Supply disruptions expose weakened supply chain

The bear lurks on the fringe of the global metallurgical coal market, but for now supply has been fragile as china in a closet, thus keeping the bull in charge.

Disrupted production from key US low-vol longwall operations, the strike at Oaky Creek, the South 32 outage and some slow loadings at terminals in Australia and hiccups in Russian production have combined to keep supplies tight. There has been enough demand from Chinese traders to make the tightness meaningful.

"Domestic prices in China are above what you're seeing on the export side out of Australia," a source noted. The impact of frequent safety inspections has slowed Chinese met coal production. Some industry sources site strategic decisions by Chinese producers as well. In any cases, Chinese domestic coal prices are strong.

In the meantime, while global met prices have responded to the tight supply conditions, a more dramatic response probably awaits inevitable demand showing itself from India. Outside China, demand from Asia is anemic. Japanese and Korean steelmakers seem well-supplied.

The Atlantic market is tame. "Europe is pretty sleepy right now and will be through August," a source said.

Eyes on India

India is the key. For now, steelmakers in the country are attempting to wait out the various global supply disruptions. Their stamina might determine whether spot prices soar or percolate around present levels. But delays in purchases might extend the length of producer-friendly market conditions.

If Indian buyers do not move soon, global met prices might remain at relatively high levels at least through the fourth quarter. There are moving pieces, but it is difficult at this time to envision meaningful price decreases before the end of the third quarter.

It is more interesting to contemplate the conditions that have propped up prices and left the market vulnerable to another significant spike. Supply/demand balance appears more vulnerable than in the past, a circumstance that probably shouldn't be surprising given the lengthy period of capital starvation that preceded the bullish market conditions of the past year.

The US is not the nimble swing supplier it has been in years past. Some of its larger longwall operations are quite elderly, and an extended period of low prices and weak demand prevented the kind of nursing care required to keep a geriatric free of periodic health woes.

"Since mines were so under-capitalized through last year, the 'unexpected hiccups' are becoming more prevalent," one US met source conceded. "Add to that very old and tired longwalls in the US and you have the recipe for plenty of volatility."

Capital constraints haunt, and while money is available, at last, it is expensive.

US domestic effect

The US domestic market is interesting and could constrain exports. In the near term, US consumers will need to replace supplies from Seneca Coal's Oak Grove low-vol longwall if production is interrupted beyond the next month. Oak Grove has declared a force majeure condition, and the length of the disruption is uncertain.

Seaborne consumers have also probed the market for potential Oak Grove replacement. The plight of seaborne buyers is exacerbated by supply issues outside the US.

But the US domestic market is intriguing for more than one reason. Coking coal consumption at domestic plants was 16.5 m short tons (st) and receipts 15.9 mst in 2016. In 2014 and 2015, respectively, consumption was 21.3 mst and 19.7 mst.

"That's a big spread to make up in one year if Section 232 brings home the bacon," one market analyst noted.

The Trump administration seems poised to invoke Section 232 of a 1962 trade law, a clause that arms it to impose tariffs on imported steel in the interest of national security. Such a move could reduce US steel imports by 10-15% and test the availability of domestic coke. Already Clairton Steel is rumored to be moving toward full production, up from 80%.

One must assume the administration will be aggressive with regard to Section 232. Last week, Secretary of Commerce Wilbur Ross finalized an antidumping duty investigation that found steel concrete reinforcing bar from Taiwan is being sold in the US market at unfair prices.

The Commerce Department determined exporters from Taiwan have sold steel concrete reinforcing bar in the US at 3.50% to 32.01% less than fair value. Commerce will instruct US Customs and Border Protection to collect cash deposits from importers of steel concrete reinforcing bar from Taiwan based on these final rates.

"The United States can no longer sit back and watch as its essential industries like steel are destroyed by foreign companies unfairly selling their products in the US markets," Ross said. "We will continue to take action on behalf of US industry to defend American businesses, their workers, and our communities adversely impacted by unfair imports."

US consumers respond

Section 232 expectations might be the major reason US cokemakers are out in force early for coal supplies. AK Steel and SunCoke led the way, which is traditional, but U.S. Steel and DTE Energy Services followed more quickly than usual, both having tendered in recent days (See related item in today's Inside Coal).

In addition to potentially increased US coke demand, domestic met coal producers have another reason to be more than usually attracted to supply opportunities at home. The market to supply the 2018 needs of domestic cokemakers will be "pretty competitive" this year, a large producer noted.

"All these new, little (coal mine) start-ups are looking to something they can hold on to for 12 months," the source said. US cokemakers typically contract most of their coal requirements for the full calendar year.

US met coal consumers do have some leverage. In addition to their willingness to offer the security of a full-year contract, they are aware the market could shift dramatically when supply disruptions end.

"If suppliers try to bid spot netbacks for annual deals, you could see 'no buys' and tenders again later" in the year, a source close to the purchasing community warned.

Absent supply disruptions, global met supply should be adequate for current demand. In fact, if producers were hitting on all cylinders, there is some argument the market is oversupplied. But some 20 mt/yr of supply is out of commission, at least for the immediate future.

Given the reduced ability of the US to respond decisively to swing demand, the overall global supply chain lacks the flexibility to provide a swift response. Perhaps some mix of supply from Mozambique, Mongolia and Russia eventually will fill the gap.

Until then, the global met market is likely to continue to be extremely volatile.

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Jim Thompson is a Research & Analysis Director with IHS Markit.
Posted 28 July 2017

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.