MORGAN STANLEY: Beware the bullish frenzy in coking coal prices

Photo by Quinn Rooney/Getty Images

Commodity markets are gripped by coking coal fever for the second time in 12 months.

Prices are surging higher, boosted by news of supply disruptions to Queensland coking coal production caused by cyclone Debbie last week.

Damage to railway lines servicing these mines is expected to take weeks to fix, whipping up a speculative frenzy nearly as fierce as the winds brought by Debbie.

Spot and swap prices have bounced strongly this week, and now Dalian coking coal futures are following suit, surging limit-up 9% upon the resumption of trade following a four-day long weekend.

They can’t go any higher, at least in the current session.

Dalian Coking Coal Future – September 2017 Contract. Source: Thomson Reuters

Traders literally can’t get enough of the black stuff, perhaps taking their cues from the enormous rally in the second half of last year that saw prices more than triple within the space of months.

Now, like then, the price surge has been driven by concerns that supply disruptions will cause scarcity in seaborne markets. Queensland, after all, accounts for around half of total seaborne supply.

While many believe prices are likely to head higher — the recent price action says it all — does the damage caused to railway infrastructure really justify the recent bout of investor enthusiasm?

Tom Price and Brendan Fitzpatrick, equity analysts at Morgan Stanley, believe there’s plenty of reason for caution.

“Are you getting lots of calls on this Queensland flood event? Are people telling you that ‘hey, now’s the time for met-coal’? Have noticed that recently dead equities are now being flagged as having ‘plenty of upside’?,” the pair wrote in a note on Tuesday.

“Yep, time for some perspective.”

Price and Fitzpatrick have been crunching the numbers on what supply disruption of around five weeks will mean, suggesting that anywhere between 13 to 19 million tonnes could be lost.

They note that this is around 4-6% of total global traded supply, a level that the pair deem justifiable to cause a lift in prices.

That’s obviously already happened, with the move continuing today, but does that mean it will be sustained?

Price and Fitzptrick suggest that there’s a lot of moving parts to this story, but the case for even higher prices depends on nothing else on the supply and demand-side of the equation changing, in their opinion

“There’s lots of other mostly-supply-side things changing at the moment,” they wrote. “In fact, its odd that most of the recently released industry specialists/media reports on Tropical Cyclone Debbie do not flag offsetting factors for metallurgical coal’s spot prices.”

They point out that “tropical cyclones don’t just randomly turn up in Queensland”, noting that they’re a wet season event which the industry prepares for by delivering lots of coal down the supply chain to ports in order to create a supply buffer.

Along with allowing for weather events, Price and Fitzptrick also say that Queensland’s wet season is now coming to an end, meaning that weather conditions are also likely to improve once repairs take place.

And, given the ability of mines to switch supply routes to unaffected railway infrastructure, they suggest that the supply recovery will be quicker than what markets expect.

Throw in the ability of other nation’s such as China and the United States to bring forward additional supply, and it explains why the pair aren’t getting caught up in the speculative frenzy seen in recent days.

“So are we suddenly metallurgical coal bulls? No, not really,” they muse.

“We’re actually still flat-to-bearish on the metallurgical coal price outlook.

“This is mostly short-term noise and the not the supply-side changing, so we’re not changing anything in our models or price forecasts.”

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