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Article06 Jan 2023

The Reluctant Embrace of Coal

A recent report by Citi Research’s Kenny Xunyuan Hu examines the recent reluctant embrace of coal, how robust prices could endure, and where alternative coal supplies and financing are coming from.

Thermal coal is meant to be an industry in its dotage. But a surge in prices as energy security challenges threaten the energy transition could mean the industry still has some power left, despite an eventual decline looking inevitable.

Many factors have led to the surge in coal prices. China has raised its production massively and Europe has kept coal power plants running for longer than expected.

And amid an already tight energy market, a cold winter, disappointments in renewable generation, losses in nuclear generation and sharp cuts in Russian natural gas exports, energy markets globally have tightened.

At the same time, coal financing in the developed markets has shifted significantly from the bank sector to the private side, as large financial institutions continue to exit the market. 

According to a recent study by the think tank E3G, private banks of the G7 nations account for over one-third of global investments in coal. Large corporations and investment firms are under heavy ESG pressure from regulators, shareholders and investors. But private investors do not face such limitations, and many naturally find coal to be a good investment choice, particularly given thermal coal’s significant YTD outperformance against the vast majority of other commodities and other asset classes as well.

High prices have also brought on alternative coal supplies and strengthened EM’s financing of coal. Citi’s report also highlights how major coal producing regions and firms globally are navigating this unprecedented environment for coal.

Retiring coal power plants were also called back into service.

Even if coal is not part of an investment portfolio, coal prices and fundamentals are key to understanding natural gas, power and carbon markets. Meanwhile, coal policies also influence energy transition policies.

Supply constraints:

  • Russia continues to struggle to replace its former largest coal customer/importer following the EU ban. Although the EU has eased the sanction somewhat by allowing Russian trade flows destined for non-EU parties to pass through, and Russian exports to Asian nations including China and India indeed reached all-time highs, the incremental export tonnages remain only a fraction of how much Russia used to export to Europe.

Moreover, logistical bottlenecks, particularly rail congestions around key ports and with eastbound traffic, continue to limit Russia’s capacity to redirect coal trade flows to Asia. And South Africa continues to experience rail freight headwinds around the Richards Bay terminal, including a recent derailment accident and strikes.

  • Global seaborne thermal coal supply remains constrained by multiple headwinds including weather, freight, sanctions and Covid. The only bright spot among key global exporters has been Indonesia, which saw record production in 3Q 2022. However, output levels are easing now as La Nina brings high rainfall levels, particularly over Kalimantan, and could continue to pressure on production levels until 1Q’23.

 

Seaborne thermal coal market S&D balances (mt)

Figure 3. Seaborne thermal coal market S&D balances (mt) Source: Citi Research, McCloskey, WoodMac If you are visually impaired and would like to speak to a Citi representative regarding the details of the graphics in this document, please call USA 1-888-800-5008 (TTY: 711), from outside the US +1-210-677-3788.

© 2022 Citigroup Inc. No redistribution without Citigroup’s written permission.

Source: Citi Research, McCloskey, WoodMac

 

Demand strength:

  • Import demand from other key buyers including Europe, Japan, Korea and Taiwan should also remain steady during the Northern Hemisphere winter. Europe had stepped up coal import and frontloaded purchases of Russian coal before the ban took effect in August, while inventory at the ARA terminal also reached record seasonal levels due to logistic bottlenecks to ship the coal inland, including record low water levels in the Rhine River. Still, with the uncertainty around winter weather and whether Russian natural gas supply could fall to zero even at already low levels, Europe is incentivized to maintain a high coal inventory. A high coal inventory could serve as a last resort in case of a full-blown energy shortage.
  • Indian imports should also remain robust amid strong power demand during the upcoming festival season. Coal power generation stayed subdued during the summer as a strong monsoon season led to robust hydro power generation while other renewables output also remained steady. In turn, domestic coal inventory reached a one-year high in August.
  • Chinese thermal coal imports jumped during the summer after staying at multi-year lows in the first seven months of this year amid weaker domestic production and power shortages. As domestic coal production remains subject to various disruptions including mining accidents, Covid lockdowns and rail freight issues, imports could remain robust during the winter as strong domestic prices and robust demand seasonality bolster import demand.
  • Import demand from other key buyers including Europe, Japan, Korea and Taiwan should also remain steady during the Northern Hemisphere winter. Europe had stepped up coal import and frontloaded purchases of Russian coal before the ban took effect in August, while inventory at the ARA terminal also reached record seasonal levels due to logistic bottlenecks to ship the coal inland, including record low water levels in the Rhine River. Still, with the uncertainty around winter weather and whether Russian natural gas supply could fall to zero even at already low levels, Europe is incentivized to maintain a high coal inventory.

Historically, the cost curve has provided a soft price floor for coal prices, while prices of global natural gas, which is a competitive fuel especially in power generation, have tended to influence coal prices.

But now, diesel and other coal types have become key drivers. Amid the unprecedented price surges in natural gas and coal prices, power generators and other coal consumers look for alternatives. Diesel is also a power generation fuel. Coking coal, based on some certain blending with thermal coal, is also a viable substitute to some extent.

Thermal coal cost versus competitive fuel prices in Europe (in $/MMBtu equivalent)

Figure 10. Thermal coal vs competitive fuel prices in Europe (in $/MMBtu equivalent) Source: Citi Research, Bloomberg If you are visually impaired and would like to speak to a Citi representative regarding the details of the graphics in this document, please call USA 1-888-800-5008 (TTY: 711), from outside the US +1-210-677-3788. Figure 11. Thermal coal vs competitive fuel prices in APAC (in $/MMBtu equivalent) Source: Citi Research, Bloomberg If you are visually impaired and would like to speak to a Citi representative regarding the details of the graphics in this document, please call USA 1-888-800-5008 (TTY: 711), from outside the US +1-210-677-3788.

© 2022 Citigroup Inc. No redistribution without Citigroup’s written permission.

Source: Citi Research, Bloomberg

© 2022 Citigroup Inc. No redistribution without Citigroup’s written permission.

Source: Citi Research, Bloomberg

Besides the global seaborne market tightness, the strength in coal prices is also highly dependent on the prices of the competitive energy commodities, particularly natural gas. As shown in the figure above, European ARA thermal coal traded largely on par with TTF natural gas prices for the most of 2021, until the relationship broke down in 4Q’21 when Europe was hit by a winter of natural gas shortage.

The price gaps between gas and coal surged further this year amid geopolitical shocks, first due to the Russian invasion of Ukraine and again this summer around the supply disruptions of the Nord Stream 1 pipeline. A tight natural gas market remains supportive for the thermal coal market despite the record gaps between coal and gas prices, as they still move in the same direction for most of the time. That said, ARA coal has been trading more closely to diesel prices YTD, which are also historically elevated now, but could face headwinds ahead amid global recession risks on the demand side and extra Chinese exports on the supply side.

Along with the rebalancing of the global seaborne thermal coal market, this could bring more downside to the historically elevated thermal coal prices.For more information on this subject, please see Global Multi-Asset - Global Coal: A Reluctant Embrace, with prices higher for longer, as security challenges energy transition; Comm/Equity views

Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure,click here.

 

 

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