Coal’s role as economic indicator
Demand gives clue to health of steel industry
Depending on who you ask, the first thing that occurs to a person when the subject of coal is brought up is the Industrial Revolution, or perhaps what Santa Claus leaves for naughty girls and boys.
Either way, the popular perception of coal is that it’s a backward energy source consigned to the days of steam locomotives and sooty London factories. But the commodity remains a key component of electricity generation and a useful economic indicator because of its role in steel manufacturing.
“It’s not on my top list of indicators, but it is a very important indicator for the steel industry and as an alternate source of energy,” said Marco Lettieri, an economist at National Bank Financial. “It can also be used as a relative indicator for historical ratios between energy prices.”
Coal has a long and colourful history, but these days it is primarily used for two purposes, depending on the grade and quality of the material, and primarily sold through contracts between coal mining companies and their customers.
Metallurgical coal, also known as hard coking coal, is a high- quality product derived from coal and is a key ingredient in the smelting process of steel because it burns cleanly at a high enough temperature.
As a result, global trends in coking coal consumption can be used as an indicator for the health of steel production and, therefore, manufacturing and construction.
Thermal coal is less expensive and primarily used to generate electricity, a purpose it shares with other fuel sources such as natural gas.
Prices for coking coal have been largely flat in 2012, with a key Australian contract up only 0.5% yeartodate, while thermal coal is down 15.9% on the year, based on data from RBC Capital Markets analysts.
Coal producers have been under pressure in recent months. Continued uncertainty around the world has slowed economic growth, while the historically low price of natural gas has encouraged many electric plants to switch to gas from coal.
For Mr. Lettieri, the pricing ratios between coal, natural gas and crude oil give a good sense of what’s happening in the energy sector.
“It gives us a good idea of how far from the median prices are, to see if anything is overbought or underpriced,” he said. “If energy prices go down, it will be a doubleedged sword. It’s a negative for producers, but it can also help profitability and demand for the product for companies that use it.”
For instance, between 2002 and 2008 coal was anywhere from four times to 14 times more expensive than natural gas. However, since then the ratio has jumped to as high as 30 times in 2010 and currently sits at about 20 times — which explains why electricity producers are dumping coal.
Michael Dudas, a senior research analyst at Sterne Agee, said this has created an indiscriminate selloff environment, with industry fundamentals suggesting the coal industry still has life left in it.
“We believe U. S. coal equities are oversold. Despite an accelerated riskoff trade, we find recent data points encouraging and shares underpriced,” he said in a note to clients. “Global macro factors have been dominating the coal trade, while industry fundamentals have not deteriorated in recent weeks, and we find in some cases improving.”
In particular, China has so far imported 71.5 million tonnes of coal, a 65% year- over- year increase, and it looks to be on pace to comfortably beat 2011’ s record imports of 184 million tonnes. As well, NTPC, India’s biggest power producer by capacity, plans to increase its coal imports by 33% this year because of difficulties expanding its domestic production, he said.