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‘Surprise’ coal rally a boon for miners, but analyst warns of bubble

The surprise surge in coal prices should provide an unexpected profit boost for the world’s biggest mining companies as they navigate a commodity downturn that sapped earnings.

Gains for coking coal, used with iron ore to make steel, accelerated in recent weeks and benchmark prices from top producer Australia jumped 9.5 per cent on Thursday, the most since at least 2013. At current prices, that would add almost US$5 billion to BHP Billiton Ltd.’s underlying earnings before interest, tax, depreciation and amortization in the year ending June 30, according to Liberum Capital Ltd.

Coal has more than doubled this year as China’s production curbs increased its reliance on supplies from other nations. The rally — which Morgan Stanley called a “complete surprise” — is a bright spot for miners still suffering from a plunge in commodities over the past five years. It will also help compensate for a worsening outlook for iron ore, BHP’s main earner, with the firm and a raft of banks expecting prices to retreat by year-end.

“Nobody saw this coming,” Richard Knights, a mining analyst at Liberum Capital Ltd. in London, said by phone. “It’s caught the whole market by surprise. If coal prices stay where they are, thermal and coking, there are huge earnings upgrades to come through in the sector.”

Australian premium hard coking coal reached US$173.40 a ton today, the highest in Bloomberg data going back to 2013. The majority of sales are based on quarterly contracts, which were set about 88 per cent below the current spot price. Producers should now be better placed to negotiate higher prices for fourth-quarter contracts.

BHP shares have climbed 34 per cent in London in 2016, rebounding from a three-year slump. That’s still much less than this year’s fourfold jump for Teck Resources Ltd., the Canadian miner whose biggest source of revenue last year was from coal.

Slowing Chinese demand had led to a global oversupply of the fuel in the past few years, while utilities used less to cut pollution. Chinese coal output is now being curbed because of a new government policy restricting working days in mines, according to Liberum.

Coal’s recent performance still caught many off guard. Morgan Stanley, which this month called it a surprise for the market, had in June forecast contract prices of US$90 a ton for the third and fourth quarters.

The doubling in coal this year overshadows almost all commodities, with zinc and silver up about 40 per cent and iron ore about 30 per cent. It may take a while for mining companies to benefit from today’s coal price, because most of their sales are based on quarterly contracts, rather than spot rates.

There’s a chance that China may soften its policy on working days in mines to ease the strain that higher coking coal prices have on its steel industry, Liberum’s Knights said.

While supply cuts, higher Indian imports and improved steel margins should keep coking coal at US$120 to US$130 in the near term, there is a risk of an “imminent” pullback given the speed of coal’s advance, BMO Capital Markets said last week.

Others are more pessimistic.

Prices have been driven higher by supply shortages that should disappear soon, said Kirill Chuyko, a strategist at BCS Global Markets, Moscow’s largest brokerage. “The global coal price rally is a clear bubble that should burst within two to three months.”

Source: Financial Post

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