The thermal market has switched from a position of oversupply to regional shortage, with Asian customers scrambling to secure tonnage while prices steadily increase.

Asia-Pacific spot prices for thermal coal have broken the US$50/t barrier, a level inconceivable only three months ago. Lower exports from China in the wake of a domestic thermal coal crisis are believed to be the root cause.

“In a twist of fate, it was sharply increased Chinese exports in 2001 that destabilized international coal markets and resulted in depressed prices,” AME said.

Seaborne thermal coal trade is dominated by Australia, Indonesia, China, South Africa and Colombia. These countries will account for around 80% of global exports this year. Exchange rate movements have had a major impact on country average FOB cash costs and mine operator profitability.

At prevailing exchange rates, producers in Colombia and Indonesia hold a FOB cost advantage of approximately US$3/t on South Africa and China, and US$6/t on Australia. The rise in the value of local currencies of South Africa, Australia and Indonesia against the greenback through 2003, severely eroded margins. By last December, the return to Australian suppliers on thermal coal export sales was around $10/t lower than twelve months earlier.

Notably, Chinese suppliers are protected against currency movements by a fixed exchange rate. The Yuan is widely regarded as undervalued against the US dollar, conservative estimates placing the figure at around 20%. A revaluation by this amount would have a large effect on the FOB cost structure and make China the highest cost major coal-exporting nation.

Ocean freight costs now have a major influence over country competitive position in export markets, with the most distant suppliers to particular destinations disadvantaged. Progressive deregulation of international electricity markets has focussed thermal coal customers on the landed cost of energy rather than FOB price.

Spot ocean freight costs on major coal routes increased by around 130% in the twelve months to February, pushing rates to record highs. Higher freight costs that will prevail through 2004 are lifting the landed cost of coal sharply, skewing traditional trade patterns and regionalizing supply/demand markets.

The North Asian markets of Japan, Taiwan and South Korea account for over 40% of total international thermal coal demand. Indonesia is currently the lowest landed cost supplier to these countries, holding a small advantage over China. Australia and South Africa come a distant third with average C&F costs around 35% higher. South African producers, effectively priced out of most Asian markets in 2003, are now becoming competitive against Australia.

Increased export capacity through expansion of the Richards Bay coal terminal may place further pressure on high cost Australian mines.

Colombian suppliers hold both FOB cost and ocean freight advantages in the second largest thermal coal market of Western Europe and are set to increase market share through aggressive export expansion plans. On a landed cost basis, Colombia holds a US$2/t advantage over Indonesia, US$4/t over South Africa and more than US$10/t over Australia.

In 2003, Japan-Australia contract thermal coal prices reached their lowest point (expressed in real terms) in over 25 years. Between 2000 and 2003 real prices fell at an average annual rate of approximately 4%. But international spot prices began a steady recovery from the second quarter of 2003, albeit from a very low base. Atlantic and Asia-Pacific spot markets followed different paths under the influence of regional supply and demand factors.

By October, Australian spot prices eventually exceeded the 2003 Japan-Australia contract price of US$26.75/t set in March.

The supply situation has been exacerbated by a range of other factors including, mine accidents in China, pit flooding and production disruptions in Indonesia, a threat of reduced exports from Newcastle arising from an export allocation system, coal loader problems at Queensland’s Dalrymple Bay terminal, and social unrest in Indonesia that forced a declaration of force majeure at the Adaro mine.

The big question now is: have Asian spot prices overshot, and what price level reflects medium term market reality? Without doubt, Asian contract prices for 2004 will be much higher, with AME placing the increase at over 60%. At the same time, South African spot prices to a highly commoditized European market (not affected by significant short-term supply and demand issues since the third quarter of 2003), have moved in a relatively narrow range over the past three months to average around US$43/t.

Higher 2004 prices will certainly provide relief for Australian thermal coal producers and mark a return to profitability. The result will be especially welcome in the Hunter Valley where major producer Coal & Allied, a leader in large-scale mining operations, recorded a break-even financial result in 2003.

“AME Mineral Economics believes that China will continue to hold the key to international thermal coal supply/demand balances and prices. We expect that China’s domestic thermal coal supply problems will ease after the winter heating season and suppliers will be able to return to export markets,” AME said.

“It appears that China’s immediate problem relates as much to domestic coal and electricity pricing structures and coal distribution infrastructure as it does to coal supply capacity. China’s coal production potential cannot be underestimated. Total production exceeded 1,700Mt in 2003, a year-on-year increase of almost 25%. At the same time, rail and port infrastructure upgrades are ongoing.

Four companies – Xstrata, BHP Billiton, Anglo American and PT Bumi Resources – each control over 30Mtpy of thermal coal exports on an equity share basis. Changed FOB cost structures and rising ocean freight rates are affecting the competitive position of export coal producers. The most competitive companies have assets concentrated in low cost countries located relatively close to markets.

PT Bumi, majority holder of Indonesia’s Adaro and new owner of Kaltim Prima Coal (KPC) is the lowest cost among these mega-companies, with cash costs in the first quartile of the company cost curve. KPC is the world’s lowest cost large export mine. Other major export coal producers in the first quartile are Samtan (Kideco Jaya Agung, Indonesia), Drummond (La Loma, Colombia), Glencore (Cerrejon Coal, Colombia) and Swabara (Adaro, Indonesia).

Multinational companies with a geographic spread of assets are placed higher on the company cost curve.