Back In The Black

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width=283If there is any commodity more fundamental to the Chinese economy than iron ore, it's coal. Responsible for the haze you can see over most Chinese factory towns, China consumes one-third of the world's coal, which accounts for 68.7 per cent of total power output in China, compared to 49 per cent in the also coal-dependant US.

Last year, a combination of a jump in international coal prices and government price fixing threw numerous coal plants and mines into the red. Many low-tiered cities were stuck with rolling blackouts as several power producers decided to go offline, but since July 2008, the price for thermal coal has dropped from around USD 190 per ton to under USD 90, and most of the major power producers are now back in the black.

That could quickly change though. Like in metals, smaller coal-mines have been closed down because of the financial crisis, and many have yet to reopen, but demand has started growing strongly, with electricity use up 4.7 per cent in July from a year earlier, after having lost 4.5 per cent in the first quarter.

Coal is heavily linked to other commodity prices, most notably in its use during steel smelting, and coal prices have now risen 30 per cent from their low in March.

For the second half of 2009, there are still risks of tight coal supply, said a statement from Huaneng Power International, one of the big five power companies in China, during its first-half meeting report. As we have not signed coal contracts, the coal market is still fraught with uncertainty and instability. Coal supply and the price of coal could present new problems and challenges.

The biggest electricity producers in China have a contract system in place with domestic coal producers similar to the international one for iron ore. And they have also been slow to come to an agreement, with power producers looking for a 4 per cent hike - or flat after tax effects - and mine owners asking for a 17 per cent increase in price.

Though some negotiations have been resolved in the power producers favors, the vast majority - including those with coal-rich Shanxi Province mine owners - have not, and the power companies are also being forced to buy on the spot market to make up the difference.

Coal is one commodity that there is no long-term shortage of - China has enough for the next 100 years - but there are still numerous short-term issues that could make mine owners rich while making power
providers poor ... or vice-versa.

Higher imports

However, Australia has seen higher Asian thermal coal imports. Strong demand for thermal coal in China and India is expected to help Asia avoid the first fall in imports for a decade this year, and push import growth even higher in 2010, an Australian government forecast showed on Tuesday.

In an updated quarterly forecast, the Australian Bureau for Agriculture and Resource Economics (ABARE) said demand for imported coal in Asia would rise by 13.6 milion tonnes, or 3.5 per cent, to 401.6 million tonnes in 2009.

Thanks to improved regional demand and new port capacity, ABARE has significantly upgraded Australia's thermal coal exports, estimating it to increase 2.6 per cent from a year ago to 140 million tonnes in 2009/10. It had expected Australian exports to fall 6 per cent to 122.5 million tonnes in 2009/10 in its June report.

Over the course of 2009, thermal coal demand in the Atlantic market has been weak, while demand in the Asian market has remained relatively strong, underpinned by increasing imports into China, ABARE said in the report.

Chinese capers

In China though, no one expected the financial crisis to be the end of Chinese steel demand, and the Chinese government, as well as many private producers, have used the low international commodities prices as an opportunity to restock after years of high costs.

Many domestic producers have arbitraged the low offshore prices [with higher onshore prices], says Ben Simpfendorfer, head China economist at Royal Bank of Scotland. This has made demand look stronger than it was in China, he added, warning that he expects a correction in the next one or two months, both due to the end of restocking, and to the regular slowdown in commodities demand that comes every summer.

Simpfendorfer and other analysts note, though, that once demand evens out, numerous supply problems still constrain most commodities. Metals, in particular copper and nickel, will be expensive in the coming few years, according to Simpfendorfer, as mines are slow to reopen and exploration of resources gradually picks up again after stagnating through the crisis.

The domestic coal industry intends to significantly increase production, the decreasing need from China's imports may change the increasing coal price for more than five consecutive months.

After the coal imports set a record of 48 million tons in the first half year, China's coal imports in July surged by 13 per cent to 13.9 million tons. It is expected that the largest coal-producing province,
Shanxi's output will be up by 60 per cent, rising 150 million tons, which is almost two times as Germany's one-year consumption.

Due to the decline in China's imports demand, the international coal price will go down, and coal price in Europe will slide by 7 per cent, analyst predict, adding that in the second half year, China's imports demand will glide by 33 per cent.

Grim scenario

Other analysts too maintain that China's unprecedented appetite for imported coal is about to be sated, jeopardizing a five-month rally in prices by adding to a global surplus of the fuel used in power plants from Perth to Chicago.

In the first half, China really supported the market and put a pretty firm floor under the thermal-coal price because it was sucking in so many imports, said Andrew Harrington, an analyst at Patersons Securities Ltd in Sydney. It's difficult to be confident that it will continue at such a rate.

China's July coal imports fell 13 per cent to 13.9 million tons from 16 million tons in June, a record high, customs data show today. Demand from China, which uses coal to generate about 80 per cent of its
electricity, helped ease a global supply glut that sent US inventories to an 18-year high.

Earnings Hit

A retreat in prices may curb profit at Xstrata Plc, the mining company that is the biggest shipper of coal for power stations, said Nick Hatch, an analyst at ING Groep NV in London. Coal was the biggest contributor to operating earnings last year for Zug, Switzerland-based Xstrata, which boosted output of the mineral by 11 per cent in the first half.

If China stops importing as much coal, it clearly may mean lower coal prices in the seaborne market, and that could have an impact on earnings, said Hatch, who has a buy rating on Xstrata and mining companies Rio Tinto Group and Anglo American Plc, which also produce coal.

Six-month supply contracts signed by Chinese buyers in February and March are expiring and aren't likely to be renewed at the same amounts as global costs remain high and as domestic supplies rise, said Huang Teng, the general manager of Beijing LT Consultant Ltd, a coal consultant based in the capital city.

Chinese provinces are accelerating the expansion of coal mines, the China Coal Transport and Distribution Association said. The reopening of small mines in regions including Shanxi will increase supplies and put pressure on prices. Coal futures for September delivery at Rotterdam, the benchmark for Europe, have risen 39 per cent to $72 a ton on August 21 from this year's low of $51.75 on March 12. Prices rebounded from a 35 per cent decline last year, when the recession slowed demand for electricity. Supplies
for delivery in January are trading 7.6 per cent higher than the September contract.

Extraordinary measures

Price momentum and volume momentum are so strong, it's difficult to see why the price should go down, said Eugen Weinberg, a senior commodity analyst at Commerzbank AG in Frankfurt. Measures to initiate demand are extraordinary.

Drax Group Plc, the owner of western Europe's biggest coal-fed power plant, has no plans to sell its surplus inventories of the fuel because the North Yorkshire, UK-based company expects the value of the commodity to increase.

We see the coal market rising, Chief Executive Officer Dorothy Thompson said on an August 4 conference call with reporters. It does not make sense to sell coal now.

US inventories

In the US, inventories jumped 15 per cent in the first four months of the year, compared with a 1.1 per cent gain in 2008 and 2.4 per cent in 2007, Department of Energy data show. Stockpiles at the end of last
year totaled 199.2 million short tons (180.7 million metric tons), the highest since 1991.

Global supply of internationally traded thermal coal is forecast at 633 million tons next year, exceeding demand by 14 million tons, according to forecasts from Macquarie Group Ltd., Australia's largest
investment bank.

St Louis-based Peabody Energy Corp (NYSE: BTU) sold 16 per cent of its coal production outside the US last year. The company's sales outside the US climbed 30 per cent to 40.3 million tons, outpacing total sales growth of 8.2 per cent to 255.5 million.

China has been an indirect market for the US, said James Rollyson, an energy analyst at Raymond James Financial Inc. It's soaked up capacity from Australia, so it kind of makes waves into other markets.

MacQuarie reiterated its bullish stance on the US coal sector and all companies exposed to coal, upping its earnings estimates for all coal producers under coverage while retaining the outperform rating for the sector. We believe spot price direction is going to be the key for coal equities over the next few months as well as data flows from China. We expect generally weaker earnings for domestic coal companies in 3Q as
thermal demand remains very weak and improvements in coking coal fundamentals are expected to drive more meaningful upside to numbers in 2010, said MacQuarie.

The price target for Alpha Natural Resources (NYSE: ANR) is set at $40, while the current price stands at $37.08 per share. Massey (NYSE: MME)'s price target was upped to $32 per share, while its current share price stands at $31.96.

International Coal Group, (NYSE: ICO) has said that its ICG Addcar Systems, LLC subsidiary, Ashland, KY, has acquired certain international patent rights that substantially expand its ability to manufacture and market its Addcar highwall mining system beyond North America. Key coal-producing countries added to the ICG Addcar marketing area include China, Russia and South Africa. The international patent rights were purchased from Addington International, LLC for an undisclosed sum.

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