Why China Is Ready to Pay a Premium for Metallurgical Coal

by: Kelvin Schulle

It is believed that China is ready to accept a 40% jump in iron ore prices in 2010 after lengthy negotiation between BH Billiton (NYSE:BHP), VALE and Rio Tinto (RTP). Meanwhile, the negotiations on metallurgical coal pricing have already started between China and big coal producers. The initial price target is $200, raised from $129 last year. This is almost a 55% jump.

Goldman Sachs also predicted a $200 price target for metallurgical coal in 2010. For BH Billiton and other western producers, more pricing power is expected for metallurgical coal as China simply does not have the high quality coal that is needed for steel production.

Back in January, Peabody Energy (NYSE:BTU) management approved more investment in Metropolitan mines in Australia to boost metallurgical coal production there to meet demand from China. The company sees continuously rising demand from Asia. Although Peabody is a small producer in terms of metallurgical coal, the Metropolitan mines can produce over 2 million tons after the new investment. Strategic acquisition may also be in play as the company shifts its weight in to the metallurgical coal market. Big producers such as Alpha Natural Resource (ANR) and Arch Coal (ACI) are already seeing strong shipments in the recent quarter.

China's Baosteel and Wuhan (NASDAQ:WUHN) steel are the two major players negotiating with Vale (NYSE:VALE) and BH Billiton. The political support from the central government will likely help strike a short term deal to secure supply for Chinese steel producers. China prefers to ink a long term pricing agreement as the country needs steel to expand its high speed railway network in the next 5 years. Time is not on China's side as the market price of metallurgical coal has been steadily moving up in the last few months. The trend continues.

Disclosure: Long BHP