Thermal coal caught in Mexican stand-off
FT / Javier Blas / Apr 2

The global thermal coal industry is in the midst of a rare Mexican stand-off, with billions of dollars of coal shipments and mining investments at stake.

The Australian coal miners, led by Xstrata, and the Japanese utilities, with Tohoku Electric Power Co. as top negotiator, have failed to reach an agreement for their annual supply contracts by the unofficial deadline of April 1.

Worse, the two sides remain far apart, and executives involved in the talks say a deal is unlikely until mid-month. But one fact appears clear: for the first time in three years the annual contracts could be settled below the key $100-a-tonne level.



The London-listed miner and the Japanese utility typically set the benchmark for thermal coal, which the rest of the industry in the Asia-Pacific then follows. The Japanese coal annual contracts, which run from April to March, affect directly and indirectly the prices used for about 30 per cent of the global seaborne market.

Although overshadowed by commodities such as iron ore and copper, the price of thermal coal, used to fire power stations, is crucial for the profitability of the global mining industry. Coal accounted for nearly a third of the operating profit of London-listed blue-chip miners Xstrata and Anglo American last year. For pure-play miners, including London-listed Bumi and New York-listed Peabody Energy, it is even more critical. The commodity is also important for commodities trading houses including Glencore and Noble Group, and utilities such as Tokyo Electric Power Co.

The rare stand-off comes amid a relatively well balanced seaborne thermal coal market. On the consumption side, Chinese demand remains strong, and India is importing more and more coal, traders say. But supply is also robust, particularly as US utilities burn more natural gas after the shale revolution sent its price sharply lower. The coal-to-gas shift is pushing huge volumes of US coal into the international market, just as Indonesian production also surges.

The annual negotiations have tended to follow a familiar script: Japanese utilities would pay a premium – often as high as $10 a tonne over prevailing prices – to secure high-grade thermal coal. In exchange, miners would offer 12-months fixed prices. The gentleman’s agreement also served to guarantee a high enough return to the Australian miners to ensure future investment. But the Japanese utilities are taking a different approach this year, refusing to pay a premium, in part because of pressure from Tokyo to cut the cost of electricity generation.
So far, neither the miners nor the utilities are moving from their early negotiating positions of $102 and $94 a tonne, respectively. “We are in an impasse,” said an executive directly involved in the annual negotiations. The utilities, nonetheless, are hinting that if a deal does not arrive soon, they could lower their offers.

If the Japanese side wins the battle, as some miners fear, the settlement could be as low as $94 a tonne, down roughly 18 per cent from the 2012-13 deal of $115.20 and even further below the record high of $129.85 a tonne set in the 2011-12 fiscal year for benchmark material with an energy content of 6,700 kcal/kg.

For the Australian miners, that prospect is particularly worrisome: the
Aussie dollar has strengthened significantly against the US dollar over the past four years, further reducing the earnings of local miners in domestic currency. The squeeze comes as the cost of running mines in Australia, particularly marginal underground operations, has surged due to higher wages and extra diesel costs.

Coal executives are worried that a double-digit settlement, rather than one at what they call the “magic” $100 a tonne level, could put many high-cost mines in Australia out of business. At current spot prices of about $90 a tonne in Newcastle, the Australian port that serves as the benchmark for Asia coal, executives believe that up to a quarter of Australian miners would lose money. In its annual report, Glencore, by far the world’s top coal trader, said: “Current spot coal prices mean that many of the world’s producers are unable to make a reasonable return.”
But the miners’ losses may not lead to lower supplies and higher prices, analysts, traders and executives say. Rob Clifford, mining analyst at Deutsche Bank in London, says that “in the short term, many producers are bound to take-or-pay infrastructure contracts which may require the Newcastle benchmark to fall further to the $72-$74 a tonne range in order to trigger curtailments”.