Market and product

China is moving to unwind coal-mining restrictions fearing winter "brownouts" due to low coal inventories that had triggered rising prices for the country's main source of power. But the moves to increase production have created fresh uncertainty over the outlook for coal prices and heightened anxiety among producers desperately seeking to restore profitability.

The production curbs, initially imposed in April, are part of the Chinese leadership's current program of "supply-side reforms," that have led to an unexpected surge in the price of thermal coal.

Three top-level meetings in the past two months called by the country's central planning body, the National Development and Reform Commission, culminated in a summit of coal miners on Oct. 27, which industry sources described as heated.

As analysts at Macquarie Group, an investment bank, noted: "NDRC announced a relaxation of coal production controls at almost 800 mines at the end of September, theoretically increasing effective production capacity by approximately 300 million metric tons per annum and, hence, fourth-quarter production by approximately 75 million metric tons."

Since then, coal prices have risen further, in part because the resumption of mining alone takes two to four weeks in China, Macquarie added.

The latest talks have been aimed at cooling the price of thermal coal that has more than doubled since January this year as the winter months approach. Thermal coal's spot price was trading at $110 per metric ton at the benchmark Australian port of Newcastle on Tuesday, up almost 30% from last month's close.

"Panic is a strong word but inventories are low and Beijing's biggest fear is brownouts during the winter months. The NDRC seems to be aiming at a price ceiling that is well below the current spot price," USB analyst Lachlan Shaw, who visited China at the end of October to meet industry executives, told the Nikkei Asian Review.

Yet, Chinese coal miners have been reportedly reluctant to commit to price caps at levels substantially below market rates, as they are keen to use the higher prices of recent months to ameliorate losses accumulated since 2012.

The effect of rising prices can be seen in the latest quarterly results. The country's biggest coal miner, China Shenhua Energy, reported net income of 7.5 billion yuan ($1.1 billion) for the July-September quarter, up a whopping 47% from about 5.1 billion yuan in the same period last year.

This compared with a 19.3 % decline in net profit for the first half compared with the previous year, and a 32.4% fall in operating profit from coal mining.

Its rival China Coal, the second-biggest miner, reported last Friday that net income swung to 401.3 million yuan in the first nine months of the year from a loss of 1.59 billion yuan a year earlier.

Uncertain future

Shaw said that the situation remained in flux, with the NDRC effectively bargaining with miners on prices. He said the NDRC's initial target was 450 yuan to 500 yuan per metric ton, but some industry insiders said that negotiations had pushed it higher to 500 yuan to 550 yuan, while others cited 550 yuan to 600 yuan.

In April, the NDRC issued an edict to cut the country's coal-mining capacity across the board by limiting the number of days they could mine to 276 from 330, aimed at cutting 500 million metric tons of supply, or about 16%.

"The cuts were originally aimed at raising the price of thermal coal from about $50 per metric ton, to $60 to $65 per metric ton to reduce the costs to the central government of restructuring the industry," Shaw said, but he added that the authorities "pulled the lever too hard."

The restructuring plan involved closing small and loss-making mines, paying out workers and in some cases curbing their use of funds from the central government, local government and mining companies themselves.

The cuts led to China's coal imports surging along with prices. Thermal coal imports rose in September to 203 million metric tons, up 44% from a year earlier.

The shortfall has bitten particularly hard over the past month, with supply tighter than usual during the traditional period of restocking ahead of the colder winter months when electricity demand rises across North Asia.

In a pointed commentary, the state-run Xinhua News Agency on Monday quoted an NDRC official as saying that recent coal price increases were due to both the government's capacity-cutting and production-control measures.

"Once the sporadic factors fade away, a periodic coal supply glut and a price decline will be high-probability events," the official told Xinhua.

While the Chinese market trades on spot prices, Japan, the world's second-biggest coal importer, prefers quarterly contract pricing to give power companies more certainty, according to the International Energy Agency.

Switzerland's Glencore, the world's biggest coal trader, struck a deal with Japanese utility Tohoku Electric Power at $94.75 per metric ton for coal delivered in the October quarter, according to reports on Oct 24.

"The October contract settlement price between Glencore and Tohoku typically becomes a benchmark that is used by other Japanese buyers," oil and gas data provider Platts said.

Shaw at UBS said the price looked "reasonable" given that they are typically based on average spot rates for the month leading up to the setting of the contract.

The rising price of thermal coal has caught markets by surprise as the structural shift from hydrocarbons at the start of 2016 met the cyclical commodities crunch to force thermal coal prices below $50 per metric ton by January, the lowest since 2012.

Falling prices over the last two years had sent the shares of Glencore sharply lower, making the company the worst performer on London's benchmark FTSE 100 index in 2015 when it plunged 372%. But the stock has clawed back most of those losses, rising about 330% from the beginning of 2016 to Tuesday. In April, U.S. miner Peabody Energy, once a byword for coal, filed for Chapter 11 bankruptcy protection.

But China's supply cuts and the concomitant price surge are already benefiting miners affected by the slump.

Production at thermal coal mines in Australia, the world's biggest coal exporting country in 2015, were mothballed but now at least half a dozen are reopening to take advantage of the price jump including Queensland mine Collinsville, which Glencore only closed last December.

Despite the current high prices, Macquarie analysts said they maintain "a bearish trajectory, expecting a supply response to eventually materialize and start putting prices under pressure from the first quarter [of 2017]."

Amid the speculation, it remains uncertain where prices will eventually settle. Only one thing is clear, as asset manager Investec noted: "The Chinese government is firmly in the driving seat on this." - asia.nikkei.com