Special report on coking coal: coming to terms with the end of the China Bull Run.

1. METALSwww.platts.com/metals
APRIL 2016
Jarek Mlodziejewski, TSI Senior Analyst
www.thesteelindex.com
COKINGCOAL:COMINGTOTERMSWITH
THEENDOFTHECHINABULLRUN

2. SPECIAL REPORT: METALS COKING COAL: COMING TO TERMS WITH THE END OF THE CHINA BULL RUN
2Copyright © 2016 by Platts, McGraw Hill Financial
Chinese steel consumption shrank in 2015 for the first time in
decades. Prior to that, the consensus had been that output
would expand every year. So the idea that China’s “peak steel”
moment had already been reached took the steel world by
surprise. This was particularly true for raw material suppliers,
which had been investing in new capacity to meet continuing
demand expansion.
The impact of the slowdown has been felt hard in coking coal
markets where the effect of supply expansions created a
market division. For a number of years there has been a ‘China
price’ and a rest-of-world (ROW) price. This was driven by
differing price elasticity between the Chinese import market,
which happened to also be the world’s largest producer, and the
coking coal-short ROW market.
Coking coal producers were caught between a rock and a hard
place. They had extra tonnage to sell, but could not fetch the
same price globally due to varying demand conditions. This
created a CFR spot market and an FOB market, of approximately
equal importance, which persisted for some time.
Regional market pricing differentials are the dichotomy at
the heart of spot coking coal pricing which hinders market
efficiency. But the market is now undergoing a change. The
spot FOB market is asserting itself as the central pricing
point worldwide.
This transition has seen index-linking increasingly pegged to
TSI’s Premium coking coal FOB Australia index, which reflects an
outright FOB pricing point. It has reportedly been embedded in
most new physical coking coal index-linked contracts since Q4,
2014. Chinese end-buyers may still pay an all-in CFR price, but
traders buy FOB.
As buyers congregate around the FOB-mark, will global pricing
reconverge? It seems unlikely in this profit-thin steelmaking
environment that ROW buyers will be content to subsidize
Chinese buyers by paying higher prices, while Chinese buyers
take the same material at lower rates. While that has helped
miners amortize production costs over increased volumes,
this situation may eventually force the producers to reconsider
output levels.
Data submitted to TSI showcases the switch in the CFR/FOB
dynamic. China import volumes fell 23% in 2015 to 48 million
metric tons, but spot cargoes sold to China on a CFR basis fell
51%. So while China is taking less material, what it is buying is
increasingly bought on a FOB basis.
With a unified purchasing point, the big question now is whether
Chinese and ROW coking coal prices will ‘equalise’ i.e. be worth
the same in either market, rather than varying by destination.
They broadly are for low-vol coking coals, but mid-vols are a
huge question mark.
This is not the only question vexing the market. The
negotiated ‘benchmark’ system of quarterly pricing has
persisted long after many had predicted its demise. The
‘stickiness’ of the negotiated benchmark has revolved
around buyers’ interests in fixing some portion of
steelmaking costs for each quarter to assist with margin
management, particularly for automotive contracts which
are often also settled quarterly.
Sellers have also had an incentive to continue pricing
quarterly. In a market which has fallen for nine quarters,
it has created a helpful lag in sales prices versus an ever-
falling spot price.
Anglo American now takes the lead with quarterly benchmark
negotiations, but given its prime assets are up for sale (with
Foxleigh just sold), we could find the market in a vacuum where
the quarterly system may collapse, encouraging more spot and
spot-linked (indexed) sales.
Inevitably the spot price is more volatile than the quarterly
negotiated benchmark, exhibiting swings as supply and demand
for coking coal fluctuates.
But as an active iron ore derivatives market has shown, this
does not mean suppliers, traders and end-users give up control
of revenues and costs to the whims of a volatile spot market.
Instead, buyers and sellers can lock-in future pricing (e.g.
monthly, quarterly, annually) as far along the forward curve as
they wish. The growth of the coking coal derivatives market is
evidence of this occurring as market participants mitigate the
risk of fluctuating spot prices.
TSISUBMITTEDVOLUMES PREMIUMCOKINGCOAL
Source: TSI
Q1 16Q3 15Q1 15Q3 14Q1 14
FOB Australia CFR China
EXCHANGETRADEDDERIVATIVEVOLUMES
(’000 mt)
Source: TSI
0
100
200
300
400
Mar-16Jan-16Nov-15Sep-15Jul-15May-15Mar-15Jan-15
CME SGX

3. SPECIAL REPORT: METALS COKING COAL: COMING TO TERMS WITH THE END OF THE CHINA BULL RUN
3Copyright © 2016 by Platts, McGraw Hill Financial
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It has been a good start to 2016 for coking coal derivative
volumes. Cumulative Q1 2016 volumes grew 87% over Q4 2015
and 71% over Q1 2015. Yet, while growth is encouraging, average
monthly volumes for the last two years across both CME and
the Singapore Exchange (SGX) are about 240,000 mt. Coking
coal futures have yet to experience the explosive growth of
iron ore, missing that core of market makers willing to build
volume to create the critical liquidity levels needed to attract the
participation of others.
For those willing to hedge significant coking coal volumes
(and there are plenty) they can take some heart from the
history of iron ore derivatives market maturation. Once
the traditional fixed annual iron ore pricing mechanism
transitioned into the use of shorter term contracts in 2010,
paper trading on SGX doubled.
It has also continued to double every year since then, providing
new market participants with confidence to trade in the
product. As the market begins to seriously contemplate the
end of the quarterly negotiated benchmark system that may
provide the spark needed to start the evolution of a physical
and paper market that has been in a holding pattern for the
past few years.