Last year, China changed the fortunes of Australian and Indonesian coal miners with a brutal cut of 9.4% in local coal production. This led to expansion of coal exports from Mongolia, North Korea, Australia and Indonesia, and substantial price increase for exported coal, both thermal and coking. The effect was so dramatic that China partially reversed the cuts to allow local production boost for the 2016/2017 winter.
Rumor that the Chinese 276-day rule is coming back
Last week, China was rumored to be considering bringing back the 276-day rule, capping annual production days, after the heating season ends in mid-March. The reported reinstatement might be for six months, with some exceptions to avoid the drastic effects seen by the brutal implementation last year.
China gets tough with Korea and stops buying its coal as of today
It started with a warning, when a 16,300 tonne shipment of coal from North Korea was rejected. The explanation given was that the shipment contained a higher than allowed level of mercury. Now China has announced a ban of all coal imports from North Korea for the rest of 2017. This ban is a consequence of tensions due to a recent North Korean missile test. Note that the ban by China follows UN sanctions on North Korean coking coal exports (essentially all of which goes to China) for 2017 of 7.5 million tons. In 2016, China imported 22.5 million tons of coal from North Korea. The political significance is that the coal exports to China make up about a half of North Korea's export income. I assume that this is China saying to North Korea to stop playing games in developing nuclear weapons. It gets more complex as there are reports that North Korean officials are planning a trip to the US, which may signal President Trump's first significant test. Effectively China has got in first. Will North Korea be quickly resolved and the ban on coal imports by China be lifted? ….or…?
Effect on share price of coal exporters
The share prices of major Australian coal exporters has been flat in recent months, indicating caution about where the coal market and price is headed. I suspect that there will be coal executives in Australia and Indonesia delighted with the above developments, but who knows where it will lead?
In today's trade on the ASX, Whitehaven Coal (OTC:WHITY) [ASX:WHC] was flat at $A2.87, BHP (NYSE:BHP) [ASX:BHP] was down 0.64% to $A26.47, while South32 (OTCPK:SOUHY) [ASX:S32] was down 1.86%. Hence, there is no clear market response to the news from China about its efforts to manage the price and supply of coal, as well as the efforts to bring North Korea to its knees.
As a counterbalance to the ban on North Korean coking coal, Mongolia has become a major source of coking coal for China and it supplies coking coal at a dramatically lower price than other countries. For the first 10 months of 2016, Australian exports of coking coal were up 11.3% (to 23.45 million tons), while Mongolia's coking coal sales to China increased by 75.3% to 17.47 million tons.
Perhaps the strangest recent share price movement was that Peabody Energy's (BTUUQ) share price was up 22.1% to $2.21 on Friday. This makes little sense as the shares will be worthless as the company exits bankruptcy within the next few months. Note that Peabody has announced a 60-day extension for filing of its Bankruptcy Plan to 1 May 2017. This does not change the intention to cancel shares, without any reward to shareholders as it exits bankruptcy.
In what is a familiar story for the company, Peabody has closed a $1 billion offering of senior secured notes. These notes will be held in escrow until the company emerges from bankruptcy, after which time the debt will sit there as a cloud on the horizon for new shareholders if/when the next bankruptcy looms. New investors might pay attention to what this $1 billion is to be used for … "to fund a portion of the distributions to creditors provided under the Peabody bankruptcy plan". I think this means that the new company is acquiring debt, which will be used to pay off the last debtors (no benefit for former shareholders). Why would anyone invest in this structure? Perhaps I am missing something?
Where will the coal price settle?
There seems to be a clear intention by China to set thermal coal prices in the range 500-570 yuan/tonne ($72-83) for coal landed in China. Prices vary for coal delivered to different ports and for different coal quality, but this is an indication.
China's monthly power coal price index fell to 528.54 yuan/tonne ($77) in January, the first fall since May. China continues to aim to reduce coal tonnage capacity from 1 billion tonnes/yr to 800 million tonnes/yr between 2016 and 2020.
Newcastle thermal coal price for April delivery was $78.40 per metric ton on February 9.
It is anyone's guess where the price of coking coal will settle with developments in Korea and Mongolia.
The situation for the coal industry has an air of unreality currently. On the face of it the good times are coming back, but these good times seem overwhelmingly due to China's brutal efforts to manage its domestic coal market and steel industry. Side issues relate to China's coal imports from North Korea (ban for rest of 2017) and Mongolia (increasing dramatically?).
However, the narrative for coal is one of long-term declines as the world begins to exit using fossil fuels as a source of energy. Coal is the initial target because it has the highest emissions profile.
There is coal to be sold and money to be made, but the complexities of this process are huge and hard to estimate. If you are comfortable betting on how the situation with North Korea will be resolved, what is going to happen in Mongolia and how the politics of China and India play out concerning their clear efforts to decarbonize their economies, then this is a time to invest. For me, even if I wasn't concerned about the looming climate disaster, I'd prefer to sit on the side and not have my cash reliant on how China, the US (and Russia?) resolve the Korean situation.
Be careful about investing in the coal industry.
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