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Domestic US coal, business edge dulled

16 November 2017 Jim Thompson

US coal producers are changing their attitudes about coal exports and are indifferent to who the counterparty is due to the extreme short-term attitude of most domestic utilities. In the grand scheme (I can still think in terms of grand schemes, plans, etc. despite my other obvious limitations), that is probably good news for everyone in the coal chain - from producers, to transporters, to, gasp, domestic generators, though in the latter case, strategic advantage might come at the cost of tactical issues.

There surely could and probably will be cases in which the quality of coal a domestic consumer requires or desires might not be available when the utility wants and needs it. But hey, I am a strategic thinker. The tactical guy is next door.

Domestic consumers no longer offer producers some of the clear advantages over the export market that existed in the past. The first and most obvious change - it is much more difficult than it once was to land a three-year contract; rare to negotiate a longer one.

Annual and quarterly transactions are more the norm than term, which drives producers to this point of indifference. As coal and gas fight for generation, utilities have discharged hedging strategies, which allow for spot tonnage if required.

But there is another change. Most domestic contracts now include broad, generous tonnage flexibility. Producers do not have nearly the volume certainty domestic contracts once offered. In some instances, domestic consumers have additional flexibility in the source of coal shipments.

Knowledge is power

Comparatively speaking, the export market, when available, is a blue-chip stock. Producers can book coal knowing when and how much will be shipped. "Price" majeure - oh come on, I'm not the first to use such language - is non-existent where export sales are done through a conservative channel.

One marketing executive who has traditionally assigned deep value to domestic business, in large part because of the security it offered, conceded - "I don't know if that's there" given changed circumstances. "If we really want to move tons, we talk to a legitimate player overseas and they move them," he said.

"Booking export out the (bleep)!" another, more exuberant source on the transportation side texted me while I was in Texas.

The question, of course, is whether such opportunity is durable. The answer isn't clear, though current evidence suggests that such is the case. Conversely, one could argue the current domestic environment is not durable nor sustainable.

Keep in mind that while changes in US coal market dynamics are most obvious on the domestic side of the ledger, international circumstances have changed as well. The US was once known primarily for its abundant supply of expensively mined low-sulfur, high-heat Central Appalachian coal.

CAPP coal was a luxury for most buyers, and much of the time, the cost of the coal made it an unaffordable luxury. To a lesser extent, the same was true of Rocky Mountains coal.

The heart of US thermal exports is now high-sulfur coal mined inexpensively from Southern Illinois and Northern Appalachia longwall operations. While relatively high transportation costs offset somewhat the low cost of mining, the US no longer is deeply out of the money with most international coal on a cost basis.

Beyond that, the loss of domestic business has motivated transporters to be as aggressive as possible in securing and pricing export business. In most cases, routing the coal to the coastline can be done efficiently, and there is little for transporters not to like about moving the product.

Evidence of the competitive position of US coal versus other basins is evident in current discounts associated with trades of high-sulfur coal for exports. Even given discounts near and above $20.00/ton, there is sufficient margin to entice producers to export.

In fact, while discounts are quite high, relative to market conditions the past few years, major producers have indicated that mine netbacks are better both in the Illinois Basin and NAPP than those offered under most new domestic business.

On discounts

The discounts are supported by front-end European delivered prices in the mid-$90.00s/metric tonne. The international market has become fundamentally backwardated, and there is little reason to expect that to change, but prices have tended to rise rather predictably as the prompt quarter approaches. As a result, US export opportunities have not vanished.

International traders seem comfortable that the trend won't change in the near term. "Some of these guys are taking some pretty big positions," a source said.

US miners have been able to book coal into 2018 and even into 2019 despite the backwardated price curve. When that can be done - and opportunities are limited - there is no obvious reason to suggest that a domestic opportunity would be superior.

What's interesting is the fact that export demand has not faded despite the growth this year in US participation. The market "still seems to be fairly active," a producer said.

"There still seem to be deals to be done. There is still demand out there."

The guess here is that some international consumers are following a path taken in recent years by domestic consumers. Given the abundance of low-cost, high-sulfur coal, they are pushing their blend percentages to accommodate as much high-sulfur as possible.

It's doubtful the sulfur content itself is an impediment in many cases. It's likely the larger issue is the ability to accommodate greater quantities of low-fusion coal without creating boiler issues.

But US consumers have shown that many boilers can accommodate relatively large quantities of high-sulfur coal in the blend without damaging plant performance. International consumers might be reaching a similar conclusion.

If high-sulfur blend percentages are increasing to take advantage of large price discounts, the good news for producers isn't limited to the short term. While large discounts might be necessary to encourage a power plant to push the limit on its blend, once the limit has been found and the plant satisfied, there is no clear reason to think consumers would eschew opportunities to take advantage of more-modest discounts.

As my mama taught me while grocery shopping, a discount is a discount.

If all of this is true, there isn't a clear reason to expect high-sulfur thermal exports to tail off as international prices recede. Discounts will get smaller, but they will still be discounts.

There is a limit, of course. If international prices fall beneath a level that allows coal to be discounted beneath the cost of its accommodation, the incentive to buy US coal will wane. But the $20.00-plus current levels suggest that international prices can recede meaningfully before the US falls out of the money.

Perhaps this explains why traders have been willing to take aggressive positions in booking US coal.

It's not that simple

There are other factors at work when US coal exports grow. Currency differentials matter. Domestic price and volume opportunity matters. International trade flow matters. The door for US coal was opened when South African and now Colombian coal found significant traction in Asia.

But the US's improved position in international thermal trade is good news this year for producers and transporters. It could continue to be good news for the foreseeable future.

You're asking yourself whether I was touched once too often by the Texas sun. I've suggested that a vibrant, perhaps more-durable thermal export market is also good news for US consumers. Why applaud the competition and its potential impact on prices?

The coal is being mined.

Make no mistake, the domestic market is a gorilla and will remain king of its cage. "You can't be a sizable player completely reliant on the export market," a source noted. Even well-positioned export mines such as CNX Coal's Bailey/Enlow Fork Complex and Murray Energy's Foresight fleet still sell most of their coal into the domestic market.

But things have changed.

This story was original published in the coal & energy price report, which makes up part of our US Coal Market News and Analysis capability.

Jim Thompson is Research and Analysis Director of Coal at IHS Markit.
Posted 16 November 2017

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