Coal Prices Set to Go Up

Sep.29.08 | About: VanEck Vectors (KOL)

Globally, coal prices are witnessing a significant spike, thanks to the growing steel demand and supply constraints. Coal, which is one of the major raw materials for producing steel, is already short of 25 to 35 million metric tons in FY 2008 across the globe, which is likely to reach 70 mn metric tons in FY 2009 (as per Steve Leer, Arch Coal Inc. chairperson and CEO). Recent floods in Australia, the world's second largest coal exporter, forced several coal producers to shut down their mines, resulting in a huge decline in coal output in the first quarter of FY 2008. According to Macquarie Bank Ltd., coal production from Australia may decline by approximately 15 million metric tons, or about 12 percent of Australia's annual exports in FY 2008.

In addition, a power crisis faced in South Africa in January 2008 and thereafter a reduced power supply from Electricity Supply Commission (Eskom, South Africa's national power supplier), resulted in a shutdown of several mines and forced coal producers to cut their output, which further decreased the coal production. Meanwhile, International Iron and Steel Institute forecast that demand for steel is going to increase by 6.7 percent in FY 2008, led by an 11.5 percent increase from China. The shortfall in production of coal along with the increasing demand for steel led world's leading steelmakers such as Nippon Steel Corporation, ArcelorMittal (NYSE:MT), JFE Holdings Inc. and Pohang Iron and Steel Corporation (POSCO), to increase contract coking coal prices approximately 200% to US$300.00 a metric ton for the 2008 coal year (commenced 01 April 2008). On a similar trend, contract prices for thermal coal, used in power plants, more than doubled to US$125 a metric ton for FY 2008.

China plans to reduce exports of coal in FY 2008, as it remains concerned with its domestic power needs, since two-third of China's energy production depends on coal. Moreover, in order to curb the ever-increasing inflation rate and the over-heated Chinese economy, the government of China raised its export tax for steel billets from 15 percent to 25 percent, effective from 1 January 2008; to reduce the inflow of funds. This resulted in a tight global coal supply condition, leading to a hike in coal prices. While China's coal exports are expected to decline moderately, coal production capacity is expected to increase to 2.73 billion tons in FY 2008, supported by expansion of coalmines and technical renovations to meet the growing demand from domestic market (Source: chinamining.org).

Furthermore, with the steep increase in oil and gas prices, coal's importance in the world energy mix is set to increase in the future. According to the International Energy Agency, there are abundance of coal resources of approximately 200 years worth of coal reserves, evenly distributed in the US (27%), Russia (17%), China (13%) and India (10%). It is estimated that by 2030, coal will account for 27% of the global energy mix, up from the 24% that it holds today. Given the abundance and accessibility of coal resources, the increased usage of coal will facilitate minimizing the global energy crisis.

Going forward, the demand-supply mismatch is expected to last for at least two to three years before it recovers from the supply bottlenecks in Australia and ease power shortages in South Africa. Hence, coal price outlook in FY 2009 is likely to remain strong with coking coal prices expected to increase to US$320 a metric ton and thermal coal to increase to US$135 a metric ton for 2009 coal year (Source: Merrill Lynch & Co Inc).

Stock position: None.