DES ARA below all FOB origins: an anomaly for how long?

The DES ARA physical market remains under heavy pressure, with spot trading in the range $47-$48/t. This actually puts the spot DES ARA market below our nominal FOB Colombia assessment of slightly above $50/t, which underlines just how abnormally depressed the European market is.

Indeed, spot DES ARA 6000 material is now below all equivalent FOB prices.

FOB NEWC and FOB R.Bay were the first to be eliminated from the European coal imports mix. The trigger for this was the world financial crisis of 2008-09, which resulted in a systemic fall in industrial and power consumption in Europe, while it accelerated Chinese demand growth.

For those who have only recently got involved in the coal market, Europe actually used to import significant quantities of Australian and even Chinese steam coal before 2008.

Since 2009, Australian exports have kept increasing but they have been swallowed up by rising Chinese and South East Asian demand.

South African production has been growing at a moderate rate and has only just been sufficient to cope with domestic demand and exports. Rising demand from India and, more recently, from Pakistan, Bangladesh and Vietnam has pushed South African prices not only above DES ARA but also Australian prices. As examined in our Long Term Price Forecast over recent years, we think this premium of South African coal over other contracts is a structural development and the rally in Q419 just served to highlight this.

Since 2009, there have only been brief windows during which Australian and South African material have been competitive to Europe, mainly due to temporary drops in Chinese demand (2015), a last spike in European and UK demand (2012-14) and low Capesize freight rates.

Consequently, Colombia and Russia have become the natural suppliers to the European market, supported sporadically by the US, depending on market conditions.

Since 2019, a new structural shift has been taking place as a result of the rapid switch from coal to gas for power generation. This resulted in a 30mt fall in European coal imports in 2019 and we are predicting a further decline of 15-20mt in 2020.

Given the persistently low Capesize rates and still growing Far East demand, Colombian suppliers have found alternative customers, first in Turkey (since 2012-13) and now in the Far East too, including in South Korea, China and even India.

However, dwindling mining investment in Colombia, initially for environmental and more recently for economic reasons, has meant that Colombian exports have been falling (and not rising) in recent years. We expect them to remain, at best, flat in 2020 at 74.5mt.

As a result of the structural fall in European demand, the cyclical fall in Colombian exports (which could become structural) and the cyclical arbitrage to India-Pacific, Colombian exports to Europe have been falling and we expect this to continue in the coming years.

In fact, we have now reached the point at which spot physical FOB Colombian prices are above DES ARA, providing no incentive for fresh Colombian coal to be delivered to Europe. This will increasingly leave Russian suppliers in the driving seat. That said, we doubt that Russian exporters will be very keen to sell FOB Murmansk below $50/t.

Consequently, even fresh Russian supply should be drying up, as things currently stand. Clearly, this wouldn't matter much if EU15 steam coal demand was non-existent. However, we are not there... yet! In fact, we still forecast EU15 steam coal imports at 45mt in 2020 and the coal will have to come from somewhere outside the bloc as, except for Poland, all significant hard coal mines in Europe have been closed.

 

Could Russian suppliers succeed where Indonesian have failed?

True, inventories at ARA remain high, and we suspect they are also high at German power plants (due to restocking during the winter 2018-19). In fact, we anticipate that current ARA (incl. small ports) steam coal stocks should cover German power plants up to Sept. 2020, at current consumption levels.

Coal inventories at the two largest ARA terminals, EMO and OBA, remained unchanged w-o-w at 5.6mt as of 20 January, just 0.2% lower y-o-y, while German power and Dutch TTF gas prices dropped back later in the week reflecting an anticipated resumption of mild weather after a brief cold spell.

As things stand, we don’t envisage any major price shift in the DES ARA market, which we expect to trade sideways.

However, at some stage Russian coal suppliers might want to exploit their increasingly dominant position. Indeed, such a squeeze could be compounded by a similar move on the gas supply front, where Russian suppliers also enjoy a sizeable share of the market.

As such, Russia could gradually become as dominant in the European electricity market as OPEC is in the global crude oil market. In fact, they could possibly be even more so, given that OPEC comprises several oil-producing countries, which complicates the decision-making process with respect to supply cuts, an issue that Russian producers would not face.

We have wondered for years why Indonesia has not exploited its own market position by restricting supply during periods of low prices, given that it accounted for 46% of total exports in 2019. One of the main reasons for this is the fragmented nature of the Indonesian mining market. The Russian mining sector is far more concentrated and, at some stage, it could succeed where Indonesia has failed and control international coal supply.