Viewpoint: Australian coal margins face weakness

A weaker Australian dollar is shielding domestic thermal coal mining firms from the worst effects of rising costs and weaker prices, but margins are still under pressure, with the big four producers all forecasting falls in 2020.

Key producers Glencore, Yancoal, BHP and Whitehaven have all said they expect margin compression in 2020, even at $80/t fob Newcastle, which is above the current spot price for 6,000 kcal/kg coal. Switzerland-based bank UBS forecasts Whitehaven, which is the only pure play thermal coal firm it covers, to slip to a loss with spot prices around $80/t or a bit lower.

In this downside scenario, these four large mining firms will have a grace period in which they can continue to operate at a loss, but smaller, higher cost curve mining firms may be forced to suspend operations or call in the administrators if average prices remain at current lows.

Argus assessed the NAR 6,000 kcal/kg price at $65.70/t fob Newcastle on 27 December, up from a low of $60.84/t on 2 September. The price has not been above $80/t since the end of May. UBS earlier in December was using a forecast average of $68/t for 2020, at which price it projects BHP's thermal coal division to make a loss before interest and tax.

Argus assessments, which cover cargoes of 50,000t and above that typically travel to Japan, have averaged $76.34/t for 2019. This proved to be the lowest annual average Argus price assessment since 2016, indicating how much more pressure producers have been under during the past year.

The 2019 average on fob Newcastle NAR 6,000 kcal/kg coal was $29.31/t lower than the average in 2018 of $105.65/t, when prices were unusually strong amid tighter supplies of high-calorific value (CV) Australian coal.

But the operating margins of Australian producers are being helped by the weaker Australian dollar, which is partially offsetting the effects of significantly lower US-dollar denominated coal prices. The Australian dollar has been at US$0.67-0.69 for much of the second half of 2019, down from around 70¢ in the first half and banks forecast it to average around 68¢ in 2020 and 2021. This is the weakest the Australian currency has been this decade against the US dollar and any rebound could damage the profitability of Australian coal mines.

Challenges ahead

Costs are being driven higher by wage increases, higher strip ratios and maintenance bills associated with older mines, as well as general inflation across the wider mining industry on Australia's east coast.

These operational challenges have come at a hard time for producers, which faced increasing competition in Asia this year from high and mid-CV Russian producers. Russian rail and export facilities have been expanded to facilitate coal exports from far eastern ports, which are close to buyers in Japan, South Korea and Taiwan. Even Japanese power utilities, previously the most loyal of buyers, have been diversifying their buying strategies amid increasing purchases of competitively priced, high-quality Russian coal. Japanese coal demand also slowed during certain periods of 2019 when nuclear power generation made a recovery after several years of closures and somewhat weaker overall electricity demand in 2019.

The plentiful availability of cheap natural gas in Asia, and the rise of renewable generation in Japan on supportive feed-in-tariffs, may also undermine some Japanese thermal coal demand in the year ahead. But Japanese thermal coal demand was largely shielded from the effects of cheaper gas during 2019 because many of its term contracts for LNG imports are linked to oil prices.

New buying trends

Sellers of Australian higher ash coal have also had some challenges from Chinese and South Korean buyers, especially in the second half of 2019.

Most Australian high-ash coal typically heads for China, but prices have been depressed in 2019 amid trade tensions between the China and Australia. The trade tensions were possibly behind unofficial Chinese port policies to ban or restrict Australian coal imports in the second half of 2019. Many Australian coal sellers did experience customs delays, with additional demurrage charges incurred. The policy uncertainty surrounding imports resulted in prolonged price pressure on Australian high-ash coal, even though its competitive price compared with Chinese domestic coal ultimately helped to support the flow of cargoes into China.

Argus' assessment of high-ash NAR 5,500 kcal/kg coal was at $51.52/t on 27 December, with the average price for 2019 at $54.44/t, the lowest annual average since 2016 when prices were particularly depressed amid oversupply. The 2019 average for fob Newcastle NAR 5,500 kcal/kg coal was almost $17/t below the average in 2018 of $71.43/t.

China's policy toward Australian imports in 2020 remains unclear, although more cargoes are likely to flow into Chinese ports in January if the current quota restrictions on imports from all destinations — imposed from late October 2019 — are lifted at the start of the new year.

The air quality concerns of fellow large-scale buyer South Korea became more pronounced in 2019 and led to the winter closures of many coal-fired plants. If these environmental restrictions continue into 2020, they may affect some demand for Australian coal given increased South Korean tender requests for coal with sulphur below 0.5pc and even 0.4pc. Only some Australian producers have such low-sulphur coal, placing more pressure on Australian sellers to find new homes for their product, including growing southeast Asian demand centres such as Vietnam.

Australian diversification of its thermal coal export destinations has led to Vietnam emerging as a key export outlet in southeast Asia. Australian coal accounted for much of the overall increase in Vietnamese import demand during 2019, with imports from Australia during January-November growing by 9.25mn t to 14.25mn t, accounting for 36pc of Vietnamese receipts. Vietnam has several more power plants coming on line, suggesting that Australian and Indonesian exports to this growing consumer base will increase in 2020.

By Claire Pickard-Cambridge and Jo Clarke