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Schork Oil Outlook: China Is NOT the Answer

The forward curve for coal prices (as measured by the Central Appalachian futures contract) has seen a significant shortening in the last few weeks.

The front month, March, was trading on the 12th of February at $49.42, a 5.33% discount to April. By February 19th, it had tightened to $50.83, just a 3.2% discount to April. The Appalachian region produces coal used for steam generation for electricity, metal production and export, so an economic recovery is expected to boost prices. Thus, in this context, is proposed infrastructure spending — at home and abroad — beginning to cause supply concerns?

Much of the major press has been focusing on China’s record high levels of imports.

To provide some historical basis, Chinese imports of coal averaged 2.18 million tons a month in 2005. With the runup to the 2008 Olympics, China began hoarding supplies of commodities, and imports increased to 4.24 million tons in January 2008.

Many thought that the hoarding would cease and they seemed to be correct: imports declined to 2.67 M/t by December 2008. Then, as the graph in today’s issue of The Schork Report illustrates, Chinese imports spiked.

By December 2009, China was importing 16.38 m/tons of coal a month. That’s a record high and 500% higher than December 2008. January 2010 saw a slight cooling-off to 16.02 m/tons, but it’s clear that China’s growing infrastructure needs and export economy will soon make it a global driver for coal demand and pricing.

Thus, last week’s rally can be placed somewhat on Chinese demand, but as illustrated in today's report, coal prices on the Nymex were little changed over last year. In fact, they dropped from $63.92 in December 2008 to $49.1 in December 2009, despite China’s booming imports.

In other words, the supply for American coal is a more complex picture than simply “China China China.” What news pundits gloss over, and traders like to overlook, is that China is very conscious of energy security. It imports not by choice, but due to domestic production falling behind demand. Of these imports, China feels safer importing from neighboring producers such as Australia and Indonesia than it does with Iran or America.

Of China’s 85.7 million tons imported between January and September 2009, the USA accounted for only 0.3%, or 0.25 million tons, almost all of which was coking coal used in the production of steel and other metals. China’s demand for American coal did increase 274.12% year-on-year, but in comparison Australian imports were 32.34 million tons and saw a 1,244.57% y-o-y increase (!).

Of the latest data available from the EIA, the U.S. produced 41.44 million short tons of coal between January and September 2009. The largest portion (around 50% or 21.1m tons) went to Europe. Canada was the largest purchasing country, with a share of 19% or 7.9m tons. 13% went to Brazil, 3.4% to South Korea, and only 0.9% or 0.4 M tons to China.

Thus, in the short term at least, China does not need U.S. coal, and U.S. coal does not need China. The EIA forecasts exports of 70 million tons for 2010. Even if we assume China ups the amount of U.S. coal it buys to 2% of total American exports, that’s still only amounts to 1.1% of total U.S. output.

Weak prices at the Appalachian hub last year were due to a cooler than normal summer and the economic recession leading to lower demand for discretionary spending on air conditioning and coal demand. Prices have picked up at the start of this year due yes, in part to China, but more importantly due to a bitterly cold winter increasing industrial production at electric utilities and upping the demand for heat generating commodities.

The bottom line is that coal prices are likely to trend higher this year. According to analysts surveyed by Bloomberg, prices will average $59.28 this year, 17% higher than current levels.

This cannot be explained away by China, which plays a small part in the American coal markets, and will do so in the short- to medium-term.

Instead, to see how much higher coal prices can go, analysts at The Schork Report look to lower domestic production, a warmer-than expected summer and continued strength from the utilities sector.

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Stephen Schork is the Editor of, "The Schork Report"and has more than 17 years experience in physical commodity and derivatives trading, risk systems modeling and structured commodity finance.