Interesting Research on Met Coal Market

Justin Smirk

October 28, 2020

Westpac's monthly update on commodities markets. We have been here many times before and see the China import bans on Australian coal to be more about managing import quotas with recent political disputes making Australian coal an easy target.

Coal prices recovered somewhat through September then, in early October, news of new Chinese bans on Australian coal hit the press. We think that, as they were before, these bans will be short lived so we are looking for a price recovery early in 2021 when the import quotas are reset just as demand and supply conditions improve. As such, our met and thermal coal forecast for end 2021 remain unchanged. We continue to expect iron ore prices to be in a gradual softening trend through 2021 while the supply and demand conditions for crude oil remain finely balanced.

This article was built upon the October Commodity Update originally published in the October Market Outlook (pdf 628kb)

For the latest commodity forecasts see: October Commodity Forecasts (pdf 71kb)

Commodity prices were firming through September...

Through September Westpac’s broad commodities index was quite steady at 286. There was little change in the bulks index with the easing in spot iron prices (from US$128/t to US$123/t) being offset by an improvement in coal prices (met coal lifted from US$87/t to US$111/t while thermal coal lifted from US$52/t to US$61/t); the overall bulks index lifting slightly from 399 to 401. Crude oil was flat at US$43/bbl, LNG lifted from US$5.93/mmbtu to US$6.45/mmbtu while the base metals index eased slightly from 160 to 158. The main revisions in October were to our coal forecasts which we have lifted in response to improvement seen through September prior to the reported China bans on Australian coal and the moderation in price. The published forecasts for met coal were lifted to US$113/t at end 2020 and US$117/t for end 2022 (we did have US$90/t and US$115 respectively in September) while thermal coal is forecast to end 2020 at US$60/t (was US$55/t) and end 2021 at US$61/t (unchanged). For end 2020 our commodities index forecast is to be 270 and for end 2021 it is forecast to fall to 233 – revised from 266 and 233 last month highlighting that the changes impacted on our near–term forecasts but not the longer–term.

...then the China bans on Australian coal imports hit.

In early October the big news for commodities came from multiple news sources, just as the October Market Outlook was going to press, reporting a Chinese government directive to several state-owned steelmakers and power plants to halt imports of Australian coal. It was also reported that Chinese ports had been directed to not offload Australian coal. If you have been watching the seaborne coal trade for some time you will know that this has happened a number of times since 2017. It was only last May when we saw a similar threat and yet Australian coal exports to China were still up 5% in the year to date to August compared to the same period in 2019 while Australia's share of China’s coal imports have averaged 32% so far in 2020 compared to the 2019 average of 24%.

There is no doubt that Chinese coal imports weakened in September with total imports falling to 18.7mt to be down -10% in the month and -38% in the year. However, rather than focus on a political action directed at Australian exports we think that looking back at historical precedent is the best way to frame this issue. When you do so you can see it has more to do with the Chinese administration using import quotas to support the domestic coal industry rather than a being the focus of a political gambit (of course it also does have political implications but the strategy is co-ordinated with Chinese industrial policy rather than in isolation to it). As we have seen before, when the coal import quotas are hit, and there is an ongoing political dispute between Australian and China, Australian coal exports are an easy target. As such, our expectation is that current import quota limits will continue to result in a sequential decline in import volumes through to the end of the year with some market participants suggesting there is an unofficial annual target of 270-280mt.

The news of trade bans on Australian coal had a meaningful impact on coal market sentiment and prices. We also know that the argument that Chinese imports focus mostly on sub- bituminous coals from Queensland for which there are few substitutes hence the bans will not be applied to there is false as we have seen again this year with the October correction in Qld Met Coal prices. But we believe that with careful consideration the bans can be seen for what they are, a short-term headwind for market sentiment and prices. We expect that, as we have seen in previous years, there will be a normalisation of sentiment and prices as Chinese demand for imported coal recovers following the release of 2021 quotas.

At the start of September Qld Met Coal was trading at US$87/t but it quickly jumped to US$115/t by the end of the month before easing back to US$110/t in the first week of October. There has been an even larger jump in premium low vol met coals from US$108/t at the end of August to US$139/t at the end of September (it has since eased a touch to US$132/t through the first week in October). Prices for domestic Chinese met coal producers also improved through September lifting from US$265/t to US$281/t.

Robust growth in Chinese steel production has been supporting the iron ore market...

As we have noted for some time, the robust recovery in Chinese steel production has been extremely supportive of iron ore prices, but until September it had not been the case for met coal. China accounts for around 25% of seaborne metallurgical coal demand compared to 75% for iron ore demand so the collapse in steel production outside of China had a larger impact on met coal than on iron ore. The eventual recovery in ex–China demand and subsequent lift in crude steel production did result in a relatively quick recovery in met coal prices through September. And from the supply side, the low–price environment led to production cuts with company guidance suggesting further adjustment by the industry to bring supply more in line with demand. Australia makes up 58% of seaborne supply and Qld coal exports were down 8%yr in August with Westpac’s latest Shipping Tracker pointing to a further contraction in September. Supply cuts out of the US have been even more severe, output down 36%yr for the January to July period. It appeared that the correction in supply was starting to outpace the correction in demand which, if it holds, should have been supportive of met coal prices. This lifted Qld met coal prices from an August low of US$85.50/t to an early October high of US$115.15/t just before the reporting of the most recent China bans on Australian coal.

...while met coal will be supported by a broader recovery in the global steel industry.

As we were updating this report Qld met coal had fallen to US$US87.85/t. Moving forward we believe that due to the COVID-19 pandemic response, and the low price environment earlier in the year, the correction in the supply of seaborne coal has overshot the decline in demand. Our base case is with the reset of the Chinese export quotas in 2021 there will be a renewed strength coal demand.

Thermal coal prices recover as both supply and demand rebalance

For thermal coal it appears that the cumulative effect of the supply curtailments is starting to have an impact price. The Newcastle spot thermal price is now trading above US$60/t compared to a September quarter average of US$51/t. Thermal coal exports to China are around 24% of total Australian coal exports. Similar to met coal, thermal coal demand was adversely impacted by the pandemic but we observer ex-China exports were up 11%yr in August and this recovery is expected to continue into the December quarter on the usual lift in northern hemisphere seasonal demand and as economies continue to adapt to the ongoing pandemic.

Iron ore prices to ease as Chinese steel production peaks and seaborne supply lifts

With the rapid recovery in Chinese steel production from the COVID shutdown and constrained growth in the supply of iron ore, the resulting tight market has been supportive of iron ore prices. The 62% iron ore price (CFR China) peaked in early September around US$130/t but has since retraced slightly and is currently at US$120/t. We continue to see a gradual softening for the remainder of the year as Brazil continues to lift production and Chinese demand softens due to seasonal factors and steel production levels out into the year end.

OPEC could not break the US Tight Oil Industry and so crude oil supply and demand remains finely balanced

Crude oil remains within the narrow range it has traded in since mid–June, from the high $30s/bbl to low $40s/bbl and it is unlikely to break out of this range until global crude demand lifts from its current COVID–19 constraints. High crude inventories and large volumes of spare productive capacity will also need to be drawn down presenting near term downside risks. If Hurricane Delta shuts in significant volumes of US refining capacity for an extended period, this could reverse the US crude oil stock drawdown that has been steadily occurring since mid–June and would likely be bearish for crude prices. Westpac has Brent down to US$40/bbl at end 2020 and US$35/bbl by end 2021.

The source is Westpac.