Coal Miners Strike It Lucky
Australian mining companies have hardly been able to catch a break over the past few years. The so called ‘mining boom’ is now effectively over and mining companies are now expending a lot of energy in cost cutting just to maintain profitability. Coal miners, however, have struck it lucky as the price for coking coal unexpectedly surged over the last couple of months. Since the end of July, the price has risen from around US$90 to current prices around US$155, this is an increase of 72% in only two months! It seems even industry experts have been caught off guard by the ferocity of this move.
The chart below shows this extreme price action.
Source: Metal Bulletin
Coking coal (also called metallurgical coal) is the type that is used in steel making. This is distinct from thermal coal which is used for power generation. One of the important features of coking coal is that it is very low in impurities as these can affect the steel quality. The coal is actually used in three different parts of the steel making process, first, as a source of energy to generate the heat required in the process, second as a source of carbon for the steel (steel is an alloy of iron and carbon) and finally as a reducing agent to extract the iron from iron ore.
Industry experts are providing reasons for the price spike after the fact. This doesn’t mean they are wrong but it highlights the fact that moves like this are very difficult or impossible to predict. Supply disruptions are cited as the main cause of the price move. Specifically, the Chinese government decided to restrict mine production to only 276 days per year, down from 330 days previously. These restrictions have led to a drawdown in inventories and therefore have traders worried that supply will be insufficient to keep up with demand. Furthermore, some of Australia’s supply has been limited due to weather related issues. Regardless of the cause, the move has caused analysts to upgrade earnings forecasts for several Australian producers.
South32 (S32), which has just been added to the Rivkin Local momentum portfolio, produces a significant amount of coking coal and will certainly benefit from the increased prices. Deutsche Bank predicts that a 10% increase in the coking coal price would add 10% to S32’s EBITDA. It should be noted, however, that most coal is delivered according to supply contracts rather than being delivered into the spot market. This means that the dramatic increase in the spot price will benefit S32 (and other miners) only once the contracts are renegotiated at the next pricing reset date. Regardless, if spot prices stay where they are, the miners will have a very strong negotiating position when this occurs.
The strong share price of S32 has caused it to be added to the Rivkin Momentum Portfolio. The basic premise of this strategy is that it buys stocks showing share price strength over the past 12 months. Contact the Rivkin team if you are interested in finding out more.