielded lower revenue for miners. Spot prices for premium hard coking coal in 2012 were on average $18.80/mt below the quarterly benchmark.

Since April 2011, BMA’s aggregated monthly pricing has so far exceeded the negotiated quarterly benchmark twice, and lost out six times. In the two years since the system started being used, a steelmaker purchasing exclusively on BMA’s monthly basis would have paid $47.40/mt less than buying exclusively quarterly-priced premium HCC, or

17MAY 2013 insight

METALLURGICAL COAL

about $6/mt per quarter, Platts calculates. With such a record, it is no surprise miners are rethinking the possible benefi ts of shorter-term pricing.

Sell-side proponents of shorter-term pricing would argue that while monthly prices could appear to leave money on the table for one of the counterparties, the fact they better espouse immediate market fundamentals leads to generally improved contract performance, especially at times when spot and quarterly prices are wide apart.

Some mills have criticized short-term met coal pricing, especially those needing long-term visibility on costs to align with steel price off ers into long-term projects. “Th e position of BMA on short-term pricing is totally opposite” to ours, a European mill buyer remarked.

“Th e only way is to be less reliant on China-driven Australian producers for quarterly and monthly pricing coals and buy more on a long term basis from the US and CIS,” the source said.

Eurofer, the European steelmakers’ group, said the move to spot-based pricing led by China was a detriment to competitiveness. “Rather than improving price stability and transparency, the new pricing systems resulted in high volatility with the risk of signifi cant price increases,” Eurofer said in a January document on coking coal.

“As far as the pricing mechanism is concerned, we get the impression from our members that EU steel companies are coping with the current mix of monthly contracts and spot buying,” added Jeroen Vermeij, director of market

analysis and economic studies at the Brussels-based group.

China’s growing role as price setterSignifi cantly, growing emphasis on the spot market in the last two years has eroded the price-setting power of Japan and South Korea’s steelmaking behemoths, in favor of China – the market of last resort and marginal buyer for seaborne exporters.

In 2012, though supply disruptions had some eff ect, seaborne prices were mostly infl uenced by destocking and restocking cycles in China, a country which accounted for two thirds of Asia-Pacifi c spot hard coking coal deals.

In the past three years, quarterly contracts have been on average within $4.80/mt of the spot price on the day of negotiation, highlighting that while these negotiations have taken place in Japan and Korea, the outcome was indirectly dictated by Chinese demand. ►

Source: Platts

$/MT FOB AUSTRALIA

TERM PRICES FOR MET COAL GUIDED BY SPOT PRICES ... MOST OF THE TIME

145

165

185

205

225

245

265

285

305

325

345

365

385

Apr-10 Aug-10 Dec-10 Apr-11 Aug-11 Dec-11 Apr-12 Aug-12 Dec-12 Mar-13

Spot premium low-vol HCC

Quarterly contract price

$225 $225

$209

$285

$315$330

$235

$210

$225

Negotiation

$170$165

$172

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METALLURGICAL COAL

While China’s role has grown, the quarterly benchmark system has shown some fl aws in recent months.

As happened in Q3 2012, the latest quarterly settlements set by BMA and Nippon Steel & Sumitomo Metal Corporation at $172/mt for April-June this year has been widely rejected by most steelmakers outside of South Korea and Japan.

European mills have been most vocal in their disagreement with the prices agreed in Asia, but other steel producers in India, Turkey, Brazil and Australia have expressed similar dissent. “I still haven’t got my head around why the Japanese agreed to $172/mt,” an Australian steelmaker commented in early April.

Sellers and buyers have increasingly asked the question of whether the benchmark system itself is dying, as it again fails to be applied globally, perhaps due to diff ering supply and demand dynamics in various regions.

Th e common point between the two contentious quarters is the gap between spot and term pricing. Both settlements were signed while spot prices were declining sharply, leading to widespread buyer dissatisfaction just a few days after the deal was done.

When this last happened, EU mills managed to win substantial discounts – in some cases $10-15/mt – from Australian and Canadian miners, and ended up paying less than their Asian counterparts.

Th is looks likely to happen again, naturally raising the question of how relevant this pricing system is.

Steelmakers drive for coke blend fl exibilitySteel producers globally are experimenting far more with their coal blends than seen in recent years for two main reasons. Ensuring operational continuity if a particular supply basin is taken out by a weather event, and to reduce costs.

Th e Queensland fl oods of 2010-2011 led to one of the sharpest price spikes on record, forcing steelmakers to scramble for alternative supplies. “Anything black will do,” one European steelmaker quipped at the time.

Th is event, together with a similar Australian fl ood in 2008, created scarcity and extreme price volatility for certain types of coal, pushing mills to reexamine their over-reliance on any given brand or coal type.

“Basically we want to create options, so that if there is a force majeure in one country, we can have options to buy from other suppliers. We want to create an immunity system against such issues,” a large Indian steel mill source said. “Of course, there are also some substantial cost-savings.”

Some market observers have compared this change to the transformation in the oil sector in the late 1970s and early 1980s, when a wave of investment enabled refi neries globally to handle new streams of crude. Refi ners had in the past been heavily reliant on local supplies, but depletion and price shocks drove them to reconfi gure their plants, enhancing their blend fl exibility.

Th e adapted processing plants were said to have weathered subsequent market fl uctuations better than the more rigid ones, and new refi neries are now by default able to use more crudes than in the past. ■