China’s ban on Australian coal has an expensive sting in its tail

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One of the curious developments of the past few months is that the slump in iron ore prices hasn’t been accompanied by similar falls in the prices of other key steelmaking ingredient, metallurgical coal.

Indeed, while the iron ore price has fallen about 34 per cent, from just under $US220 a tonne in mid-July to around $US145 a tonne, Australian metallurgical coal prices have soared from around $US100 a tonne at the start of this year to about $US220 a tonne. In China, the steel mills have been paying as much as $US440 a tonne for metallurgical, or coking, coal.

There are a number of influences at play to explain the divergence between the prices of what should be quite highly correlated commodities.

The iron ore price slump was the obvious consequences of a decision by China’s authorities to cap annual steel production at the same level as last year’s 1.05 billion tonnes. Given that the mills’ production was up 12 per cent in the first half of this year that has forced an equivalent cut to output in the second half.

That directive was part of a broader effort in China to curb soaring commodity prices, reduce China’s reliance on Australia for iron ore (part of the broader “punishment” for our leaders’ supposed intemperate remarks) and reduce emissions from one of its most emissions-intensive industries.

Metallurgical coal was, with energy coal, among the Australian exports targeted by the Chinese authorities for both explicit and unofficial bans late last year.

Initially buffeted by the abrupt cessation of demand from the biggest market for Australian coal, both energy and metallurgical coal prices have rebounded quite dramatically.

Metallurgical coal is interesting because Australia, and BHP in particular, dominate the seaborne trade in metallurgical coal with a market share of around 60 per cent. BHP accounts for roughly two-third of those exports. The next biggest supplier, the US, has a share of only about 16 per cent.

Unlike iron ore, where China is by far the dominant customer, demand for metallurgical coal is far more widely spread. China, Japan, the European Union and India each absorb about 20 per cent of seaborne supply.

While, as occurred with energy coal and other Australian products, the Chinese bans created initial shocks and disruptions as China’s demand completely evaporated – for months cargoes of Australian coal sat fruitlessly off China’s coast and prices dived – China appears to have miscalculated how quickly the producers would respond and how significantly its bans would rebound on its own industries.

Having lost China as a customer the Australian coal producers scrambled to find new customers, perversely aided by the slump in the prices. Buyers in Japan, India, the EU and South Korea, presented with high-quality coal at bargain prices, grabbed the opportunity.

Having shut off access to Australian coal, China had to find supply elsewhere. For metallurgical coal it turned to North America, Russia, South Africa and Mongolia.

Unsurprisingly, given the dominance of Australian supply in the metallurgical coal market in particular and the extra distance and costs involved in shipping North American coal to China relative to Australian coal, that caused some significant dislocations in a market already being impacted by the first half boom in China’s steel production.

China’s domestic prices for coking coal began spiking sharply even as the cost of its imports was rising.

Some production shutdowns in Australia when the initial loss of China as a customer and the price plunge forced the producers into losses, curtailing supply while COVID-related border closures that impacted access to Mongolian production and mine closures in China itself flowing from safety and environmental concern were other influences on a price for China’s own supply that surged quite dramatically. It’s now solidly over $US400 a tonne, having peaked at $US440 a tonne.

The price rise for the Australian metallurgical coal producers hasn’t been as dramatic but is above $US220 a tonne – it has more than doubled since the start of the year – dragged up by the prices China has been forced to pay to replace the Australian volumes with higher cost and lower quality products.

Australian coking coals are premium products, helping to maximise production yields and minimise the environmental effects. The redirection of Australian exports at prices way below those China is paying is good for China’s competitors in Asia and Europe and not so good for its own mills.

China has imposed price caps on its domestic coal producers and the big second-half cutbacks to steel production (if the mills do fully comply with Beijing’s directive) will also have an impact on demand for coal.

The outsized role of the Australian producers in the market for metallurgical coal, the premium quality of their products, the proximity of Australian supply to the key Asian markets and China’s own need for high-quality coal ought, however, to provide a relatively elevated floor under prices.

The super-premium prices China is paying are the unintended consequences of its efforts to punish Australia for the temerity of our leaders asking for proper investigations of the origins of the pandemic, criticising China’s treatment of Uighurs and its actions in Hong Kong.

For the moment, at least, while some of the exports China has targeted haven’t had the ability to adjust as easily or seen their markets recover in the same way as energy and metallurgical coal, the Chinese sanctions are hurting its companies and economy more than Australia’s.

Source: The Age

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