Metallurgical coal supply outlook -- Supply shock potential to persist Macquarie Research

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Metallurgical coal supply outlook
Supply shock potential to persist
 Metallurgical coal remains a fundamentally compelling story, with the key
regions for blast furnace output growth in the coming years all increasingly
reliant on the seaborne market. In this report, we focus on the supply side for
met coal, which like many other commodities faces the twin challenges of
main supply growth and infrastructure availability.

No avoiding continued overreliance on Australia
 Quite simply, Australian supply has to perform in order to satiate seaborne
demand growth in the coming years. If there is one unique differentiating
factor for met coal, the supply side “risk portfolio” is not very diverse vis a vis
other commodities, with over 50% of seaborne supply coming from
Queensland. As we have seen thus far in 2011, this situation does leave the
market highly exposed to supply shocks. Furthermore, with more than half of
seaborne supply growth through 2014 emanating in Australia, there is no
alleviating this overreliance.
Growth from frontier geologies is crucial
 Quite understandably, a lot of supply focus in the met coal space is on the
developing regions of Mongolia and Mozambique. In commodity analysis, it is
not usual to pin too much hope on frontier geologies. However, in met coal,
there is no option but to assume these countries perform, otherwise the
market would be pushed strongly into deficit.
 Mongolian coal is particularly crucial in easing China‟s reliance on the
seaborne market; however, even with strong growth this will remain minor in
terms of overall Chinese demand. With the domestic Chinese market dwarfing
international trade, even a small shift in the Chinese internal supply-demand
balance can have a profound effect on seaborne volumes and prices.
Prices well above cost support will be the norm
 As with many commodities, rising capital intensity and cash production costs
are afflicting the met coal space. However, current price levels still represent a
massive premium to cost support with the entire curve making considerable
cash margins; a situation which is likely to prevail through our forecast period.
 With the market incredibly tight, we don‟t think long run prices will be tested
until nearer 2020 until which point they will be strongly underpinned by
Chinese cost support. Meanwhile, the requirement for projects in high
geopolitical and infrastructure risk regions will keep long-term prices elevated.
 In our view, the new „normal‟ through the medium term is a $225–250/t FOB
Australia price for hard coking coal, with brand sensitivity from Japanese
buyers driving an increasing „premium for premium‟.