As increasing amounts of U.S. produced coal of all types and specifications is sold into the ever-expanding global marketplace, buying, selling and determining a price for each different type of coal becomes increasingly more complex. Unless a customer buys long term, price volatility is the name of the game—and even with long term contracts in place, uncertainty is certain. While historically U.S. met coal has always played a role in the global seaborne market, only recently has American-mined steam coal been shipped in large numbers abroad. As expanding economies in Asia begin to buy more coal from around the world, additional market clarity will be needed.

Prior to 2001, coal pricing, in general, was flat. Natural gas was much more volatile. This trend in coal prices continued for years into the 2000s with little volatility until roughly 2006 to 2008. Coal trades started to increase on the New York Mercantile Exchange (NYMEX) and with more speculators involved, coal became more affected by market forces and there was an increase in price volatility.

In today’s world, if a utility buys coal for a power plant in Iowa, a tropical depression in Australia may affect pricing. With an increasingly global outlook, today, U.S. coal prices are influenced by a combination of three markets: the domestic, the international metallurgical and the international thermal. “We know the market is tight when a gearbox fails at Westshore Terminal in Vancouver and it’s front page news,” said Matt Schicke, managing director of Americas Coal Trading, Mercuria, a leading worldwide energy trading company.

“The domestic market continues to play a key role, but it too has fundamentally changed with natural gas being cheaper than coal for power production. The international met coal market benefits from increased steel production. U.S. opportunities to ship thermal coal into Europe

and elsewhere are causing a shift as well,” said Schicke.

Domestic markets are overshadowed by natural gas, which is increasingly cheaper than Appalachian coal for power generation. Appalachian coal, particularly coal mined in Central Appalachia (CAPP), has become more expensive as underlying production costs have been on the rise. Inexpensive natural gas in the U.S. southeast is changing the buying behavior of energy consumers as well as the types of deals being struck. More decisions are being made on a longer-term basis. “Natural gas is cheaper than coal long term so it makes sense to buy longer term than coal,” said Schicke.

During the slowing economy of the Great Recession, coal prices often fell below the production costs of many mines. This caused a 60 million ton drop in CAPP production from 2008 to 2010. Coal production costs comprise a firm floor in the coal price, despite cheaper gas. Coal producers cannot simply cut the underlying costs, in fact, due to increasing difficulty in obtaining permits and the associated environmental mitigation costs, production is actually becoming more expensive, pricing CAPP coal even further out of the marketplace.

As these physical tons are taken out of the marketplace, there’s no replacement for them. In the fall of 2009, increased interest in CAPP coal moving to Europe has tightened domestic markets, further pricing CAPP coal out of traditional ranges. “With these tons now out of the market, prices are bound to move upward. While fluctuations most likely will not be as pronounced as in 2008, price volatility has gone up again, especially for the nearer term,” said Tom Hiemstra, director, coal markets, Evolution Markets Inc.

Coals from other regions are taking advantage of this displacement. PRB coals, despite lower calorific values, are moving further east because of its cheaper inherent costs. These coals are going head to head with relatively inexpensive Illinois Basin coal as well, despite the latter’s higher heating qualities. For scrubber-equipped utilities with flexibility in their boilers, there are a great many options.

The IB “is a large growth market. It’s another low cost region and will continue to expand. We’re seeing more coal from the IB travelling further than before, going long into India and Asia. It’s also going into the Southeast because utilities have to keep dispatching as cheaply as possible. They are converting over in large ways,” said Schicke.

Export capacity is constricting supplies worldwide. Producers and shippers are working on addressing logistics issues. Today there are more midstream and Gulf export options. But there are still limits to capacity, often brought on by a lack of available barges and ocean freighters. However, “U.S. mined coal, because of transportation prices, is now cheaper internationally,” said Schicke.

The expansion of the Panama Canal will also open new trade flows from the U.S. to Asia beginning in 2014. The increasing amounts of panamax vessels now under construction are also an indicator about long-term demand.

Swaps: Financial Instruments Designed to Bring Clarity

One of the few options buyers have to mitigate price volatility is through hedges. “In this market, for merchant generators, it makes more sense for them to peg the price of coal then attempt to jump in at some point,” said Hiemstra. To facilitate domestic and international sales, coal traders and brokers deal in both physical and fiscal instruments to help bring some transparency to the marketplace and reduce risk for buyers and sellers. In 2001, the NYMEX coal contract was developed. Since then, other indexes have also been created to help determine prices for different coals going into different markets.

Hiemstra estimates the size of the Over the Counter (OTC) market is roughly between 350 million mt to 400 million mt. This has changed tremendously in recent years. “Ten years ago, almost all trades were physical. Now it’s gone the other direction,” said Hiemstra.

While the steam coal market is growing, the international metallurgical coal market remains tight and pricing is much higher. “They really are two completely different markets. The met market is very small and is almost always physically traded. The steam market is more generic, more commodified and more standardized,” said Schicke.

One purchasing strategy speculators suggest might help ensure market transparency is employment of financial instruments such as futures contracts and swaps. Using one of these tools, buyers and sellers can lock in prices. “A swap is a financial transaction between two parties to exchange a fixed price for a floating price at some fixed date or dates in the future,” said Ted O’Brien, vice president, Doyle Trading Consultants. Swaps can be used by all interested parties to hedge their position in such volatile markets. “In no circumstance can swaps result in the delivery of physical coal. With swaps you can separate this outcome from the conclusion of the deal,” said O’Brien.

The first global steam swaps trade was settled in 1998. Steve Doyle, founder of Doyle Trading, was involved in the first swap. The success of this transaction led to a growth in market participants. This and other financial instruments to trade coal have been widely adapted especially by the European paper market which now outweighs the physical markets there. Today, O’Brien estimates there are roughly 200 million mt of physically settled coal compared to the roughly 400 million tons being traded or touched by the financial markets.

Trading Coal

When navigating the markets, it’s important to understand different terms. Coal traders generally are the principal of the transaction. They take and hold title to a specific commodity. A coal broker will never take title. “They just help facilitate the transaction and they get paid a fee for their efforts connecting buyer to seller,” said Schicke.

Traders often do more than just sell coal. Some will also help market, store and/or blend it with other coal to attain a higher specification or to add value to the original product. Much like the stock market, coal traders work to “smooth out, absorb and warehouse risk out from the market. Traders absorb risk and help make markets more efficient and transparent,” said Schicke. Based in Houston, Texas, Mercuria, like other traders, maintains several river docks in Central Appalachia, one on the Big Sandy and one on the Kanawha, to store and blend either its or its customers’ coals. Mercuria, which physically moved about 5 million mt in the U.S. last year, also buys, sells, blends and stores physical coal. “We buy from producers and move coal to the Gulf Coast and export to end point destinations, generally in Europe,” said Schicke.

As the coal markets continue to evolve, all parties hope for increased standardization. “A lot of investors that own stock would like more transparency there. This in turn could create more opportunities for traders if there were more instruments available,” said Schicke.

Developing the International Metallurgical Markets

As nuanced as thermal coal might be, coking is even more so. The energy content and special chemical properties of coking coal is different from one coal to the next. “You have specific users for specific types of coal. With swaps, the end user can take a familiar type of coal and lock in prices for it,” said O’Brien.

O’Brien and others feel the market is now ready for coking coal swaps as evidenced by the fact that a year ago, in February of 2010, there were no coking coal indexes to refer pricing against. Today there are at least 15 markets including products into Hampton roads, Queensland, China, India and Japan. These began after Energy Publishing published its first index, others have since followed suit.

There are also more market participants now than there were in 2002. “It’s important to notice how the mix in the market has prompted the change. About 20% of the market members are hedge funds.  Banks and hedge funds are 50% of volumes. Compared to Natgas, grain and other commodities, coal is a late-comer to the commodities market,” said O’Brien.

As more buyers enter the marketplace and less high quality coking coal is produced, the price of metallurgical coal has begun to climb over the last few months from $200 per ton to recent unconfirmed reports of almost $400. “Coking coal markets are becoming increasingly volatile and this trend will persist for some time,” said O’Brien.

Chinese traders and producers are looking to capitalize on these disruptions. As India continues to buy coal internationally, “they too will contribute to future volatility. As more U.S. coking coal leaves U.S. shores for Asia, markets will become increasingly volatile as there is more sustained competition in the procurement process,” said O’Brien.

Coal Trading Organizations

The two largest coal trading groups are the Coal Trading Association and the New York Coal Trade Association.

Established in 1913, the New York Coal Trade has served as a forum for key industry professionals involved in the commerce of coal. The association provides a means to meet with other coal professionals in a relatively relaxed business environment to socialize with customers and associates. As the early individual coal traders, promoters and developers have changed with the evolution of large integrated coal companies that both produce and market coal, the association has changed as well. Membership has expanded to include industries that serve coal, such as transportation, quality control, exploration and production services.

While the association is headquartered in New York City, it has members throughout the United States, reflecting its commitment to coal and the members who serve the industry. This association has historically consisted of New York-based physical coal traders who would take coal out of the U.S. and sell all over the world. In the past, members were generally representatives of smaller firms that had specific relationships with both producers and end users all around the world. A century ago, a lot of the production market consisted of small and private firms. With the rise of today’s consolidated corporations, the role of the New York Coal Trade group has changed as well.

The Coal Trading Association was established in 1999 to promote coal trading capability and liquidity in the U.S. CTA develops and maintains industry standards for coal trading activity with the goal of achieving a disciplined, liquid and efficient coal trading industry.

“The CTA was started because the industry needed a group to facilitate

the discussion around what our standards for contracts, for contracts terms and conditions, master contracts, as well as development of new products and standards,” said Schicke, who, along with Tom Hiemstra, was a recent past president of the group.

The CTA also puts on educational and networking events such as its mid-year member conferences and its annual December conference in New York City, conducted in tandem with the American Coal Council.

Recently, on March 4, 2011, the CTA approved a new technical specification for a CSX Rail Product in Central Appalachia. According to current CTA President Sean Murphy, also director of fuels, Mirant Energy Trading, “the quality of coal being mined in Central Appalachia is changing and our membership indicated that a new specification was in order to reflect this reality. After discussions with coal buyers, sellers, and traders, we jointly developed a new spec, which will be added to the standard products for the traded coal market to consider.” The CTA has also set up an IB spec, but its not yet traded.

Both groups serve as forums to assist buyers and sellers in their transactions.

While not a trading organization, Doyle Trading Consultants, provides vital consulting services, data and analysis to help buyers and sellers as well. “We need data, whatever you think you need to make a bet on coal price direction, production info, consumption information, delivery info, what’s happening with mine issues, logistics, understanding pricing signals where pricing is at, regulatory info and news about other competing fuels such as natural gas. DTC’s news service, which provides information on a daily and weekly basis, helps provide all the components we need to make an informed decision,” said Schicke.

Several primary coal brokers and traders in the U.S. are:

•             ICAP United, directed by Dan Vaughn,

•             TFS Energy LLC, directed by Joseph Cacioppo,

•             Evolutions Markets, directed by Tom Hiemstra, and

•             Mercuria Energy Traders, Managing Director Matt Schicke.

For metallurgical coal:

•             Xcoal Energy and Resources, led by Ernie Thrasher.

Others include:

•             EDF Trading, Constellation Energy, Peabody COALTRADE and Glencore.

Buchsbaum is a Denver-based freelance writer and photographer specializing in industrial subjects. He can be reached through his Web site at www.lmbphotography.com or by phone at 303-746-8172.