Coal prices set for readjustment

Coal prices set for readjustment

The policy-driven spike in Chinese demand for coal is nearly over, and prices will be brought “back into balance” in coming months, says Nikko Asset Management.

Commenting on the recent strength in coal prices, Nikko Asset Management head of Australian equities Brad Potter said Chinese demand has been driven by domestic undersupply of coal in China – the result of an “abacus miscalculation of the supply and demand balance” in recent policy initiatives.

“The shortages have essentially been caused by some extreme supply side reforms that prevented coal mines from working on weekends called the 276 day rule,” Mr Potter said.

“The reforms were designed to take out excess capacity in the system and raise thermal coal prices to enhance returns for producers that were struggling.”

The 276 day rule has resulted in shortages of both thermal and coking coal, said Mr Potter, adding that the latter was “the innocent bystander of the regulatory forces trying to manage price and volume of the 3.2 billion tonne thermal coal market”.

“The government policy has obviously overshot its objective, with coal prices exceeding RMB700 per tonne and power producers struggling to adjust,” he said.

Chinese authorities have already begun to take action to address the “severe” price reaction, Mr Potter said, and “new production initiatives from the government should eventually bring the system back into balance” but the timeframe for this re-balance is “difficult to gauge”.

“Nikko AM Australia does not see any reason to change our underlying long term view that China's consumption of commodities will reduce over time, as property and infrastructure fixed asset investment fades,” Mr Potter said.

“In the short term, the only constant is uncertainty regarding direction and quantum of government intervention.”

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