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Coking Coal Rally Driven by Supply Constraints
Overview: VanEck’s natural resources investment strategy spans the breadth of raw materials commodities sectors, and the coal and consumable fuels sub-sector can play an important role. Not least, the global steel industry is dependent on coal. Metallurgical coal is essential to the steel making process with approximately 70% of the steel produced today using coal as a primary raw material. Metallurgic coal is also called “coking” coal because it is used to create coke, an irreplaceable input for steel production. Coking Coal Rally Driven by Supply Constraints
By the end of September, metallurgical coal prices had climbed more than 100% since the beginning of the year.1 The overwhelming driver behind this price recovery has been restriction in supply. In addition to both lower seaborne and domestic supply, inventories are also at multi-year lows. Although our view is that current prices are not likely to hold, we do foresee a continuation of a market environment that will be supportive of higher prices.
What is Metallurgical Coal?
Global steel production depends on coal. Metallurgical coal, or coking coal, is used in the process of making steel, and hence is often referred to as “steel making coal”. Coking coal is heated to about 2,700° F (1,100° C) in a coke oven, forcing out impurities to produce coke. Coke itself is almost pure carbon. Because of its high thermal energy and dearth of impurities, coke is used to convert iron ore into molten iron. This is then used to make a range of steel types.
Global Demand is Solid
Over the past three years, global demand for coking coal has been relatively solid at an annual level of around 990 million tonnes (Mt). China is one of the most important consumers in terms of setting prices, since it accounts for approximately 60%, or 590Mt, of global coking coal demand. It is followed by Japan at 69Mt, India at 49Mt, and South Korea at 40Mt. Demand from the U.S. is for about 21Mt per annum.
China has invested heavily in its steel industry and currently accounts for approximately 55% of the world’s steel production. The net result of this is that domestic Chinese coking coal supply has had to be supplemented by imported, or seaborne coal (Chart A). “Seaborne” refers to coal that is transported internationally overseas by ship, and refers mostly to the coking coal export market.
Chart A: Chinese Seaborne Coking Coal Demand and Steel Production
Yearly in Tonnes: 2000-2016
(click to enlarge)
Source: VanEck, Bloomberg, World Steel Association, Australian Bureau of Statistic, Statistics Canada, and Chinese General Administration of Customs, as of 9/30/16.
Coking Coal Supply: The Seaborne Market and the Domestic Market
The global coking coal market is generally considered as being split between the seaborne (or export market) and the domestically traded market.
The Seaborne Market
The size of the global seaborne coking coal market was approximately 290Mt as of 2015 (Chart B). Despite being a much smaller market than the domestically traded coal market, the seaborne market is actively traded and, therefore, regarded as the price/trend indicator for all contracts.
Australia, the U.S., and Canada are the key suppliers of coking coal to the seaborne market. Seaborne supply reached record levels in 2014 as shown in Chart B. However, supply fell 8% in 2015 as producer profitability decreased, balance sheet quality deteriorated, and capital spending contracted. In 2016, supply has collapsed even more dramatically, and on an annualized basis, 2016 seaborne supply could be as low as 185Mt, or down 37%, a level last seen in 2004.
Chart B: Global Seaborne Coking Coal Supply
Yearly in Tonnes: 2000-2016
(click to enlarge)
Source: VanEck, Bloomberg, Australian Bureau of Statistic, Statistics Canada, Chinese General Administration of Customs, and U.S. Census Bureau, as of 9/30/16.
The U.S. has had the largest impact on the shrinking supply to the seaborne market. Over the past three years, U.S. coking coal exports have fallen consistently, driven by subdued prices, lower margins, and/or restrictive environmental policies (Chart C). U.S. exports peaked at about 70Mt in 2012, but since then they have contracted by nearly 42% and 2016 exports are estimated at 40Mt. The export decline has been particularly pronounced over the past twelve months, a period in which 20Mt in capacity was lost.
Chart C: U.S. Coking Coal Exports
Quarterly in Tonnes: 2000-2016
(click to enlarge)
Source: VanEck, Bloomberg, and U.S. Energy Information Administration, as of 9/30/16.
The Domestic Market
Domestic coking coal markets have also seen a dramatic reduction in supply. In 2016, China made a fundamental shift and implemented supply-side reforms in the domestic coal industry to curb overcapacity. In short, the reforms reduced the number of statutory working days for coal miners from 330 to 276. By mid-2016, in China, year-on-year production was down 20%, and in the coking coal-rich Shanxi province it was down 25% to 30%. As a result, because of lower supply and relatively solid demand, coking coal inventories in China are currently at multi-year lows.
Our Positive Outlook for Coking Coal
Current physical market conditions remain very tight. We believe that just as low prices have resulted in reduced supply, higher prices should lead to increased supply. At current spot market prices, virtually every tonne of seaborne coking coal will be cash positive.
While we do not expect current prices to hold, we do foresee a strong and supportive market that will keep prices higher than the current contract price (around $92.50 per tonne). This outlook is supported by a number of different factors. In addition to the fact that 70% of deals are executed by coking coal end-users and not traders, some 80% of concluded transactions were in Asia. On top of this, not only are coking coal inventories at coke plants at their lowest levels on record, demand for steel is also expected to remain solid. Taken together, we believe these factors provide a solid base for firm prices going forward.
AUTHORED BY
Charl Malan
Senior Analyst
________________________________________
Senior Analyst for the Natural Resources Equity strategy; specializes in Base and Industrial Metals; also serves on the investment team for the Gold Equity strategy
Investment Management Team member since 2003
Prior to joining VanEck, an equity research sales analyst specializing in South African mining, natural resources, and financial sectors at JPMorgan Chase; actively involved in the merger of BHP Billiton/SAB Miller and unbundling of Iscor Steel/Kumba Resources as well as capital raisings and NYSE listing of Harmony Gold, Gold Fields, and Telkom SA
Previously an equity research analyst and junior portfolio manager at Standard Corporate and Merchant Bank, Asset Management (South Africa); developed and applied various fundamental and quantitative models within the natural resources, mining, and consumer sectors; established an equity research department and managed Standard Corporate and Merchant Bank, Asset Management (Namibia)
Media appearances include ROBTv; quoted in The Wall Street Journal, Barron’s, Forbes, CNBC, and The Financial Times, among others; also featured in mining journals such as miningmx, Mining Journal, and Resource Investor
MBA, University of Stellenbosch (South Africa); Honours in Business Administration, University of Stellenbosch (South Africa); BA, Arts, University of Pretoria (South Africa)
IMPORTANT DISCLOSURE
1 Source: Bloomberg. Data as of 9/30/16 is based on the TSIPPCAE Index: Premium Hard Coking Coal Australia Export (FOB East Coast port) USD/tonne. This price index is compiled by The Steel Index Ltd (TSI), and it represents the volume-weighted average of actual transaction price data submitted confidentially online to TSI by companies operating within the relevant supply chain, including buyers and sellers, based on their latest sales and/or purchases within this product category. An index’s performance is not illustrative of a Fund or strategy’s performance. Indices are not securities in which investments can be made.
Last week, I was in Washington, DC to attend the DC Blockchain Summit and to meet with regulators and policymakers to share our experiences as a crypto-focused asset manager over the last seven years.
The Summit, hosted by The Digital Chamber, included speeches from dozens of members of Congress, regulators, and industry leaders. After listening to presentations and speaking with a number of regulators and policymakers I have one key takeaway: Regulatory clarity for crypto will come much faster than I previously anticipated.
A dramatic shift in tone
As I wrote in January, US policymakers and government leaders—at nearly every level—are embracing this technology. For years, the lack of clear rules for digital assets in the US has been a major obstacle for institutional investors and financial firms looking to enter the crypto space. However, this past week in DC, as well as several of the conversations I’ve had with advisors and wealth managers over the last several weeks, has left me with an even higher sense of optimism.
One of the most striking takeaways from my meetings was the shift in how policymakers are discussing crypto. Just a year ago, many in Washington viewed digital assets primarily through the lens of risk—concerns over fraud, illicit finance, and speculative volatility dominated the conversation. While these concerns still exist, the discussions now are much more nuanced and focused on the opportunities that crypto can create to the American economy and how to address these risks through a clear regulatory framework.
Bipartisan support for legislation
Perhaps the most encouraging sign is the concrete progress being made on both legislative and regulatory fronts. Several key developments indicate that clearer guidelines for crypto businesses and investors could arrive sooner than expected. There is growing bipartisan momentum behind crypto-related legislation. The House Financial Services Committee and the Senate Banking Committee are moving forward with stablecoin legislation, and it is possible legislation could be signed into law as early as this summer. Stablecoins have also been a key focus of regulatory discussions, with growing consensus that they should be subject to clear guidelines similar to those governing payment systems and money market funds.
House and Senate committees are also actively discussing proposals that aim to define the jurisdiction of regulatory agencies, clarify the status of digital assets, and establish consumer protections. Unlike previous years, these efforts are being taken seriously by both parties, increasing the likelihood of meaningful legislative progress.
Adding to these regulatory discussions is the growing demand for crypto exposure from institutional investors. This demand is influencing policymakers and regulators, as they recognize that a lack of clarity is pushing innovation overseas.
What does this shift mean for investors?
The acceleration of regulatory clarity is a significant development for investors. While the approval of spot bitcoin ETFs last year was a watershed moment, it’s just the beginning. Several large financial institutions, including major banks and asset managers, are actively exploring tokenization, digital asset custody, and blockchain-based financial infrastructure. These institutions are engaging with regulators, advocating for a clear framework that allows them to enter the market with confidence.
Uncertainty has been one of the biggest barriers to broader crypto adoption by financial institutions and institutional investors in particular. As regulations become clearer this year, we expect to see:
• Increased institutional participation: With regulatory uncertainty diminishing, more traditional financial institutions will feel comfortable offering crypto products and using crypto technologies such as stablecoins to offer more efficient services, driving further mainstream adoption.
• Growth in tokenization and blockchain use cases: Clearer regulations will pave the way for asset tokenization, improving efficiency in markets like real estate, bonds, and private equity.
• A stronger US crypto market: By establishing a clear regulatory framework, the US can assert itself as a global financial leader, which we believe will help spur more regulatory clarity in other jurisdictions.
Final thoughts
The message from Washington is clear: crypto regulation is coming, and it’s coming faster than many expected. While there are still hurdles to overcome, the shift from uncertainty to structured regulation is well underway. For investors, this marks an important transition. Clearer rules will reduce risks, enhance market stability, and unlock new opportunities for institutional and retail participants alike.
At Hashdex, we remain committed to navigating these changes and providing investors with access to the best opportunities in this evolving landscape. As we move forward, continued engagement with regulators, policymakers, and financial institutions will be key. The crypto industry has a critical role to play in shaping the future of regulation, and by working collaboratively, we can help ensure that the next phase of crypto’s growth is built on a foundation of clarity and trust.
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