Will there be enough steam coal for China in Q4?

The central question for thermal coal markets heading into the end of the year is whether Chinese demand can come back and support the recent price gains seen in Atlantic markets.  It's debatable how much of the recent strength in API#2 and #4 has been driven by fundamental factors and either way it can't be sustained unless China starts to lift domestic prices an imports.

To answer this question I have put together a little model to gauge stocks compared to apparent demand in coastal regions.  First step is to get supply, which I have taken as domestic coal shipments plus imports of steam coal and lignite.  The lignite component has been adjusted given its assumed lower energy content (average of 3900kcal).

To get to apparent demand we also have to account for stock change.  In this instance I have used stock at power plants in the East and South grids in China as well as stock at the major ports.

This is not perfect, as there is also non-shipped supply to these regions and consumer inventory doesn't account for all power plants.  It also doesn't account for changes in mine inventory, which has been important in the last few years.

But looking at the market from a quarter to quarter perspective, just using port and consumer inventory seems to be useful enough as it is the most readily available inventory on the most marginal part of the coal supply chain (coal that is moved to ports and shipped to coastal provinces.

To be sure, the quarterly movements in these inventories relative to apparent consumption has for the most part appears to have decent explanatory power when it comes to movement in coal prices.

It's interesting that as of the end of Q3 we have seen quite a fall in stock in terms of days of consumption, but prices for the most part fell through the month.

There are two challenges in understanding whether this will lead to a meaningful bounce in Chinese domestic prices. Firstly, the drop in days of use is partly because apparent consumption is a lot higher in Q3, rising 16%YoY. Understanding how much of this is driven by hot weather vs. hydro availability vs. underlying macroeconomic momentum is central to forecasts for expectations for Q4.

The second challenge is understanding how much could be supplied to China in Q4 and what this means for inventory levels. This is particularly pertinent to import demand, given it seems likely that at these prices, volumes delivered to ports is likely to be fairly stable in Q4 relative to Q3.

Using a few simple assumptions I have used this model to estimate how much China will need to import to keep inventory levels stable at a given level of demand growth.

For example, lets assume that Q4 demand growth is around 10%YoY.  This is my base case, given the likely continued fall away in YoY hydro generation and the decent momentum in some of the macroeconomic indicators in the last few months.

In this instance, to keep inventory levels at 21.5 days of consumption, China would need to import ~12mt of coal relative to Q4 of 2012.

Is this tonnage available at current trends and prices? On balance, it appears the market may be a little short and China may have to bid more competitively to capture tonnes.

There does appear to be a lot more tonnage available from Australia in 4Q12.  Ive assumed China will import most of the increase in imports relative to last year, with total shipments to China of 19mt to China in the quarter.  This ~4.5mt more than last year

Increased supply of lignite from Indonesia is also likely to lift given both stronger production and the availability of some cargoes that were bound for India but now need a new home given the uncertainty there.  The chart above adjusts this for energy content, with an increase of ~6mt on an unadjusted basis.

There seems to be little upside from elsewhere at prevailing prices.  There is little incentive for far flung countries like the US and Colombia to start shipping to China given the lack of arbitrages.  Other countries do not have a lot of extra capacity.

So if China is 1.5mt short of import availability, it is likely to come out of inventory.  This is only a small reduction in overall stockpiles, but remember that consumption is rising, so days of use will drop further.  This should help push up prices.

We can also flip this question for a different demand assumption.  For example, lets assume that there is an extra 10.5mt YoY of seaborne supply that China needs to absorb in Q4.  But what if demand growth was only 5% rather than 10%?  This is a real possibility for many who are not convinced by the improvement macro indicators.

In this instance, coal inventory would actually be way too high and it seems unlikely that we would get any improvement in the price.

We should actually know what kind of growth we will get through the quarter by the early stages of November and a pretty good sense of inventory direction in the next few weeks.  So we don't have to hang around to the end of the quarter to update this analysis.

For those that have different assumptions I'd be happy to run them through the framework to see what kind of results come about. But hopefully this post gives a good idea of how the model reacts to different demand and import assumptions.