May 19, 2023 - The metallurgical coal market is poised to consider its next steps as pricing structures continue to evolve after world events again delivered extreme price volatility over the past two years.
Recent trends are indicative of a market in search of new directions, including an uptick in derivatives volumes, emergence of partially fixed- and partially floating-priced trades, the prevalence of brand optionality and the growing voice of end-users in an increasingly transparent spot market.
Changing paper liquidity
Coking coal futures volumes on the Singapore Exchange typically lag the more developed iron ore market, with the volume of FOB Australia premium coking coal derivatives contracts on the SGX at 5.83 million mt in 2022 outpaced by the 3.04 billion mt for CFR China 62% iron ore fines.
While coking coal volumes saw a steep decline from November 2020 in SGX data, signs of recovery emerged over January-April 2023 when FOB Australia derivatives traded 21% more than in the same period of 2022, recovering to 2021 levels. By March the monthly volume stood at 0.94 million mt, recovering from a low of 0.36 million mt in October 2022.
Sources have linked this recovery to the emergence of spot cargoes priced on a combination basis; partially fixed and partially floating.
"The rising number of such cargoes reflects the increasing preference of floating prices, and hedging interest is recovering as a result," a trader said. Such growing futures-based risk management follows the earlier trend observed in iron ore, where low liquidity plagued the derivatives market in its fledgling stages, too.
The steep physical market volatility of the past 18 months has seen participants shy away from taking fixed price positions. Of the spot trades published by Platts, part of S&P Global Commodity Insights, an increasing portion -- 39% so far in 2023 -- has included a combined pricing basis, featuring both fixed-price and floating-price components, as a tradeoff between risk management and the need for price discovery amid low spot liquidity.
Hedging a mixed-price-basis cargo is easier than for a full cargo, as only a portion of the cargo needs to be hedged, some market sources said. Other sources have noted the transparency limitations of such mixed-priced cargoes, with a potential for cross-subsidization between the two pricing components, meaning that the fixed-price component may be priced lower or higher than the market level, while the floating-priced component may be priced higher or lower, but when considered together, the full cargo is priced at market levels.
Additionally, details of the floating-price components, such as brand and payable percentage, are not usually disclosed to the market, and even in cases of full transparency, derivatives values are still hard to lock in given the low paper liquidity.
Growing brand optionality
In recent years, it has become increasingly common for spot contracts to contain brand options that allow the seller to supply from a basket of coal brands, with or without price adjustments on the brands.
Under this brand optionality, sellers do not need to declare the brand of coal to be delivered until the deadline, a couple of weeks prior to the first day of laycan. Although such optionality grants the sellers supply flexibility, some market sources see it limiting the on-selling potential of such cargoes and therefore constraining market liquidity.
"If the on-selling is before the brand declaration, finding another buyer with the same brand flexibility may not be easy," a trader said. "But if the on-selling is after the brand declaration, the cargo may have become distressed, as it could be too close to the laycan."
The impact on spot market liquidity may be more profound. As brand optionality becomes more common in spot contracts, buyers may want to further reduce their reliance on spot supply and secure more of their requirements through term contracts instead, as through term contracts they can pre-agree with the sellers and narrow down the possible coal brands they may receive for the entire duration of the contract in advance. In other words, brand optionality may reduce spot demand.
On the other hand, the growing prevalence of brand optionality reflects a higher level of commoditization of metallurgical coal, where buying preferences are becoming less centered on brands and more around general coal properties.
Ex-China end-users finding voice
After China stopped halted its buying of Australian coal, end-users outside China gradually stepped up participation in the FOB Australia spot market, lifting end-user participation from 40% in 2021 to 48% in 2022, according to an analysis of market information headlines, or heards, published by Platts.
The resumption of China-Australia trade and softened prices to date in 2023 have lifted the end-user participation rate further to 54%, Platts data showed.
In addition to growing participation from end-users outside China, Platts also observed increased transparency in the information reported for publication in its coking coal price assessment process, including steel mills reporting fully transparent tenders.
Between February 2022 and March 2023, Platts published 10 sell tenders from steel mills – a level of transparency previously unprecedented in the coking coal market. During the same period, Platts also published more transparent price information, including bids and trades, from traders and steel mills. They were more transparent not only because one or both counterparties were named in the published information, but some also incrementally demonstrated price changes and therefore proved market value.
With greater appreciation of high-quality price information, more market sources are stepping up to drive the metallurgical coal market toward transparency. A Japanese end-user, who has been reporting spot trades to Platts, said they plan to participate more in the spot market and in turn report more price data. Another international trader told Platts they were setting up a price reporting process. "After that, we plan to report all our spot trades on a regular basis, rather than selectively," the trader said.
Will CFR-FOB relationship recouple?
As China has reopened its doors to Australian coal, there are signs that the CFR-FOB price relationship may be recoupling. The CFR China-FOB Australia price spread for Platts premium low vol (PLV) hard coking coal averaged $10.30/mt in April, approaching the average freight rate between Australia and China at $13.39/mt over the same period.
However, the former high trading volume between the two countries is unlikely to return any time soon.
Chinese mills adapted well without Australian coal under the unofficial import ban, thriving on supply from domestic alternatives and North America. Furthermore, Chinese steel output will likely remain capped in the future, while quasi-captive supply from Mongolia is set to increase further in coming years and Russian coal is likely to maintain its presence in China due to the war in Ukraine. Australia has meanwhile secured more term contracts with other willing buyers.
Finally, as some market sources pointed out, the geopolitical relationship between the two countries could ebb again in future, and we have seen how it can impact the metallurgical coal trade -- an important point to consider when Australian producers and Chinese end-users plan their sales and purchases for the longer term.