Feb 24, 2012

An Imminent Coking Coal Settlement At $195-$210 Per Tonne Had Better Be A Bottom by Peter Epstein

The following report, if confirmed, is moderately negative for coking coal sentiment, therefore coking coal producers such as Walter (WLT), Teck, (TCK), Alpha, (ANR), Arch, (ACI), Peabody, (BTU), Cliffs, (CLF), Patriot, (PCX) and Consol Energy, (CNX).
A few days ago we got the following comment,
It is reported that the Jellinbah group (a privately owned independent Queensland based coal company with operations in Central Queensland's Bowen Basin) has entered into a price settlement with JFE Steel in Japan for the quarter Apr-June. They have set the price for HCC at $205 and PCI at $153/ton.
Yesterday it was reported that coking coal was offered in Asia at $195 per tonne on the spot market. Steve Doyle of Doyle Trading Consultants flagged this news item, but his team is waiting for more definitive news before passing final judgment on 2nd quarter pricing.
First quarter pricing of $235 per tonne is down approximately 29% from the high of $330 per tonne last year. A settlement at $200 per tonne would be a disappointment and may weigh on investor sentiment. However, if $200 per tonne is perceived to be a bottom, which many think that it will, then investors might take comfort.
Last week, Gerard McCloskey stated at coal conference that coking coal prices might bottom around $200 per tonne, McCloskey is quoted as saying,
There will be a correction of prices down towards $200," McCloskey predicted. "It's a great price. Until two years ago we had not had prices above $200 except for one brief period in 2008.
While McCloskey has been dead on in his prediction of where coking coal prices were headed from last summer, I respectfully disagree with his comment that a benchmark coking coal price of $200 is a, "great price." Three or four years ago, a price of $200 per tonne was indeed great. But since then, the marginal cost of production has risen substantially. Some market participants believe the higher end of the cost curve is at $150-$160 per tonne.
There are four main implications here. First, it appears that downside below $200 per tonne should be fairly limited. Second, whereas $200 was a great price 3-4 years ago, it's only a good price today. Third, low-cost producers around the world should be especially attractive going forward. Names that most readily come to mind in this regard are Consol and SouthGobi Resources (SGQRF.PK). Fourth, a price of ~$200 per tonne for the 2nd quarter had better turn out to be a bottom or many coking coal producers will be missing analyst expectations for 2012.
Consensus earnings estimates for coking coal companies appear to incorporate a 2nd half of 2012 up-tick in U.S. economic activity, a rebound / soft landing in China and, to a lesser extent, a slight increase in demand from Europe. Many sell-side research shops have penciled in an average price of $225-$250 per tonne for CY 2012. However, if we average ($235 + $200 = $217.5) in the first half, we will need to achieve 2nd half pricing of between $232.5 to $282.5 to reach a full year average of $225-$250.
This suggests again that 2nd quarter pricing of roughly $200 had better mark the bottom, and that 3rd quarter pricing had better bounce back to $235-$250, or analyst estimates will have to come down. I have repeatedly said that my hurdle rate for investment in the volatile coal sector is 25%. Many investors are excited that coking coal fundamentals are in the process of turning. For me, if a sustainable rally in coal stocks hinges upon a fairly strong rebound in 3rd quarter pricing, I will remain on the sidelines waiting for better visibility.
Disclosure: I am long ACI, CNX, BTU, ANR, PCX.

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