Metallurgical coal is used to make metallurgical coke (“coking coal”), a key input in the blast furnace steelmaking process, as well as coal for pulverized coal injection (“PCI coal”), which is injected into blast furnaces as a supplemental source of energy. As reported by the U.S. Energy Information Administration (“EIA”), in 2015 the U.S. supplied about 66 million tons of metallurgical coal to serve North American customers as well as the seaborne export coal market. According to EIA, in 2015 U.S. producers supplied approximately 18.6 million tons of coking coal to the domestic U.S. market, as well as exported 4.3 million tons to Canada and 0.4 million tons to Mexico. Despite the fact that western Canada is a large producer of metallurgical coal, the coal used by steel mills in eastern Canada is largely supplied by U.S. metallurgical coal producers. U.S. metallurgical coal primarily is produced from underground mines located in the Northern Appalachia, Central Appalachia, and Southern Appalachia coal basins, all located in the eastern United States. Due to logistical advantages, North American metallurgical coal producers supply all of the requirements of the North American steel industry as imported coal has historically been uneconomic due to transportation costs. Supply in excess of what can be consumed in the U.S. and Canada is exported to the seaborne market.
The largest importers in the world seaborne coal market for coking coal are in Asia (India, Japan, China and South Korea), Europe and Brazil. Recent swings in world seaborne metallurgical demand are largely due to China. Although China historically produces roughly half of the total metallurgical coal produced worldwide, it is also the largest metallurgical coal consumer in the world by a significant margin, consuming nearly all of its own metallurgical coal production. For example, the International Energy Agency (“IEA”) estimates that in 2015 China produced about 611 million metric tons of metallurgical coal, consumed nearly 660 million metric tons of metallurgical coal, but exported less than a million metric tons, while importing about 48 million metric tons. Therefore, Chinese policies controlling metallurgical coal production and steel demand have a disproportionate impact on global metallurgical coal prices. We believe that a recent policy curtailing the number of working days at Chinese coal mines, and the continuing closure of small, unsanctioned, coal mines, thus creating an anticipated shortfall in supply, is the primary cause of the recent rise in global metallurgical coal prices.
According to IEA, the U.S. is the second largest global supplier to the seaborne metallurgical coal market behind Australia with 46.0 million tons exported in 2015. U.S. producers, with their variable production volumes, generally serve as a swing supplier to the international metallurgical coal market. U.S. metallurgical coal exported off the east coast of North America compete with Australian metallurgical coals that are generally produced at lower cost but are geographically disadvantaged to supply Western Europe. According to EIA, Europe accounted for 23 million tons, or nearly half, of the 46.0 million tons exported by U.S. metallurgical coal producers in 2015. Conversely, Australian production has a much shorter logistical route to East Asian customers. Any supply shortfall out of Australia (or increase in global demand beyond Australia’s capacity) has historically been serviced by U.S. coal producers. Flooding in coal producing areas of Australia in late 2011 resulted in an increase in global benchmark prices and, subsequently, an increase in U.S. domestic metallurgical coal prices.
The decline in global prices since 2011 forced high-cost U.S. suppliers who could not compete in the export market to reduce output. The closure of high-cost operations is expected to result in a “new normal” for U.S. metallurgical coal production of approximately 50.0 million tons per year, down 23% from estimated 2015 production of 65.2 million tons. U.S. metallurgical coal exports are expected to fall from 46.3 million tons in 2015 to approximately 36.0 million tons in 2016.
Metallurgical coal contracts in the U.S. tend to have a term of one year or longer. In some cases certain mines have served as essentially captive operations to cokeries because of their proximity in transportation and their unique coal properties that are ideally suited for that cokery. North American cokeries rely on domestic coal miners for a stable source of supply and domestic miners rely on cokeries as a stable source of demand. As such, domestic prices are historically not as volatile as benchmark prices—domestic cokeries are hesitant to accept higher prices given the diversity of supply competing for the domestic market but are also willing to accept higher prices to an extent in order to prevent significant idling of coal mines that would reduce diversity of supply in the longer term.
However, premium global quarterly coal benchmark prices have rebounded significantly since early 2016, rising from $81 per MT in the first quarter of 2016 to $285 per MT in the first quarter of 2017, as government policies in China curbed domestic supply. Metallurgical coal spot prices have declined from $308 per MT on November 11, 2016 to $176 per MT as of January 18, 2017. We believe this decline has been driven by (i) the reversal and relaxation by China of policies that were aimed to reduce metallurgical coal production, (ii) new production has been recently brought online and idled metallurgical coal mines have been recently restarted in Mozambique, Australia, the United States and Canada and (iii) due to the strengthening of the U.S. Dollar, non- domestic producers became more competitive and caused a metallurgical coal price based in U.S. Dollars to fall as the U.S. Dollar became relatively more expensive.