Stagflation 2008 Style: No Disco For Coal

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Forget oil, coal prices have been going through a bull market for the last year with the curve taking on hockey stick proportions over the last four weeks. Spot prices for thermal coal used in power stations reached $130/ton last week, a 37% increase from the beginning of the year following a 73% rise in 2007. Power station prices reached $145/ton CIF North European seaports in response to severe coal production and shipping constraints in Australia, China and South Africa, three of the largest coal producing countries. Vessels queuing at Australia’s Newcastle port face a month delay and production has been hit by bad weather in Australia’s NW territory and China. Price pressures are exacerbated by critically low inventories according to Goldman Sachs.

All eyes are now on the 2008 annual contracts which, like the iron contracts just concluded, will be under pressure from the high spot prices to show another dramatic rise. Goldman Sachs are predicting thermal coal to rise to $110/mt starting in April, when the new prices come into effect. This represents a rise of 98% from last year’s $55.65/mt.

China has switched from being a coal exporter of 83m tons five years ago to a coal importer today as power demand has rocketed and new coal power stations can not be built fast enough to meet demand. Vietnam, China’s largest supplier, plans to reduce exports by 32% this year due to rising domestic demand for power and  coking coal. South Africa, a net coal exporter will have to import over 22m tonnes this year to replenish depleted stocks. Australia cannot increase exports because of port congestion; new investment is planned but will take a long time to reach fruition.

Cement producers (the third largest user after power and steel) outside Asia are switching from coal to petroleum coke as a cheaper alternative, an option not open to the steel industry.

Meanwhile the steel producers are quickly pushing through price increases on the back of rising costs. Like thermal power companies, the steel industry buys the majority of its high quality coking coal on longer term agreements, usually negotiated annually. Prices have more than doubled this year to over $200/ton but the effects won’t kick in until May-June just as several of the world’s economies may begin to show a softening of demand.

With oil and gas prices high and coal rising fast, do not expect any respite in electricity costs this year. The cost of power may not immediately hit the big western metals producers who buy their power on longer term contracts but it will certainly affect producers in developing countries where contract terms tend to be of shorter duration. This will hit the small to medium sized metal smelters in Asia, Africa and South America particularly hard. These producers have been cushioned from rising power and ore prices by rising refined metal costs over the last few years but the relentless surge in power and ore prices may well meet a stagnant refined metal price if the demand curve flattens towards the end of this year.

What will that mean for metal prices? It’s anyone’s guess but there could be a lot of pain out there if high power prices agreed to now can not be sustained with high metal prices as the year unfolds.

–Stuart Burns

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