Regional Coal: Wood Mackenzie: JPU coal settlement price as benchmark seen to decline in importance

As Japanese Power Utilities (JPU) are approaching a crucial negotiation period with Australian coal producers in March, when large volumes are contracted annually, market players can expect JPU prices to remain above market prices for the foreseeable future, according to Wood Mackenzie.

As for price trends, JPUs will have to pay high premiums till 2015, before dipping from 2016 to 2020, the consultancy firm added in a statement received Thursday.

Post-2020 to the longer term, premium over spot prices will trend upwards again, the statement said. This is a result of a move away from JPU-type coal in key demand markets, which also acts to reduce the significance of JPU price as a benchmark, although not negating it altogether.

In the next few years the JPU premium over market price will remain high, settling below US$7 per tonne ($/t) by 2015. Prakash Sharma, Asia Pacific Coal Market Analyst for Wood Mackenzie said: "Although global oversupply persists in the overall seaborne thermal coal market, for the highly specific JPU-type coal supply, the market will be progressively tight as other customers increase their consumption of this type of coal.?

In the medium term from 2016 to 2020, Wood Mackenzie forecasts a period where the JPU premium will decline to as low as US$3.80/t over market price as additional JPU-type supply is set to come online and producers seek to gain market share by competitively pricing their product. However, growth in demand for lower quality coal in key markets is impacting producers' product mix strategies; thus reducing the availability of JPU-type coal. This combined with a longer-term decline in JPU-type supply capacity is projected to support the premium over spot prices.

Rory Simington, Coal Supply Research Analyst for Wood Mackenzie further said: "Fast growing demand markets of China, India and South Korea, to some degree are turning away from higher priced JPU-type low ash coal towards a more inexpensive higher ash product available on the spot market. Producers who have experienced low prices throughout 2013, and have had their margins squeezed, have reduced production costs by switching much of their incremental production towards this higher ash 5,500kcal/kg NAR market. This leaves the supply growth picture for JPU-type coal fairly flat."

Japanese power plants cannot absorb a higher ash product due to their ash disposal concerns and have only used relatively small amounts of low-ash sub-bituminous coal from Indonesia. Therefore JPUs will likely still demand predominantly JPU-type coal. However, Japan's role in the Asia Pacific coal market place will diminish as its proportion of the thermal market declines from 31 percent to only ten percent by 2035. Consequently, this reduces the significance of JPU price as a benchmark.

Sharma said, "With the fairly flat supply growth outlook for JPU-type coal, a tighter market will result for Japanese procurement. JPUs are acutely aware of this development. Since Japan is completely reliant on coal imports, JPUs are willing to pay a premium over spot prices to lock-in the price for twelve months rather than risk supply availability by switching to index-linked pricing. This is crucial as we believe nuclear capacity in Japan will not return to pre-Fukushima levels. As such, other fuels including coal will need to play a larger role."

"Even if headlines suggest Japan is increasing imports from North America to reduce reliance on Australian producers, the negotiations are still of great importance to Japan as we do not foresee North American supply satisfying their requirements to the same extent Australian producers can."

North America currently supplies two percent of Japan's thermal coal requirements. By 2025, Wood Mackenzie estimates North America will still only make up less than ten percent of Japan's thermal coal requirements.

For the longer term past 2020, Wood Mackenzie forecasts premia rising steadily again as the availability of JPU-type coal continues to decline. The margin between JPU settlement price and cost of JPU-type coal production will support the development of new projects. Therefore, JPUs will have to recognize the need to offer higher premiums in order to incentivise new supply. The steadily rising premium will reach US$5.50/t by 2027 and US$10/t in 2035 as higher cost coal projects are developed.

In summary, Sharma said: "Japan recognizes the need to secure supply and price stability. Therefore, JPUs favor contracts to the spot market, even at a premium. This will keep JPU pricing relevant albeit playing a diminishing role as a benchmark due to the growing market proportion of higher-ash coal in the region. In the longer term post-2020, this need will translate to JPUs having to pay higher premiums so as to incentivise Australian producers to maintain supply capacity. Hence, the JPU benchmark may lose the status of price-setter but will not likely become a price-taker even if it means that the premium will persist."

Editing by Reiner Simanjuntak