Complicating Coal Markets

Jake Horslen, Argus Media, UK, explores how China’s diplomatic spat with Australia is complicating the global coal market’s recovery from COVID-19.

COVID-19 inflicted an unprecedented demand-side shock on global thermal coal prices and seaborne trade in 2020, and the post-pandemic recovery has so far been just as tumultuous.

High calorific value thermal coal prices assessed by Argus Media hit decade highs in July. Seaborne NAR 6000 kcal/kg thermal coal prices reached US$151/t fob Newcastle, US$121/t fob Richards Bay, and US$135/t in the middle of July. This marks a dramatic turnaround since the economic impact of the pandemic peaked last summer, when those three thermal coal benchmarks sank as low as US$46.18/t, US$44.53/t and US$38.19/t, respectively.

Prices in global energy markets have staged a remarkable recovery so far this year, with crude, liquefied natural gas (LNG) and EU carbon allowances being just some examples of markets that have not only clawed back last year’s losses, but overtaken their pre-pandemic levels.

Thermal coal

Thermal coal has been swept up in this broader, bullish global sentiment, buttressed by fundamental drivers particular to the seaborne coal market. Last year’s La Niña weather phenomenon brought freezing conditions to northeast Asia and triggered a spike in seasonal power demand, while also creating unusually high precipitation in parts of Indonesia, Australia and South Africa, which hampered production at a time of peak consumption.

A string of non-weather-related supply disruptions have also kept the market tight, including production suspensions and protests at key mines in Colombia, train derailments

and bottlenecks in South Africa, and shiploader faults at Australia’s key Newcastle thermal coal export port.

China’s ban on Australia imports

Aside from the post-pandemuc recovery, the main issue disrupting the orderly functioning of global thermal coal markets in 2021 has been China’s informal ban on imports from Australia. This has driven a wedge between what would normally be closely correlated markets and changed the landscape of seaborne trade flows over the past 12 months.

Diplomatic tensions between China and Australia had been simmering prior to the first peak of the pandemic, but they came to a head around May 2020 aft er Canberra called for a probe into the origin of COVID-19. The Chinese government has since clamped down on imports of coal and a range of other commodities from Australia, in an apparent act of retaliation against one of its biggest trade partners.

Chinese imports of Australian bituminous thermal coal fell gradually from as high as 6.3 million t in April 2020 to zero in December and have been absent ever since, Chinese customs data shows.

At first glance, China’s thermal coal imports from Australia may seem almost inconsequential. China itself produced 3.8 billion t of all types of coal in 2020 according to off icial statistics, importing an additional 304 million t of thermal and coking coal from the seaborne market to supplement domestic supply and cater to its enormous demand. Of its total seaborne coal receipts – which represented around 8% of total coal supply in China – Australian thermal coal accounted for only 42.5 million t, or 1%, of China’s total coal supply.

But while it may seem like a rounding error within China’s overall coal supply mix, Australian bituminous coal made up a much more significant 59% of the country’s total bituminous coal imports over 2017 – 2020, and the current ban shows what an important staple the fuel has been for Chinese consumers in recent years. Key reasons for this include the specification and quality of Australian coal, the reliable availability of the fuel and its price and logistical advantages over other origins.

Given that a significant proportion of China’s coal-fired generation is situated in the country’s southern coastal regions, seaborne imports are competitive in terms of both cost and logistics with domestically produced coal, which must be railed and/or shipped from China’s inner regions.

Regarding quality, the typical Australian thermal coal favoured by Chinese buyers is a NAR 5500 kcal/kg high-ash, but low-sulfur product, used for cement production or in a blend to create a feedstock for power plants. Non-Australian alternatives are available, but they usually come with drawbacks.

Non-Australian alternatives

Indonesian coal is more plentiful but typically of a lower calorific value, with much of the country’s higher-quality grades already tied up in term agreements to other markets, such as Japan. Russia has limited Pacific-facing export infrastructure to support a significant ramp-up in supply, the fluorine levels in South African coal are typically too high to meet Chinese customs requirements, and imports from Colombia entail a much longer voyage to China than Australian or any other origin.

For these reasons, the increase in Chinese imports from its non-Australian partners has so far not been suff icient to fill the void created by Beijing’s informal ban. China's January – June 2021 bituminous coal imports from Indonesia and Russia averaged 2.4 million tpm and 2.5 million tpm, representing respective 19% and 80% increases from January – June 2020. The country has also received 573 000 tpm from South Africa, an increase from zero in 2020, and 362 000 tpm from Colombia, up from just 137 000 tpm in the first six months of 2020 (Figure 1).

In total, China has imported an additional 2.3 million tpm of bituminous coal from non-Australian partners compared with January – June 2020, off setting only approximately 43% of the 5.3 million tpm it received from Australia in the first six months of last year.

Chinese power demand

Figure 1. Chinese 1H21 bituminous coal imports (million tpm). Replacing 42.5 million tpy of bituminous coal imports from Australia was always going to be a tall order for Chinese buyers, and domestic circumstances early in 2021 have made the task particularly challenging. Chinese power demand has grown at breakneck speed this year and, despite rising wind, solar and nuclear capacity, thermal power generation – the majority of which is coal-fired – remains critical to meeting growth in electricity consumption. China's January – June power output grew by 15% on the year to 3858 TWh, according to the country's bureau of statistics. Wind, solar, and nuclear generation recorded impressive proportional increases of 14 – 30%, but in outright terms were a long way from satisfying the overall increase in electricity consumption. Thermal generation – 69% of which was coal-fired in 2019 – still rose by 16% or 394 TWh on the year as a result, to ensure

that supply met demand. This corresponds to an additional 17.7 million tpm of NAR 5500 kcal/kg-equivalent coal consumption in 40% eff icient power plants, Argus estimates.

China’s domestic coal production

China has also struggled to sustain an increase its own domestic coal production in 2021, compounding the impact of weaker seaborne imports on overall supply availability in the country’s key coastal demand hubs. National production grew strongly in January – February, but slowed over March – May and was lower on the year in June, according to off icial statistics, with aggregate utility stocks 17.6 million t lower than a year earlier – 60.3 million t as of the end of June.

This supply crunch has underpinned a surge in domestic Chinese coal prices, which are now trading at a wide premium to international seaborne benchmarks. Argus Media’s assessment of domestic NAR 5500kcal/kg Chinese coal averaged more than US$235/t fob Qinhuangdao at the height of winter in January, with the premium for domestic coal over imported tonnes averaging more than US$37/t in June. Prices eased as the winter weather abated, but the market began to strengthen again ahead of the peak summer cooling period, with the premium for domestic coal over imported tonnes averaging more than US$30/t in May.

Prior to the ban on Australian coal imports, domestic Chinese prices were approximately US$20/t higher than those for imported coal during 2018 – 2019, with the spread ranging between US$11 – US$28/t (Figure 2).

The China-Australia impasse is also aff ecting the wider regional coal market in the Pacific. The most notable impact has been on the price of Australian NAR 5500 kcal/kg coal, which has established a wide discount to other benchmarks in the absence of regular Chinese demand.

The effect on the wider Pacifi c coal market

With Australian coal shut-out of China, India has become a valuable outlet for some of the shunned volumes as the relative weakness in Australian prices has made the origin unusually competitive against the country’s more typical suppliers. In January – May, Australian customs data shows that approximately 1.8 million tpm of thermal coal was exported to India, up from just 325 000 tpm in the same months of 2020.

Despite this, Australian exporters have not fully off set the China ban with an equivalent increase in shipments to other markets so far in 2021. This is partly because of supply constraints caused by inclement weather and broken shiploaders at Newcastle early in the year, but also due to the consequences of a decision taken by several producers to reduce their production guidance in the wake of extremely low prices in 3Q20. It is hard to imagine that China’s ban on Australian coal, with all the future uncertainty it has created, was not also a factor leading Australia’s miners to reduce their output, in order to avoid an oversupply of coal that they would not be able to sell to their usual customers.

There are also signs that the pool of non-Australian bituminous coal available to countries other than China has tightened, as Beijing’s ban has forced Chinese buyers to pursue coal from other corners of the market as an alternative to their usual Australian diet. China, Japan, South Korea, and Taiwan imported a total of 35.4 million t of bituminous coal from Russia, Indonesia, Colombia, and South Africa in 1Q20. That total barely changed in 1Q21, but China’s share rose to 15.2 million t from just 11 million t in the year before, with Japan and South Korea’s share falling by 2 million t and 1.8 million t, respectively.

Those countries can and have taken more coal from Australia in 2021, but this shift adds needless ineff iciency to the flow of thermal coal around the region. Japan and South Korea are not typically big buyers of the NAR 5500 kcal/kg Australian coal that used to go to China, usually preferring to purchase a higher calorific value product to feed their power plants for technical reasons, which further complicates such a swap.

Figure 2. Chinese domestic vs imported thermal coal prices (US$/t).

Conclusion

History shows that commodities markets and the traders, producers, and buyers that comprise them are able to work around issues that stop products flowing eff iciently from where they are produced to where they are consumed, but this can oft en take time and inevitably saddles consumers with additional cost burdens. China rode out extremely high prices last winter without backtracking on its Australia ban, which says something about its determination to persist with its current policy and means there is little to suggest that a quick return to ‘normal’ is forthcoming. The international Asian coal market may now be faced with an extended period of re-organisation as it seeks a new regional supply and demand balance.