Q&A: Adapting to 2017 coking coal price volatility
Sergey Stepanov is vice-president of Russian vertically integrated steelmaker and mining company Evraz's coal division and chief executive of Evraz Raspadskaya Coal. In an interview with Argus, he discussed how this year's coking coal price volatility has created opportunities for Evraz to experiment with exporting to new destinations, and how the company has developed a more spot-linked approach to coking coal pricing to help it navigate choppy waters.
How are you structuring your export sales for coking coal? Are you still primarily selling on a long-term contract basis?
As usual, we aim to sell under five-year contracts, but these contracts mainly define volumes and the price formula. And most of our contracts are linked to international benchmarks, so we are choosing which benchmark is valid for which type of coal and putting that into the formula.
The only problem this year is that benchmarks have been coming out with delays, and so for most of 2017 we have been working with what we call "provisional pricing". For example, hard coking coal (HCC) on spot is currently around $180/t fob Australia, so at the beginning of a quarter we would agree with the client that the provisional price would be $180/t fob, let's say. Then at the end of the quarter, that price is recalculated according to how the official quarterly benchmark being used in the contract has moved. So we define a soft provisional price for hard and semi-soft coking coal, and at the end of the quarter we make a correction of around $5-10/t.
When did you shift to this approach?
We started using provisional pricing from around the second quarter. We set fixed first-quarter price formulas in December, and after that there was a lot of tension from buyers because the spot price dropped in January. So they decided to make it more spot-linked. It's a bit inconvenient, but in general I would say it's a working price mechanism — especially in such a volatile market.
We are more or less fine with the approach, because we are price-takers. Maybe the environment will stabilise, but let's see. I think around half of Russian producers have moved to this kind of pricing.
How does this translate into your domestic coal pricing? Are you now looking at seaborne spot price movements more than you were previously?
Domestically, we also have formulas with most of our clients related to the fob price, after analysing the relationship between fob prices and domestic prices with them two or three years ago. I think more than half of our clients accepted this approach. We signed long-term domestic formula contracts at the end of 2015 and the beginning of 2016, when the price had been fairly stable for a while. But then we talked to them each time the fob spot price moved, and agreed that those discussions should start being factored into the formula. So now, at the end of each quarter, we all look at the formula and if both sides are comfortable then we can go on. There are just more discussions and negotiations now than there were when prices were more stable.
Has this year's coking coal price volatility had an impact on your export sales destinations?
Our traditional overseas customers are taking more or less the same volumes as before. And there are new customers — we see interest from Vietnam, India, even from Brazil. But mostly these directions are dependent on logistical costs, so we cannot sell there with low coal prices. When the coking coal price is nearer to $100/t, you are limited to Russia, Japan, South Korea, China and maybe Turkey — you can reach only these markets. If prices go higher, you can reach almost any market. But it can change with time.
So, with a higher coal price, it is easier to experiment. And I think that some of these new directions could stay with us during lower-price periods, because right now we and the new clients can try, and if they like our product we can try to do some business in future.
Our volumes heading into eastern Europe have also gone up this year, and we are selling some coal from Baltic ports to the European seaborne market, which was not the case previously. In October, we will send around 150,000t to the Baltic Sea from Kuzbass. It's a new rail route for us, and the first time that our coal shipments to the Baltic have exceeded 100,00 t/month. Now we understand how it works, we believe that we can use that knowledge in the future.
So within the past year, your sales geography has widened?
Yes. With a higher coking coal price, we have a much more diverse customer base and sales geography, which is good because with the logistical limitations that we face it is better to have several directions in which to sell, and it's good to have more diversity in terms of what coal products we can launch and sell.
How much are you currently sending to India, Vietnam and Brazil?
Just trial shipments — maybe 30,000-50,000t — with material for them to try out.
In the past year, have you seen any shifts in demand for different coking coal grades?
In the international market — not really. But in the Russian market, we do see some changes. Metallurgists have started to understand coal qualities in more depth. There are two trends.
Firstly, when the price goes too high, they start to take more semi-hard coking coal, which we would usually export. When prices went up this year, we started to send some hard coking coal abroad — something we never usually do — mainly to Ukraine. Then, when prices are low, Russian buyers take a lot of hard coking coal. So in the first quarter, we saw this change, and we found that Russian steel mills can work with cheaper coals than they could before.
The second — long-term — trend is that Russian metallurgists are seeking higher-quality coal and coke in order to increase productivity in the blast furnace. We have seen in the last year that many Russian metallurgists have a better understanding of how the different types of coal work in the mix, and they are becoming much more precise about the types of product they want from us. It means we need to understand exactly what each client needs and be in line with that.
What are the growth areas for Evraz coal operations in 2018?
We want to boost output of new products. We started producing low-volatile hard coking coal in Mezhdurechensk in August. Evraz usually buys this coal on the market because our own output is typically high-volatile hard coking coal. Mezhdurechensk coal is low volatile and closer in quality to Australian hard coking coal. We aim to produce at least 1mn t of it in 2018, although we will try to dig out more. This is a new direction for us, and we want to increase our presence in this category.
Of that 1mn t, how much would be put towards your own steelmaking?
I think 75pc of it would be the Australian-type hard coking coal, which we would mostly like to sell to our own steel plants. This is part of our programme of increasing our self-sufficiency. We have a long-term goal of 100pc self-sufficiency in coking coal supply.
When will you reach that goal?
It depends. We might need new coalfields, so I think maybe in five years. This year, we have been using around 60pc our own coal, and buying 40pc on the market.
Where are the gaps in Evraz's coking coal production, in terms of grades?
This low-volatile category. We already have the whole spectrum of coals for high-volatile — hard coking coal, semi-hard, semi-soft, and all the chemical qualities.
Do you already have the necessary reserves in your portfolio to achieve self-sufficiency, or would you need to buy more?
I think we have up to half of the reserves that we need, so I would say not enough. We have enough to move on for the next two or three years, but we need more beyond that point.
Are you in any discussions about future reserves acquisitions?
We approved a strategy to increase our coking coal self-sufficiency around three months ago. There are not many good licences still available in Kuzbass because the area has been under development for so many years. Maybe another option would be to look at junior players, but there are no discussions on that yet. I think we need to concentrate on our existing reserves for the next couple of years, and in the meantime analyse our options for the future.
What are your main challenges and concerns regarding logistics constraints?
It looks like Asia is the fastest developing region now for coal consumption, and Russia historically has just one long rail route from Siberia to the far east. This used to be enough, but in the past five years — when coal exports have risen to record levels — it has become over-stretched. Coal accounts for around 20pc of Russian rail transportation in terms of tonnage, so it has a big impact on the network. The Russian rail network is simply not ready. It is developing — there is a government programme to develop the far east — but it is more long-term.
In the short-term, I think we should redirect deliveries to the west, which we have already done. There are some real physical constraints, such as maintenance in the summer, or there could be cyclones. And you cannot catch up after that, because you are always working at maximum capacity on the rail line. We have reconsidered our internal logistics in the past couple of months, so for 2018 we are much more ready to adapt quickly.
We have found at least two ways to do better in this environment. One is to use new routes. The other is to improve our internal reserves, such as by having stockpiles of coking coal concentrate ready, so when the rail transportation window suddenly opens we can load as much as they can take.
What are your expectations for fourth-quarter coking coal production and sales?
In terms of production, we will be at the same level as in the third quarter – maybe a slight change as a result of longwall changeovers.
We should sell more, because in summer we had severe logistics constraints. Now we are already selling more than in August-September because we have focused more on this logistics issue. If we can keep up this pace in November-December, I think sales should go up by at least 5pc compared with the third quarter because we have product in stockpiles that has been there since summer. The demand is there — it's all about logistics, and grades to an extent.
We have three mines out of seven with no stockpiles — the coal sells straight away because it is good quality. But we have big stockpiles at three of the other mines — we have contracts in place for that coal, but it's all about having better infrastructure. That stockpiled coal is mostly semi-hard and semi-soft grades, which we would sell for export.