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© Copyright The Steel Index 2016 /1
TSI Market Watch: Coking Coal June 15, 2016
Executive Summary
Physical market pricing evolution stalled since 2011.
Offshore derivatives struggle to regain momentum of 2014, flux in choice of SGX/CME.
Basis risk high and present both onshore and offshore.
FOB buyers could conceivably end up pricing off the CFR market, after all.
Coking coal – A changing market, interrupted
Six years ago coking coal had two major shocks to the system: devastating floods and a change to
the pricing mechanism. Today, after many changes, the market is fragmenting and risks sliding into
a retail-led, China-led pricing system. There is nothing wrong with the latter and it works perfectly
well for iron ore, however for coking coal, China accounts for only 15% of the global import market.
In April of 2010, BHP Billiton-Mitsubishi Alliance (BMA) replaced annual prices with a quarterly
pricing system which it argued offered a better reflection of market fluctuations. It was soon
followed by other miners. Shortly afterwards, BMA moved to pricing on a monthly basis.
Many expected the widespread switch in index-linked contracts to TSI’s FOB Australia index at the
end of 2014 to result in more optionality being offered by miners other than BMA and South32,
since FOB buyers and sellers would feel reassured by the disconnect of the FOB and China link.
However, the move towards pricing terms which more closely follow the spot market has been
frozen since 2011. Now, the industry seems poised for another change – for better or worse.
Here comes the futures market – again?
Western derivatives contracts were offered by CME Group (CME) and Singapore Exchange (SGX)
soon after the collapse of the yearly pricing system, to fill the void left by the demise of long-term
benchmark pricing. These were expected to
follow on the success of iron ore futures which
had launched a few years earlier.
The chart below documents the level of open
interest on the first contract on the CME, basis
the Platts PLV FOB Australia assessment. Whilst
open interest is rising once again, it is yet to
return to the highs seen in 2014.
© Copyright The Steel Index 2016 /2
Two factors led to the trading slowdown, which persisted almost till the end of 2015. First, Credit
Suisse, a key counterparty at that time, closed its commodities desk in Q3 of 2014, denying the
market a counter-party willing to trade both sides. Second, TSI became the predominant index for
physical index-linked deals, which dramatically increased basis risk, for parties looking to hedge
physical positions. Basis risk is when physical prices moves differently to paper prices, resulting in
a “dirty” or imperfect hedge. Traders with physical off-take basis TSI and futures positions on the
CME ran the risk of an $8 swing: 10% of the underlying at current coking coal prices (as below).
This led the market to shift towards the SGX contract, which was settled against TSI’s FOB
Australia index.
0
200
400
600
800
1,000
1,200
1,400Th
ou
san
d t
on
ne
s
CME open interest
-$4
-$2
$0
$2
$4
$6
$8
Feb
-13
Ap
r-1
3
Jun
-13
Au
g-1
3
Oct
-13
De
c-1
3
Feb
-14
Ap
r-1
4
Jun
-14
Au
g-1
4
Oct
-14
De
c-1
4
Feb
-15
Ap
r-1
5
Jun
-15
Au
g-1
5
Oct
-15
De
c-1
5
Feb
-16
Ap
r-1
6
USD
$/t
on
n
Spread TSI PHCC FOB / Platts PLV FOB
Source: CME
Source: TSI/Platts
© Copyright The Steel Index 2016 /3
However, the market has not been able to decide whether to trade on SGX or CME over the last 15
months or so, with trading activity flitting between the two.
Offshore or onshore futures? This fragmentation has led to many questioning the utility of the offshore coking coal futures
contracts, with only a few key players providing much of the liquidity and a lack of a key market-
maker to ensure that both buyers and sellers are able to execute trades.
Offshore trading in 2015 stagnated, but by contrast, volumes on the physically-settled China-based
Dalian Commodities Exchange (DCE) contract remained highly liquid. Yet, for FOB buyers (85% of
global import demand), this “on-shore” contract (i.e. on the Chinese mainland) does not
accurately reflect the supply and demand dynamics of non-China markets, so is not a preferred
venue for hedging. It is also impossible to access the exchange for companies without a wholly
owned subsidiary in China. Finally, the DCE contract is heavily ‘retail led’ i.e. traded by individual
investors, rather than companies with genuine physical exposure, leading to skepticism about its
utility as for hedging.
Global price point under threat
But, beggars may not be able to be choosers. Some traders with physical offtake agreements
appear to be retreating from taking part in offshore derivatives markets on CME and SGX. The
physical FOB market has changed over the past few years, with a common lexicon emerging,
widespread understanding of how to value individual coking coal brands versus each other and
versus the indices, more experimentation on blending and trading through electronic platforms.
However, a pullback by traders, frustrated by slow liquidity growth on offshore futures contracts
opens the market up to the possibility of either retrenching back into a quarterly or annual
physical pricing system, and limiting opportunity for physical and paper trading, or ceding control
of pricing to a tightly controlled and broadly inaccessible on-shore market in China.
0%
20%
40%
60%
80%
100%
120%
Au
g-1
4
Sep
-14
Oct
-14
No
v-1
4
De
c-1
4
Jan
-15
Feb
-15
Mar
-15
Ap
r-1
5
May
-15
Jun
-15
Jul-
15
Au
g-1
5
Sep
-15
Oct
-15
No
v-1
5
De
c-1
5
Jan
-16
Feb
-16
Mar
-16
Ap
r-1
6
May
-16
Pe
rce
nta
ge m
arke
t sh
are
SGX % Market share CME % market share
Source: SGX, CME
© Copyright The Steel Index 2016 /4
Those who complain about the lack of correlation between DCE prices and international prices
should not be surprised. The onshore futures price is, after all tracking a domestic Chinese coking
coal price in a completely different currency. Over the past two years, spreads between the active
month DCE coking coal contract and TSI have been as low as $5 or as high as $25 (adjusted for
historical currency rates).
The onshore contract is a prime source of financial pricing and physical pricing within China. The
size of market liquidity at DCE opens up the possibility that the future of coking coal pricing may
not be on an outright FOB basis, where the global market coalesces to buy coking coal, but on a
physical market representing just 15% of global demand, and a futures market where 80% of the
participants are purely speculative players, retail–based with no physical exposure.
Faced with that option, might FOB sellers look to roll-back pricing terms to a long-term basis? They
should not. As Chinese steel exports continue to rise and trade sanctions repeatedly prove
ineffective, the logical response should be for mills to match the flexibility of Chinese input costs,
rather than give-away cost advantages every month. If the market has shown anything over the
last three years, it is that coking coal supply is far from limited and mills are getting more and
more flexible in their coke making.
Throttling the ability of steelmakers to compete on a level playing field (with regard to raw
material prices) may simply end up reducing the pool of potential customers outside of China for
sellers to trade with.
For further information
Please contact: Jarek Mlodziejewski (Singapore) +65 6530 6412 [email protected]
Jing Zhi Ng (Singapore) +65 6216 1056 [email protected]
Yukun Yan (Shanghai) +86 21 5110 5459 [email protected]
© Copyright The Steel Index 2016 /5
Note to Editors:
The Steel Index (TSI) is a leading specialist source of impartial steel, scrap, iron ore and coking coal price
information based on spot market transactions.
Transaction price data is submitted confidentially to TSI on-line by companies buying and selling a range of relevant
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