Minews - Glencore’s thermal coal output cut set to warm market

(Minews) - It is a measure of the distress in the thermal coal market that one of its lowest cost producers — the Swiss resources group Glencore — recently announced plans to cut output. In theory the opposite should happen.

But high-cost miners have decided to play a game of last man standing, increasing output to compensate for lower prices, efforts that have been aided by falling oil prices and weakness in commodity currencies such as the Australian dollar.

The result is a market blighted by oversupply and prices that have fallen by 25 per cent over the past year. However, Glencore’s plan to cut exports from its Australian mines by 15m tonnes in 2015 has raised hopes that the worst might be over for thermal coal, the single largest source of energy for power generation.

Analysts estimate around a fifth of the thermal coal industry is lossmaking based on current prices — a position that is usually unsustainable in commodity markets.

“When you are that far into the cost curve, the downside is pretty limited,” says Tom Price, commodities strategist at Morgan Stanley. “Price buoyancy is already indicating that this is the case.”

Last week’s announcement from Glencore and an earlier decision to close all of its Australian mines over the Christmas period — a move which took 5m tonnes out of the market — has boosted Australian thermal coal prices — the benchmark for the large Asian market. After slumping to $58 a tonne a month ago, the price has rallied 20 per cent to $68.90 a tonne, according to Argus, a price reporting agency.

Glencore, the world’s biggest supplier of seaborne thermal coal, believes its Christmas shut down is partly responsible for the rally in prices, pointing to the number of vessels queueing off the port of Newcastle in New South Wales as evidence.

As for its move to cut 15m tonnes of “special quality” export production, Glencore says it does not want to be responsible for tipping more material into an oversupplied market.

“We represent 150m tonnes of managed production in a 1bn tonne seaborne market ... we do not want to cannibalise our own production and, therefore, we’re not going to put our tonnes where we believe it can have a negative effect on pricing,” Ivan Glasenberg, Glencore’s chief executive, said after the company announced annual results this week.

However, others note that Glencore’s decision to cut production comes as the company starts negotiations with Japanese utilities over a big annual supply agreement.

The April-to-March supply contract accounts for around 70 per cent of Japan’s annual thermal coal imports. It also sets the benchmark for other contract prices in Asia. A low settlement price can weigh on the profits of the large producers, which include Glencore, Anglo American, and Rio Tinto.

“We expect this rally to fizzle out,” said Colin Hamilton, head of global commodities research at Macquarie, who notes there is always a funny dance in prices around the time of the Japanese negotiations. This is because the contract is set with reference to the price in the physical market.

Indeed, over the past month there has been a flurry of activity on GlobalCoal, a physical trading platform that helps set the index price for thermal coal. Traders say several small blocks of 25,000 tonnes have changed hands at high prices over the past month.

For its part, Glencore says the cuts are likely to have an effect on the Japanese negotiations and also market prices. This is because it believes other producers will “not be able to fill the hole” left by its decision to cut production.

“We don’t see where else this type of material, let alone tonnage for that matter, will be coming from,” says Tor Peterson, the head of trading at Glencore.

Aside from Glencore’s production cuts, there are other reasons to be positive on the outlook for thermal coal, say analysts. Indonesia supply growth should stabilise after expanding 15 per cent annually for the past five years. At the same time demand from India is growing. Indeed, the country is widely tipped to overtake China as the biggest importer of seaborne thermal coal.

But for all the talk of supply cuts and rising Indian demand, China remains the key influence on the seaborne thermal coal market.

While China has a large domestic coal mining industry it still imports hundreds of millions of tonnes of thermal coal. But late last year, the government, introduced a series of measures to help protect its domestic coal mines from competition and reduce pollution. This sent a shudder through the export industry because China has effectively acted as the market of last resort for surplus coal.

“This is the big risk of investing in the seaborne market; a policy shift in China can radically change the outlook for thermal coal,” says Mr Price.

On Thursday, China announced plans to cut the country’s energy intensity, with Premier Li Keqiang saying it would for “strive for zero growth in the consumption of coal in key areas of the country”.

While imports have held up even Glencore admits Chinese policy will be the “big determining factor” for the thermal coal market.

“In coal the only unknown factor, which is difficult for us to predict, is how much is China going to import. In 2014, China imported 200m tonnes of coal. We believe that will go lower this year, but we are not sure of the exact number,” said Mr Glasenberg.