Underpinned by the same factor that has driven iron ore prices higher since the beginning of the year — strength in Chinese steel prices due to low inventory levels and a rebound in construction activity — coking coal has also enjoyed a stellar run of late, rallying by close to 27% this year.
While it gets little attention compared the wild daily swings in the spot iron ore price, as a key Australian commodity export the recent strength has been welcomed by coal producers and governments alike.
Although questions remain over whether the recent strength will last, to Vivek Dhar, an energy commodities analyst at CBA, the rebound in China’s industrial sectors has some way to run yet, and will likely support coking coal prices in the months ahead.
“The stimulus led recovery in China’s industrial sectors will likely see China’s coking coal imports lift in 1H16 and help support seaborne prices,” says Dhar. “We forecast premium coking coal prices to average US$87.5/t (FOB Australia) in 2H16, alleviating financial pressures for a number of coking coal producers.”
The chart below, supplied by Dhar, reveals the current cost curve for coking coal producers based off CBA estimates. Given the current surge in the key steel making ingredient, many previously marginal producers have become profitable at current price levels.
Although Dhar suggests that the spot coking coal price will remain firm in the months ahead, beyond that, he believes price pressures will likely resurface over the medium to longer term.
“The reprieve will likely only delay the exit of marginal producers though,” he says. “We anticipate surplus conditions to return to seaborne coking coal markets once policy makers in China stop providing stimulus. We forecast coking coal prices to average US$83/t (FOB Australia) next year, which should pressure coking coal exports lower, particularly from US.”
Dhar suggests that policymakers will continue to provide support for its commodity intensive sectors until June or July this year.
Looking further ahead, Dhar describes the long-term steel outlook as “dim”, suggesting that China’s long term crude steel output will unlikely increase from here, citing the example provided by Japan’s steel industry in past decades.
“The 20% fall in Japan’s crude steel output from its peak in 1973 to 1998 is a scenario worth considering for China’s crude steel market today, particularly as many still believe that China’s steel demand will emerge again in coming years,” notes Dhar.
“The 10-year long process to curb overcapacity in Japan after the country reached peak steel output may also mean that China’s steel industry could face similar issues in years to come.
“Given that the problem is considerable in China already, there could be more pain, for longer, in store for China’s steel industry. In any case, the emergence and fall of Japan’s steel industry offers a precedent that China’s steel output and iron ore demand may stall for decades.”
Using Japan as an example, and taking into account severe overcapacity that continues to plague China’s industrial sectors, Dhar suggests that this underscores the belief that commodity prices are yet to bottom.
Not great news for coking coal, nor iron ore, should that scenario eventuate.