By Jonny Sultoon and Prakash Sharma

March 24, 2017 - Chinese supply reform in 2016 sent a stuttering coal industry into a tailspin. Its main state planner, the National Development and Reform Commission (NDRC), implemented strict controls on domestic mines, limiting their operations to 276 days a year. The goal was twofold: eliminate outdated capacity and improve industry profitability. Domestic coal production plummeted 7.8 percent year on year.

The market wasn't ready for it: prices for coking coal quadrupled, and thermal coal doubled. When it was obvious prices were not going to retreat, and winter heating demand was threatened, the NDRC succumbed to pressure. From November, all mines were allowed to return to operating at 330 days a year. Since then, coking coal prices have halved and thermal coal prices are down 30 percent. But fatalities also increased with unsafe mines re-entering the market.

But what is Beijing's ultimate goal? Is it to reduce state-owned debt, consolidate a fragmented supply base, improve a crippling mine-safety record, maintain social order while handling mass lay-offs, support regional growth goals, ensure price stability or reduce air pollution in urban areas? Most developed nations have had to tackle some of these challenges, from the UK's Thatcher-led years in the mid-1980s, to Japan's steelmaking contraction of the 1990s. No single path has been clear and simple. China is moving more swiftly to address these challenges because of the scale and complexity of its sectors, and the fact it is mostly state-owned capital at risk. Unfortunately, individual goals often clash head-on and send mixed messages to markets.


Many different ideas have been proposed to reform China’s complex and sprawling coal industry comprising several thousand mines. The 276-day policy may count as one of China's most successful reforms to date. In fact, it might have been too successful. The annual target for eliminating outdated capacity in 2016 was between 60m and 250m tonnes depending on which planning agency issued the target. Ultimately, it was exceeded with 290m tonnes cut. If sustained, the industry is on schedule to deliver an 800m reduction in outdated capacity by 2020. But with low-hanging fruit picked last year, the hard work starts now. Fresh ideas are needed to develop a competitive, efficient and safe coal industry without compromising some of the goals above. 


As indicated by an NDRC official earlier this month, the 276-day policy may not be a key feature of 2017. A Goldilocks-zone of pricing was introduced in January: not too high (above Rmb600 a tonne), not too low (below Rmb470 a tonne), but just right (Rmb500 to 575 a tonne). Intervention if prices stray from the ‘reasonable range’ will be a central tenet as stronger supplies return to the market through the second quarter of 2017. Returning to a national 276-day production limit will be a last resort.


But what happens if this jawboning fails? Prices initially moved upwards not downwards after the NDRC official's comments. The agency's ability to communicate to the market was impaired last year: ideas were proposed, modified, implemented or rejected at fast pace throughout the fourth quarter. Don't be surprised if other levers are introduced during 2017. The modification or suspension of price indices to help flush out speculation, a hard cap on production and more long-term contracts to avoid spot price volatility within the domestic market could all be ushered in. On the demand side, reduction in heating, steelmaking and construction needs in 28 major cities should also help balance markets.


What will it mean for the international market in 2017? When China sneezes, the rest of the world still catches a cold: imports may only be 5 percent of Chinese demand but they are 20 percent of the seaborne market. China’s thermal coal imports moved up 40m tonnes with major bituminous exporters — Australia, Colombia, Russia — operating at maximum capacity; Indonesia filled the gap with low energy coals. We expect imports to decline slightly this year.


The market had been pricing-in a decline in benchmark Asian coal prices from $70-$75 a tonne by the end of the year. That is if the latest plan from the NDRC holds firm and there is no knee jerk reaction to restrict imports. Demand fundamentals in and outside China are not promising. Suppliers — most notably the US — are keen to ride elevated international prices while they last. Wood Mackenzie's latest estimates drawn from its database of 1,400 coal assets show 98 percent of the seaborne thermal coal production is cash positive above $70 a tonne. After three fallow years, suppliers are eager to cash in. An even stronger supply response could pressure prices further.


Copyright The Financial Times Limited 2017. All rights reserved.