Could Coal Recover?

With only a few days left until Christmas, you have to believe that Santa has already purchased the coal he's going to need for all those naughty children around the world. If he bought earlier this year, it probably cut into the big guy's budget: Coal prices were sky-high until early fall.

But you'd better watch out - coal is predicted to be a lot cheaper for Santa next year - which could mean more coal in people's stockings in 2009.

2008 Coal

Coal has a wide variety of uses, with different types of coal used for electricity generation, industrial production and other factors. Each is driven by a different set of pricing trends.

The 2008 bull market in coal was kicked off in part when steelmakers such as Posco in South Korea agreed in April to huge 200% price increases for coking coal, a critical ingredient in steel production. This left steelmakers with contracts for around $285 per metric tonne. Spot prices for certain coking coals went as high as $350 per metric tonne in July, so for a while, the folks in charge of negotiating these deals seemed like heroes. It wasn't fun for the manufacturers to pay that price, but they were able (and were counting on being able to continue) to pass the buck along to their buyers in the form of higher steel prices.

But the global economic downturn stopped all of that, and steel manufacturers found themselves between a rock and a hard place, locked into high-priced contracts.

Now it's negotiation time again, and this time, things are going to be different.

Here's how domestic coal looks as of December 12:

How different negotiations will be is hard to tell, especially this early, but we are beginning to get some clues. UBS lowered its 2009 and 2010 forecasts for coal last week, with analysts now forecasting $85 per metric tonne of coking coal in 2009 instead of its previous estimate of $180 - a phenomenal 50% drop. 2010's forecast was cut from $130 to $115 per metric tonne, implying that we're looking at a shorter-term weakness, with a chance for real recovery within the next 18 months. The same report forecasts thermal coal prices to fall $15 to $70 in 2009, and to fall $5 to $60 in 2010. (The prices are for short tons which are 0.91 of a metric tonne.)

Negotiations between Japanese steel companies and Australian mining companies have usually begun by this time of year for Japan's April 1 fiscal year start, but this year there have been some delays. The steelmakers have begun to idle some of their furnaces and say that they don't know what demand will be like in 2009. Australian News reports:

"We don't know about production next year," said a spokesman for JFE Steel, Japan's No. 2 steelmaker, which recently cut current year output by 1.5 million tonnes. "Our plans are based on user demand."

Last year, it was the miners who were dragging their heels, postponing new agreements as the cost of coal went higher and higher. Now, the situations are reversed, and the steelmakers are in the driver's seat.

It's Not Just Demand

For those of us worshiping at the Church of Microeconomics, there are always two sides to a price, and demand isn't the only driver into this catastrophic plunge in coal. There's also a supply glut.

The supply theory is that the high contract and spot prices for coal led to mining companies pulling coal out of the ground as fast as they could. Similarly, steelmakers made all the steel they could during the boom times for that industry.

But when the music stopped and the construction and economic slowdowns hit, steelmakers were left with huge surpluses. Some companies, such as ArcelorMittal, stopped shipments of coking coal. That pushed the coal into the energy market, causing ripples through the thermal side of the coal industry.

"‘There is simply too much met coal around. Australia has huge stocks of semisoft coal to sell. This will push prices lower, there is nothing that can be done to reverse it,' a Russian coal exporter said" (from the U.K. Guardian).

Some companies are rushing to lock in prices where they can. Xstrata purportedly just locked in thermal coal contracts with some Japanese electrical companies for $80 per tonne. Given what UBS is forecasting for 2009, $80 sounds good, but it's way down from the $155 per tonne Xstrata was able to get in September.

Look for these reduced prices to hurt upcoming quarterly earning forecasts in companies like BHP and Rio Tinto too.

Coal, Climate And Politics

Just as with oil, there are analysts that speak of peak coal, mostly in terms of how much coal is left to burn and how that affects global warming. There are differing views of the numbers. On one side, the World Energy Council posits that as of 2007, there are 850 billion tons of recoverable coal left in the world. On the other side of the argument is Caltech's Dave Rutledge, who theorizes that there are only a total 662 billion tons of recoverable coal in the world, a number that includes everything we've pulled out of the ground already.

How much coal is left is interesting to scientists working on climate change because burning coal to produce electricity is a significant contibuter to global warming. And with President-elect Obama's recent appointments of Steven Chu to DOE and John Holdren as the White House science adviser, climate change is going to take center stage. Steven Chu has done a lot of research on scientific solutions to climate change, and stated that "coal is my worst nightmare" in a speech earlier this year. John Holdren's field of interest includes the causes and consequences of climate change.

How coal works into Obama's energy plan will be interesting to see with these two on board.

Comments

[Robert Nabloid:]

I'm going to stay away from coal for now (waiting to see what Obama does). If he does something negative toward coal and coal tanks, that is when I'll consider buying some.

2008 Dec 22 07:25 PM

[Greg Pinelli:]

The logic of supply and demand...unfortunately... not going to be relevant for coal. It's a political whipping boy and the key player's will be the environmental hard cases..Carol Browner..et al. There is a reason Obama gave her an in house "new" position. The EPA will be remade in an image that coal investors are going to abhor.
Those of you who've read my posts know that I'm very bullish hard/real assets and resources by next Summer..However, coal is a frightening example of what a committed group of ideologues can do to a critical resource if they hate it enough.
Beward ALL coal related investments..the upside?? Nat gas will be the love child until renewable energy plays its hand...and this is a niche hand at best. I'd keep my eye on nuclear energy also.

2008 Dec 22 08:35 PM

[Anthony Alfidi:]

Coal may recover, but I clearly remember how it tanked in mid-to-late 2006 when the price of natural gas collapsed. That was the same event that sank Amaranth's hedge fund when a junior trader bet the wrong way on NG.

Coal forecasts from investment firms are as meaningless as Goldman Sach's forecast for oil at $200. The EPA's new policies, plus whatever carbon-trading markets are created, will be much more important to watch.

2008 Dec 23 12:48 AM

[NOWHEREMAN:]

You have to see what the Obama Stimulus package entails before you write off coal. If it really pushes infrastructure, then coal will start another run to the upside simply because of there will be no alternatives.

It won't matter what Obama or the Greenies intend for the future, Coal is what we have now. Besides, its a Global commodity, it is not limited to the US. China, India and any Asian or Gulf State construction will need steel.

Yes indeed, those Nat. Gas plants which will replace our Coal fired plants will never see the light of day unless the construction materials are available, ditto reinforced concrete, water pipes, etc. Hundreds of Billions of dollars spent on the steel ergo coal that no one seems to be interested in at the present time because of the Green Initiatives which Obama is supposed to represent.

So far, Obama's representatives are all Old School.

Please tell me what will replace coal in the steel making process? IMHO

2008 Dec 23 02:03 AM

[john s. gordon:]

interesting you would mention water pipes. most of our municipal water distribution infrastructure is over 100 yrs old and breaks down regularly. rebuilds anyone?
> jack

2008 Dec 23 09:52 AM

[NOWHEREMAN:]

John: that's exactly my point. Where will the necessary replacements come from? Certainly not with electricity generated from nonexistent NG plants. Coal usage can be replaced for electricity generation but our steel companies are unable to use NG for their products.

Coal has undergone the same demand destruction as have other commodities. Infrastructure projects will give it the same sort of boost as they will to other commodities. If Coal is Dead, Infrastructure is Dead too.

IMO

2008 Dec 23 11:34 AM

[NOWHEREMAN:]

But who knows, I might do a 180 without explaining why and leave all of you wondering if I was blowing smoke the first time around.

It could be like saying I bought BTU on 11/04/2008 at $28 because Obama did not understand the fundamentals of Coal and coming back 6 weeks later and much poorer to say that Obama will affect the Fundamentals.

Either Coal is vital to our Infrastructure or it isn't. I personally would like BTU to approach its $16 lows before entry. IMO

2008 Dec 23 12:10 PM

[beegdawg007:]

Regarding supply vs. demand... this time its different!
Really....

What has changed..

For the following reasons, coking coal miners can now cut back on supply in 2009 to map it closely to demand.

1. Most are comming up on what what will be the three best quarters they have ever had. Q408, Q109 and Q210. Q210 will be strong because spillover tonnage that was sold at $300/tonne for delivery through March 2009 will be delivered in Q2 of 2010. Because steel mills are postponing deliveries, there is a significant quantity of $300/tonne coking coal that will be delivered in the spring of 2009.

2. The Brazilian coal year runs July 1 to June 30. Companies like WLT have sold large quantitites to Brazil.

3. The balance sheets are exceptionally strong, so miners do not need to sell coking coal at marginal profits just to make interest payments.

4. Labor is stil tight, and most miners have had their employees working overtime just to meet demand. They can simply stop hiriing, move crews to the most productive portions of the mine, and discontinue any overtime if they need to.

5. Most coking coal miners believe that there is a serious shortage of coking coal in the long run. I doubt they will sell much coking coal at $90/tonne in 2009 if they believe that same coal will fetch $200/tonne in 2010.

6. Several miners have already put the brakes on expansion plans and idled poorly producing portions of their operations. Many of the smaller mining operations can not produce coking coal FOB port for less than $90/tonne. Very few of these companies are going to risk going broke by selling coking coal for less than it cost to produce.

7. The one very vulnerable and large producer of coking coal, TCK, has already indicated a willingness to sell as much as 20% of Elk Valley to strengthen its balance sheet. Companies like BTU, and ACI have indicated an interest in expanding, and major steel companies like Posko and Nippon steel have also shown interest in locking in a long term supplyl of met coal.

I think that this time, we will see very protracted negotiations and prices that will likely surprise on the high side simply because the miners are willing to curtail supply to meet demand. Alwso, many of the met coal miners are also thermal coal miners. Those companies have 2009 thermal coal sales mostly locked by now at very favorable prices and many have high percentage of 2010 thermal coal sales locked. WLT, for example sold all of its thermal coal for three years at $100/ton. And BTU and Massey have most of their 2009 thermal coal now under contract with as much as 80% of 2010 thermal coal under contract.

The met coal miners are actually in a very strong position now vs. anytime during the previous 10 years or so...

2008 Dec 24 01:09 PM

[The Proclaimer:]

One New Clean Coal Technology will prove to be a double blessing for the coal industries. The first is obvious, Clean Thermal Energy. The second is that this new process will create a new use for coal. That being coal as a source of construction materials that are stronger than steel, I am talking of carbon fibers and other industrial valuable chemicals.

Check the US Patent Office for the facts:

www.faqs.org/patents/a...

2008 Dec 29 07:25 AM

[The Proclaimer:]

Ohhh Yeah, Aitvaras asked "What will replace coal used for making steel?" the answer is Hydrogen, but then that is a product of the new Clean Coal Technology. Anyone care to speculate on the Thermo Efficency of using Hydrogen to heat with?

Jan 02 12:29 PM

[Freedoms Truth:]

"That being coal as a source of construction materials that are stronger than steel, I am talking of carbon fibers and other industrial valuable chemicals."

That's beyond dubious. Coal is priced in dollars per ton, while carbon fiber is dollars per pound and nanotubes are dollars per gram or centigram. Point being - what are the volumes for these uses? Nothing compared with the volumes needed to burn for electricity, I'd wager.

Jan 03 04:12 PM