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Coal Slump Seen Ending on Deal at Four-Year Low: Energy Markets

Coal Slump Seen Ending on Deal at Four-Year Low
A slump in Chinese imports and rising output in Indonesia are suppressing demand for Australian coal at the same time as miners from Xstrata to Rio Tinto Group fire workers to reduce costs. Photographer: Ian Waldie/Bloomberg

April 26 (Bloomberg) -- A deal to sell Australian thermal coal at the cheapest level since 2009 is raising the prospect of production cuts in the world’s second-biggest exporter and an end to a slide in prices.

Xstrata Plc, which negotiates Australian power-station coal deliveries under annual contracts, agreed this month to sell a year’s supply at $95 a metric ton. The settlement, down 17 percent from last year’s level, is likely to prompt miners to trim some output, according to CIMB Group Holdings Bhd. and UBS AG. Australian spot prices slid to $85.85 last week, the lowest since November.

A slump in Chinese imports and rising output in Indonesia are suppressing demand for Australian coal at the same time as miners from Xstrata to Rio Tinto Group fire workers to reduce costs. Peabody Energy Corp., the largest U.S. coal company, has taken control of most of its Australian sites from contractors to limit losses. More than 5 million tons of Australian thermal coal production is uneconomic at the level of the Xstrata deal, according to CIMB, Malaysia’s second-biggest bank.

“It’s right on the limits in terms of inducing some reasonable supply cuts,” said Daniel Hynes, the Sydney-based head of commodity strategy at CIMB, who predicts spot prices may climb to $100 by the end of the year. “It does put a very solid floor on the spot market in the short term.”

Spot Prices

Coal at the Australian port of Newcastle, Asia’s benchmark price, dropped by $2.50 a ton in the seven days ended April 19, the fifth decline in six weeks and the biggest in more than a month, data from IHS McCloskey show. Prices averaged $94.29 last year after slipping to a three-year low of $78.05 on Oct. 19.

The nation’s thermal coal exports are projected to climb to 189 million tons in 2013 from 171 million last year, according to a March report from Australia’s Bureau of Resources and Energy Economics in Canberra. Japan bought 75 million tons, or 44 percent, of last year’s supplies, the report shows.

Japan’s Tohoku Electric Power Co Inc. agreed to the supply deal with Xstrata, according to two people with knowledge of the deal who asked not to be identified because the information is confidential. The price Japan’s utilities negotiate with Xstrata is typically used as a benchmark for contracts around Asia.

Japan Contracts

The Asian nation agreed to pay a record $129.75 a ton for supplies in 2011 as flooding curbed output in Australia and Indonesia, the world’s biggest exporter. Contracts were settled at $98 a ton in 2010 and $70 to $72 in 2009. Japan’s coal imports will drop to 130 million tons this year from 133 million in 2012, the Bureau of Resources and Energy Economics said.

Australian miners need to sell seaborne coal at $90 a ton to cover the cost of production and shipment, Goldman Sachs Group Inc. said in an April 12 note, cutting its 2013 forecast for the fuel by 6 percent to $93. Years of inflation and an appreciating currency have pushed the country’s mines toward the top half of the cost curve, the bank said.

“The mining sector has experienced significant cost increases in recent years, and it continues to do so,” Sam Walsh, chief executive officer of Rio Tinto, said at the company’s annual general meeting in London on April 18. “Since 2008, the employee cost base of our Australian coal business has more than doubled, while coal production has increased by only 10 percent.”

Job Cuts

Zug, Switzerland-based Xstrata, the world’s biggest thermal coal exporter, last month shut its office in Brisbane, the capital of Queensland state, after announcing in September that it would cut about 600 jobs. Whitehaven Coal Ltd. said March 22 that it would revise a mine plan and shed about 40 workers because of continued weakness in prices, an unfavorable foreign exchange rate and increasing pressure on operating margins.

“The Australian coal industry is struggling to remain globally competitive in the face of high costs, a strong Australian dollar and low prices,” Darren Yeates, acting managing director of Coal & Allied, a unit of Rio Tinto, said in a statement on April 22.

Rio Tinto has hired Deutsche Bank AG to sell stakes in some of its Australian coal mines while the company seeks to reduce its interest in Coal & Allied, the Wall Street Journal said this month, citing unidentified people. The London-based producer cut 84 jobs at its Clermont thermal coal mine in Queensland, The Australian newspaper reported in September.

Australian Dollar

Australia’s currency climbed 1.8 percent against the U.S. dollar last year to $1.0394, the biggest gain since 2010. A stronger domestic currency reduces the value of coal exports that are denominated in U.S. dollars. The Australian dollar has weakened 0.9 percent this year.

“There’s no doubt there’s a lot of the Australian coal industry that would be under pressure with negative margins,” said Daniel Morgan, a commodity analyst at UBS in Sydney. “They are going to be looking at cost cutting and more strategic things like shutting down a portion of production.”

While companies will continue to reduce expenses, they may defer outright production cuts for now, according to Macquarie Group Ltd., Australia’s biggest investment bank.

“Australian, Indonesian and to some extent Russian tonnage may be under pressure but so far no cutbacks have been seen,” Colin Hamilton, the bank’s global head of commodities research, said by phone from London. “The price in the contract has been well flagged and miners could have already adjusted to some extent. Cutting output is especially difficult for miners with take or pay contracts.”

Peabody Loss

A take or pay contract is an agreement in which a buyer purchases a specific amount from the seller and pays the equivalent cost even if the goods or services aren’t needed. They are used by power stations to ensure they have access to fuel, which obliges their coal-mining counterparties to keep supplies available.

Peabody this month reported a narrower first-quarter loss than analysts estimated after expenses in the St. Louis-based company’s Australian segment, which accounted for 43 percent of its revenue in 2012, fell 9.5 percent to $77.15 a ton.

Peabody now operates about 85 percent of its Australian production after taking over the running of mines from contractors, the company said in the statement. Early-stage projects continue to be deferred, with timing dependent on market conditions, it said.

Indonesian Output

Xstrata’s agreement won’t have an impact on Indonesia’s output, according to Supriatna Suhala, the executive director of the Indonesian Coal Mining Association, a group of 114 mining and mining services companies that includes PT Bumi Resources, the nation’s biggest coal exporter.

“Australian and American producers are more sensitive to prices,” Suhala said by phone from Jakarta. “They would be the first to reduce production when prices are low. They are more flexible to cut output for example by reducing workers. It won’t be easy to cut workers in Indonesia.”

Prices will average about $90 a ton this year, while Indonesian production will rise to 400 million tons from 386 million in 2012, he said.

Conditions within the Australian coal industry remain challenging, Yancoal Australia Ltd., a unit of China’s Yanzhou Coal Mining Co., said in its first quarter production report on April 18. Markets remain oversupplied and prices are expected to remain under pressure for some time, the company said.

China Purchases

China’s overseas purchases of power-station and steelmaking coal slumped 34 percent in January and February to 23.3 million tons, before partially recovering in March to 26.2 million, customs data show.

Metallurgical coal is used in the process to forge steel, while utilities need the thermal variety to generate electricity.

Imports into the country, the world’s largest buyer of seaborne thermal coal, may be capped as long as arbitrage conditions favor domestic supplies, according to a Feb. 12 report by Bloomberg Industries. Chinese prices fell below Australian levels for the first time since late 2011, which may translate into weaker price support for seaborne coal, the report showed.

Australian producers “have been protected somewhat from the fall in the spot price for a good six months or so,” said CIMB’s Hynes. “Now reality is going to hit.”

Power-station coal prices in Indonesia, the biggest exporter of the fuel, fell last week. Indonesian bituminous grade with a calorific value of 5,800 kilocalories a kilogram and as much as 2 percent sulfur, averaged $71.25 a metric ton in the week ended April 19, according to the median forecast of five traders surveyed by Bloomberg. That’s down from $72.50 a ton a week earlier.

To contact the reporter on this story: Ben Sharples in Melbourne at bsharples@bloomberg.net

To contact the editor responsible for this story: Alexander Kwiatkowski at akwiatkowsk2@bloomberg.net

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