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Pressure on coal market grows as foreign exchange rates fall

13 Jun 2013 16:26:02 | csd

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The depreciation of the Australian and South African currencies against the US dollar is allowing coal producers to drop prices, adding more potential downside to an already oversupplied international coal market.

The currencies of emerging markets and commodity-producer economies such as Australia have slid dramatically in recent weeks against the US dollar, as the economic picture has soured in recent months - particularly because of revised growth expectations in China and India.

In the past week, physical prices for 6,000Kcal/kg NAR [net as received] coal have started to drop steeply. August-loading physical FOB [free on board] RB prices from South Africa traded at $77.50/tonne on Thursday, a drop of $3.75/tonne in a week. Physical FOB Newcastle prices from Australia have dropped in a similar fashion.

Australian and South African producers have been protected against the drops in US dollar-dominated coal prices because of the sliding foreign exchange rates in their countries, as the drop is not or barely reflected in rand- and Australian dollar-denominated prices. "A 10% drop in currency will allow producers to drop prices to adjust to the demand, not to cut production," said one analyst at an energy trader.

New lows

The trend has accelerated since Monday. The currencies of many emerging markets took a big hit in the first half of this week, with South Africa's rand hitting a four-year low against the US dollar on Tuesday. The slide in rand coincided with FOB RB physical prices shedding almost $2/tonne between Monday and Tuesday.

If foreign exchange rates continue to drop in South Africa - which has a relatively low production cost base - and in Australia, then both FOB markets have even more potential to drop steeply, sources said.

Production costs in South Africa have been estimated at about $75/tonne, but if the rand continues to depreciate this figure could shift lower. Further depreciation of the rand could also see FOB RB start to influence CIF ARA more than has been the case recently, because the depreciating rand will give more room to cut cargo prices in US dollar terms, trading sources said. However, some think Colombian producers could go as low as high-$60/tonne range in the third quarter, so the rand would have to really drop for it to start driving CIF ARA.

Australian producers have some of the highest production costs, but like South Africa a depreciating domestic currency has allowed producers to drop prices in US dollar-denominated coal.

Coal production costs in Australia are still relatively high with producers hooked into take-or-pay contracts with rail and port companies complicating miner companies' ability to slash production. Australian producers are willing to export coal at current prices to cover the take-or-pay costs they must pay one way or the other, because it is still cheaper than reneging on the contracts.

But with most participants of the view production in Australia needs to be curtailed, FOB Newcastle prices could drop a lot, especially if the Australian dollar depreciates more. "It has a long way to go [drop] yet," said one source at an energy trader. Fionn O'Raghallaigh

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