What's next for China's domestic coal markets?

We forecast the short-term impact of chronic oversupply, slowing demand growth, pollution concerns and weak prices 

The domestic thermal coal benchmark price reached a low of RMB 510/t FOB Qinhuangdao in February and although the following month saw the beginnings of recovery, the increase was subdued.

Those who managed to access credit booked cargos in March, hoping for robust restocking demand from the utilities ready for summer.

To their dismay, hydro generation came back strongly in April/May, helping to drive coal demand even lower. At the same time, the return of the Daqin rail line quickly replenished stocks in northern ports resulting in floating cargoes with little buying interest, putting greater pressure on prices.

We forecast domestic thermal coal prices will remain around RMB 500-550/t in 2014, with a possible uptick on restocking demand. We don’t anticipate further downside risk as prices are already close to domestic coal cash costs delivered into coastal China.

Looking at coking coal, it’s clear that producers sharply lowered prices in March to stave off seaborne imports and win back lost market share.

Margins at steel mills have also tightened due to lower economic growth, high raw material prices and a scarcity of low-cost government credit.

Rising pollution and emission levels in steel-intensive regions such as Hebei have compounded the problem, with environmental compliance costs continually increasing.

As a result, the outlook for the domestic coking coal price is not encouraging in the near-term. For while prices are unlikely to fall further, we believe the recovery will remain sluggish and not occur before the end of next year.

In terms of supply, it’s clear that Key-SOE mines will maintain a dominant position during the rest of the year, having cut prices to acquire greater market share from imports as well as local-SOE and private mines.

Benefitting from their low cost structure and strong financial position, coal output from Key-SOE mines has jumped while local mines have only experienced moderate growth.

Our analysis shows that production by private miners is able to catch up with demand quickly, and so we do not expect the oversupply situation to abate in the near-term unless there is drastic reduction in output, or closure.

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