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Metallurgical Coal

|Includes: AKS, ARCH, BTU, CLF, MEE, NUE, STLD, TECK, X

Metallurgical Coal

May 10, 2010  

·      We forecast a 10% increase to $220/Mt for Asia benchmark coking coal prices for the 2Q of 2010 beginning July 1st.  We forecast a further 50% YoY increase to $300/Mt for 2011 and $400/Mt for 2012.  We expect metallurgical coal prices to remain elevated well above marginal cost through 2012 due to limited capacity additions and transportation bottlenecks

·      Coking coal is positioned to benefit from an improving economy stimulated by unprecedented fiscal and monetary stimulus initiated in 2009. The recent move by BHP to enter into a quarterly contract with JFE at $200/Mt signals a probable future upward price movement.  China turning into a net metallurgical coal importer has put intense pressure on the global demand/supply balance.  In 2003, China exported a little less than 10 million Mt of coking coal, but in 2009 it imported 34.5 million Mt.  China’s 1Q coking coal imports annualize at about 45Mtpa and we expect this run rate to be maintained as China seeks to replace lost tonnage from coal mine consolidation

·      We forecast China to grow pig iron output by 10% in 2010.  We believe that growth will moderate to 6% in 2011 reflecting credit tightening measures and increased raw material costs

·      We expect coking coal producers to have continued pricing leverage through 2012 until port expansions and mine capacity can improve supply.  We believe steel mills can currently pass on higher raw materials costs and are able to accept higher coking coal prices

We forecast a 10% increase to $220/Mt for Asia benchmark coking coal prices for the 2Q of 2010 and expect continued upside through 2012

We forecast a 10% increase to $220/Mt for Asia benchmark coking coal prices for the 2Q of 2010 beginning July 1st.  We forecast a further 50% YoY increase to $300/Mt for 2011 and $400/Mt for 2012.  We expect metallurgical coal prices to remain elevated well above marginal cost through 2012 due to limited capacity additions and transportation bottlenecks (Exhibit 1).  The supply of premium hard coking coal will be exceptionally tight with most of the capacity additions coming from lower quality PCI, semi-soft, and crossover thermal coal. We view recent China seaborne imports for crossover thermal coal from the United States as an indication of the tight supply in the current market. We expect China metallurgical coal seaborne imports to increase by 16 million Mt in 2010 and see upside to this estimate should the consolidation of China’s small coal miners take longer than expected.

Exhibit 1:  Seaborne metallurgical coal supply/demand, in millions of metric tons

Seaborne imports

2004

2005

2006

2007

2008

2009

2010E

2011E

2012E

China

0

0

-2

1

0

34

50

55

60

Japan

56

55

52

54

54

45

48

50

51

Korea

15

11

12

16

19

16

19

21

22

India

18

22

22

23

25

27

30

40

55

Europe

51

51

54

59

63

37

51

51

51

South America

11

11

12

14

15

11

14

18

20

Other

42

50

40

42

43

33

38

41

44

TOTAL

193

200

190

209

219

203

250

276

303

Seaborne exports

 

 

 

 

 

 

 

 

 

 

 

Australia

117

125

124

137

134

134

154

163

180

USA

20

21

22

26

35

30

43

47

47

Canada

22

23

25

27

29

24

29

34

36

Other

34

31

22

21

21

9

22

23

25

TOTAL

193

200

193

211

219

197

248

267

288

 

 

 

 

 

 

 

 

 

 

Asia Coking Coal  ($/MT)

$58

$125

$116

$98

$300

$129

$220

$300

$400

Source:  EIA, Estimates

Purchasing managers indexes rebound

The economic outlook has improved significantly in response to unprecedented fiscal and monetary stimulus initiated in 2009.  Purchasing managers indexes have reflected an impressive global rebound in manufacturing.  China is once again the fastest growing major economy within the G20 and its steel intensive industrialization is a key demand driver for coking coal.  

World steel production sets new record high in March

World steel production in March registered 120.3 million Mt, (+30.6% YoY) surpassing the previous record in March 2008 of 119.9 million Mt.  The strength in coking coal prices and steel production reflect the increasing infrastructure demand of China as well as a G7 recovery.  Steel mill capacity utilization for the 66 countries covered by the World Steel Organization was 80.2% in March up from a low of only 58.1% in December 2008.

We forecast China to grow pig iron output by 10% in 2010

Chinese steel demand is geared towards the property and infrastructure sectors. These two sectors accounted for approximately 60% of China’s 2009 steel demand.  Floor space sold / under construction and fixed asset investment data are showing strong positive trends, indicating continued demand strength.  We expect China’s pig iron output growth to remain robust, although growth rates may moderate some due to recent credit tightening policies and government efforts to remove inefficient overcapacity.  We forecast China to grow pig iron output by 10% in 2010.  We believe that growth will moderate to 6% in 2011 reflecting credit tightening measures and increased raw material costs. (Exhibit 2) 

Exhibit 2:  China metallurgical coal market supply/demand, in Mt

Mt

 

2004

2005

2006

2007

2008

2009

2010E

2011E

2012E

 

Pig iron production

 

252

345

414

477

471

541

600

635


670

 

Coke demand

 

160

204

249

297

298

334

361

378

393

 

Coke net export

 

15

13

15

16

12

1

0

0


0

 

Coke production

 

175

216

263

312

310

335

361

383


393

 

Coking coal demand

 

245

303

369

437

434

469

512

536


561

 

Coking coal production

 

247

302

368

433

430

438

462

481


501

 

Balance (imports)

 

-2

0

0

4

3

31

50

55


60

 

YoY %

 

 

 

 

 

 

 

 

 

 

 

Pig iron production

 

 

37%

20%

15%

-1%

15%

10%

6%


5%

 

Coke demand

 

 

27%

22%

19%

0%

12%

8%

5%

4%

 

Coke net export

 

 

    -15%

14%

6%

-21%

-94%

-

-


-

 

Coke production

 

 

24%

22%

19%

-1%

8%

8%

5%


4%

 

Coking coal demand

 

24%

22%

19%

-1%

8%

8%

5%


4%

 

Coking coal production

 

22%

22%

18%

-1%

2%

9%

6%


4%

 

Source:  CEIC, SXCoal, Estimates

Coking coal producers to enjoy continued pricing leverage

We expect coking coal producers to have continued pricing leverage through 2012 until port expansions and mine capacity can improve supply.  We believe steel mills can currently pass on higher raw materials costs and are able to accept higher coking coal prices going forward. Coking coal accounts for about 26% of Chinese steel producers’ costs on an integrated cash cost basis as compared to iron ore’s 40% share of costs. 

China metallurgical coal supply dynamics

China faces a structural shortage in premium hard coking coal and will increasingly rely on imports. We note that 70% of new steel capacity being built is expected to be strategically located in coastal regions with access to seaborne imported coking coal. In 2010, China’s domestic coking coal supply bottlenecks are expected to ease somewhat. According to coking coal producer Hidili, production volumes in Shanxi province should increase by 5- 10% YoY.  However, other major coal producing provinces plan to push forward with their own industry consolidation plans.    

Small coking coal mine consolidation reduces supply

Growth in coking coal production was curtailed in 2009 due to aggressive consolidation in the major mining province of Shanxi.  Falling production from Shanxi was a key factor behind a surge of coking coal imports in 2009.  We believe the recent move by China to consolidate small coking coal mines in Shanxi is an effort to improve output by increasing productivity levels.  Chinese underground mines produce 0.2 tons per miner hour compared with the US underground productivity levels of 3.2 tons per miner hour.  China’s large coking coal producers have limited growth potential and reserve quality is declining as the best hard coking coals have been developed.  Consolidation is happening at a slower rate than expected due to differences in what private miners are wiling to sell out for and legal issues that delay the process.  We don’t expect this to change as coking coal prices have gained momentum.

Transportation issues limit coking coal transportation in China

Transportation bottlenecks for coking coal are unlikely to be solved before 2011. The improvement in coal railroad transportation has been primarily focused on thermal coal recently, while the transportation for coking coal continues to remain tight. We don't see the situation improving before 2011 until the TaiZhongYin Line is in service.

China and India continue to increase investments in overseas coking coal assets

With the coking coal market likely to remain in a tight balance, we expect Chinese steel producers will increase investments in overseas coking coal assets.  In addition to China, India's coal firms are also actively seeking overseas acquisition opportunities to secure supply.  India will also be a key growth driver with demand for hard coking coal slated to increase dramatically the next three years.  India today is producing about 60Mt of steel. This is expected to increase to approximately 125Mt by 2012, requiring coking coal imports of 55Mt.  Acquisitions of coking coal assets could further exacerbate the supply issues by removing seaborne coking coal from the market.

Australia constrained by bottlenecks in port and rail capacity

We believe there will be a modest improvement in Australia port and rail capacity, but export volumes will continue to be constrained by transportation bottlenecks.  An additional 25Mt expansion in Queensland is scheduled to be operational in 2012. This positions the US for higher metallurgical coal exports.  We estimate US metallurgical coal exports of 43 million Mt up from 30 million Mt in 2009.  We assume a 10% improvement to 47 million Mt in 2011.   

New sources of hard coking coal supply in Mozambique and Mongolia will only provide some relief for the market, but not until 2014

Mozambique has the potential to be a new major coking coal producer. We forecast 13Mt of export by 2014, with the potential to increase to 25Mtpy provided the two projects proceed on schedule.  We note that liquidity remains constrained to all but the highest quality borrowers, further limiting capacity expansions.

Key risks

Steel production and prices - any slowdown in the steel sector would likely hurt demand and pricing.

 

 



Disclosure: No Positions

Disclosure: No Positions