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A rapid rise in US coal exports has temporarily compensated for falling demand [ClearOnMoney]
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A rapid rise in US coal exports has temporarily compensated for falling demand

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Commentary

A rapid rise in US coal exports has temporarily compensated for falling demand

19 Jun 2012 by Jim Fickett.

As domestic consumption of coal fell about 14% from its pre-financial-crisis high, net exports rose from about 3% of production in 2007-9 to about 12% of production in March of 2012. However exports are unlikely to continue growing strongly, and the long-term future of domestic coal producers will be determined by the domestic market.

Here is a repeat of a recent graph on US domestic production and consumption of coal (US coal consumption down 14% from peak):

Note that although the production and consumption curves have diverged lately, they are still not too far from the same absolute level – i.e. exports are a relatively small portion of the US market. The same point is made nicely by the following flow diagram (for 2010) from the Energy Information Administration, which shows that by far the most important part of demand for US coal is the domestic electricity power industry.

Although exports are a relatively small part of the market, they do matter to US coal miners, with the latest data (for March), showing net exports as 12.5% of production. The main purpose of this post is to explore the extent to which they matter. Here is a history of US coal net exports, with annual data 1995 - 2009, and monthly data for the last two years or so (all amounts shown are on a monthly scale, with annual figures divided by 12).

This makes it clear that net exports have risen extremely rapidly to make up for the drop in domestic demand. Can this continue? I doubt it.

First let me dismiss one incorrect argument. Although the common assumption that net export growth is driven by rising exports rather than falling imports is correct, common ideas on the destination of those exports is often wrong. For example, many people think that most US coal exports are taken by China, and go into convoluted arguments based on their analysis of the Chinese economy to predict the future of US coal markets. However, although China does import a lot of coal, most of that coal comes from closer sources, e.g. Australia and Indonesia.

A breakdown by country shows that the top 10 destinations for US coal in 2011, in order of decreasing volume, were the Netherlands, South Korea, Brazil, UK, Japan, Canada, Italy, China, Ukraine, and Germany. The highest growth in 2011 was seen in exports to Latvia, Australia, Morocco, Japan, South Africa, Ukraine, Denmark, Croatia, Chile and South Korea. That is a sufficiently mixed picture that it is hard to make any definitive judgements about coal based on national growth trends.

However there is one simple fact that helps to clarify greatly the export picture: coal is bulky and cheap, and so shipping costs are large compared to commodity costs. The World Coal Association says:

Overall international trade in coal reached 1083Mt in 2010; while this is a significant amount of coal it still only accounts for about 16% of total coal consumed. Most coal is used in the country in which it is produced.

Transportation costs account for a large share of the total delivered price of coal

For example, the current price of Appalachian coal (the most relevant regional price for export to Europe) is about $60/ton and, according to UN data, the cost of transport from Brazil to China (a key route due to Brazil's iron ore and China's steel industry) was $20-$30/ton in 2010 (the latest data available).

High transport costs mean that, in order for export to make sense, the coal price at the destination must be significantly higher than at the origin. The high exports of US coal, however, have driven down destination prices, to the point where such trade may no longer make sense. According to the Financial Times,

The surge in US exports, initially into the Atlantic but increasingly now into the Asia-Pacific region, has overwhelmed demand, even if consumption in Asia remains healthy.

Thermal coal for delivery in three months in the European hub of Amsterdam, Rotterdam and Antwerp fell last week to a two-year low of $82 a tonne. Coal prices hit a record high of $220 in July 2008, but plunged after the global financial crisis to a low of $61 in March 2009.

In Europe coal demand is weak due to the eurozone debt crisis and substitution for renewables in the power sector, particularly in Germany, executives say.

Asia is at least offering a counterweight with robust imports. From January to May, Chinese coal imports rose above 90m tonnes, almost 60 per cent higher than in the same period of last year. However, even in China, low electricity production coupled with strong hydroelectric generation has led to a lower coal burn and, thus, a dramatic increase in inventories. With stocks full and prices down, local traders have defaulted on contracts.

The arrival of US coal into Asia also comes just as regional producers increase output. Indonesian supply is heading towards a 10 per cent jump from last year’s level and Australian coal production has recovered from last year’s flooding disruption.

The bottom line is that coal prices globally have fallen far enough that many mines are losing money. Hence miners are going to have to decrease production, rather than trying to make up for poor domestic demand by shipping coal somewhere else.

The combination of supply and demand forces means that thermal coal prices are unlikely to recover any time soon, executives and traders say. But they do believe further downside is limited as prices are already below the cost of production of some collieries in the US, Australia and Russia. Traders estimate that in the seaborne market of roughly 850m tonnes, mines accounting for around 90m tonnes are now losing money.

One other fact is worth noting for the longer term. Currently there is a great excess of bulk dry ships, which are used to transport coal, iron ore, and grain. This is because orders hugely increased during the boom years, and production is slow, so that many new ships are still coming on-line, even as demand is much lower than when they were ordered. This situation will take years more to correct, but it does mean shipping costs, currently fairly low, will be rising in the long run.

Although it is difficult to predict the particulars of the coal export market, it is a fairly safe bet that transport costs will be a significant hindrance over the long haul, and that the future profitability of US coal miners will be driven primarily by the domestic electric power industry.

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