Australian thermal coal contract prices fall 44%

UNCLAS SECTION 01 OF 02 CANBERRA 000250 SENSITIVE SIPDIS STATE FOR EAP/ANP; STATE PLEASE PASS USTR TAGS: EFIN ETRD ECON AS SUBJECT: Australian thermal coal contract prices fall 44% ¶1. (SBU) Summary. Australia's leading thermal coal exporters have signed a key benchmark contract agreement with Japanese buyers for the country's third most valuable commodity export (after iron ore and coking coal). The deal means export values will fall around $3.2 billion ($A5 billion),approximately 0.5% of GDP. Given the global economic crisis and lower spot prices, producers are reportedly relieved the price cut of 44% was not deeper, as reflected in a lift in their share prices. End Summary. THE NEW BENCHMARK PRICE ¶2. (SBU) The majority of Australia's thermal coal trade is conducted on a contract basis. Traditionally the benchmark contract price is set by the first major Japanese utility to come to agreement with its suppliers. Chubu Electric announced March 7 that it had reached agreement with suppliers to purchase coal at $70-72 per ton. Market observers expect this to be the new benchmark price for the coming Japanese fiscal year that begins April 1. The new price represents a 44% fall from the previous year, but is still the second highest price recorded and 25% above the 2007-08 price of $55.65. Notably, back in 2003-04, the contract price was only $US26.80. Lower world demand has forced prices down (as shown by the shrinking queues of ships at Newcastle, down from 70 in early 2008 to around 15 currently). Thermal coal is Australia's third largest commodity export (after coking coal and iron ore) and the most valuable export for NSW. Export earnings are forecast to fall by 28% to $A13.2 billion (down from $A18.5 billion in 2008-09) as higher export volumes are offset by lower $US contract prices - although the depreciation of the $A is shielding producers from the full price decline. The price fall could push Australia into a trade deficit. ¶3. (SBU) Xstrata and Rio Tinto collectively produce over half of Australia's annual exports of 130 million tonnes of thermal coal. Chubu Electric is Japan's third largest coal buyer by volume at 10 million tonnes a year. Its term prices for Australian thermal coal are used as a benchmark by other Japanese electricity utilities and large buyers in the Asia Pacific region. Japanese utilities typically pay higher prices than on the spot market (currently around $US60 a tonne for thermal coal) for their term coal supplies to ensure high quality and stable delivery. The cut in thermal prices appears reasonable as crude oil prices have fallen 55% since ¶2008. A stronger yen also helped Chubu accept the prices due to lower yen-term costs. Analysts at Citi believe a price of around $US70 a tonne will provide exporters with a reasonable margin as they expect production costs will fall by 10% this year to $US30 a tonne, due to lower mining costs and exchange rate changes. The share prices of Rio Tinto and Xstrata rose after the new contract price was announced. The price is slightly below that forecast by ABARE last week, when it estimated that thermal coal revenue could decline 28% to $A13.2 billion in 2009-10 from $A18.5 billion in 2008-09. Notably, ABARE has forecast a $US100 a tonne price for thermal coal in 2010-11. MARKET PERSPECTIVES ¶4. (SBU) Japan is by far the leading buyer of Australian thermal coal, followed by Korea (China accounts for only 1% of exports as it has sufficient domestic reserves). In Japan, one third of thermal coal is used to generate power for heavy industry, with the rest for Qcoal is used to generate power for heavy industry, with the rest for residential and commercial electricity users. Hence, the 30% decline in Japanese industrial output in early 2009 will cut demand for thermal coal volumes by at least 10%. Outside of heavy industry, there demand for electricity and base load requirements for coal-fired power are relatively high and stable even in a global downturn. Growth in thermal coal demand in Japan is projected by ABARE to decline by an average of 1% a year over the outlook period to reach 127 million tonnes in 2014. Japan's coal-fired power stations operated at capacity in 2008 but thermal coal-fired power generation is forecast to decline in the medium term owing to policies aimed at reducing carbon emissions. ¶5. (SBU) Outside Japan, the outlook for thermal coal exports is more promising. Global thermal coal imports are projected by ABARE to increase at 2.5% a year to 832 million tonnes toward 2014. Thermal coal is preferred as a fuel in developing Asia because of its low cost and reliability of supply. Rising electricity demand in developing Asia will be a key driver of thermal coal imports. In these economies, energy demand growth typically exceeds growth in real GDP as the use of electricity expands and consumers begin to purchase energy consuming products. China, India and Vietnam are investing heavily in new coal-fired power generation capacity to meet growing demand. ABARE forecasts continued growth in China's imports of thermal coal, at an average annual rate of 12% a year to 65 million tonnes in 2014 (as the local industry shrinks and CANBERRA 00000250 002 OF 002 consolidates). There are extensive plans for the expansion of coal-fired electricity generation capacity in Asia (580 gigawatts by 2030 according to ABARE). If only 20% of these plants come on stream they would require an extra 340 million tonnes of coal annually. ¶6. (SBU) Comment: Thermal coal and coking coal supply different markets as thermal coal is only used for power generation, while coking coal is used for steel production. The stable demand for thermal coal contrasts with the sudden collapse of world steel demand in 200, with production 40% down in Europe and a 30% decline in Japan and Korea). Coal producers expect more significant price cuts for coking coal vis-`-vis those achieved by thermal coal exporters (currently negotiators are expecting a 50 to 60% drop for coking coal). End comment. CLUNE