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Glencore’s HVO play falters as regulators probe pricing power

09 March 2018 Marian Hookham

Glencore is facing regulatory delays over its proposed joint venture with Yancoal at the Hunter Valley Operations as Japan’s competition authority mulls a market inquiry on the impact of the Swiss miner’s dominance on both Newcastle coal flows and liquidity on trading platforms and hence pricing.

The move by Japan’s Fair Trade Commission (JFTC) to consider an investigation comes even as Glencore failed to complete the acquisition of minority partner Mitsubishi Development’s (MDP) 32.4% stake in the Hunter Valley Operations (HVO) – a key condition of the joint venture agreement.

Failure to secure the MDP stake within six months of the Coal & Allied Industries (C&A) transaction (from 1 Sept 2017) could trigger Yancoal to honour its tag-along provision and buy Mitsubishi’s stake for $710m. It is unclear if Yancoal is moving ahead with that or the JV partners have agreed to extend the timeline for the MDP acquisition.

Glencore declined to comment and Yancoal didn’t return calls.

After losing the bidding war for Rio Tinto’s C&A operations to Yancoal, Glencore and the Chinese company struck a JV deal last June that would see the Swiss miner holding a 49% stake in HVO, and marketing rights into key markets including Japan, Korea and Taiwan, among others.

HVO is seen as the crown jewel in the erstwhile C&A stable, with the mine producing around 14 mt/y of saleable coal in 2016. Outside of the benchmark-setting semi-soft coking coal of which Japan’s Nippon Steel is a major buyer, the mine also produces premium Hunter Valley thermal coal, sought after by quality conscious Japanese power utilities.

The mine produced close to 4 mt of semi-soft product and 10 mt of thermal coal.

Even without having HVO coal in its corner, Glencore is a major player in New South Wales, accounting for over 50 mt of the close to 158 mt of Newcastle exports. With the addition of HVO, Glencore will have a production capacity of 69 mt/y of high quality Hunter Valley coal.

Trading sources suggest almost 80% of the HVO coal currently is exported to countries such as Taiwan, Korea and Japan, where, if the JV is formalised, Glencore will have marketing rights. It is understood around 50-60% of the HVO coal is destined for Japan, for both steel production as well as power generation.

And it is the marketing rights that have caused unease among both traders and Japanese end-users alike, who fear the consolidation could not only impact coal availability but also further entrench Japanese customers as price takers. Sources say that there are concerns that Glencore will be able to exert its influence beyond the 80% of HVO that it might be able to market. It is believed the use of HVO coal for blending would allow them marketing rights over the entire shipment.

“They will end up calling the shots on most of Yancoal’s high quality thermal and semi-soft,” said a trading source.

Japanese sources say major steel mill Nippon is especially concerned with the supply of semi-soft coking coal, with the mill holding significant exposure to the premium Hunter Valley supplies. It is understood the mill buys around 10 mt of semi-soft coals, with over 40% or in excess of 4 mt coming from Glencore and a little over 1 mt from ex Rio mines.

Assuming the JV partnership takes hold, Glencore would be able to market more than half of Nippon’s semi-soft intake, sources say.

“More volume will be coming from these two companies, as others don’t have such a large volume of semi-soft production,” a Japanese trading source said.

Sources say over 80% of the premium semi-soft market (roughly 10 mt/y) was held between Glencore and Rio Tinto, and now will be controlled by the Glencore/Yancoal JV, leaving Japanese steel mills, especially Nippon, in a weaker bargaining position.

It would seem the possibility of this becoming a reality is not lost on Nippon, which last December is understood to have made a submission to the JFTC, seeking a review of the deal ahead of a pending approval.

Nippon’s concerns are mirrored by Japanese power utilities that are typically keen on certain coal qualities and have sought single mine products, and paid premiums to ensure security of supply.

As Japan’s retail electricity market deregulates, some utilities have become more price sensitive and have taken to using generic coal types, though most baseload generators are still beholden to Hunter Valley coal. Some say Glencore’s dominance means buyers are still dependent on certain qualities for annual volumes from a dwindling pool of producers.

“One of the concerns is the overall share of the market, if you combine that with the quality sensitivity of many of the Japanese end users, you can see a situation arising where the producers end up in a situation where they can dictate the price,” said a Japanese trading source.

“There isn’t much competition left as not many of the end users have a lot of flexibility on which coal they source,” the source said.

Glencore’s stranglehold in the Hunter Valley becomes more of an issue as the miner has dominant positions in other coal basins, holding sizeable control over the premium Richards Bay market as well as significant position in Colombia. It is also seen as a contender for Drummond coal assets in Colombia, which will only consolidate its hold over supply.

Liquidity concerns

While most agree concentration of Hunter Valley coal resting with few producers poses price risks for Japanese end-users, they also say it raises concerns about dominance in the globalCOAL NEWC Index, set by brokerage globalCOAL (gC) and based on transactions through its trading platform.

“If there’s already a concentration in the market and if then one of the largest parties is becoming even larger and more powerful and limits trading, it has an impact on the liquidity of the index, with the risk of that index falling over,”the Japanese trading source said.

A successful HVO deal could take Glencore’s share of the physical coal that could be used to set the index to around 50%.

“globalCOAL has procedures and policies around index compilation and around the screen which mean we can maintain a fair and orderly market,” gC's CEO Martin Abbott said.

Many point out that Rio Tinto traditionally used to sell a fair bit of their tonnes to traders and also through the gC platform. Now with Yancoal’s purchase of C&A, that supply to traders has dried up, while concerns about dominance in the market have also contributed to a reduction in liquidity, according to traders.

Trading data from gC shows liquidity both on an index and fixed price basis hit a record high in 2015 at around 14.49 mt, but fell to 12.52 mt in 2016 and registered a 42% decline in 2017 to 7.29 mt.

The reduction in liquidity is compounded by the fact that either other producers who have the spec don’t have the tonnage for spot trading or producers that have volumes, lack the quality.

The impact is not limited to pricing or trading of Newcastle coal, market participants say, and that it extends to other markets and coal types.

“Even the bilateral contracts not just from Australia, but Indonesia, Russia, and US a lot of those are based on gC NEWC index. It is important in international trade, and that’s why the reduction in liquidity should be a concern to the market,” said a third trading source.

Anti-trust and trade practice concerns

Japanese sources say potential JFTC scrutiny over the JV could also be looking at trade practices, especially regarding specifying destination clauses into the contracts. Typically many producers, across commodity, require destination to be specified on any cargo sold, with the intent that the sold commodity is utilised for the stated purpose and not onsold. The argument from the producer’s side is that they wouldn’t want to compete against their own coal, should a trader be long and holding a cargo.

However, in a recent ruling on LNG trading, the JFTC declared that specifying of destination, especially when a cargo is sold on an FOB basis, to be anti-competitive, in that it acted as a barrier to entry to those who wanted to be in the trading space.

Sources say destination clauses have been normal in coal contracts and even though they are not written out anymore, producers’ commercial power ensures they are followed.

“Whether or not you can put it on a contract, they’ll try to force it with their commercial power. It’s quite obvious that Glencore’s strategy is to become as strong as possible on the supply side, they want to dominate the market, and they want to convert it to a sellers’ market, which is what it is,” said the first trading source.

Given that Glencore could ultimately control not just index pricing but also supply is less surprising. That it passed regulatory scrutiny the first time round last April when it got prior approval from the JFTC for its bid for Rio’s assets has many in the market flummoxed.

Nippon’s willingness to lend its heft to have an investigation possibly would make regulators take notice, sources say, as it would have the backing of the Japanese establishment.

It is understood that submissions to the regulator over a proposed investigation were due earlier this week and a decision on whether to hold an enquiry is expected in the next few weeks.

Many believe the JFTC will hold an enquiry, a likelihood that’s evident from Glencore’s own thinking. The miner is understood to be focusing its energies on the Japanese process and is yet to apply to EU regulators for approval.

As such it has already pushed its expected date for completion of the transaction by three months to the end of June.

A Glencore spokesperson declined to comment on the approval process or competition concerns, but said the miner was “cautiously optimistic” about getting the deal over the line.

Learn more about our global coal news analysis.

Marian Hookham is a Research and Analysis Associate Director at IHS Markit
Posted 9 March 2018

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