API 2 upside limited, but tight margins to slow losses
The new year-ahead API 2 calendar 2021 contract has begun the year on a firm note, although risks remain skewed to the downside as strong competition from natural gas along the forward curve continues to weigh on the European demand outlook.
The new year-ahead swap settled at $62.35/t in its first session of the year. This was down by $19.80/t compared with its predecessor at the start of 2019, although the swap has since gained 3pc in value and recorded six consecutive daily increases over 31 December-8 January.
API 2 calendar 2021 fell by nearly $6/t in December and looks to have found some technical support after plunging below its 50-day and 100-day simple moving averages at the end of last year. Rising oil prices amid heightened geopolitical tension in the Middle East also lent support to global energy commodities, including coal, early in 2020.
But the European coal market continues to face downside price risk as power sector demand is unlikely to recover while natural gas prices remain more competitive for base-load generation. Forward API 2 coal prices are currently at a level that will make it difficult for a 40pc-efficient coal plant to compete with 55pc-efficient gas-fired generation throughout most of the 2020-23 period (see chart).
Growth in open interest on API 2 calendar 2021 via the Ice has also slowed during the latest rebound, suggesting that counterparties may have been closing short positions to take profit rather than building long positions early this year. Calendar 2021 fell by $6.60/t to as low as $62.15/t over 26 November-30 December, with open interest rising by around 3.9mn t to 16mn t across the month. But open interest slipped to 15.7mn t by 8 January following the recent price recovery.
Rising renewable capacity and strong competition from natural gas amid high stocks and firm LNG supply means European power sector coal demand is unlikely to recover the ground it lost in 2019, but prices and consumption are also unlikely to fall as sharply as they did last year.
The scope for additional coal-to-gas fuel switching across some of the biggest European power markets is likely to be limited in 2020 after a significant proportion of coal was displaced by gas from March 2019. The biggest year-on-year declines will come early in the year, as aggregate coal-fired generation of 12.5GW across Germany, Spain, the UK and France during the first quarter of last year will be heavily reduced in 2020 as a result of gas' current cost advantage for base-load generation.
Coal-fired generation across the four markets averaged 6.4GW in April-December 2019, down from 13.7GW in the same months of the previous year. But coal demand may stabilise in 2020 as flexible coal-fired generation was already largely displaced from the generation stack during the second half of 2019, meaning there is limited potential for further fuel switching this summer.
A more stable demand profile could steady API 2 coal prices in 2020, following a volatile year in 2019 that saw the year-ahead shed around a third of its value in January-December. The calendar 2020 swap began the year at $82.15/t and settled at $56.45/t on 31 December.
Coal price weakness is also likely to be limited by an adjustment in seaborne supply availability in the Atlantic, with US exports set to fall again in 2020. Strong seaborne coal prices through 2018 and early last year helped to sustain European imports early in 2019 as some US volumes were hedged forward, but the same is not true in 2020.
The EU imported a net 1.6mn t/month from the US in 2018 and nearly 1mn t/month in the first quarter of 2019, but the rate fell to 500,000 t/month in the seven succeeding months and is unlikely to recover at current price levels. Colombian supply to Europe has also slowed in the past year, falling to an average of 900,000 t/month in January-October 2019 from 1.7mn t/month in the same period of 2018.
Thermal coal imports to the EU fell to their lowest since 2000 last summer at around 5.4mn t/month and are likely to fall considerably short of the 9.3mn t/month average recorded in the first quarter of 2019. This may help to balance the likely drop in power sector consumption in the near term and thereby limit future downside price risk, compared with the drop seen in 2019.
Price support may also come from increasingly tight margins for producers in Russia — the EU's biggest supplier of seaborne coal. Argus' NAR 6,000 kcal/kg netback price to the Kuzbass production region from Murmansk ports was below $1/t at the end of 2019, compared with $26.16/t at the start. This means that costs to transport coal from Kuzbass mines to export ports are nearly as high as fob export prices available in the spot market, making exports to Europe increasingly challenging.
API 2 liquidity stable in 2019
API 2 swaps liquidity slipped by 2pc on the year in 2019 to 1.26bn t, according to data collated by Argus.
This was comparatively stable compared with 2018's 14pc annual decline and the 50pc reduction in trade to 1.49bn t in 2017.
Ice exchange trade accounted for a third of total API 2 liquidity, with 39pc of trade cleared through the same exchange and the remaining 28pc handled by the CME.
Of the 899mn t of exchange-executed and cleared trade handled by the Ice, 566mn t of liquidity was on calendar year delivery contracts, which was down from 734.3mn t in 2018. Forward hedging activity among utilities was likely depressed as the year-ahead API 2 swap was uncompetitive with gas for power generation throughout nearly all of the second half of the year.
But API 2 liquidity through the Ice grew on the year for monthly, quarterly and seasonal delivery periods, the bourse's data show. Some 260.6mn t of trade on quarters was done, compared with 207.2mn t in 2018, with 71.7mn t on the monthly swaps, up from 70.1mn t a year earlier. And 450,000t on seasonal swaps was traded, compared with just 30,000t in 2018.
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