Thermal coal prices are running hot but Macquarie thinks it's unlikely to last

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Much like the price action in coking coal recently, thermal coal prices — used predominately in electricity production — have been running hot.

In the space of five months, prices have risen 35%, helped in part by planned Chinese production cuts. As a consequence, Chinese import demand has risen after two years of steady declines, helping to support the profitability of producers.

Here are three charts from Macquarie Research. The first tracks Chinese and seaborne thermal coal prices.

The second looks at Chinese import levels which have accelerated recently to make up for 10% to 20% year-on-year contractions in Chinese production seen since April.

And here’s the cost curve for seaborne thermal coal producers at present.

Prices are up, imports are up and profitability is up. After years of relentless pressure, things are suddenly looking good.

However, according to Macquarie Bank, this may be as good as it gets for the sector, suggesting that the demand picture for thermal coal — not only in China but globally — remains dire.

Here’s the bank on why higher prices are providing an incentive for high-cost Chinese mines to restart production, not only creating headaches for policymakers aiming to curb excess production but also heightening risks of a price correction in the period ahead.

We think there are good reasons to think that from 490 RMB/t currently (versus 380RMB/t when the cut production started), Chinese price risk is skewed to the downside: virtually all listed players who report cost data (~40% of total Chinese thermal output) are now comfortably cash-positive, and demand will weaken sequentially as we exit the summer. It simply becomes tougher for the government to fight the market in these circumstances.

Feedback from trading sources suggests that with prices approaching 500 RMB/t, the government will even actively look to start cooling the market. However, with coal companies still laden with large debt, the ultimate aim is to finely calibrate the price so that margins remain positive but not so large that smaller private sector players, potentially tougher to control, look to return.

Should policymakers succeed in tapering production levels — something that is not guaranteed given the fragmented nature of the sector — Macquarie believe that “any price reset over the next couple of months is arguably more likely to be 5–10% rather than 20%, in order that prices remain well above pre-intervention levels”.

However, while the bank doesn’t expect any large-scale decline in prices near-term, it acknowledges that there’s still a lot of uncertainty in relation to how industry consolidation attempts will play out.

“One thing that does look inevitable is that with negative demand growth ex China, there will be a growing ‘surplus’ of seaborne tonnes that need to clear through China,” it says.

“Does this become a problem for the government at some point? Certainly tonnes won’t be cut by international producers at these prices.”

Adding to downside price risks for thermal coal, Macquarie suggests that “continental Europe is on the verge of mass switching from coal to gas and multiple waves of LNG supply remain around the corner” with “Europe the most likely dumping ground”.

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