It’s a gorgeous day here in Melbourne. Everywhere else it’s wet. Cyclone Nicholas is bearing down on the North West port of Exmouth. Off-shore, oil and gas producers Santos, AED, Chevron, and Woodside have already shut down some production and evacuated personnel. On shore, Rio Tinto’s done the same.
In Queensland, Rio Tinto (ASX:RIO) became the latest company to declare force majeure. Heavy rains prompted Rio Tinto to default (legally) on previously agreed sales of coking coal from Hail Creek. The mine produces about 4.5 million tonnes of coal per year. Rio Tinto is the sixth company in Queensland to be affected by the rains. It joins a star-studded list of coal producers including, BHP Billiton (ASX:BHP), Mitsubishi, Wesfarmers Ltd. (ASX:WES), Ensham Resources Pty, and Macarthur Coal Ltd. (ASX: MCC).
“A confluence of disruptions with three of the top five exporters around the world having problems has resulted in record prices which are unlikely to moderate,” an anonymous coal analyst told Reuters. But we could have told you that!
The good news is that Australia supplies 65% of the world’s coking coal. Bloomberg reports that coking coal (used in steel making) rose to $270 per tonne last week on supply disruptions in China, Australia, and South Africa. This, coupled with Vietnam’s announcement last week that it will cut coal exports to China by 32%, could send the price of coking coal over $300.
Couple this rise with the rise in the contract iron ore price-Nippon Steel has reportedly agreed to 65% increase in negotiations with BHP Billiton and Rio Tinto-and you get a huge spike in costs for steel producers. This is the bad news, and could lead to reduced demand for coking coal and iron ore.
Yes, yes. We know that iron ore prices and coking coal prices seem to do nothing but go up lately. But if the Nippon story is true (and none of three parties is willing to confirm it yet) a 65% increase over last years price of US83.40 per tonne means Japan’s largest steel maker is now paying $137.61 for iron ore and nearly $300 per tonne for coking coal. Steel is getting expensive.
Central Queensland’s hard coking coal is world famous, both for its quantity and its quality. Queensland’s State government reckons the region has 11 billion tonnes of high grade coking coal. This coal commands a greater price than thermal coal because you need coal with less water and fewer impurities when making steel. The map below from Queensland’s Department of Mines and Energy gives you an idea of where the flooding is (near Mackay) and which mines are affected.
By the way, thermal coal is doing just fine. In Newcastle, thermal coal for export was up $13.68 to $139.16. That was an 11% increase on the week and again shows how quickly things can go wrong in today’s world of just-in-time supply chains that are thousands of miles long. Indeed, the logistics tail behind global energy supplies is remarkable… and vulnerable.
And here’s something to think about. We know China wants to clean up the air before the Beijing Olympics begin in August. Already petrol stations are closing and the government is warning cars to stay off the road. You can also expect a large portion of heavy industrial activity to shut down, especially energy-intensive activity that requires power from coal-fired stations.
That means that in addition to aluminium smelting, you can probably add lead, zinc and other base metals production to the list of things that might by systematically idled in the coming months. We’ll be keeping an eye on how these shutdowns affect underlying commodity prices.
The other thing to watch for is unemployment. Full employment is a major policy goal of China’s central planners because it promotes stability. Unemployment-idle hands-is not good for stability. Yet there are bound to be many idle workers without a wage as China shuts down production to clear the air before August. Hmmmn.
The Daily Reckoning Australia