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Is China Shaping A Coal War?

Commodities | Oct 15 2020

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If China's importers have been warned not to buy Australian coal until further notice, what does this mean for the price and outlook for Australia's second largest export by value?

-Is China just pulling back bullish expectations of additional import quotas?
-Difficult for China to replace Australian hard coking coal
-Thermal coal prices likely to decline on material reduction in China's imports


By Eva Brocklehurst

Confused about China's coal import policy? Apparently both power stations and steel mills in China have been warned not to buy Australian coal until further notice. The directive appears to have come from Beijing rather than local authorities.

Morgan Stanley cites reports that two vessels with Australian coal are being diverted to India instead and BHP Group ((BHP)) has indicated some Chinese customers have asked to defer purchases.

Australia's hard coking (metallurgical) coal price has fallen to US$124/t, widening the arbitrage with China's domestic price. In thermal coal, the Newcastle 6000kcal October futures price fell to US$55.50/t and the high ash equivalent to US$36/t.

However, Credit Suisse's coal analyst is not hearing a lot about a special ban on Australian coal, although notes import quotas are very tight, and believes it is unclear whether China intends to punish Australia or whether it is just "cooling bullish hopes that additional import quotas will be released".

The bulls have helped lift Australian prices since February but traders have now assumed the worst in the latest reports and started panic sales of thermal and metallurgical coal to other destinations, undermining prices.

Commonwealth Bank analysts note China's coal import quotas, which affect all countries, are the most significant driver of coal imports, which are set to drop -38% in the December quarter to meet the target of 270mt.

Australia may be impacted more extensively, but this is not a certainty and they conclude that, while seaborne coal prices are likely to be adversely affected in the short term, rising demand outside of China should keep prices well supported.

China may be the largest importer globally, but imports account for only a fraction of its total coal demand. China's coal production has lifted since 2017 and is expected to keep rising.

The sustainability of domestic coal sectors is at the centre of China's policies and ANZ Bank commodity strategists point out restrictions and quotas are usually adjusted in an effort to balance domestic and international coal consumption.

Australian Specifics

Australia's thermal and coking coal exports to China accounted for 0.8% and 2.5%, respectively, of the value of total goods and services exports in 2019-20. These proportions, while less than LNG and iron ore exports to China, are still large enough to have a meaningful impact.

The CBA analysts highlight it's important to be aware that the growing tension between the Chinese and Australian governments is just a suspected motive and clarity is difficult to obtain because of the unofficial way China communicates its coal import policy.

As an example, concerns that arose in February 2019 stemming from an increase in customs clearance rates for Australian coal were attributed to reduced hours for unloading cargoes and quotas on imports at specific ports.

However, the underlying fear at the time was that China was targeting imports of Australian coal because Chinese firm Huawei had been banned from building Australia's 5G network.

Coking Coal

Credit Suisse is positive about coking coal as China relies on Australia for premium low-volume grades as it has a domestic deficiency. It would harm the steel industry's productivity if this were unavailable, given China has a structural shortage of premium quality. China is also depleting port stocks of imported coking coal so it will likely return to buy Australian premium coal in 2021 if not before.

Morgan Stanley also asserts China could struggle to find alternatives to Australian metallurgical coal. From a volume perspective, Canada and Russia could redirect coking coal exports and offset Australia shipments to China but such a large shift in flows is unlikely, the broker observes, given the contracts in place.

Moreover, Russia's metallurgical coal is not of comparable quality. In the midst of US/China trade tensions it also is unlikely a large share of US coal exports would go to China. However, on the seaborne supply side, Morgan Stanley does not envisage sufficient buyers for stranded Australian supply if a ban were to come into force.

The timing of the current restrictions is also consistent with a recovery in coking coal imports from Mongolia, the CBA analysts point out, which accounted for around 45% of China's coking coal imports in 2019.

Earlier in the year Mongolian imports slumped -45%, reflecting a brief closure of the border related to the pandemic and a higher price for Mongolian coking coal relative to seaborne prices. Mongolian coal is not subject to import quotas explicitly which provides a distinct advantage.

The ANZ strategists estimate around 36% of Australia's coking coal exports have ended up in China in 2020 so far, up from 28% in 2019. This seems to suggest the current restrictions are an effort by authorities to support the domestic market. Regardless of the motive, the restrictions are expected to weigh on prices of premium hard coking coal.

Thermal Coal

China's restrictions are usually targeted at the thermal market in an attempt to protect domestic supply and stabilise prices. Yet, Morgan Stanley considers thermal coal less of an issue for Australia as it ships around 25% of its thermal supply to China. Replacing Australian thermal coal would not be difficult for China as constrained domestic output could be ramped up, or Russia could come to the party.

Still, the CBA analysts do not envisage a natural buyer for displaced Australian thermal coal exports over the next few months, particularly the low-quality thermal coal that China consumes. Significantly, a switch to gas is likely in Japan and South Korea given the low price of oil-indexed LNG relative to high-quality thermal coal.

Hence, Australian thermal coal benchmark prices are likely to decline on any material reduction in Chinese imports. At current prices, around 30% of Australia's thermal coal exports are already loss-making and the CBA analysts suggest this will rise to 57% if thermal coal prices fall to 2020 lows again.

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