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:
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.
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Seaborne thermal coal market S&D balances (mt) |
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© 2022 Citigroup Inc. No redistribution without Citigroup’s written permission. Source: Citi Research, McCloskey, WoodMac |
Demand strength:
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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)
© 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.