Research Director : Lee, Won-Woo Senior Research Fellow, KEEI

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3 Research Director : Lee, Won-Woo Senior Research Fellow, KEEI

4 ABSTRACT 1. Background and Issues Korea is the world s third-largest importer of bituminous coal followed by Japan and China, importing 106 million tons as of 2010, of which 24 million tons is coking coal and 82 million tons steam coal. The imported coking coal is used in the iron and steel industry, and the steam coal is mostly fired in the power generation and cement production plants like other countries. In particular, coal has played a significant role in the electricity sector, as it has accounted for about 40 percent of power generation since 2008, which is 9 percentage points higher than that of the nuclear energy. Therefore, ensuring the supply of steam coal is very important for the stable and economically sound power supply. Recent international coal market is experiencing structural changes in the medium- and long-term as well as price volatilities. Since 2008, the leading international market has moved from Europe to Asia with increased coal imports in rapidly developing countries such as China and India. In line with this, the coal exports to the Asian market from South Africa and the US are remarkably increasing. Of course, Australia and Indonesia, existing major supply countries to Abstract i

5 the Asian region, have become more important than ever. In addition, the nuclear accident caused by the Great Earthquake in Japan on 11 March 2011 will bring about the expansion of coal use. Of course there might be limited impacts in the long run, since China and India seem to carry out their construction plan of nuclear power plants without a hitch. In the medium- and short term, however, it is expected that Japan increases its coal imports. This import growth will tighten more the Asian coal market, which is already very tight. The above mentioned changes become a significant risk factor in the coal market. Therefore, it is important to analyze structural changes of the market, and then to find out countermeasures for the stable and economical supply of power as well as for the competitiveness of the coal intensive industry. This study analyzes influencing factors on the international coal market changes, such as demand growth in the Asian region, impacts of the nuclear accident in Japan, price co-movement phenomenon, and effects of the climate change convention. Through these analyses it seeks for measures to minimize the impacts of coal market changes. 2. Research Results Korea s Bituminous coal demand is expected to peak in the second ii

6 half of the 2010s and then decline. This is the same with the coal demand forecast in the power sector. Therefore, until the second half of the 2010s, the coal demand will increase steadily. As for the international coal market, the Asian market only is enlarging, while that of Europe and North America tends to shrink. The Asian coal market has showed rapid growth in production, consumption, and trade, so its proportion in the world s coal imports significantly increased to 67 percent in 2010 from 51 percent in But, the European market has been declining due to import reduction since Also in the North America which is self-sufficient market, coal production and consumption is stagnating or declining, and imports were peaked in 2006 and then began to decrease. For this reason, Asia is now leading the international coal market. In particular, unlike the past, steam coal prices in Asia have been continuously higher than in Europe since early This resulted from the steady growth of coal imports in the Asian region thanks to a higher economic growth in developing countries like China. Steam coal prices have risen since March 2009 with increased imports in developing countries including China and India. In particular, the prices showed a steady rising tendency, exceeding 146 dollars per ton in January This is because major exporting countries production and transportation were disrupted due to heavy rain caused by La Niña phenomenon. In addition, the severe cold Abstract iii

7 wave in the northern hemisphere boosted coal demand. However, since January 2011 the coal price has been stabilized thanks to the recovery of supply facilities from the flood damage and decrease in coal demand due to temperature rise and the earthquake in Japan. The ocean freight charge, which is an important factor for the cost of imported coal, is very volatile due to a mismatch between ship building and the quantity of seaborne trade. The Baltic Dry Index (BDI), the most widely used freight index for bulk carrier, has been fluctuating a lot. In May 2008, the BDI reached the highest, but 7 months later, it declined to 1/20 of the peak level. In the meantime, the nuclear accident caused by the Great Earthquake in Japan on 11 March 2011 would have limited impacts on the international coal market. But, it is expected that the accident will influence the construction of the nuclear power plants in developed countries, particularly Germany, Italy, Switzerland and Japan, while countries like China and India, who are in the process of building extensively nuclear power plants, will be hardly affected. The IEA and the IAEA, despite the accident, forecasted in their 2011 outlooks that the use of nuclear energy would increase by about 70 percent in the 2030s, compared to the current level. This forecast is around 5 percent lower than that in There is a tendency of price co-movement between steam coal and other various primary commodities such as cocoa, cotton, wheat, soybean oil, copper, zinc and crude oil. In particular, the price of iv

8 steam coal shows strong relationship with those of crude oil, natural gas, wheat and copper. This phenomenon is expected to continue with the development of the spot markets and the growth of money supply. From a long-term point of view, the progress in climate change negotiations will largely affect the coal consumption. The attempts to limit greenhouse gas emissions will bring about decrease in coal consumption, in that coal emits most intensively the carbon dioxide. According to the IEA s New Policies Scenario, the global coal consumption will increase fast until 2015, and be at standstill thereafter. In contrast, the 450 Scenario, which assumes the earth temperature rises less than 2 degrees Celsius compared to the pre-industrial revolution level, shows the peak of coal demand before 2020 and then great decline. Given the above conditions, the international coal market is likely to be stabilized after 2020, but until then, the market seems to be unstable because of demand growth and increasing price volatility. Therefore, various efforts are required for ensuring stable coal supply and enhancing coal supply economy. In particular, it is necessary to prepare countermeasures for the instability of the coal market. 3. Policy Suggestions In order to prepare a countermeasure, it is required to identify in a Abstract v

9 timely manner the changes of the market situations, analyze their impacts, and project the direction of their development. Therefore, a deeper analysis should be made on the foreign markets. For this purpose, it is suggested to seek establishment and operation of the Council for the Bituminous Coal Market in which the related companies and experts participate. In addition, the SWAP can be utilized to hedge the price risk. As time goes by, spot trading of coal will be increasing more and more, and thus coal prices will be even more volatile in the future. Therefore, the government should encourage the use of price hedging mechanism. In this sense, it is recommended to change the criteria of management evaluation for public power companies from a single year base to a multi-year one (e.g. 3 years). It is also desirable to participate in coal trading businesses. Entrance to the trading sector will highly contribute to securing coal supply as well as sale and value maximization of overseas coal produced by Korean companies. In particular, it is meaningful that this would pioneer a new business in the area of coal trade. For the easy entrance in this business, it may be taken into consideration to make an acquisition of a foreign trading company. It is needed to seek ways to stabilize fluctuating ocean freight charges. In order for this, the proportion of the ships owned by importing companies and chartered in the long-term should be maintained in a certain level. In particular, it is recommended to vi

10 utilize the above mentioned ships for the supply quantity of coal based on the long-term contract, which can be foreseeable. For the short-term and spot chartering, efforts should be made to ensure the stability of freight costs by utilizing the Forward Freight Agreement (FFA). Furthermore, it is encouraged to continuously expand coal development in overseas. The current share of coal produced in overseas by Korean companies is 48.3 percent of total coal imports, almost reaching the target of 50 percent in However, it should be noted that the Asian coal market is likely to be steadily tightening, and the share by Japanese companies in 2010 was above 57 percent which is equally close to the Japanese target of 60 percent. In addition, efforts are needed to strengthen the long-term contract. It is relatively easy to reduce the share of long-term contracts for enjoying the price decline of coal. However, if there is a growth in prices or supply difficulties, it will be difficult to increase that of long-term contracts. Therefore, a more cautious approach is required in reducing the share of long-term contract. Also, it is necessary to complement important clauses of long-term purchase contracts, such as temporary prices for the delay of agreement renewal. It is requested to strengthen the cooperation among purchasing companies. If they share the information on negotiations, it will give them an advantageous position in negotiation. In particular, when Abstract vii

11 Korean companies negotiate with a high-risk country or when many Korean importers are in negotiation with a single exporting company, it is desirable to work on through joint negotiations. Furthermore, to maintain cooperative relationship with foreign importers including Japan is helpful to enhance the bargaining power. But, to entail active cooperation between importing companies, it is important to build up trust in advance by exchanging their information on markets and purchases. In addition, it is important to foster experts on coal markets and trading, and coal development in overseas. In fact, training professionals takes a long time in that it requires not only theoretical education but also considerable practices. Therefore, the government s active support should be combined together with the willingness of coal developers and importers. All the possible measures should be taken in advance. Once prices start to rise and the market is tightened, it will be almost impossible to take any particular measures. Moreover, even if measures were taken, there might be little positive outcomes. For this reason, it is essential to prepare and take all the countermeasures during the buyer s market. viii

12 4. Expected effect This study is expected to contribute to enhancing the ability to respond to the coal market changes as well as to strengthening coal import capability. First of all, establishment of the Council for Bituminous Coal Market will give opportunities to share and exchange information on coal markets, and be helpful for coal importers to detect market changes and find solutions for these changes. Secondly, the analysis on price co-movement between coal and primary commodities such as crude oil will be significantly useful for forecasting coal prices, together with the factor of changes in supply and demand. Thirdly, the utilization of SWAP and FFA will largely contribute to stabilizing coal import prices and ocean freight charges which are fluctuating highly. Fourthly, if Korea successfully enter into coal trading businesses, it is helpful to follow market changes more quickly so that this will largely contribute to enhancing the ability to respond to the market. Furthermore, this will bring about the secondary effect such as better valuation of coal produced in overseas by Korean companies and creation of new business areas. Fifthly, taken into consideration that the Asian coal market will be Abstract ix

13 continuously tight, the expansion of coal development in overseas will lead to strengthening the coal import abilities. In addition, it will be highly helpful in promoting the supply stability of coal to complement the provisions of the long-term coal purchase contract such as tentative prices and option quantities. Sixthly, organizing a joint-negotiating team among importing companies will improve the economics of coal imports in that it increases the bargaining power of Korean companies. Finally, fostering experts on coal markets and trading as well as coal development in overseas will not only enhance Korea s ability to respond to changes in the international market, but also build up the capability to import coal economically and stably. x

14 Table of Contents Ch 1. Introduction 1 Ch 2. Domestic Coal Market Trends and its Future 5 1. Coal consumption trends 5 2. Coal imports 7 3. Coal demand forecast 12 Ch 3. International Coal Market Trends and Structure World Coal Market Trends 17 a. Production and Consumption 17 b. International trade International hard coal market structure 26 a. North American market 26 b. European market 28 c. Asian Market International hard coal prices Ocean freight charges 34 Ch 4. Major Exporting and Importing Countries Trends in importing Countries 37 Table of Contents i

15 a. China 37 b. India 40 c. Europe and Other regions Trends in the exporting countries 43 a. Australia 43 b. Indonesia 46 c. South Africa and Mozambique 48 d. Russia and Mongolia 51 Ch 5. Influencing Factors on the Changes Japanese Earthquake and Nuclear Accident 55 a. Changes in Japanese coal demand for power generation 55 b. Changes in global coal demand Price Co-movement Phenomenon 66 a. Methodology 69 b. Preliminary analysis of sample data 78 c. Identification of boom and slump 81 d. Correlation coefficient and Concordance coefficient 98 e. Causes of Price Co-movement and their implications Progress In Climate change negotiations 112 Ch 6. Countermeasures against the Changes in the Future 121 ii

16 1. Enhancing the Market's Ability to React 121 a. Analysis on Overseas Markets 121 b. Advanced Risk Management 123 c. Participation in Trading Business 127 d. Ocean Freight Charge Management Strengthening Coal Import Infrastructure 133 a. Coal Development in Overseas 133 b. Reinforcement of Long-term Contracting 136 c. Cooperation among Purchasing Companies 139 Ch 7. Conclusion and Policy Suggestions 143 Bibliography 151 Table of Contents iii

17 List of Tables Table 4-1 New Coal Development Projects in China 39 Table 4-2 Coal Development Projects in Australia 44 Table 4-3 Extension Projects for Coal Terminal in Australia 44 Table 4-4 Coal Development Projects in Indonesia 47 Table 4-5 Coal Development Projects in South Africa 49 Table 4-6 Coal Development Projects in Mozambique 50 Table 4-7 Coal Development Projects in Russia 52 Table 4-8 Coal Development Projects in Mongolia 54 Table 5-1 Coal-fired Power Plants in the earthquake area 56 Table 5-2 IEA's Low Nuclear Scenario 64 Table 5-3 Concordance Coefficient Estimates of Response Surface Regression 75 Table 5-4 Specifications of analyzed commodities 79 Table 5-5 Basic Statistics of Sample data 80 Table 5-6 Summary of Booms and Slumps: Non-correlated commodities 90 Table 5-7 Summary of Booms and Slumps: Correlated commodities 98 Table 5-8 Correlation Coefficient of level variables: Non-correlated Commodities 101 iv

18 Table 5-9 Correlation Coefficient of Log difference variables: Non-Correlated Commodities 102 Table 5-10 T-statistics on correlation coefficients: Non-Correlated Commodities 102 Table 5-11 Significance Level of Correlation Coefficients: Non-Correlated Commodities 102 Table 5-12 Concordance Coefficient of log variables: Non-Correlated Commodities 103 Table 5-13 Minimum (μ/σ) ratios: Non-Correlated Commodities 103 Table 5-14 Significance Level of Concordance Coefficients: Non-Correlated Commodities 103 Table 5-15 Correlation Coefficient of level variables: Correlated Commodities 106 Table 5-16 Correlation Coefficient of Log difference variables: Correlated Commodities 107 Table 5-17 T-statistics on correlation coefficients: Correlated Commodities 107 Table 5-18 Significance Level of Correlation Coefficients: Correlated Commodities 107 Table 5-19 Concordance Coefficient of log variables: Correlated Commodities 108 Table 5-20 Minimum (μ/σ) ratios: Correlated Commodities 108 Table 5-21 Significance Level of Concordance Coefficients: Correlated Commodities 108 Table of Contents v

19 Table 5-22 Carbon Emissions by fuel 114 Table 6-1 Examples of SWAP transaction 126 Table 6-2 Risk Premium for a Vessel 128 Table 6-3 Risk hedging of Freight Charge through FFA 132 Table 6-4 Develop & Import Scheme vs Simple Import 134 Table 6-5 Target Countries for Overseas Coal Development 135 Table 6-6 Changes in Long-term Contract method and terms 139 vi

20 List of Figures Figure 2-1 Energy consumption Structure in Korea 5 Figure 2-2 Coal(Bituminous) Consumption by use in Korea 6 Figure 2-3 Coal(Bituminous) Imports in Korea 8 Figure 2-4 Coal Imports by nations(2010) 9 Figure 2-5 Steam Coal Price Stability by country 11 Figure 2-6 Stabilities in Steam Coal Import market share 12 Figure 2-7 Coal Demand Forecast in Korea 13 Figure 2-8 Steam Coal Demand Forecast for Power Generation in Korea 14 Figure 3-1 World Hard Coal Production 18 Figure 3-2 World Steam Coal Production 18 Figure 3-3 Hard Coal Consumption Trend 20 Figure 3-4 Steam Colal Consumption Trend 20 Figure 3-5 International Trade of Hard Coal 22 Figure 3-6 Hard Coal Imports by region 23 Figure 3-7 Steam Coal Imports by region 23 Figure 3-8 Hard Coal Exports by region 24 Figure 3-9 Steam Coal Exports by region 25 Figure 3-10 Hard Coal Supply/Demand and Import/Exports in North America 27 Table of Contents vii

21 Figure 3-11 Hard Coal Supply/Demand and Import/Exports in Europe 29 Figure 3-12 Hard Coal Supply/Demand and Import/Exports in Asia 30 Figure 3-13 International Steam Coal Spot Prices 32 Figure 3-14 Freight Charges for Dry Bulk Carrier 35 Figure 3-15 Dry Bulk Carrier Fleet and Delivery of Newly-Constructed Vessels 36 Figure 5-1 Steam Coal Spot Prices before and after the Japanese Earthquake 58 Figure 5-2 Trends of Steam Coal and Crude Oil Prices 67 Figure 5-3 Price Correlation among Steam Coal, Crude Oil and Soybean Oil 68 Figure 5-4 Boom and Slump Analysis: Steam Coal 83 Figure 5-5 Boom and Slump Analysis: Cocoa 84 Figure 5-6 Boom and Slump Analysis: Copper 85 Figure 5-7 Boom and Slump Analysis: Cotton 86 Figure 5-8 Boom and Slump Analysis: Hard logs 87 Figure 5-9 Boom and Slump Analysis: Wheat 88 Figure 5-10 Boom and Slump Analysis: Zinc 89 Figure 5-11 Boom and Slump Analysis: Australian Newcatle coal 92 Figure 5-12 Boom and Slump Analysis: Indonesian natural gas 93 Figure 5-13 Boom and Slump Analysis: Brent crude oil 94 Figure 5-14 Boom and Slump Analysis: Dubai crude oil 95 viii

22 Figure 5-15 Boom and Slump Analysis: WTI crude oil 96 Figure 5-16 Boom and Slump Analysis: Uranium 97 Figure 5-17 World Coal Demand Forecast 115 Figure 5-18 Coal Demand Forecast by region (New Polices Scenario) 116 Figure 5-19 Coal Exports/Imports by region (New Policies Scenario) 118 Figure 5-20 EIA's Forecast for Coal Imports by region 119 Figure 6-1 FFA tradings in the Dry Bulk Cargo Market (Estimation) 130 Figure 6-2 Long-term/Spot Purchase ratio for Power generation companies in Korea 138 Figure 6-3 Long-term/Spot Purchase Prices for five Power Generation Companies in Korea 138 Table of Contents ix

23 Ch 1. Introduction Korea is the world s third-largest importer of bituminous coal followed by Japan and China, importing 106 million tons in 2010, of which 24 million tons(mt) is coking coal and 82 million tons steam coal. The imported coking coal is used in the iron and steel industry, and the steam coal is mostly fired in the power generation and cement production plants like in other countries. In particular, coal has played a significant role in the electricity sector, as it has accounted for about 40 percent of power generation since 2008, which is 9 percentage points higher than that of the nuclear energy. Therefore, ensuring the supply of steam coal is very important for the stable and economically sound power supply. Recent international coal market is experiencing a medium- and long-term structural change, with high price volatility. Since 2008, the leading international market has moved from Europe to Asia with increased coal imports in Asian developing countries such as China and India. In line with this, the coal exports to the Asian market from South Africa and the U.S. are rapidly growing. Of course, Australia and Indonesia, existing major providers for the Asian region, have become more important than ever. In addition, the nuclear accident caused by the Great Earthquake in Japan on 11 March 2011 will bring about an increase of coal use. Of Ch 1. Introduction 1

24 course there will be a limited impact in the long run if China and India carry out their construction plan of nuclear power plants without a hitch. In the medium and short term, however, it is expected that Japan will increase its coal imports. The growth of imports will tighten even more the Asian coal market, which is already very tight. The above mentioned changes are a significant risk factor in the coal market. Therefore, it is important to analyze structural changes in the coal market, and then to seek countermeasures for the stable and economic supply of power as well as for the competitiveness of the coal intensive industries. There are some precedent studies such as 'A study on rational methods of steam coal purchasing for power generation' (MOCIE, 2004), 'A study on import diversification of steam coal for power generation through enlargement of coal imports from Russia'(MOCIE, 2006). The US DOE and the IEA also provide annually coal market outlooks through 'World Energy Outlook' and 'International Energy Outlook'. The Korea Energy Economics Institute (KEEI) carried out a study on optimal procurement of steam coal for power generation over the period of In addition, in 2009, the KEEI published 'An outlook for international coal market' and 'An outlook for global coal demand/supply and steam coal prices for 2010', though these publications are not research papers, but policy informations, Like this, all of the domestic studies were carried out before the year of 2007, and the 'International Energy Outlook' of the US DOE 2

25 is mainly focusing on petroleum and North America. The IEA report deals with the coal problem as a part of global energy outlook so that it doesn't provide detailed information on the changes of coal market and countermeasures. In other words, there are some reports on the coal market trend for the pre-2008(pre-financial crisis) period, but there is little analysis on recent structural changes in the coal market. In particular, there have been no studies which treated comprehensively medium and long-term factors heavily influencing the coal market, such as climate change negotiations. In this study, we will analyze the changes of the Asian coal market after the crisis to improve Korea's stability of coal imports and to enhance their economic efficiency. That is, the purpose of this study is to review the trend of global coal market, understand the main factors influencing the supply and demand of coal, and analyze the structural changes in the coal market due to the progress of climate change negotiations. Based on this analysis, we will try to find out some countermeasures. This report consists of seven chapters including introduction. In Chapter2, we will review current domestic coal market situation and forecast its future. In Chapter3, we analyze international coal market structures in North America, Europe and Asia, and examine the ocean freight charges and the past and recent trends of steam coal prices. For a better understanding of these trends, in Chapter4, we analyze the actual trends and prospects for major coal importing Ch 1. Introduction 3

26 countries(china, India and Europe), major exporting countries(australia, Indonesia, South Africa, Russia, Mongolia, Mozambique, Columbia) and new potential exporting countries. In Chapter5, we suggest the nuclear accident caused by the Great Earthquake in Japan, the price co-movement between steam coal and other various primary commodities such as crude oil, and the climate change negotiations, as main factors of the structural changes in coal markets, and try to quantify their effects. In Chapter6, based on these analyses, we seek some medium and long term countermeasures against such changes. In the conclusion, we recommend some policies needed to realize the countermeasures, summarizing our study. For your guidance, we'd like to say that we are focusing on steam coal. That is because the consumption of coking coal is less than a quarter of total coal consumption and the increase of demand in the future will be negligible. In addition, as the trade pattern of coking coal is significantly different from that of steam coal and its use is concentrated on iron & steel industry, we consider it should be reserved for another inquiry. 4

27 Ch 2. Domestic Coal Market Trends and its future The share of coal in total primary energy consumption in Korea fell to nearly 18% in 1995 owing to decline of briquette(anthracite) consumption, but since then it has increased continuously, reaching 22.2% in 2000, 24.0% in 2005 and 29.2% in 2010, thanks to rising demand in the power generation sector. Figure 2-1 Energy consumption Structure in Korea Renewables Nuclear Natural Gas Petroleum Coa Source: KEEI, "Monthly Energy Statistics", May Ch 2. Domestic Coal Market Trends and its future 5

28 In physical terms, the coal consumption increased from 60 million tons(mt) in 2000 to 76 Mt in 2005, 99 Mt in 2009 and 109 Mt in By coal types, the consumption of steam coal increased two times in 10 years, from 41 Mt in 2000 to 84 Mt in 2010, while the consumption of coking coal increased only by 6 Mt over the same period, from 19 Mt to more than 25 Mt in Figure 2-2 Coal(Bituminous) Consumption by use in Korea Mton Others Cement Generation Iron & Steel Source: KEEI, "Monthly Energy Statistics", May The steam coal consumption for power generation increased rapidly from 33.3 Mt in 2000 to 47.9 Mt in 2005, 77.5 Mt in 2010 so that it accounts for more than 70% of total coal(bituminous) consumption as of In particular, the increase of coal demand after 2006 in the generation sector can be explained by the fact that in spite of a fast increase of electricity demand after 2006, there was no entrance of new nuclear power. The coal-fired generation capacity 6

29 increased by 37% from 16,840 MW in 2005 to 23,080 MW in 2010 while the nuclear capacity maintained the level of 2005, 17,716 MW, until 2010, without any addition of new capacity. The coking coal consumption for iron & steel manufacturing had maintained a level of 20 Mt after 2000, but began to increase, after 2007, thanks to the completion of a POSCO's FINEX steel plant(facility size, 1.5 Mt) and Chinese economic boom, reaching 23.5 Mt in But, in 2009 and 2010, the consumption showed a fluctuation, decreasing by 3 Mt in 2009 and increasing by 5 Mt compared to the previous year. The drop of 2009 is caused by the global economic recession during which POSCO overhauled its blast furnaces. The increase of 2010 can be explained by the resumption of POSCO's blast furnaces and the new operation of Hyundai Steel's first and second blast furnace(4 Mt of annual capacity, respectively). In contrast, the coal consumption in other sectors such as cement industry has decreased or stagnated due to the recession in construction and the increased public concerns about the environment. Coal imports exhibit almost the same trends as coal consumption. As mentioned earlier, the increase of steam coal imports has led the Ch 2. Domestic Coal Market Trends and its future 7

30 increase of total coal imports. The coal imports from Australia and Indonesia occupy a great part of total imports, accounting for more than 35% respectively. The aggregate amount of imports from the two countries accounts for 73% while the imports from Canada and Russia represent less than 10% respectively. The imports from China, the biggest exporting country vis-a-vis Korea early in the 2000s, have decreased so rapidly that China occupies only the 5th position as of Figure 2-3 Coal(Bituminous) Imports in Korea Mton Others Cement Generation Iron & Steel Source: KEEI, "Monthly Energy Statistics", May As for the import of steam coal, the imports from Indonesia are the greatest, followed by Australia and Russia. But, in terms of 8

31 market share, Indonesia(46%) and Australia(31%) provide most of the coal used in Korea. In contrast, as for the coking coal, the imports from Australia, Canada are the greatest, market share being 58% and 21% respectively. Taken into consideration even the imports from the US(11%), Kore's coal imports are heavily dependent on the three countries which account for about 90% of coal imports in Korea. Figure 2-4 Coal Imports by nations(2010) 8% 4% 2% 4% 9% 36% 37% Australia Indonesia China Russia Canada U.S.A Others Ch 2. Domestic Coal Market Trends and its future 9

32 Steam Coal Imports Coking Coal Imports Source: Korea Resources Corporation, Coal Inside, April 2011 We can review the stability of import sources in terms of price and quantity. It appeared that the prices of steam coal were volatile. The standard deviation of annual average prices was significantly high, compared to the average price in the 2000s. Even in the US where the price was relatively stable, the ratio of standard deviation to mean(sd/mean) reached 37%, while 52% in China. It is due to the price fluctuation in the 2000s during which the steam coal prices increased until 2008 and thereafter plunged owing to the financial crisis in the US. But comparatively, the price stability of the United States, Indonesia, Canada, Australia was high while that of China and Russia was relatively low. On the other hand, in terms of physical import volumes, the imports from Australia were the most stable while the imports from 10

33 other countries less stable. The imports from Russia were relatively stable. To be more exact, in terms of SD/mean which is estimated based on the market shares of each countries, Australia showed the lowest value of 13%, Russia 30%, Indonesia 46%, China 53%, Canada 62% and the US 87%. Indonesia is currently the greatest coal exporting country to Korea, but its stability in volume was low because Indonesia played a role of offsetting the decline of imports from china. The proportion of imports from Indonesia increased from 11.5% in 2000 to 46.4% in 2010 while that of China dropped from 44.2% to 4.2%. Figure 2-5 Steam Coal Price Stability by country Note: Based on the Annual prices over the period Source: Korea Customs Service, "Statistical Year Book of Foreign Trade". Ch 2. Domestic Coal Market Trends and its future 11

34 Figure 2-6 The Stabilities in Steam Coal Import market share by country Note: Based on the Annual prices over the period Source: Korea Customs Service, "Statistical Year Book of Foreign Trade". The long term bituminous coal demand forecast for Korea can be found only in the National Basic Plan for Energy(NBPE). According to a demand forecast(reference case) which was prepared for the revision of the National Basic Plan for Energy in 2010, the bituminous coal demand will increase at an annual average rate of 1.8% until But, in the case of low demand(policy objective case), it will decrease after In the 1st National Basic 12

35 Plan for Energy announced in 2008, however, the coal demand was projected to increase by an annual average rate of 1.3%. The coal demand forecast for the power generation sector, the largest coal user, can be derived from the Basic Plan for Electricity Supply & Demand. According to this plan, the demand for coal in the power generation will increase until 2020 then decrease thereafter, showing the same trend as in the low demand case of the revised National Basic Plan for Energy. Figure 2-7 Coal Demand Forecast in Korea Source: Korea National Energy Commission, "The 1st National Basic Plan for Energy", 27 August Korea Energy Economics Institute, "Energy demand forecast and Policy Objectives", presented at the public hearing on the National Basic Plan for Energy on 7 December Ch 2. Domestic Coal Market Trends and its future 13

36 Figure 2-8 Steam Coal Demand Forecast for Power Generation in Korea Note: The demand for coal in the Basic Plan for Electricity is estimated based on the forecast of generation and the performance of Source: Ministry Knowledge Economy, "The 5th Basic Plan for Electricity Supply and Demand", December Korea Energy Economics Institute, "Energy demand forecast and Policy Objectives", presented at the public hearing on the National Basic Plan for Energy on 7 December The policy objective case(low demand case) of the NBPE reflects not only the long term trend but also the Korean government's willingness to reduce the energy demand. But, the Basic Plan for Electricity Supply and Demand is an action plan. So, the Electricity Plan may be more realistic than the National Plan. In the end, we project that the steam coal demand for power generation will be 10 Mt more than the demand in the policy objective case of the revised 14

37 NBPE, even though both the demand forecasts predict the same downward trend in demand for coal in the mid and late 2010s and thereafter. The demand for coal in the iron & steel and cement industries will be a little greater than now, but there will be no chance of big change. It is because the increase of blast furnaces in the steelworks and of production facilities in the cement industry is not expected to be great. Currently, POSCO plans only to repair or replace its existing blast furnaces meanwhile Hyundai Steel has a plan to construct only an additional blast furnace. Therefore, considering the coal demand for generation will increase until the mid and late 2010s and then decline, we can expect the same trend holds true for the total demand for coal. However, the demand for coal after 2020 will be greatly affected by climate change negotiations, changes in public acceptance of new nuclear build. In particular, a deterioration in public acceptance of nuclear generation due to the nuclear accident caused by the Great Earthquake in Japan can bring about an unexpected rise of coal demand. Ch 2. Domestic Coal Market Trends and its future 15

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39 Ch 3. International Coal Market Trend and Structure a. Production and Consumption Global hard coal production has consecutively increased for the last 11 years. It increased by 6.8% in 2010, compared to the previous year, reaching 6.19 billion tons. This increase in 2010 was much higher than the increase in 2009(1.8%), which is mainly explained by an expansion of production in the non-oecd countries such as China, Russia, Indonesia, Kazakhstan, India, South Africa, Columbia and Vietnam. By region, the production increase in Asia, including China, is the most remarkable. Ex-Soviet and Australia show also a pronounced increase in production. In contrast, the production in Europe is decreasing. In North America, the coal production started to decrease from In Africa, the production is increasing but very slowly. The world production of steam coal shows the same trend as the total production of hard coal. The production in Asia, including China, is increasing very fast while the production in Europe is deeurope is declining. Ch 3. International Coal Market Trend and Structure 17

40 Figure 3-1 World Hard Coal Production Source: IEA, Coal Information, 2011 Figure 3-2 World Steam Coal Production Source: IEA, Coal Information,

41 creasing. The production in North America stood still until 2008 then began to decrease. But the production in ex-soviet, Latin America, Australia has been rising steadily. The consumption of hard coal is increasing significantly in the Asian region. In Latin America and Africa, it is also increasing steadily but slowly. On the contrary, the coal consumption in Europe and North America is in decline. In particular, the decrease in coal consumption in Europe is a long term trend since the late 1980s. The consumption of hard coal in the ex-soviet region decreased rapidly in the 1990s, due to economic recessions, but returned to an increasing trend, though moderate, since the late 1990s. The consumption of steam coal shows a similar trend to hard coal, as in the case of production. The steam coal consumption in China and other Asian regions is greatly increasing and the consumption in latin America is also steadily increasing. On the contrary, the European consumption is in a long term trend of decline. The consumption in North America stood still until 2008 and then started to decline. The ex-soviet region shows a standstill or a marginal increasing trend. As we reviewed above, the production and consumption of hard coal in Asia and Latin America is significantly increasing, while declining in Europe. Ch 3. International Coal Market Trend and Structure 19

42 Figure 3-3 Hard Coal Consumption Trend Source: IEA, Coal Information, 2011 Figure 3-4 Steam Colal Consumption Trend Source: IEA, Coal Information,

43 The production and consumption in North America showed a standstill until 2008 and then a declining trend. Like this, the coal production has a tendency of going side by side with the coal consumption all over the world. It is because coal is so voluminous and heavy that the long distance transportation of coal will generate a great deal of cost and environmental problems. b. International trade The international trade of hard coal had increased continuously but it has been at a standstill since The international trade increased at an annual average of 6.8% over the period, but it returned to a downward trend in 2008 and 2009 due to the global economic recession, reaching 940 Mt in 2010, only 10 Mt more than the level of Such a trade volume accounts for no more than 15.2% of world coal production, 61.9 Mt. By coal type, 24% of coking coal production and 12.8% of steam coal production are internationally traded. Considering that 65.2% of oil production and 30.5% of natural gas production are internationally traded 1), we can see that the proportion of traded volume in coal production is much lower than in other types of energy production. The trade of coking coal has not increased greatly, but that of 1) This is estimated for 2010, based on the statistics of BP(2011). Ch 3. International Coal Market Trend and Structure 21

44 steam coal has shown a great increase. That is to say, most of the increase in coal trade is accounted for by steam coal trade. The traded volume of coking coal increased by 80 Mt from 180 Mt in 2000 to 260 Mt in 2010 while the trade of steam coal increased by 270 Mt, from 400 Mt to 680 Mt. Figure 3-5 International Trade of Hard Coal Source: IEA, Coal Information, 2011 By region, the coal imports of North America, Europe and Aisa account for more than 90% of all the imports. But, the imports of Europe and North America is on a declining trend while that of Asia is increasing. This is mainly due to the increase in China and India as well as Korea, Japan and Taiwan. 22

45 Figure 3-6 Hard Coal Imports by region Source: IEA, Coal Information, 2011 Figure 3-7 Steam Coal Imports by region Source: IEA, Coal Information, 2011 Ch 3. International Coal Market Trend and Structure 23

46 The import of steam coal shows a similar trend to hard coal, but it is remarkable that the imports of China have been increasing since The steam coal imports of China reaching 33 Mt in 2008 and almost 100 Mt in 2010, China become the second largest coal importing country after Japan as well as a net importing country. The exports of coal are increasing in Asia(Indonesia in particular), Australia and ex-soviet region. The increase of coal exports from Asian region has a little slowed down since 2006 because the exports from China have dropped dramatically even though the exports from Indonesia have steadily increased. In contrast, the exports from Europe are on a declining trend. The exports from North America had been at a standstill but after 2005 turned bullish with an increase of its coal prices. Figure 3-8 Hard Coal Exports by region Source: IEA, Coal Information,

47 The steam coal export shows also a similar trend to the hard coal export. However, the importance of North America and Australia where the export of coking coal is relatively important has decreased significantly. The steam coal export from Australia, the largest coal exporter in the world, is roughly the same as that from Russia because about 50% of exports from Australia are coking coal. The steam coal exports from North America are also at a standstill at the same level from Europe. This is also because the coking coal exports account for about 60% of all the hard coal exports. Figure 3-9 Steam Coal Exports by region Source: IEA, Coal Information, 2011 Ch 3. International Coal Market Trend and Structure 25

48 In contrast, the major steam coal exporting countries such as Indonesia, ex-soviet states and South Africa play a more and more important role in the world steam coal market. As most of the hard coal trade in the world occur in Europe, Asia and North America, various types of coal markets are developed in these regions. In particular, steam coal spot markets are well developed in these regions. Though coking coal trading markets are also developed, spot trading of coking coal is not frequent because its trade volume is small and many transactions take place through bilateral long-term contracts. Another reason for this is that many steel companies prefer stable supply of coking coal and coal companies also seek stable demand for their products. a. North American market The North American coal market is a self-sufficient market in the sense that almost all the production is consumed within the region. Actually, in North America, the coal exports over the period account for only 7.9% of the total production and the imports 26

49 account for only 4.6%. The coal imports of North America have been decreasing since the middle of 2000s. Meanwhile, the coal exports had increased until 2008 with a rise of international coal prices, but decreased in 2009 with a decline of coal prices. This means that North America is a marginal exporting region. In other words, North America can expand its exports when the coal prices rise, but lose its competitiveness when the prices drop. In addition, as a significant part of exports from North America consists of coking coal, global economic conditions affect greatly its coal exports. Figure 3-10 Hard Coal Supply/Demand and Import/Exports in North America Source: IEA, Coal Information, 2011 Ch 3. International Coal Market Trend and Structure 27

50 In North America, various coal markets are well developed. The Central Appalachian coal is quoted on the future markets of New York and Chicago Mercantile Exchange and the steam coal of Australia, South Africa, China and Indonesia is traded over the counter. But, it is difficult to say that the coal prices in this region represent the global coal market prices since the international trade volume in this region is relatively small. b. European market In Europe, coal spot markets are well developed as a significant part of demand for coal is covered by imports. The proportion of imports in the total coal consumption increased gradually from 40% in 1995 to 53% in 2000, 65% in 2005 and more than 70% in 2008 while the coal production decreased due to coal industry rationalization policies. The coal production and consumption in Europe have declined continuously since the middle of 1980s and the coal imports have also declined since 2007 when the coal imports were a record high. In fact, the coal consumption which had declined more slowly than the production began to fall abruptly in Therefor, the European coal market which represented global coal market in the past is expected to be less important than ever. In particular, the decline of coal consumption in Europe will be intensified with the 28

51 implementation of EU ETS(Emission Trading Scheme) and the reinforcement of carbon tax. Figure 3-11 Hard Coal Supply/Demand and Import/Exports in Europe Source: IEA, Coal Information, 2011 c. Asian Market The coal production and consumption as well as the imports and exports are increasing greatly in the Asian region. The proportion of Asian coal consumption in the world increased from 51% in 2000 to 60% in 2005 and 70% in The share of Asian imports increased also from 51% in 2000 to 55% in 2005 and 67% in Such an increase is due to a great increase of coal production and consumption in China. The increase of coal production and Ch 3. International Coal Market Trend and Structure 29

52 consumption in Korea, Japan and Taiwan has also attributed to the Asian coal boom. Figure 3-12 Hard Coal Supply/Demand and Import/Exports in Asia Source: IEA, Coal Information, 2011 The increase of coal exports was made mainly through the increase in export from Indonesia and China. The exports in Asia stagnated temporally in 2008 due to the decline of exports from China but recovered its increasing trend after 2009, thanks to the increase in Indonesia. The coal exports from China are not likely to return to increasing trend in the near future because of the increase of coal consumption in the Chinese power generation sector. Though the Asian coal market is bigger than the European market 30

53 in terms of traded volume, spot market is not sufficiently developed because the distance between importing and exporting countries is relatively long and concerned parties prefer stable transactions based on the long-term contracts. However, Asian coal markets will lead the global coal market if new market participants like Russia expand their exports to Asia. Especially, as it is expected that rapidly developing countries like China and India will meet their increased demand for electricity with coal-fired generation, only the Asian coal market will be able to expand its trade volume. International steam coal prices have been in an increasing trend since March In March 2009, the steam price dropped to $75.25 per ton, but rebounded to $ in March 2010 and then $ per ton in January ). 2) Based on Asian marker(platts, October 2011) Ch 3. International Coal Market Trend and Structure 31

54 Figure 3-13 International Steam Coal Spot Prices Jan 2006 Apr 2006 July 2006 Oct Note : NW Europe is based on the ARA(Antwerp/Rotterdam/Amsterdam). Asia is based on Japan Source : Platts, ICR Coal Statistics Monthly, October The main factor leading such increase in coal prices is the increase of coal demand in Asian countries, especially in China and India. After becoming for the first time a net coal importing country in 2009, China imported 85.8 Mt(72.2 Mt of net imports) of coal in 2010 and became the third largest coal importing country in the world, following Japan(124.7 Mt) and Korea(90.9 Mt)(AME, October 2011) 3). India also increased steadily its coal imports, though not 3) Estimates of Chinese steam coal imports in 2010 are different between IEA and other organizations. IEA's estimation is 129 Mt while AME's is less than 90 Mt. 32

55 dramatically like China. It imported 59.8 Mt in 2010, becoming the 4th largest coal importing country in the world. As a result, the total coal imports in Asia amounted to Mt in 2008(3.1% increase compared to the previous year), Mt in 2009(12.3%) and Mt(10.3%). In comparison, the global trade volume showed a sign of stagnation or even decline in 2008 and The rise of coal prices in the end of 2010 and in January 2011 are explained by heavy rains in coal exporting countries. La Niña phenomenon brought about heavy rains in major coal exporting countries such as Australia, Indonesia, South Africa and Venezuela, resulting in disruption to coal production, transportation by rail and port closing. Abnormal cold weather in the northern hemisphere aggravated additionally the coal market situation. Indonesian government's reinforcement of export control and the increase of rail fare(26-30%) in South Africa are also thought to be another factor contributing to the increase of coal prices. Steam coal spot prices in Asia have been stabilized since January 2011 at about $130. Resumption of coal production, restoration of transportation facilities, rise of temperatures and power plant shut-down due to the Japanese earthquake have contributed to the stabilization of coal markets. Ch 3. International Coal Market Trend and Structure 33

56 The ocean freight charges are extremely volatile due to a mismatch between ship building and the quantity of seaborne trade. For example, the Baltic Dry Index (BDI), the most widely used freight index for bulk carrier, has been fluctuating a lot. In May 2008, the BDI reached the highest, but 7 months later, it declined to 1/20 of the peak level. Even though the freight charges have been fluctuating repeatedly since 2009, current fare levels are much lower than the level of period. The demand for marine transportation of dry cargo is expected to increase at an annual rate of less than 10% in the medium-term. In particular, it is difficult to expect a significant increase of marine trading volume, in the situation that outlook for economic growth is adjusted downward as European economy is very uncertain. In contrast, delivery of newly constructed vessels is expected to increase by more than 20% in 2011 and 15% in Therefore, a sharp increase in freight charge is not likely to occur in the near future. However, as the past has shown, there will be a great deal of volatility in freight charge. As current excessive delivery of newly-constructed vessels can be followed by a short supply in the future, it is necessary to keep a close eye on the bulk carrier market. 34

57 Figure 3-14 Freight Charges for Dry Bulk Carrier 02 Jan May Sep Source: Korea Maritime Institute( Ch 3. International Coal Market Trend and Structure 35

58 Figure 3-15 Dry Bulk Carrier Fleet and Delivery of Newly-Constructed Vessels < Cape-size Bulker> < Panamax Bulker> Note : Cape-size bulker is a vessel of more than 80,000 DWT which cannot pass through the Suez Canal. Panamax bulker is a vessel of 50,000-80,000 DWT which can pass through the Panama Canal. Source: : Korea Maritime Institute, 2011 Outlook for world freight, pp 83-84, November

59 Ch 4. Trends in the Major Exporting and Importing Countries a. China The coal demand in China is expected to increase continuously due to the current shortages of electricity and the continual increase in electricity demand. IEA(2011b) projects in its New Policies Scenario that the coal demand in China will increase at an annual average rate of 4.0% until 2015, but thereafter the growth rate will slow down to 0.8% for the period and -0.2% for the period. The annual average growth rate all over the forecast period to 2035 is expected to be 1.0%. But, FACTS(2011) expects a higher increasing rate than IEA. According to FACTS, the coal demand in China will increase from 3.4 billion tons in 2010 to 4.6 billion tons in 2020(annual increasing rate of 3.1% for the period) and 5.2 billion tons in 2030(annual increasing rate of 1.2% for the period). In this case, the annual average increasing rate over the forecast period is 2.1%, which is similar to the forecast of IEA based on the Current Policies Scenario. Ch 4. Major Exporting & Importing Countries 37

60 In response to this increase in coal demand, the Chinese government plans to increase the coal production by 550 Mt over the 12th five-year economic plan period 4). That is, it plans to increase the production from 3,240 Mt in 2010 to 3,790 Mt in For this, the Chinese government is going to establish 10 coal companies with an annual capacity of 100 Mt each and another 10 companies of 50 Mt each. As a policy of enlarging the coal mines, the Chinese government is now building some hubs of 'mines-rail-electricity'. That is, the government tries to deal with the shortage of electricity, enhancing the productivity of coal-fired generation by interconnecting state-owned mining companies, electricity companies, rail road and transportation companies one another. As of 2011, 14 hubs with a minimum capacity of 100 Mt for each are planned to be established to cover half of the Chinese total coal production. These hubs will be operated by state-owned companies and the central government (BMI, November 2011). Some new coal projects are now being developed in China: Gaohe project of Banpu, Gansu project of Chalco and Haerwusu project of Shenhua Group. If these projects are completed without a hitch, the Chinese coal production in 2015 will be more than 4,500 Mt, a level about 1,000 Mt higher than the production in ). 4) The increase of coal production over the 11th economic plan period was 890 Mt. 38

61 Table 4-1 New Coal Development Projects in China Companies Locations Production/Reserves Date of Operation Banpu(Thai) Gaohe 6 Mt per annum 2013 Chalco(China) Gansu 10 Mt per annum 2015 Shenhua(China) Haerwusu 150 Mt per annum (double output) Chinese Government Xinjiang 1,100 Mt (Reserves) na Chinese Government Ningxia 2,700 Mt (Reserves) na Source: BMI, China Mining Report, Q In spite of China's efforts to increase its domestic coal production, the increase of coal import in China will be inevitable. In particular, the South-Eastern coastal regions will heavily depend on imported coal because of the limited capacity of Chinese rail transport. In fact, though about half of the Chinese total rail transport capacity is used for coal transportation, the high transport cost due to the long distance between production regions and consuming areas and some bottleneck problems have made it inevitable to import the coal. The imports of steam coal are expected to increase from 86 Mt in 2010 to more than 100 Mt in 2013 and 120 Mt in ). 5) BMI expected an increase of 1,000 Mt in its report released in May 2011, but 1,400 Mt in the report released in December 2011(QI 2012). 6) The imports in 2013 are estimated by AME(October 2011) and the imports in 2015 are quoted from a consultation paper of Lee Yong-Jae(KOSEP) & An Sang-yong(KORES). Ch 4. Major Exporting & Importing Countries 39

62 China makes great efforts to develop overseas resources to secure a stable supply of coal. It agreed with Russia on purchasing a mine on the condition of a loan of $6 billion 7). In other words, China will be supplied 475 Mt of coal for 25 years, in return for offering a loan of $6 billion for the development of a large scale coal mine. The imports from Russia will be 15 Mt per annum for initial 5 yearss 8) and thereafter 20 Mt per annum. On the other hand, China plans to participate in the development of a large scale Mongolian mine, Tavantolgoi. In addition, China's Chalco and Monglia's state-owned company ETT agreed on a coal purchase contract of $2.5 billion in July b. India According to IEA(2011b)'s New Policies Scenario, the demand for coal in India will increase at an annual average rate of 3.1% over the perod to reach 880 Mt, about twice the 2010 level. Though this increasing rate is much higher than that of China(1.0%), the demand increase in India in absolute terms is equivalent to 70% of the increment in China(640 Mt). In fact, the coal demand in China in 2010 was 3,400 Mt, much higher than the demand in India. As in other countries, the increase in coal demand in India is 7) EIU(September 2011) p18. 8) The imports in 2010 was 11 Mt. 40

63 derived from the increasing demand in electricity generation sector. Of the newly constructed power plants in 2010, 91%(13 GW) were coal-fired power plants and most of the power plants which are planned to be constructed will be also coal-fired. The total capacity of newly constructed coal-fired power plants will be 98 GW; 31 GW for the plants under construction, 61 GW for the planned plants and 6 GW for the proposed plants(ame, February 2011). If the construction of these coal-fired power plants is completed, the coal consumption in these plants will be 250 Mt per annum. Of course, part of these plants will replace existing plants and some others cannot be completed as planned. However, most of the planned power plants will be realized with the surging demand for electricity. Currently, Indian coal industry has a big chance as the Indian government encourages private investments in the coal industry. Therefore, the coal production in India will increase with the increase in domestic demand. BMI(Q3 2011) projects that the hard coal production in India will increase by 200 Mt from 560 Mt in 2010 to 770 Mt in But, the production can be lower than expected because of inefficiency of government administration such as mining permission. Even though the domestic coal production increases at an annual rate of 6.6% as BMI expected, the steam coal imports will also increase by 40 Mt until 2015 to reach 100 Mt, because the domestic coal consumption will increase faster than the domestic production 9). Ch 4. Major Exporting & Importing Countries 41

64 c. Europe and Other regions The coal consumption and imports in Europe and North America are on a declining trend. According to IEA(2011b)'s New Policies Scenario, the coal demand in Europe and North America will decline at an annual average rate of 1.3% 10) and 0.6% respectively. This is because it will be inevitable to reduce coal consumption due to the reinforcement of environmental regulations and the mandatory greenhouse gas reduction. The coal exports from the United States, especially coking coal, have increased, replacing Australian coal exports which were disrupted by the heavy rains in But, such increase in American coal exports, which has occasionally occurred also in the past when the international coal prices soared because of shortage in supply, is not likely to continue in the long-term because the caol production cost in America is relatively high and the limited capacity of inland coal transportation restricts the increase in coal exports. Nonetheless, current increasing trend in coal exports will continue for a few years with the stagnation of shipping market 11). The coal imports in Japan will increase in the medium-term, but decrease in the longer term. The coal demand in power generation in 9) Quoted from the consultation paper of Lee Yong-Jae(KOSEP). 10) Except Russia. The coal demand in OECD Europe is expected to decrease 2.0% per annum. 11) See the consultation paper of Lee Yong-Jae(KOSEP). 42

65 2012 will be 99.2 Mt, an increase of 9.8 Mt compared to 2010, due to the delay of reactivating nuclear power plants(murakami, 2011). However, as in Europe and North America, it will be inevitable in the long term to reduce coal consumption for the greenhouse gas reduction. According to the "Basic Plan for Energy" published in 2010, the Japanese coal demand in 2030 will be lowered by 35%, compared to 2010(METI, 2010). Though the Basic Plan for Energy has been reviewed since the Fukushima nuclear accident, the coal demand reduction seems to be inevitable. The steam coal imports in 2010 in Taiwan were 59 Mt(total coal imports were 67 Mt). But, the increase in the steam coal imports will be slowed down in the medium term because of the operation of new nuclear and gas-fired power plants. Nonetheless, the increase in coal imports will be continued as about 80% of the steam coal consumption in Taiwan takes place in power generation sector and the share of coal-fired generation is expected to increase from 32% to 36% in ). a. Australia Australia had been the largest steam coal exporting country in the 12) quoted from the consultation paper of An Sang-Yong. Ch 4. Major Exporting & Importing Countries 43

66 Table 4-2 Coal Development Projects in Australia Companies Mines Production(Mt/yr) Date of Operation Xstrata Mangoola Xstrata Rolleston Peabody Energy Millenium Wesfarmers Curragh QCoal Byerwen BHP Billiton Goonyella Rio Tinto Hail Creek Hancock Coal Alpha Waratah Coal Galilee BHP Billiton Hunter Valley Shenhua Group Watermark 10 n/a Total Source: BMI, Australia Mining Report, Q Table 4-3 Extension Projects for Coal Terminal in Australia Projects Companies Locations Com. Date Expansion (Mt/yr) Abbot Point Coal Terminal X 50 North Queensland Bulk expansion Ports Bowen Abbot Point Coal Terminal X 80 North Queensland Bulk expansion Ports Bowen Abbot Point Coal Terminal X 110 North Queensland Bulk expansion Ports Bowen QLD Balaclava Island coal terminal Xstrata 50 km N of Gladstone Hay Point Coal Terminal(Phase 3) BHP Billiton Mitsubishi 20 km S of Alliance (BMA) Mackay Wiggins Island Coal Wiggins Island Coal Terminal(stage 1) Export Terminal Gladstone Wiggins Island Coal Wiggins Island Coal Terminal(stage 2) Export Terminal Gladstone NSW Kooragang Island coal terminal Port Waratah Coal Newcastle expansion Services Newcastle Coal NCIG export terminal(stage 2) Newcastle Infrastructure Group Total Note: Quoted from the consultation paper of Ann Sang-Yong. Original sources are from Australia Black Coal Industry(March 2011). 44

67 world until 2003, and is still one of leading countries which are exporting high quality steam coal. As of 2010, Australia is the second largest steam coal exporting country after Indonesia, exporting 145 Mt of coal(ame, October 2011). In respect of total coal exports, Australia is still the largest exporter in the world, exporting 294 Mt. The coal production in Australia is expected to increase continuously in the future. The coal production in 2015 will amount to 560 Mt, 150 Mt more than the production in 2010(BMI, Q4 2011), even though the production in 2011 is expected to decrease a little due to the flood. This forecast reflects the planned coal development projects. The production capacity of Australia will increase by 130 Mt until 2014, with the completion of the planned coal development projects. With the increase in production, coal exports increase also by 150 Mt, total coal exports amounting to 440 Mt in In particular, the steam coal exports in 2015 will be 225 Mt with an increase of 80 Mt from 145 Mt in ). In response to this increase in exports, the capacity of coal terminals will be extended. Most of the extension projects for coal terminal are planned to be completed by So, 220 Mt of export capacity will be added in Therefore, the current problems of 13) Quoted from the consultation paper of Lee Yong-Jae(KOSEP). Ch 4. Major Exporting & Importing Countries 45

68 demurrage will be alleviated after b. Indonesia Indonesia is the largest steam coal exporter and a leading provider of low calorific value coal in the world market. In 2010, Indonesia produced 360 Mt of hard coal and exported 260 Mt. The coal production in Indonesia will increase steadily and fast in the future, thanks to the fast-growing coal demand in China and India and the high prices in international coal markets. The coal production in 2015 is expected to be 530 Mt, 170 Mt more than the production in 2010, and the coal exports to be 350 Mt, 90 Mt more than ). A sharp rise in coal exports from Indonesia is not likely to occur as Indonesian domestic coal demand is in a increasing trend and the obligatory supply ratio for domestic demand is expected to be raised. In particular, the Indonesian government intends to induce domestic consumption of low calorific value coal and to raise the value added of coal exports, by prohibiting the exportation of some low calorific coal(less than 5,600kcal/kg) from On the other hand, an Indonesian state-owned electricity company, PT PLN, plans to extend its coal-fired power plants by 12.6 GW until If this plan is realized, Indonesian domestic coal demand 14) Quoted from the consultation paper of Lee Yong-Jae(KOSEP). 46

69 will be increased by 44 Mt per annum. However, this plan will be delayed for 2 years more than expected, as a considerable part of the planned plants have not yet been commissioned(bmi, Q4 2011). Table 4-4 Coal Development Projects in Indonesia Companies Projects Production (Mt/yr) Date of Operation Kangaroo Resources Jawana,Borami, MBK, & BP na Exploration Kangaroo Resources GPK 141(Reserve) Consider purchase/partici pation Banpu Bharinti Harum Energy Tambang Batubara Harum, Santan Batubara, Mahakam Sumber Jaya 20(Production Capacity) 2012 Adaro Energy Envirocoal-Wara, etc Adaro Energy Kelanis Terminal 30 (Increase in capacity) 2012 Kangaroo Resources Mamahak Project 10.22(Reserve) 2012~2013 Churchhill Mining East Kutai Bumi Resources-KPC Sangatta Gunung Bayan Pratama Bayan FKP BHP Billiton & Dianlia Setyamukti Bukit Asam Lampunut Rail extension and Mine purchase (Kalimantan) Source: BMI, Indonesia Mining Report, Q Nevertheless, as power plants consuming pitch coal are in an increasing trend in China, India and South-East Asia, and Indonesian coal has some advantage over other coals, such as the lowest production cost in the world and relatively short traffic distance, the Ch 4. Major Exporting & Importing Countries 47

70 demand for Indonesian coal will be increased continuously. So, a number of coal companies seek to increase their production. Berau Coal and Bumi Resources plan to increase their production by 3 Mt and 6 Mt respectively in Adaro Energy also plans to double its production from 42 Mt in 2010 to 80 Mt in c. South Africa and Mozambique The coal production and exports in South Africa have been at a standstill for the last 5 years. The production has remained at a level of 270 Mt and the export at 70 Mt. The sluggish production and exports in South Africa are mainly caused by the recession of European market, the increase in production cost and the limited capacity for transport. However, in the future, the increase of coal demand in China and India and the expansion of transport capacity can make it possible for South Africa to increase its production more rapidly than ever before. The expansion of production capacity will be implemented by existing companies. The largest coal company in South Africa, Anglo American, will maintain its dominant position by increasing its annual production capacity to 25 Mt by 2015 through Elders and New Largo Project. BHP Billiton also has a plan to expand its capacity of Douglas-Middelburg mine to 10 Mt. Sasol is planning to offset the dwindling production of Twistdraai coal mine(4 Mt in 48

71 2010) which is scheduled to be closed in 2014, by developing Thubelisha mine(a production capacity of 4.5 Mt per annum). With such expansion plans, the coal production in South Africa is expected to be 370 Mt in 2015, an increase of 90 Mt compared to 2010(BMI, Q4 2011). Especially, the capacity expansion of Richard Bay coal terminal, from 72 Mt to 91 Mt per annum, in May 2010 will do much to increase the production and exports in South Africa. Companies Table 4-5 Coal Development Projects in South Africa Projects Production (Mt/yr) Date of Operation BHP Douglas-Middelburg Xstrata Goedgevonden Sasol Thubelisha Exxaro Grootegeluk project Anglo American Elders Anglo American New Largo Source: BMI, South Africa Mining Report, Q In contrast, Mozambique produces mainly coking coal. So, China and India, suffering from shortage of coking coal, take a great interest in the country and a lot of coal development projects are being conceived. As coking coal prices are expected to be high for a considerable period of time, Mozambique can become as big an coal exporter as South Africa, exporting as much as 100 Mt of coal in Ch 4. Major Exporting & Importing Countries 49

72 2025, despite the poor transport facilities. Most of the coal development projects are now centered on Tete region rich in resources. As Vale of Brazil, Rio Tinto of Australia, Coal India Ltd of India, Nippon Steel of Japan and POSCO of Korea are all involved in the development of Mozambique's coking coal, the production level will increase almost 25 times from 2.4 Mt in 2010 to 60 Mt in 2015(BMI, December 2011). Table 4-6 Coal Development Projects in Mozambique Companies Locations Production (Mt/yr) Date of Operation Vale Moatize, Tete 1st stage: nd stage: Beacon Hill Resources Minas Moatize, Tete Rio Tinto Benga, Tete (with expanded capacity) 2011 Rio Tinto Zambeze Province 45 90with expanded capacity) 2014 Coal India Ltd. Tete Nippon Steel, POSCO Revuboe, Tete 5 10with expanded capacity) 2014/2015 China Kingho Maravi, Tete Early stage of exploration na Source : BMI, Mozambique Mining Report, Q : Energy Economist, September 2011, pp 18~21 50

73 Vale, the largest iron ore company in Brazil, has invested $1.7 billion in Moatize I project so that its coal production will be 12.7 Mt per annum at the end of 2013(9.8 Mt for coaking coal, 2.9 Mt for steam coal). If Moatize II project is completed, its production level will reach 24 Mt per annum. Riversdale(Rio Tinto) of Australia started to produce coal at the end of 2011 with its Benga Project. Its production is expected to reach 5.3 Mt per annum(coking coal: two thirds, steam coal: one thirds) in 2013, but the maximum production level is estimated at about 20 Mt per annum, with the reserve being 4,500 Mt(Energy Economist September 2011 and BMI Q4 2011). Coal India Ltd is also planning to increase its production to a level of 15 Mt per annum, starting from Meanwhile, a consortium consisting of POSCO, Talbot and Nippon Steel is planning to develop Revuboe coal mine to produce 10 Mt of coal per annum for 25 years. d. Russia and Mongolia The coal production in Russia has been increased by 3.4% per annum since 2005, reaching 250 Mt(hard coal) in The increase in production is expected to continue in the future, but it is difficult to expect a dramatic rise of coal export because of the need for long-distance transportation and the high production cost. However, Russia is now trying to improve its transportation Ch 4. Major Exporting & Importing Countries 51

74 facilities to increase its coal exports to Asia where the coal demand is greatly increasing. The largest steam coal company in Russia, SUEK, has undertaken a project in March 2011 to expand coal terminal capacity in Vanino from 12 Mt to 24 Mt(Bulk Solid Handling, 2011). Mechel, a company mainly dealing with coking coal, is also constructing a first stage coal terminal(capacity of 5 Mt) in Vanino. This terminal will be expanded to the scale of 25 Mt through the second and the third expansion projects(rzd partner, 2010). If these expansion projects are completed without a hitch, the Russian coal exports to Asia will be greatly increased in parallel with the exports to China by rail. Table 4-7 Coal Development Projects in Russia Mines st Stage ( 2015) 2nd Stage ( 2022) 3rd Stage ( 2030) Donetsk 8 7 5~6 7~8 5~8 Ural 5 4 2~3 3~4 5~8 Pechora ~13 12~13 12~13 Kuznetsk ~ ~ ~205 Kansk-Achinsk ~55 55~87 90~115 East Siberia ~46 53~54 58~60 Far East ~38 39~46 44~57 Total ~ ~ ~470 (Coking Coal) (69) (66) (70~84) (90~94) (101~106) Note: Quoted from the consultation paper of Ann Sang-Yong. Original sources are from Russian Federation Energy Strategy 2030 (unit: Mt) 52

75 On the other hand, the coal production in Mongolia in 2010 was not so great, 12.7 Mt. But, with its large scale coal reserve, Mongolia is likely to be an important coal producer. Neighboring countries including China, which can exploit directly the Mongolian coal, are more active in the coal development in Mongolia. In fact, China, Russia, Japan and Korea have expressed an active interest in the development of Tavan Tolgoi coal mine the reserve of which is estimated at 6,500 Mt. A Chinese company, Chalco, agreed with the Mongolian state-owned ETT (Erdenes Tavan Tolgoi) on the trade of $250 million coal of East Tsankhi coal mine in July 2011(BMI, Q4 2011). As of 2011, six projects for coal development are being implemented. Most of these projects are expected to commence their operation by Therefore, the production in 2015 will be more than twice the production in 2010, but the production increase is as small as 14 Mt in absolute terms. A large scale coal production in Mongolia will be possible only after Tavan Tolgoi coal mine(reserves 6,500 Mt) is fully developed. Tavan Tolgoi's coal reserves account for 79% of all the Mongolian coal reserves, 8,200 Mt. However, a recent dispute over the development rights on the western block of Tavan Tolgoi, West Tsankhi(reserves 1,200 Mt), can delay the development of the mine. In July 2011, the Mongolian government announced that a consortium of Peabody Energy(US), Shenhua(China), a Russian rail Ch 4. Major Exporting & Importing Countries 53

76 railroad company and a Mongolian company had been selected as a developer of West Tsankhi. However, as some Korean and Japanese companies which were participating in Shenhua and the Russian railroad company were excluded from the consortium, the Korean and Japanese government called into question the selection so that the final decision was delayed. Table 4-8 Coal Development Projects in Mongolia Companies Mines Production (Mt/yr) Reserves (Mt) Date of Operation KOCOAL Boroo 1 n/a 2013 South Gobi Ovoot Tolgoi Rise from Prophecy Resource Ulaan Ovoo /2014 Hunnu Coal Tsant Uul and Unst Khudag 4 n/a 2014 South Gobi Tsaagan Tolgoi n/a Mongolian Gov. Tavan Tolgoi n/a 6, /2015 Source: BMI, Mongolia Mining Report, Q4 2011

77 Ch 5. Influencing Factors on the Changes in the International Steam Coal Market a. Changes in Japanese coal demand for power generation The size of generation facilities which have been closed due to the Great Tohoku Earthquake(on 11 March, 2011) amounts to a total of 27,160 MW(including regular overhaul facilities), representing 27.5% of the total generation capacity in the affected area(ieej, March 2011). By electricity company, Tohoku Electric Power's facilities are 5,600 MW, Tokyo Electric Power 15,900 MW and other wholesale electricity generators 5,600 MW. By energy, 12,370 MW of nuclear power and 7,050 MW of coal-fired plants were closed(lee W.W., May 2011). Some of damaged nuclear power plants can be reactivated, but it will take a long time to restore them because of safety inspection. Any way, it will be inevitable to shut down the units 1-4 of the Fukushima Daiichi nuclear plant in which some explosions and radiation leakages have occurred during the accident. The 7,050 MW of coal-fired power capacity which was shut down Ch 5. Influencing factors on the changes in the International Steam Coal Market 55

78 by the earthquake accounts for about 70% of all the coal-fired capacity(10,150mw). The reason why coal-fired plants were damaged so greatly is that the plants are located in the vicinity of coal importing ports or in the seaside. Of the stopped plants, 1,000 MW of Hitachi coal-fired plant (Tokyo Electric Power) resumed the operation in May 2011, another 1,800MW, including Nakoso steam plant, in June and July, 4,250MW in September Like this, it took much time for coal-fired power plants to resume their operation because the docking facilities in the ports were destroyed as well as the plants themselves. Table 5-1 Coal-fired Power Plants in the earthquake area Investor owned (unit: MW) J-Power IPP Total Tohoku Electric 3,200-4,150 7,350 Tokyo Electric 1,600 1,200-2,800 Note: Coal-fired plants in Japan are a total of 85, 37,952MW. Source : Handbook for Electricity Business(2010)(Japanese) Because of the shutdown of coal-fired plants, the estimated Japanese coal imports for power generation in 2011 decreased by Mt, compared to the previous year(ieej, June 2011). The coal demand in Tohoku and Tokyo Electric areas is estimated to have decreased by Mt, taken into consideration that the coal 56

79 demand in 2010 was relatively high. Meanwhile, the demand in Chubu Electric area seems to have increased by 1.6 Mt as Chubu Electric raised the capacity factor for its coal-fired generation to response to the shut-down of its Hamaoka nuclear plant. Hamaoke nuclear plant was slightly damaged by the earthquake, but Japanese Prime Minister Naoto Kan requested the plant to stop the operation because experts at the Ministry of Education, Science and Technology had warned that there would be an earthquake and tsunami in the magnitude of more than 8 with a probability of 87% within 30 years in the area. Chubu Electric Power accepted this request on 6 May 2011 and decided to stop the operation of Unit 3, 4, 5 of Hamaoka nuclear plant(a total of 3,473MW). Unit 1 and 2 had already been shut down permanently in January Therefore, the electricity shortage of Chubu Electric have had to be dealt with by other sources of power. The steam coal spot market responded to the earthquake with a drop of coal prices. The Australian steam coal spot prices dropped by $10 per ton in the next week after the earthquake, compared to the very week when the earthquake happened. When the earthquake happened on 11 March 2011, the Australian Newcastle Spot price(fob) was $130 per ton, but it dropped to $120.5 after a week on 18 March Thereafter, it maintained a level of $120 even in the third quarter of Ch 5. Influencing factors on the changes in the International Steam Coal Market 57

80 Figure 5-1] Steam Coal Spot Prices before and after the Japanese Earthquake Note : This is based on FOB Newcastle(Australia), 6,300kcal/kg, average price of the week including the marked day. Source : KOMIS In the short term, the steam coal demand will increase with the rise of capacity factors in existing plants. But the effects on international coal market will be not so great. Even if the capacity factors of all the coal-fired power plants(10,150mw) in the damaged area were raised to 90%, the expected increase in coal demand would be just 5 Mt. The increase of 5 Mt in coal demand accounts for only a 4% of all the steam coal imports in Japan and 1% of all the imports in Asia. Of course, as the coal demand in 2010 has decreased by about 7 Mt, the expected increase in demand in 2012(12 Mt including the increase due to the rise of capacity factor) can be seen remarkable. But the effects of this increase on 58

81 international market may be moderate as it was fully expected. Nonetheless, the shut-down of all the nuclear plants in Japan, the worst case, will have a great impact on the international coal market. If the capacity factor of all the coal-fired power plants in Japan is raised to 90%, an incremental 20 Mt of steam coal will be needed. This amount is equal to 15% of Japanese steam coal imports and 4 % of Asian imports. As we mentioned earlier, Chubu Electric accepted the request of Prime Minister Naoto Kan to stop the operation of Unit 3, 4, 5 of Hamaoka nuclear power plant on 6 May However, it will be almost impossible to stop the operation of all the Japanese nuclear power plants, being aware of all the problems of limited power supplies. In fact, in the middle of June 2011, the Japanese government expressed an intention to reactivate some nuclear plants which had completed the safety inspection. From a realistic point of view, even if all the nuclear plants are shut down, the additional demand for coal will be less than 10 Mt. The additional demand of 20 Mt, mentioned earlier, will be a maximum for the worst situation. For example, the Institute of Energy Economics, Japan(IEEJ), projected on 13 June 2011 that the additional steam coal imports for 2012 would be 9.1 Mt. And, according to a short-term forecast, released by IEEJ in July 2011, the coal demand in 2012 will increase by 9.8 Mt(8.65 Mt for power generation), compared to These forecasts are based on an Ch 5. Influencing factors on the changes in the International Steam Coal Market 59

82 assumption that maximum capacity factor for coal-fired power plants will be 85% as in the past. b. Changes in global coal demand The nuclear accident following the Great Tohoku earthquake brought about a great spread of opposition to nuclear power generation. After the earthquake, Germany, Italy and Swiss have decided to close up the existing nuclear power plants and to suspend the construction of new nuclear plants. Germany has decided to close up 17 nuclear plants(20,339mw) in operation until 2022, and Swiss has decided to suspend the construction of new plants so that all of the 5 existing nuclear plants would be shut down by 2034(WNN, May 2011). In Italy, a ban on new construction of nuclear generators was approved by a majority of voters(94%) in a referendum in June 2011(WNN, June 2011). Japan, the country where the nuclear accident happened, is though planning to restore the stopped nuclear plants. But, Prime Minister Noda mentioned that the dependence on nuclear power would be reduced in a longer term. And, a reduction of nuclear power program will be also formalized even in the "Basic Plan for Energy" which is currently being reviewed. In contrast, other countries have not yet expressed officially the 60

83 closure of nuclear plants, even though they have been strengthening their safety management of nuclear plants. Many countries, including the US, France, Russia, Korea, China, the UK and India, continue to implement their own existing nuclear programs. China, which has planned to construct the largest number of nuclear plants, is now strengthening safety measures, delaying the final approvals of newly constructed nuclear plants. However, China is expected to increase in the end its nuclear power capacity to 60-70GW as it has originally planned(wnn, September 2011d) 15). Indian Prime Minister Singh proclaimed that India would continue to implement without a hitch its nuclear plan to expand its capacity to 63GW by Russia also reaffirmed it would double its nuclear power capacity by Recently, Spain allowed two nuclear plants to prolong their lives. South Africa is implementing a new nuclear project of 6 plants(9.6 GW)(IEA 2011b, Reuter 2011, EBR 2011, Business Standard 2011). In respect of long term nuclear outlook, it is difficult to analyse the effects of the Japanese nuclear accident. IEA(2011b) also makes it clear that its Less Nuclear case does not show the paths after the Fukushima nuclear accident. Anyway, in the following section, we will try to review indirectly the effects of the Japanese accident on 15) The Chinese nuclear objective for 2020 was set at 40Gw in 2007 but revised at 80GW in A long term objective for 2030 is set at 200GW and for 2050 is set at GW. As of early 2011, a total of 30GW nuclear capacity is being constructed(andrew-speed, 2011). Ch 5. Influencing factors on the changes in the International Steam Coal Market 61

84 the new construction of nuclear plants in the future, comparing the long term energy outlook with the forecasts of 2010 which are conducted before the nuclear accident by major energy organizations. According to a report of WNA(World Nuclear Association) released on 15 September 2011, the world nuclear capacity will be increased by 69% until 2030(WNN, Sep 2011c). That is, the nuclear capacity will increase from 364GW in 2010 to 411GW in 2015, 471GW in 2020 and 614GW in This means that the world energy situation will not change significantly despite the closure of nuclear plants in Germany and Japan. In particular, this report expects that of the countries(the US, China, India, Russia etc.) which will play a determinant role in nuclear power, China, India, Korea and the UK will be likely to continue their nuclear expansion policy. In the case of upper scenario, the nuclear power capacity in 2030 will be 790GW, showing an increase of 117% compared to now. In contrast, the IAEA(International Atomic Energy Agency) projects the nuclear capacity in 2030 will be GW, an increase of % compared to now(iaea 2011, WNN 2011b). This forecast is a little lower than that in 2010, reflecting the shut-down plans in Germany and Japan and the construction delays in other countries. In some respects, we can say that the forecasts of WNA and IAEA are a little optimistic about the future of nuclear energy because they are professional organizations in the field of nuclear 62

85 energy. Nevertheless, they are not much different from those of IEA or EIA. The US EIA projected in its International Energy Outlook released on 19 July 2011 that the nuclear energy consumption would increase by 75% until The world consumption is expected to increase by 2.4% per annum. Especially, China and India will show an high increase of more than 10% per annum. This increase will be caused by an increased awareness of energy security and enhanced regulations of carbon emissions as well as improved utilization of nuclear power facilities. In fact, the capacity factor of nuclear power plants was only 65% in the 1990s, but it reaches now a level of 80% and will improve continuously in the future. Anyway, the forecast of the EIA in 2011 is 9% higher than the forecast in 2010, suggesting that it did not consider the effects of the Japanese nuclear accident, either. The IEA projected that the world demand for nuclear energy would increase by 68% until 2035 in its World Energy Outlook released in November This forecast is 5% lower than the forecast in 2010(New Policies Scenario). Thanks to the reduced demand for nuclear energy, the demand forecast for natural gas is increased by 5% and coal by 4% respectively, compared to the forecast in The demand forecasts for total primary energy and renewable energy are also modified 16). Even 16) In the forecast of IEA in 2011 compared to the forecast in 2010, primary energy demand is 1.3% higher than the 2010 forecast, coal 4.3%, gas 4.8% meanwhile the demands for oil, nuclear and renewable energy are 04.%, 4.8% Ch 5. Influencing factors on the changes in the International Steam Coal Market 63

86 though it is difficult to say that the increase in coal demand is directly related to the decrease in nuclear energy, we need to keep in mind that the coal demand can increase as fast as the demand for natural gas or a little less. However, the coal prices are expected to increase by only 10% from $100 per ton in 2010 to $110 17) in In absolute terms, this forecast is not much different from the IEA's 2010 forecast which projected that the steam coal prices would increase by 9.5% from $97.3 in 2009 to $ ) in Shares in power generation Table 5-2 IEA's Low Nuclear Scenario Nuclear Coal Natural Gas Renewable (2009) actual 13%* 41% 21% 19% (2035) Low Nuclear 7% 36% 24% 32% (2035) New Policies(ref) (17%) (33%) (22%) (31%) Changes in Low Nuclear case(compared to New Policies case) Capacity -298GW +80GW +122GW +260GW Fuel Requirements 5% 3% Fuel Prices 2% 4~6% * Actual record for 2010 Source: IEA, World Energy Outlook, 2011(b), pp 447~467 and 1.8% lower than the 2010 forecast respectively. 17) This price is an average import prices in OECD, based on 2010 constant prices(iea 2011b, p.363). 18) This is based on 2009 constant prices(iea 2010b, p.71). 64

87 In the IEA's World Energy Outlook 2011(IEA 2011b), a Low Nuclear Case is also reviewed. In the Low Nuclear case, nuclear generation capacity is expected to be 335GW 19) in 2035, a decrease of 15% from 393GW in 2010 and an increase of 47% compared to the 2035 level in New Policies Scenario(NPS). The proportion of nuclear energy in power generation in 2035 is reduced by 10%p while the proportion of coal is increased by 3%p, natural gas by 2%p and renewable by 11%p respectively, compared to the NPS. As a consequence, the demand for coal is increased by 5%, natural gas by 2% respectively and, in terms of prices in 2035, the coal price is increased by 2%, natural gas by 4-6% according to region, compared to the NPS. Taken together, the nuclear accident caused by the Great Tohoku Earthquake will bring about a reduction in construction plans of nuclear power plants in the near future. But, most of the forecasts for 2035 projected that its long-term effects would not be so great. The 2011 forecast for nuclear energy is just a little lower, 5%, than the 2010 forecast. And, such a relative decline in nuclear energy, compared to the 2010 forecast, seems to have little effect on 19) This is based on an assumption that the facilities under construction will be completed, but there will be no new construction project in OECD countries and, in non-oecd countries, only 50% of the objective in New Policies Scenario will be implemented. In addition, it is assumed that the lifespan of nuclear plant will be reduced by 5 years compared to the New Policies case, so that the lifespan of pre-1980 nuclear plants is 45 years and post-1980 is 50 years. Ch 5. Influencing factors on the changes in the International Steam Coal Market 65

88 international coal markets. On the other hand, even in the IEA's Low Nuclear Scenario, the coal price is just 2% higher than the price in the NPS. However, we need to keep in mind that the coal markets in the Asian region are currently tight and the increase in demand for coal will also occur mainly in the Asian region. Even though not so realistic, the demand for coal in the Low Nuclear Scenario is increased by 290 Mt, compared to the NPS. In this case, it will be possible for international trade volume to increase by about 50 Mt 20). Generally, the prices of commodities which are related to one another have a tendency to move in the same pattern. It has been believed that such price co-movement is caused by macro-economic impacts which have the same influence on world commodity markets at the same time. And, some complementarity or substitutability which exist between the correlated commodities are regarded as a main cause to bring about such phenomenon. However, this price co-movement phenomenon has been often found among the commodities which appear to be not related to one another. 20) The current international trade volume for steam coal accounts for 12.8% of total coal consumption. An increase of 50 Mt in trade volume corresponds to an increase of 5% in this proportion. 66

89 When the prices of non-correlated commodities move in a similar way, we call it Excess Co-movement. The fact that two commodities are not related to each other means that the cross price elasticity of demand and supply between the two commodities is almost zero. In addition, the excess co-movements have been observed even when the effects of macro-economic impacts are fully considered. Figure 5-2 Trends of Steam Coal and Crude Oil Prices Source: The steam coal prices have moved in the same pattern as crude oil prices since Though, before 2005, the prices of steam coal and crude oil moved in a similar way, the movements were a little different. However, the movements after 2005 have shown a very similar pattern in terms of amplitude as well as direction(see Figure 5-2). So, we can say that the price co-movement of steam coal and Ch 5. Influencing factors on the changes in the International Steam Coal Market 67

90 crude oil has been intensified since the middle of 2000s. Figure 5-3 shows such price relationships in a more intuitive manner. There, we can find that the steam coal prices have an intimate relationship with soybean oil as well as crude oil. From now on we will make an analysis on the price co-movement phenomenon between steam coal and other primary commodities. Figure 5-3 Price Correlation among Steam Coal, Crude Oil and Soybean Oil Source: 68

91 a. Methodology 21) Pindyck and Rotemberg(1990) is a representative study on excess co-movement of commodity prices. This study shows that there may be some excess co-movement phenomena which cannot be explained by the impacts of common macro-economic variables, treating the commodities which have low cross price elasticity among them, such as wheat, cotton, copper, gold, crude oil, rubber and cocoa. Since the release of Pindyck and Rotemberg(1990), the excess co-movement phenomenon has been dealt with in various studies. Especially, these studies have tried to measure the degree of excess co-movement, using various types of time-series analysis. Palaskas & Varangis(1991), Palaskas(1993), Trivedi(1995) are representative studies on this matter. These studies showed that the degree of excess co-movement is less severe than expected in Pindyck & Rotemberg(1990). In particular, Cashin et al.(1999), McDermott & Scott(2000), Cashin et al.(2002) have proposed a new clearer definition on the price co-movement phenomenon among non-correlated commodities. In these studies, a concept of 'concordance' is introduced as an alternative method to measure the degree of co-movement in time-series data. It is Pagan(1999) and Harding & Pagan(1999) who 21) This section is based on a consultation paper of Yoon, W.C. (Hanyang University)(Yoon, 2011). Ch 5. Influencing factors on the changes in the International Steam Coal Market 69

92 estimated some concordance for the first time. And, McDermott & Scott(2000) described some statistical characteristics of these estimates. Major concerns of our study are to make an empirical analysis on co-movement between steam coal price and other major commodity prices. For this, we try to make a concordance analysis, which were introduced by Cashin et al.(1999) and McDermott & Scott(2000), in parallel with a traditional correlation analysis. Then, we will explain some causes of price co-movement, comparing the two analytic results. Correlation Analysis is a method to find a certain linear relationship between two variables, with probability theory and statistics. The two variables may be independent of or related to each other. At this point, the degree to which the two variables are related to each other is called 'Correlation'. The Correlation Coefficient,, is an indicator which represents a degree of correlation. The correlation coefficient represent only a degree of relationship between two variables, but it does not explain a casual relationship between them. The direction and the degree of casual relationship between the two variables can be identified by a regression analysis. 70

93 There are two types of correlation analysis. The degree of correlation between two variables is measured by a simple correlation analysis while the correlation among more than three variables is measured by a multiple correlation analysis. Partial correlation analysis is a method to measure the correlation between two particular variables in a multiple correlation analysis on a condition that other variables are constant. At this moment, if 0 < +1, there is a positive correlation between the variables. If -1 < 0, there is a negative correlation. The fact that = 0 does not mean there is not any correlation between variables, but it means just there is no linear correlation. Various types of correlation coefficient are also used according to the purpose of analysis. Pearson correlation coefficient is most widely used. This coefficient represents a proportion between the degree of co-movement of two variables and the degree of their independent movement. So, the Pearson correlation coefficient between two variables is defined as follows. (1) Roughly speaking, if -1.0 < -0.7, there is a strong negative linear relationship between two variables, and there is a considerable negative linear relationship for -0.7 < -0.3, a weak negative Ch 5. Influencing factors on the changes in the International Steam Coal Market 71

94 for -0.3 < -0.1, a negligible linear relationship for -0.1 < +0.1, a weak positive for +0.1 < +0.3, a considerable positive for +0.3 < +0.7 and a strong positive linear relationship for +0.7 < The sample distribution of Pearson Correlation Coefficient is assumed to have approximately a t-distribution(with N-2 degrees of freedom where N is the number of samples). The statistical significance test can be made by using the t-statistics as follows. (2) The term concordance means a degree to which cycles of two variables take place at the same time. The concordance is measured as a proportion of the period during which two variables exist at the same time on same phase(upward or downward), in the whole period. This concept of concordance can be used to analyse the price co-movement phenomenon. It is because we can summarize informations on clustering at the turning point. In other words, the concordance explains whether different commodity prices change at the same time from peak to slump or vice versa. In comparison with correlation analysis, concordance analysis can explain more properly the price co-movement phenomenon. In the 72

95 sense that price co-movement tells whether two commodity prices exist at the same time on an upward or downward trend, concordance analysis may be more appropriate than correlation analysis. In fact, concordance analysis considers a degree of simultaneity as well as whether the two commodity prices exist at the same time on a particular phase. In contrast, correlation analysis focuses only on periodicity of two time-series data. But correlation coefficient has nothing to do with how much the two time-series data move together on a particular phase. Another advantage of concordance analysis lies in its ability to avoid some errors correlation analysis makes when a great market disturbance like a temporary jump or drop in prices occurs. For example, the correlation coefficient of two commodity prices which show an almost independent and random pattern may be considerable low when there is no market disturbance, but it will be high when there is a temporary price spike. In other words, the correlation analysis can provide an erroneous information in a way that the correlation appears higher than it actually is when the two serial data show a dramatic change at the same time. In effect, as we can see frequently a dramatic change in economic serial data such as commodity prices, the correlation analysis focusing on price co-movement is likely to lead to an erroneous conclusion. The Concordance Coefficient or Measure of Concordance which represents a degree of co-movement between two serial data shows Ch 5. Influencing factors on the changes in the International Steam Coal Market 73

96 whether a proportion of the period during which two serial data, and, exist in the same state at the same time in the whole period is statistically significant or not. The two states can be on a boom(expansionary phase) or a slump(contractionary phase). Let's assume that if a commodity price is on a boom at the time of t, the state variable equals 1 and if on a slump, the state variable equals 0. Similarly, let's assume that the state variable for another commodity price takes 1 or 0 in the same manner. Then, the concordance coefficient of two serial data which have different cycles is defined as follows. (3) where T represents the sample size used. McDermott & Scott(2000) propose a test procedure on the statistical significance of an estimated concordance. In this study, a result of response surface regression, instead of critical values by significance level according to different sample sizes and minimum ratio of serial data, is reported. The response surface regression equation, which was derived from a simulation, is as follows. 74

97 exp (4) Table 5-3 Concordance Coefficient Estimates of Response Surface Significance level 1% 5% 10% 7.18 (1.35) 4.78 (0.96) 3.42 (1.16) Regression 0.67 (0.51) 0.80 (0.35) 0.92 (0.41) 1.57 (0.89) 1.23 (0.54) 1.02 (0.60) Note: Figures in parenthesis refer to standard deviations Source: Yoon(2011), Original source is McDermott and Scott(2000), p.11 Table 1. Table 5-3 shows concordance coefficients of a response surface regression equation at the 1%, 5% and 10% levels of significance. For example, in the case that the sample size is 155 and the minimum ratio is 0.32, the critical value for determining whether the concordance coefficient is statistically significant or not at the 5% level of significance is calculated at 0.68 as follows. exp = 0.68 To utilize the concordance coefficient suggested earlier, we should identify whether an individual serial data is on a boom or on a Ch 5. Influencing factors on the changes in the International Steam Coal Market 75

98 slump. Generally, we can see with the naked eye whether the commodity market is on a boom or a slump. However, for an objective analysis, it is necessary to define exactly the expansionary phase and contractionary phase and to standardize the definitions. An alternative is to define the boom and slump based on a business cycle theory which was suggested by Burns & Mitchell(1946). The boom is defined as a period during which commodity prices are in an increasing trend. On the contrary, the slump is defined as a period during which prices show a downward trend. And, when the price of a certain commodity passes a local peak and then decreases, we define it as a change from the boom to the slump of the commodity market. Actually, the standardization of such definitions can be done by utilization of a business-cycle dating algorithm suggested by Bry & Boschan(1971). The procedure to seek the turning points from boom to slump or vice versa, utilizing Bry & Boschan(1971)'s algorithm, is as follows. (1st phase) We identify the peak and slump time. The peak time refers to a moment when a commodity price reaches locally a maximum level which is higher than any prices which appear for 2 months off and on. That is, ±, where it is assumed that. On the contrary, the slump time refers to a moment when a commodity price reaches locally a minimum level 76

99 which is lower than any prices which appear for 2 months off and on. That is, ±, where it is assumed that. (2nd phase) The peak and slump time identified earlier have to appear alternately. In other words, the peak or slump time should not be identified consecutively. (3rd phase) According to an additional censoring rule, the peak and slump time is re-identified. First, the duration of a cycle, such as peak-slump-peak or slump-peak-slump, should be not less than 12 months. Second, if a peak or a slump is located at the beginning or the end of an individual serial data, the duration between the two extremes should be not less than 6 months. In addition, expansionary phase(slump-peak) or contractionary phase(peak-slump) should last for more than 6 months. (4th phase) We identify final peak time and slump time which meet the constraint condition specified earlier. Earlier, we have set the duration of a cycle and of expansionary phase(contractionary phase) at 12 months and 6 months respectively, seeking the turning points of boom and slump. The US NBER(National Bureau of Economic Research)'s criteria to identify business cycles are as follows: the duration of a cycle is 15 months and that of boom(slump) is 6 months. In the studies of Cashin et al.(1999), McDermott & Scott(2000) and Cashin et al.(2002), the Ch 5. Influencing factors on the changes in the International Steam Coal Market 77

100 durations of a cycle and a boom(slump) have been set at 24 months and 12 months respectively. Like this, there is no specific criteria for setting the durations of a cycle and a phase. Generally, they used to be established empirically. In our study, the period of analysis is not long enough. If we set the duration of a cycle and a phase to be long, we cannot identify proper number of booms or slumps needed to estimate concordance coefficient. So, we set the duration of a cycle and a phase at 12 months and 6 months respectively, arbitrary though it may be. b. Preliminary analysis of sample data The purpose of this section is to test empirically the price co-movement between steam coal and other primary commodities. For this, we divide sample data into two groups and estimate the correlation coefficient and the concordance coefficient of commodity prices for each group. One group consists of commodities which are regarded to be correlated with steam coal, Another group consists of non-correlated commodities. In our study, 6 commodities are considered as non-correlated commodities; cocoa, copper, cotton, hard logs, wheat and zinc 22). Another 6 commodities are considered as correlated 22) We selected similar commodities, as in Pindyck & Rotemberg(1990), as non-correlated commodities. They used as sample data seven commodity(wheat, 78

101 commodities; Australian Newcastle coal, Indonesian natural gas, Brent crude oil, Dubai crude oil, WTI crude oil and uranium. Table 5-4 Specifications of analyzed commodities Commodities Specifications Steam coal Non-correlated commodities Cocoa Copper Cotton Hard logs Wheat Zinc correlated commodities Australian coal Indonesian natural gas Crude oil(brent) Crude oil(dubai) Crude oil(wti) Uranium ICR Asian Marker coal price ($/mt) Beans, International Cocoa Organization cash price, CIF US and European ports, US$ per metric tonne Grade A cathode, LME spot price, CIF European ports, US$ per metric tonne Cotton Outlook A Index, Middling 1-3/32 inch staple, CIF Liverpool, US cents per pound Best quality Malaysian Meranti, import price Japan, US$ per cubic meter No.1 Hard Red Winter, ordinary protein, FOB Gulf of Mexico, US$ per metric tonne High grade 98% pure, US$ per metric tonne Australian thermal coal, 12,000- btu/pound, less than 1% sulfur, 14% ash, FOB Newcastle/Port Kembla, US$ per metric tonne Indonesian Liquified Natural Gas in Japan, US$ per cubic meter of liquid Dated Brent, light blend 38 API, FOB UK, US$/bbl Dubai medium, Fateh 32 API, FOB, US$/bbl West Texas Intermediate 40 API, Midland Texas, US$/bbl Uranium, NUEXCO, restricted price, NUEXCO exchange spot, US$ per pound Source: cotton, copper, gold, crude oil, rubber and cocoa) prices(monthly prices over April November 1985). Cashin et al.(1999) and McDermott & Scott(2000) have also used these commodities in order to compare their study with Pindyck & Rotemberg(1990) Ch 5. Influencing factors on the changes in the International Steam Coal Market 79

102 Asian marker prices, released by International Coal Report, Platts, are used as steam coal prices 23). A serial data provided by IMF(International Monetary Fund) is used as other commodity prices. The period of analysis is from January 1998 to April 2011 and all the data are composed of 160 monthly data. Table 5-4 shows specifications about commodity prices or indices. Table 5-5 summarizes basic statistics of sample data by group. It is notable that the null hypothesis that the serial data follows a normal distribution at the 1% level of significance is rejected by a test of normality on all the serial data. N o of Sample Steam coal Cocoa Copper Cotton Hard logs Wheat Zinc Mean , , , Standard Deviation Table 5-5 Basic Statistics of Sample data , Minimum , Maximum , , , Skewness Kurtosis Normality , ) Spot prices are based on Japanese CIF(6,000kcal/kg). 80

103 N o of Sample Steam coal Aus. coal Natural gas Brent Dubai WTI Uranium Mean Standard Deviation Minimum Maximum Skewness Kurtosis Normality Source: Yoon(2011) c. Identification of Boom and Slump The figures from Figure 5-4 to Figure 5-10 show a result of investigation, based on Bry and Boschan's algorithm, about the booms and slumps of non-correlated commodities. Asian Marker steam coal prices and 6 other non-correlated commodity(cocoa, copper, cotton, hard log, wheat and zinc) prices are analyzed 24). To 24) The fact that two commodity prices are not related to each other means that the cross price elasticity of demand and supply between the two commodities is almost zero. In other words, steam coal and 6 other commodities are not complementary or substitute goods for one another. In addition, they don't go into the production of a certain commodity at the same time and they are not an input for the production of another commodity. Ch 5. Influencing factors on the changes in the International Steam Coal Market 81

104 facilitate a comparison with other studies, we have had all the serial data of commodity prices to take the natural log. In these figures, the sections included in the rectangular represent expansionary phases during which the commodity price increases, meanwhile the other sections represent slumps. In the case of steam coal, the first slump occurred in September 1998, the second slump in August And, the first peak occurred in May 2001, the second peak in July The first boom lasted for 30 months from October 1998 to May And, the first slump lasted for 13 months from June 2001 to August The first slump cycle consisting of slump-peak-slump corresponds to 43 months from October 1998 to August The first boom cycle consisting of peak-slump-peak corresponds to 34 months from June 2001 to July

105 Figure 5-4 Boom and Slump Analysis: Steam Coal Boom/Slump Begin End Duration(month) Slump Jan 1998 Sep Boom Oct 1998 May Slump Jun 2001 Aug Boom Sep 2002 Jul Slump Aug 2004 Dec Boom Jan 2006 Jul l Slump Aug 2008 Mar Boom Apr 2009 Jan Slump Feb 2010 Aug Boom Sep 2010 Arp Source: Yoon(2011) Ch 5. Influencing factors on the changes in the International Steam Coal Market 83

106 Figure 5-5 Boom and Slump Analysis: Cocoa Boom/Slump Begin End Duration(month) Slump Jan 1998 Feb Boom Mar 2000 Feb Slump Mar 2003 Jun Boom Jul 2004 Mar Slump Apr 2005 Nov Boom Dec 2005 Jan Slump Feb 2010 Sep Boom Oct 2010 Apr Source: Ibid 84

107 Figure 5-6 Boom and Slump Analysis: Copper Boom/Slump Begin End Duration(month) Slump Jan 1998 Mar Boom Apr 1999 Sep Slump Oct 2000 Oct Boom Nov 2001 May Slump Jun 2006 Jan Boom Feb 2007 Apr Slump May 2008 Dec Boom Jan 2009 Apr Source: Ibid Ch 5. Influencing factors on the changes in the International Steam Coal Market 85

108 Figure 5-7 Boom and Slump Analysis: Cotton Boom/Slump Begin End Duration(month) Slump Jan 1998 Dec Boom Jan 2000 Dec Slump Jan 2001 Oct Boom Nov 2001 Nov Slump Dec 2003 Dec Boom Jan 2005 Mar Slump Apr 2008 Mar Boom Apr 2009 Apr Source: Ibid 86

109 Figure 5-8 Boom and Slump Analysis: Hard logs Boom/Slump Begin End Duration(month) Slump Jan 1998 Jun Boom Jul 1998 Sep Slump Oct 1999 Jan Boom Feb 2002 Jan Slump Feb 2009 Apr Boom May 2010 Apr Source: Ibid Ch 5. Influencing factors on the changes in the International Steam Coal Market 87

110 Figure 5-9 Boom and Slump Analysis: Wheat Boom/Slump Begin End Duration(month) Slump Jan 1998 Dec Boom Jan 2000 May Slump Jun 2001 May Boom Jun 2002 Apr Slump May 2004 Apr Boom May 2005 Mar Slump Apr 2008 Jun Boom Jul 2010 Apr Source: Ibid 88

111 Figure 5-10 Boom and Slump Analysis: Zinc Boom/Slump Begin End Duration(month) Slump Jan 1998 Jan Boom Feb 1999 Sep Slump Oct 2000 Aug Boom Sep 2002 Dec Slump Jan 2007 Dec Boom Jan 2009 Jan Slump Feb 2010 Apr Source: Ibid Ch 5. Influencing factors on the changes in the International Steam Coal Market 89

112 Table 5-6 summarizes the number of slumps and peaks, slump cycles(slump-peak-slump cycles) and boom cycles(peak-slump-peak cycles) of each serial data. As we know in this table, each commodity's booms and slumps and its boom cycles and slump cycles do not coincide with other commodities', and their durations are also different from one another. Table 5-6 Summary of Booms and Slumps: Non-correlated commodities Slump Peak Slump Cycle Boom Cycle Steam coal Cocoa Copper Cotton Hard logs Wheat Zinc Note: Slump cycle means a slump-peak-slump cycle and boom cycle means a peak-slump-peak cycle. Source: Ibid The figures from Figure 5-11 to Figure 5-16 show a result of investigation, based on Bry and Boschan's algorithm, about the booms and slumps of correlated commodities. Asian Marker steam coal prices and 6 other correlated energy commodity(australian 90

113 Newcastle coal, Indonesian natural gas, Brent crude oil, Dubas crude oil, WTI crude oil and uranium)are analyzed. As in the case of non-correlated commodities, we have had all the serial data of commodity prices to take the natural log to facilitate a comparison with other studies. In these figures, the sections included in the rectangular represent expansionary phases during which the commodity price increases, meanwhile the other sections represent slumps. In the case of Australian coal, the first slump occurred in September 1998, the second slump in September And, the first peak occurred in August 2001, the second peak in August The first boom lasted for 33 months from August 1998 to July And, the first slump lasted for 11 months from August 2001 to August The first slump cycle consisting of slump-peak-slump corresponds to 44 months from September 1998 to August The first boom cycle consisting of peak-slump-peak corresponds to 32 months from August 2001 to July As we see above, the Australian coal case shows a repetition of booms and slumps in a similar pattern to the Asian Marker steam coal price case. Ch 5. Influencing factors on the changes in the International Steam Coal Market 91

114 Figure 5-11 Boom and Slump Analysis: Australian Newcatle coal Boom/Slump Begin End Duration(month) Slump Jan 1998 Aug Boom Sep 1998 Jul Slump Aug 2001 Aug Boom Sep 2002 Jul Slump Aug 2004 Nov Boom Dec 2005 Jul Slump Aug 2008 Mar Boom Apr 2009 Apr Source: Yoon(2011) 92

115 Figure 5-12 Boom and Slump Analysis: Indonesian natural gas Boom/Slump Begin End Duration(month) Slump Jan 1998 Feb Boom Mar 1999 Oct Slump Nov 2000 Jan Boom Feb 2002 Jul Slump Aug 2002 Jul Boom Aug 2003 Jul Slump Aug 2008 Feb Boom Mar 2009 May Slump Jun 2010 Apr Source: Ibid Ch 5. Influencing factors on the changes in the International Steam Coal Market 93

116 Figure 5-13 Boom and Slump Analysis: Brent crude oil Boom/Slump Begin End Duration(month) Slump Jan 1998 Dec Boom Jan 1999 Sep Slump Oct 2000 Dec Boom Jan 2002 Feb Slump Mar 2003 Sep Boom Oct 2003 Jul Slump Aug 2006 Jan Boom Feb 2007 Jul Slump Aug 2008 Apr Source: Ibid 94

117 Figure 5-14 Boom and Slump Analysis: Dubai crude oil Boom/Slump Begin End Duration(month) Slump Jan 1998 Feb Boom Mar 1999 Oct Slump Nov 2000 Nov Boom Dec 2001 Jul Slump Aug 2006 Jan Boom Feb 2007 Jul Slump Aug 2008 Apr Source: Ibid Ch 5. Influencing factors on the changes in the International Steam Coal Market 95

118 Figure 5-15 Boom and Slump Analysis: WTI crude oil Jan-1980 Jul Boom/Slump Begin End Duration(month) Slump Jan 1998 Dec Boom Jan 1999 Nov Slump Dec 2000 Dec Boom Jan 2002 Feb Slump Mar 2003 Sep Boom Oct 2003 Jul Slump Aug 2006 Jan Boom Feb 2007 Jun Slump Jul 2008 Feb Boom Mar 2009 Apr Slump May 2010 Apr Source: Ibid 96

119 Figure 5-16 Boom and Slump Analysis: Uranium Jan-1980 Jul Boom/Slump Begin End Duration(month) Slump Jan 1998 Jan Boom Feb 2001 Mar Slump Apr 2002 Sep Boom Oct 2002 Jun Slump Jul 2007 Jun Boom Jul 2010 Apr Source: Ibid Ch 5. Influencing factors on the changes in the International Steam Coal Market 97

120 Table 5-7 summarizes the number of slumps and peaks, slump cycles(slump-peak-slump cycles) and boom cycles(peak-slump-peak cycles) of each serial data. As in the case of non-correlated commodity case earlier, each commodity's booms and slumps and its boom cycles and slump cycles do not coincide with other commodities', and their durations are also different from one another. Table 5-7 Summary of Booms and Slumps: Correlated commodities Slump Peak Slump Cycle Boom Cycle Steam coal Aus. coal Natural gas Brent Dubai WTI Uranium Note: Slump cycle means a slump-peak-slump cycle and boom cycle means a peak-slump-peak cycle. Source: Ibid d. Correlation Coefficient and Concordance Coefficient Table 5-8 and Table 5-9 show an estimation result of the Pearson correlation coefficient like the expression(1), using serial data on the 98

121 prices of 6 non-correlated commodities in the form of price level and log difference. As commodity price data show a volatile serial pattern, we will focus on the results based on log difference form. As Table 5-9 shows, the correlation coefficients of 21 cases(a combination of two commodities out of seven commodities: (7 6)/2) have a minimum of and a maximum of in absolute value. Table 5-10 summarizes t-statistics for statistical significance test on the Pearson correlation coefficients defined as the expression(2). Table 5-11 summarizes the statistical significance levels of the correlation coefficients using the t-statistics. In the table, the values of 1, 5, 10 mean that the correlations are statistically significant at the 1%, 5%, 10% respectively. It appears that out of the 21 correlation coefficients, 6 coefficients are statistically significant at the 10% level of significance, 13 coefficients at the 5% level and 9 coefficients at the level of 1%. In particular, all the commodities, except hard logs, show statistically significant correlations with steam coal at the 5% level of significance. This result is roughly in accord with the results of Pindyck & Rotemberg(1990), Cashin et al.(1999), McDermott & Scott(2000) and Cashin et al.(2002), Table 5-12 summarizes an estimation of concordance coefficients based on the expression(3). Different from the estimation of Pearson correlation coefficient, variables in the form of natural log are used because of some characteristics of concordance analysis. As the table Ch 5. Influencing factors on the changes in the International Steam Coal Market 99

122 shows, the concordance coefficients of 21 cases have a minimum of and a maximum of in absolute value. Table 5-13 summarizes minimum ratios for a statistical significance test on the concordance coefficient estimates, based on the expression(4). In this table, and are estimated by a random walk model as follows, based on the log difference individual serial data. (5) Table 5-14 summarizes a statistical significance test of the concordance coefficients. In the table, the values of 1, 5, 10 mean that the correlations are statistically significant at the 1%, 5%, 10% respectively. It appears that out of the 21 concordance coefficients, 12 coefficients are statistically significant at the 10% level of significance, 8 coefficients at the 5% level and 6 coefficients at the level of 1%. As the table shows, statistical significance of concordance coefficients is a little lower than that of Pearson correlation coefficients 25). However, in this test, all the commodities, 25) In the study of Cashin et al.(1999) which is based on the same period of analysis and almost the same sample data as in Pindyck & Rotemberg(1990), 9 correlation coefficients out of 21 coefficients appear to be statistically significant at the 5% level of significance, but any concordance coefficient out of 21 coefficients appears not to be statistically significant at the 5%. Even in the case where the sample period is prolonged, only one concordance coefficient out of 21 coefficient appears to be statistically significant at the 5% 100

123 except hard logs, show statistically significant concordance relation with steam coal at the 10% level of significance. Steam coal Steam coal Cocoa Copper Cotton Hard logs Wheat Zinc Cocoa Copper Cotton Hard logs Wheat Zinc Source: Yoon(2011) Table 5-8 Correlation Coefficient of level variables: Non-correlated Commodities level of significance. So, contrary to the conclusion of Pindyck & Rotemberg(1990), they suggested that there is no price co-movement between the non-correlated commodities. Ch 5. Influencing factors on the changes in the International Steam Coal Market 101

124 Table 5-9 Correlation Coefficient of Log difference variables: Non-Correlated Commodities Coal Cocoa Copper Cotton Logs Wheat Zinc Coal Cocoa Copper Cotton Logs Wheat Zinc Source: Ibid Table 5-10 T-statistics on correlation coefficients: Non-Correlated Commodities Coal Cocoa Copper Cotton Logs Wheat Zinc Coal Cocoa Copper Cotton Logs Wheat Zinc Source: Ibid Table 5-11 Significance Level of Correlation Coefficients: Non-Correlated Commodities (%) Coal Cocoa Copper Cotton Logs Wheat Zinc Coal Cocoa Copper Cotton Logs Wheat Zinc Note: Figures in the table mean the 1%, 5% and 10% level of significance. Source: Ibid 102

125 Table 5-12 Concordance Coefficient of log variables: Non-Correlated Commodities Coal Cocoa Copper Cotton Logs Wheat Zinc Coal Cocoa Copper Cotton Logs Wheat Zinc Source: Ibid Table 5-13 Minimum (μ/σ) ratios: Non-Correlated Commodities Coal Cocoa Copper Cotton Logs Wheat Zinc Coal Cocoa Copper Cotton Logs Wheat Zinc Source: Ibid Table 5-14 Significance Level of Concordance Coefficients: Non-Correlated Commodities (%) Coal Cocoa Copper Cotton Logs Wheat Zinc Coal Cocoa Copper Cotton Logs Wheat Zinc Note: Figures in the table mean the 1%, 5% and 10% level of significance. Source: Ibid Ch 5. Influencing factors on the changes in the International Steam Coal Market 103

126 Table 5-15 and Table 5-16 show an estimation result of the Pearson correlation coefficient like the expression(1), using serial data on the prices of 6 commodities correlated to steam coal price in the form of price level and log difference. As Table 5-16 shows, the correlation coefficients of 21 cases(combination of two commodities out of seven commodities: (7 6)/2) have a minimum of and a maximum of in absolute value. Table 5-17 summarizes t-statistics for statistical significance test on the Pearson correlation coefficients defined as the expression(2). Table 5-18 summarizes statistical significance levels of the correlation coefficients using the t-statistics. It appears that out of the 21 correlation coefficients, 19 coefficients are statistically significant at the 10% level of significance, 17 coefficients at the 5% level and 14 coefficients at the level of 1%. In comparison with the case of non-correlated commodities, a greater number of correlation coefficients appear to be statistically significant. In particular, all the commodity prices show a statistically significant correlation with steam coal price at the 1% level of significance(uranium, 1%). Table 5-19 summarizes an estimation of concordance coefficients based on the expression(3). Different from the estimation of Pearson 104

127 correlation coefficient, variables in the form of natural log are used because of some characteristics of concordance analysis. As the table shows, the concordance coefficients of 21 cases have a minimum of and a maximum of in absolute value. Table 5-20 summarizes minimum ratios for statistical significance test on the concordance coefficient estimates, based on the expression(4). Table 5-21 summarizes statistical significance tests of the concordance coefficients. It appears that out of the 21 concordance coefficients, 12 coefficients are statistically significant at the 10% level of significance, 10 coefficients at the 5% level and 7 coefficients at the level of 1%. As the table shows, the statistical significance of concordance coefficients is a little lower than that of Pearson correlation coefficients. It is however interesting that, in comparison with the case of non-correlated commodities, there is not much difference in the respect of concordance. In this test, all the commodities, except Brent crude oil and uranium, show statistically significant concordance relation with steam coal at the 5% level of significance. In the case of crude oil prices, however, there may be some distortions in the concordance coefficient statistics as the entire period from August 2008 to the end of 2011 are regard as a contractonary phase because of a sharp decrease in crude oil price for a very short period of time in the second half of ). In Ch 5. Influencing factors on the changes in the International Steam Coal Market 105

128 other words, the assumption that the minimum period of boom phase(or slump phase) is 6 months seems to have an influence on the concordance coefficients and the significance levels because both the period of price decreases in the second half of 2008 and early 2009 and the period of price increases thereafter are all regraded as a slump phase according to the assumption. Therefore, the interpretation of concordance related statistics needs some attention. S.Coal A.Coal Gas Brent Dubai WTI Ur. S.Coal A.Coal Gas Brent Dubai WTI Ur Source: Yoon(2011) Table 5-15 Correlation Coefficient of level variables: Correlated Commodities 26) As Dubai and Brent have peaked in July 2008 and then declined to record a slump in December 2008, they do not meet the criteria(6 months duration of decline). But WTI meets the criteria as it has peaked in June As a result, for Dubai and Brent, the period from August 2008 to 2011 is regarded as a slump phase, but for WTI, the period from August to December 2008 is regarded as a slump phase and the period thereafter as a boom. 106

129 Table 5-16 Correlation Coefficient of Log difference variables: Correlated Commodities S.Coal A.Coal Gas Brent Dubai WTI Ur. S.Coal A.Coal Gas Brent Dubai WTI Ur Source: Ibid Table 5-17 T-statistics on correlation coefficients: Correlated Commodities S.Coal A.Coal Gas Brent Dubai WTI Ur. S.Coal A.Coal Gas Brent Dubai WTI Ur Source: Ibid Table 5-18 Significance Level of Correlation Coefficients: Correlated Commodities (%) S.Coal A.Coal Gas Brent Dubai WTI Ur. S.Coal A.Coal Gas Brent Dubai WTI Ur Note: Figures in the table mean the 1%, 5% and 10% level of significance. Source: Ibid Ch 5. Influencing factors on the changes in the International Steam Coal Market 107

130 Table 5-19 Concordance Coefficient of log variables: Correlated Commodities S.Coal A.Coal Gas Brent Dubai WTI Ur. S.Coal A.Coal Gas Brent Dubai WTI Ur Source: Ibid Table 5-20 Minimum (μ/σ) ratios: Correlated Commodities S.Coal A.Coal Gas Brent Dubai WTI Ur. S.Coal A.Coal Gas Brent Dubai WTI Ur Source: Ibid Table 5-21 Significance Level of Concordance Coefficients: Correlated Commodities S.Coal A.Coal Gas Brent Dubai WTI Ur. S.Coal A.Coal Gas Brent Dubai WTI Ur Note: Figures in the table mean the 1%, 5% and 10% level of significance. Source: Ibid 108

131 e. Causes of Price Co-movement and their implications Recently, price co-movement phenomenon with a greater price volatility has appeared in international commodity market as the demand for raw materials increased. In fact, there is an increase in demand for grain, energy and metals thanks to economic growth in developing countries and reorganization of world economic structure, and an increase in alternative investment in commodity markets due to an increased market liquidity with low global interest rates and quantitative easing, and a dollar depreciation. Therefore, price fluctuations in international commodity markets has been intensified and correlations among the commodity prices and their volatility have been also increased. Some people suggest that the price co-movement phenomenon should be brought about by the fact that commodity prices respond to the impacts of macro-economic variables such as inflation rate, industrial production index, exchange rate and interest rate, in a similar pattern(pindyck and Rotemberg, 1990). Some others argue that market participants' common belief that commodity prices will move in the same direction should cause some irrational behaviors such as 'herding' or 'following the fad', intensifying the price co-movement phenomenon. Such arguments contradict the traditional standard theory of market competition(sameulson, 1971). We can find another empirical analysis on the causes of price Ch 5. Influencing factors on the changes in the International Steam Coal Market 109

132 co-movement in the studies of Chaudhuri(2001), Ai et al.(2006) and Baffes(2007). These studies show that an increase in crude oil prices entails a similar increase in the prices of agricultural and metallic products through the rise in the production cost. This can imply that if there is a change in raw material markets, the prices of raw materials can affect one another 27). Eventually, the complementarity and substitutability between commodities can basically explain the price co-movement phenomenon. Recently, in connection with the causes of price co-movement, the financial instruments for general commodities have attracted much attention. In the past, international commodity markets did not bear much relation to international financial markets and their price volatility was also relatively low. However, the importance of financial instruments for general commodities in the international financial markets has increased significantly. So, there is an increasing tendency for the prices of cereal, energy and metallic and non metallic products to be determined by the forces of supply and demand in the financial markets as well as in the commodity 27) For example, if international oil prices are increased, cereal prices can be also increased because the production of ethanol, one of the alternative energy sources, will be increased. On the contrary, if the combined production of corn and sugar cane is reduced by an abnormal climate, international oil prices will be pressed to increase because the production of ethanol, an alternative energy, will be reduced. Another example is the case of sugar and coffee. An increase in demand for coffee will cause a similar increase in sugar demand because they are complementary to each other. So, if coffee price increases, sugar price is also pressed to increase. 110

133 markets. In this situation, general commodity prices can move in the same direction and pattern as the investment patterns in the financial market move in a cycle. In this study, we have analyzed empirically the price co-movement between Asian steam price and some principal commodity prices. For the sake of comparison with previous studies, we have made an concordance analysis as well as a traditional correlation analysis and have presented the difference between the two analyses on the price co-movement phenomenon. Interestingly, the degree of price comovement between the seemingly non-correlated commodities depends on the time-period. Pindyck and Rotemberg(1990), who made an correlation analysis based on the sample data from 1960 to the middle of the 1980s, showed there is a correlation between non-correlated commodities in about one half of the cases. But Cashin et al.(1999), who did an concordance analysis, did not found any price co-movement phenomenon in the seemingly non-correlated commodities even though they used the same sample data. However, in our study in which we made an empirical concordance analysis on a similar sample data set with a different period of analysis (from the second half of the 1990s to present), we could identify a price co-movement phenomenon, with statistical significance, in more than half of the cases. From this we can find out that the price co-movement phenomenon between seemingly non-correlated commodities has been sticking out more distinctly than ever before. Ch 5. Influencing factors on the changes in the International Steam Coal Market 111

134 Now, the increase in international commodity prices and their price volatility is expected to continue as the demand for raw materials and commodities in rapidly developing countries like China and India will increase with steady economic growth. The principal commodity prices will be able to increase in the same direction with common variables like macro economic factors. Such price co-movement phenomenon can appear regardless of their mutual relationship. Therefore, such possibility of price co-movement should be reflected in our commodity price projections. And, for a better result, it is also more helpful to consider such price co-movement when we establish an investment portfolio in commodity markets or a purchasing strategy for raw materials. After the United Nations Framework Convention on Climate Change(UNFCCC) had been adopted at the United Nations Conference on Environment and Development in Rio de Janeiro, Brazil, in June 1992, a Protocol was adopted at an UNFCCC meeting(the 3rd Conference of the Parties) in December 1997 in Kyoto, Japan, and entered into force in February According to the Kyoto Protocol, the industrialized countries(38 countries) should reduce their greenhouse gas(ghg) emissions by 5.2%, compared to the 1990 level, for the period of

135 Just before the end of Kyoto mechanism, a conference of the parties(cop) to the UNFCCC, held in Durban, South Africa, in December 2011, agreed to extend the Kyoto mechanism to But, as Japan, Canada, Russia, in addition to the United States, which had been opposed to the ratification of the Kyoto Protocol, have withdrawn from the group of obligatory reduction counties and decided to make a voluntary GHG reduction, the significance of Kyoto Protocol has been decreased. Nonetheless, each country has planned and introduced various policies for the GHG reduction. This means that all countries of the world recognize at least the necessity of GHG reduction. In respect of GHG reduction, coal is the most unfavored fuel. Coal emits much more greenhouse gases than any other fuels in terms of emissions per unit of calorie: 1.7 times more emissions than natural gas, 1.5 times more than LPG and 1.3 times more than crude oil. So, if carbon tax, restriction on emissions or emission trading are introduced to reinforce the convention on climate change, it will be the coal use that should be rationalized first of all. Ch 5. Influencing factors on the changes in the International Steam Coal Market 113

136 Table 5-22 Carbon Emissions by fuel Crude oil LPG Nat. Gas Bituminous Anthracite ton-c/tj (nat. gas=100) 20 (131) 17.2 (112) 15.3 (100) 25.8 (169) 26.8 (175) Note: Bituminous is based on hard coal, The figures in parenthesis are a relative emission level when the emissions from natural gas are set at 100. Source: IEA, CO 2 Emissions from Fuel Combustion, 2010 According to the IEA's "World Energy Outlook"(2011b), it is necessary to reduce the coal consumption in 2035 by 30%, compared to the 2009 level, in order to restrict the increase in the earth surface temperature within 2 compared to pre-industrial age(450 Scenario). This is comparable to the increase of 65% in coal consumption when the current policies are maintained(current Policies Scenario). That is, when the current policies maintained, the coal consumption in 2035 will be 2.3 times higher than the case of 450 Scenario in absolute terms. In contrast, when each country introduces new policies for GHG reduction(new Policies Scenario), the coal consumption in 2035 will increase by only 25% compared to the 2009 level. Even in this case, however, the coal consumption in 2035 in absolute terms will be 1.8 times higher than the case of 450 Scenario. Therefore, the IEA regards the reinforcement of GHG reduction policies as an important factor for the decreased coal consumption. 114

137 In the case of New Policies Scenario, the coal demand will be increased rather rapidly at an annual rate of 3.0% until 2015, but thereafter the growth rate will be slowed down and, after 2020, it will be at a standstill. In particular, in the 450 Scenario, the coal demand will peak in the second half of the 2020s and then start to decrease so that the coal demand in 2025 will be lower than in Figure 5-17 World Coal Demand Forecast Source: IEA, World Energy Outlook, 2011 In the case of Current Policies Scenario, the coal demand will increase rapidly at an annual rate of 3.5% from 2009 to 2015, but thereafter the growth rate will be slower, 1.7% per annum in the Ch 5. Influencing factors on the changes in the International Steam Coal Market 115

138 period to 2020, and 1.4% in the period to In the New Policies Scenario, it is expected that the coal demand in the Asia/Pacific region will steadily increase while it will decrease in North America and Europe. In particular, it is expected that the increase in coal demand in the Asia/Pacific in the period to 2015 will be very remarkable. It is because North American and European countries are now GHG emissions obligatory reduction countries, but Asian/Pacific countries do not have an obligation to reduce GHG emissions even though their economic growth rates are expected to be much higher than that of industrialized countries. Figure 5-18 Coal Demand Forecast by region(new Polices Scenario) (Mtoe) Asia/Pacific North America Europe Source: IEA, World Energy Outlook,

139 According to the IEA(2011b), it is expected that the coal exports from the North America region will be steadily at a standstill. This is because North America is a marginal coal supplier. In contrast, the coal imports in Europe(except Russia) will be flat in the period to 2020, and then decrease. This expectation is based on the assumption that the coal production as well as the coal consumption in Europe will be flat. However, taken into account that the coal production in Europe is expected to decrease continuously, such a projection seems to be a little optimistic. On the other hand, the coal imports in Asia is expected to increase rapidly in the period to 2020, and then stay at a certain level. It is because the imports in China and India will rapidly increase by 2020, but the increase in exports from Indonesia will not catch up with this increase in imports. However, after 2020, the decline in imports in China due to the expansion of nuclear power plants, as well as the decline in Japan, will be sufficient enough to offset the increase in imports in other Asian countries. Ch 5. Influencing factors on the changes in the International Steam Coal Market 117

140 Figure 5-19 Coal Exports/Imports by region(new Policies Scenario) Source: IEA, World Energy Outlook, 2011 The US EIA projects also that the imports in the Asian region will increase remarkably. According to the EIA's "International Energy Outlook" released in 2011, the increase in imports in Asia for the period of will account for almost 60% of all the increase in world coal imports, and 70% for the period of Of course, it is difficult to compare directly the EIA's forecast with the IEA's because there are some differences in demand forecast, calculating method of imported coal and regional classification between the two forecasts 28). However, the two forecasts agree that 28) The EIA's forecast for coal consumption in 2035(7,530 Mt) is similar to the IEA's forecast(7,740 Mt) based on Current Policies Scenario, which is much higher than the New Policies Scenario case(5,860 Mt). In addition, the EIA's forecast is based on the net amount of imports while the IEA's based on the 118

141 the increase in coal imports will occur mainly in the Asian region in the future. Figure 5-20 EIA's Forecast for Coal Imports by region Source: EIA, International Energy Outlook, 2011 total amount of imports. Ch 5. Influencing factors on the changes in the International Steam Coal Market 119

142

143 Ch 6. Countermeasures against the Changes in the Future International coal markets are changing very rapidly. Especially, Asian markets are steadily being expanded while European markets which have played a central role in world coal market are now at a standstill. And, with the development of spot market, the importance of traditional long-term contract has been greatly reduced. Even though a form of long-term contract is taken, there are many cases that spot prices are used as actual transaction prices. Sometimes, there is a special form of contract in which if price negotiation is broken off, the long-term contract is automatically terminated. Likewise, uncertainty in the market is now increasing so that it is more and more necessary to provide against it. Therefore, from now on, we try to find out some medium and long term countermeasures against uncertainties and risks in the market. First of all, it is necessary to strengthen analysis function on world Ch 6. Countermeasures against changes in the Future 121

144 markets in order to deal with market uncertainty. If we can understand the changes in the exporting and importing countries through proper analyses, we can easily come up with medium and long term countermeasures against such changes. It is China that have brought about the greatest changes in world market. China, a great coal exporting country in the past, is now importing more than 100 Mt of coal and is expected to increase continuously its coal imports. Like in China, the coal imports in India have been also rapidly increasing. This increase in coal imports in the Asian region makes Asia the most important coal market in the world. There are two respects in the reinforcement of market analysis function; short term and medium/long-term analyses. The short-term analysis will be made by importing companies as it was before. However, it is necessary that professional market analysts or institutes should be in charge of the medium and long-term analysis function. It's because common discussions and cooperation between experts in various energy markets as well as coal markets are necessary to understand comprehensively the market situation. It is necessary that every information, opinion and research result should be shared and refined through proper discussions. Through these processes, we can not only understand exactly the main stream of coal markets, but also forecast the potentials of change and their effects in the future. For this purpose, we recommend a regular 122

145 forum for discussion about coal markets. Establishment and operation of a 'Council for the Bituminous Coal market' in which the related companies and experts participate can be an alternative. b. Advanced Risk Management Coal was traded for the first time on the futures market when the Central Appalachian Coal(CAPP) was floated on the NYMEX in July As OTC(Over the Counter) 29) transactions have been expanded, since then, with the development of Spot markets, even the NYMEX is now dealing with swap transactions, a kind of OTC transaction. The related commodities are as follows; Indonesian McCloskey Sub-bituminous, Power River Basin(Platts OTC Broker Index), FOB Newcastle(Argus/McCloskey), FOB Richard Bay(Argus/McCloskey), CIF ARA(Argus/McCloskey), China Coal(IHS McCloskey), CSX Coal(Platts OTC Broker Index). In the Asian region, SGX(Singapore Exchange) are dealing with swap transactions of Indonesian coal. As the swap transaction allows to hedge the price risk without flotation on the futures market, its use is increasing rapidly. The swap transaction takes basically a form of pure financial transaction. After an agreement on transaction period, price and trade volume, 29) The OTC transaction is made through an intermediary agent or an electronic system and settled directly between the contracting parties, not through the clearing house. Ch 6. Countermeasures against changes in the Future 123

146 buyer(bidd) and seller(offer) settle the account at the end of the transaction period, according to agreed index prices. <An example of swap transaction> A is a buyer and B is a seller A and B agree to trade 25 thousand tons of coal at $27.00 per ton in September If index price is $28/ton, B(seller) pays A(buyer) $2,500 (2,500 tons $1/ton). If index price is $25/ton, A(buyer) pays B(seller) $5,000 (2,500 tons $2/ton) This means that the actual transaction price is fixed for the buyer and is pegged to the spot price(index price) for the seller. However, various combinations of spot and fixed price contracts can allow buyer and seller to achieve what they want. Source: MOCIE, "A study on rational methods of steam coal purchasing for power generation"(written in Korean), November It is estimated that the size of coal swap transaction increased from 70 Mt in 2001 to Mt in 2004(Doyle 2003, Gubbins 2004). Such a transaction volume was much bigger than the spot 124

147 transaction volume of the Europe's ARA (Antwerp/ Rotterdam/ Amsterdam) market. In contrast, there had been little coal swap transaction in the Asian markets until However, a swap transaction was settled for the first time on the Singapore Exchange(SGX) in November 2010 after swap transactions had been activated in the second half of the 2000s with the deepening of uncertainty in coal markets. After that, swap transactions on the SOX was increased to reach a level of more than 1 Mt in 7 months. The expansion of swap transactions as well as long-term contracts can be a good measure to overcome the price volatility on the coal market. In the case of swap transaction, participants can easily change the price terms with offsetting transactions. In contrast, under the long-term contract, it is difficult to change the price terms because of the rigid transaction structure. And a combination of swap transaction, long-term contract and spot purchase makes it possible to use various purchasing strategies(see Table 6-1). So, it is necessary for Korean coal importing companies (in particular, power generation companies) to consider and prepare for an active participation in swap transactions of coal. It is also requested to foster experts on swap transaction as well as to get the government and management interested in the swap transaction. Ch 6. Countermeasures against changes in the Future 125

148 Table 6-1 Examples of SWAP transaction Situations SWAP transactions A B C D - Generator(buyer) intends to fix spot purchase price for the next year. - Coal company(seller) thinks it is the time to determine the contract price for the next year, but buyer is delaying negotiations. - Generator(buyer) expects that coal prices will decrease for years to come. So, it insists an one year contract but coal company insists a two year contract. - As a specific type of coal is appropriate to its boilers, generator wants to secure the coal for years to come, but does not want a fixed price contract. - Generator purchases Coal Swap for the next year + purchasing the same amount of coal in the next year realizing a fixed price transaction - Coal company sells Coal Swap for the next year + selling the same amount of coal in the spot market realizing a fixed price transaction - If buyer hopes to purchase, coal company settles the Swap transaction through the purchase of Swap and makes a contract with buyer, or refuses buyer's proposal. - Generator makes a two year contract with coal company and sells Coal Swap for the 2nd year contract realizing an one year contract with spot purchase for the second year contract. - Generator makes a contract of 100 thousand tons per annum with coal company at $40/ton for 5 years. At the same time, it sells a Coal Swap of 100 thousand tons per annum at $40/ton to an intermediary agent. (one months later) Index price is $38/ton: Generator receives $2/ton from the intermediary, and pays $38/ton to coal company purchase at $38/ton (two months later) Index price is $43/ton: Generator pays $3/ton to intermediary, and pays $40/ton to coal company purchase at $43/ton (three months later) Index price is $39/ton: Generator receives $1/ton and pays $40/ton to coal company purchase at $39/ton Generator purchases what it want at spot price. E - One year later, the generator like D above expects that the spot price will not decrease any more, so it intends to fix the price for 4 years(in this case, the Coal Swap price is assumed to be $37ton). - Generator purchases from Intermediary2 a Coal Swap of 100 thousand tons for 4 years at $37/ton. (one month later) Index price is $36/ton: Generator receives $4/ton from intermediary1, and pays $1/ton to intermediary2 and $40/ton to coal company purchase at $37/ton (two months later) Index price is $39/ton: Generator receives $1/ton from intermediary1 and $2/ton from intermediary2, and pays $40/ton to coal company purchase at $37/ton (three months later) Index price is $35/ton: Generator receives $5/ton and pays $2/ton to intermediary2 and $40/ton to coal company purchase at $37/ton Generator purchases what it want at fixed price. Source: MOCIE, "A study on rational methods of steam coal purchasing for power generation"(written in Korean), November For original source, see Doyle, Swap shop, World Coal(Oct. 2003) 126

149 c. Participation in Trading Business It will be also desirable to participate in coal trading business. Entrance to the trading sector will highly contribute to securing a stable coal supply as well as sale and value maximization of overseas coal produced by Korean companies. By participating in various types of coal trading, we can reduce the cost of imported coal and enhance the stability of coal imports. It can also allow an optimal utilization of shipping vessels and an adjustment of coal quality(lee, Y.J., 2011). In particular, it is meaningful that this would pioneer a new business in the area of coal trade. However, it is difficult for Korean companies to participate in the coal trading business because the trading sector is already dominated by companies of developed countries. As a solution to this problem, we can take over a foreign trading company. Even though the company is small, we can secure basically an certain amount of trade volume and, at the same time, utilize a group of well-experienced experts. If we can take advantage of our current spot purchase amount, which is equivalent to 30% of total purchase amount, with this company, we will be able to foster our trading business as soon as possible. d. Ocean Freight Charge Management 30) 30) Ko, B.U., A Consultation Paper, Korea Maritime Institute, 2011 Ch 6. Countermeasures against changes in the Future 127

150 Ocean freight charges account for a great part of coal supply cost. Generally, freight charges represent about 10% of import price, but sometimes the proportion rises to more than 30%. In addition, the charges show a high level of volatility. Therefore, it is necessary to stabilize the ocean freight charges. A basic policy for the stabilization of ocean freight charges is to maintain a certain proportion of industrial carriers and long-term charters. As of 2010, the proportion of industrial carriers and long-term charters is more than two thirds, similar to the proportion of medium and long-term contract. As, under medium and long term contracts, coal is transported repeatedly from point to point for a certain period of time, it may be desirable to use industrial or long-term chartered vessels. Table 6-2 Risk Premium for a Vessel (unit: US $) Period Short-term Freight (A) 3 years' Charter Freight (B) A-B ,524,526 15,561,000 8,963, ,785,647 37,366,000 28,419, ,610,125 42,588,000 63,022, ,418,538 7,976,500 8,442,038 Source: Ko, B.U., A Consultation Paper, Korea Maritime Institute, The original source is Korea Ship-owners' Association(2010) 128

151 However, for spot trading in which transportation demand occurs irregularly, it is unavoidable to use short-term charters. But, as, in the short-term chartering, one should pay a risk premium to shipowner, the cost of short-term chartering is generally higher than that of long-term chartering and is more volatile. For the stabilization of short-term charter charges, participation in trading of freight derivatives on Baltic Exchange can be an option. World dry bulk carrier businesses have used the FFA(Forward Freight Agreement) trading since 1992 to hedge the volatility risk of short-term charterage. The FFA is a kind of forward transaction in which shipowner and shipper can agree on the charterage of individual sea route and, basically, there is no standard for the FFA trading. So, it is possible for customers to make a customized contract. The FFA trading has greatly increased since they were introduced in In the FFA trading, two contracting parties pony up the freight charge or charterage at a certain point in the future for a dry cargo or a seaway for oil tanker in terms of a specific amount of cargo or a certain type of vessel 31). The term 'seaway' refers to a specific sea route or a basket of routes. Such forward trading for the ocean freight charges is based on the 'freight rate assessment' for the 31) On 28 June 2011, Shanghai Shipping Exchange announced it had established an electronic exchange for trading of freight derivatives for container ship. Like this, the FFA tradings are being expanded to container liner market as well as bulk carrier(dry bulk carrier and oil tanker) market. Ch 6. Countermeasures against changes in the Future 129

152 related seaway which is offered by market information providers such as Baltic Mercantile and Shipping Exchange and Platts(for oil tankers). In the FFA trading, the difference between the contract price and the clearing price which is calculated by a predetermined formula is paid for in cash(or in other equivalent payment options). Figure 6-1 FFA trading in the Dry Bulk Cargo Market (Estimation) (unit: 1,000 lot) Note : 1 lot corresponds to a cargo of 1000 tons or a day's charterage Source: Ko, B.U., A Consultation Paper, Korea Maritime Institute, The original source is Alizadeh & Nomikos(2009), p.129. The FFA trading can be divided into three types, according to what place the trading takes place in: 1) Direct transaction between contracting parties(over-the-counter transaction). 2) Transaction 130

153 through the Exchange such as NYMEX, LCH(London Clearing House), SGX, NOX(Norwegian Futures and Options Clearing House). 3) Transaction through the Hybrid Exchange 32). For your guidance, let's take an example of FFA trading through which a shipper(charterer) intends to hedge the risk of freight charges. Let's assume that a shipper needs to secure in early July a ship which will travel from Europe to Far East in mid September. As the shipper expects the freight charges to increase, he wants to make a contract of carriage in early June instead of toward the end of August. So, the shipper decides to purchase a FFA for August for a seaway BPI(Baltic Panamax Index) 2A 33) from Europe to Far East. The clearing price of the FFA for August for the BPI 2A is determined by the average of the prices for last 7 trading days of August for the BPI 2A which are provided by the Baltic Shipping Exchange. The spot freight charge for the BPI 2A is $11,158 per day on 2 July 2010, but the FFA transaction price for August is $10,050 per day. That is, the FFA is being traded with 9.93% discount. Like this, the market expects that the freight charges will decrease from July to the end of August. This means that the freight charges in the future 32) The transaction is made through internet, but the settlement through the clearing house. Norway's Imarex provides now an electronic trading system, but has the settlement of transactions to be made through NOS(National Ocean Service). 33) It's a seaway from Skaw(Denmark)/Gibraltar(Spain) to Taiwan/Japan via India, with a sailing period of days. Ch 6. Countermeasures against changes in the Future 131

154 will be $603,000($10,050 60). Eventually, the shipper decides to fix the freight charge at this amount and purchases the FFA. Table 6-3 Risk hedging of Freight Charges through FFA Spot Market FFA Market on 2 July BPI Spot price: $11,158/day - BPI FFA for August: $10,050/day - Freight Charges($): 669,480 - Expected Charges($): 603,000 (=$11,158/d 60d) (=$10,050/d 60d) Shipper purchased the FFA for August 2001 on 31 August BPI Spot price: $13,500/day - Freight Charges($): 810,000 (=$13,500/d 60d) - Additional Charges in the Spot market($) : $207,000 = $810,000 - $603,000 - BPI Clearing price of FFA August: $13,450/day - Profit from the FFA transaction($) $204,000 = ($13,450/d-$10,050/d) 60d Net loss = (-)$3,000 Source: Ko, B.U., A Consultation Paper, Korea Maritime Institute, The original source is Alizadeh & Nomikos(2009), p.129. In this situation, if the shipper who has fixed the future's freight charge at $10,050 per day makes a new carriage contract, on 31 August, with the shipowner at a spot price of $13,500 per day, the shipper will pay $810,000($13,500 60) as a freight charge. This payment will be $207,000 higher than expected in July. On the other hand, let's assume that the FFA clearing price increased also to $13,450 per day. Then, the shipper will make a profit of $204,000 ({13,450-10,050) 60) as a result of the FFA contract in July. In the 132

155 end, the shipper will make a net loss of $3,000 with an additional charges of $207,000 in the spot market and a profit of $204,000 from the FFA contract(see Table 6-3). In addition, we assume that the broker's commission is $1,507.50(0.25% $ ). In this case, the freight charges without hedging through FFA will be $810,000, but actual charges will be $607,507.50(including the commission) thanks to the FFA transaction. In the end, with the FFA transaction, the shipper can fix his freight charges at $10, per day. a. Coal Development in Overseas 34) About 48.3% of annual coal demand in Korea is now met by imported coal which is developed by Korean companies. Though this amount is nearly satisfying the Korean government's official objective(50%), it will be not enough to dispel all the worries about stable coal supply even in the emergency situation such as energy crisis and war. In addition, as most of the coal development in overseas is currently carried out in South-East Asia and Oceania, there is an increasing need to diversify supply sources. 34) Kwon, S.J., "A review on Bituminous coal Policies in Korea"(written in Korean), A Consultation Paper, Korea Resources Corporation, Ch 6. Countermeasures against changes in the Future 133

156 Table 6-4 Develop & Import Scheme vs Simple Import (unit: US $) Advantages Disadvantages Simple Import o More choice for purchaser, prompt and economic purchase in a stable demand & supply o Flexible adjustment of supply o No risk of investment o Supply instability in a tight market situation o Price volatility, especially risk of price spike Develop & Import o Stable supply o Stable purchase cost and Development gain o Informational advantages and some side effects Sources: Kwon(2011) and KEEI(1988) o Heavy development expenditure o Risk of exploration, development and production o Inflexible adjustment of supply On the other hand, the coal development in overseas is now mainly carried out by private general trading companies. In this situation, the stability of coal supply can be vulnerable to economic ups and downs. In fact, private companies have often withdrawn from coal business or disposed of their coal business units for the sake of profit. Therefore, for the security of coal supply, it might be more desirable that the public enterprises or coal users should secure a minimum capacity of coal supply. And, for the enlargement of overseas capacity of coal supply, it is also necessary that public institutions or enterprises should participate more actively in developing coal projects in the broader regions and more countries. 134

157 Australia Canada Indonesia China South Africa Target regions QLD NSW British Columbia, Alberta Kalimantan, Sumatra Advantages Vast reserve Strong coking coal Vast reserve Strong coking coal Competitive Price Various investment opportunities Shaanxi, Shanxi, Vast reserve Low freight Shandong, charges Heilongjiang Entire East region Russia Yakutsk, Kuzbass Table 6-5 Target Countries for Overseas Coal Development Vast reserve Various investment opportunities Vast reserve Strong coking coal Mozambique New new NewZealand investment Entrants Mongolia opportunities Comparison Disadvantages High labor cost Existing Major Players High rail freight charges High production cost National risk Poor Infrastructure Insufficient rail capacity Poor investment climate High freight charges Used mines Increased rail charges Insufficient port infra Insufficient infrastructure Note: Reserves are based on the BP(2010) data. Source: Kwon(2011). Reserve (100Mt) 762 (9%) 66 (1%) 43 (0.5%) 1,145 (14%) 304 (4%) 1,570 (19%) Development Strategies Cooperation with middlesize firms(e.g. Whitehaven) Interest in underdeveloped areas(galilee, Surat, Gurneda) Cooperation with new companies(e.g. WCCC) Interest in British Columbia region Coal for power generation Interest in Central region (for coking coal) For steam coal/coking coal Investment in exploration/ development Cooperation with Leeuw, Continental In connection with Ambatobi project Cooperation with Mechel Steel Interest in Elga project For coking coal Interest in Tavantolgoi As natural resources companies are becoming larger and larger through mergers in world markets, it may be a daunting task for small and medium-sized domestic companies to enter the coal development business individually. In this case, the formation of a consortium, which can allow each participant to maximize its Ch 6. Countermeasures against changes in the Future 135

158 strengths, can be an alternative. The establishment of a consortium with foreign companies such as Japanese electric companies can also be an option to consider actively. In sum, to reinforce the stability of coal imports, we should implement steadily some policies as follows: 1) to revise the objective for the develop and import scheme upwards: 2) to activate Korean style consortiums for resources development in overseas; 3) to encourage coal users to participate directly in overseas developments and guarantee to purchase the developed coal; 3) to induce public sectors to play a leading role in diversifying supply sources; 5) to expand financial support for the enlargement of overseas resources development. b. Reinforcement of Long-term Contracting In 2010, the proportion of long-term contracts in the coal imports of the five biggest thermal power generation companies in Korea decreased by about 10%p. The proportion had been maintained at a level of about 80% until 2008, thanks to stable coal prices, but it have dropped to a level of 70% since the coal price decreased abruptly in the second half of It is because the power generation companies have been more dependent on spot markets with increased competition among themselves. As a result, even though the power companies could reduce their purchasing cost, the 136

159 stability of supply and their bargaining power on long term contract have been weakened. For reference, Taiwan Power Company is trying to secure a stable coal supply by setting a guideline for purchase on long term contract: not more than 35% for an individual country and 15% for an individual supplier. It is also recommended that the contract period should be set at 4-6 years or 6-12 years. Generally, long-term contract prices and spot prices move in a similar way. But, in 2008, the spot price was $30/ton higher than the long-term contract price. In this case, coal purchasers would have suffered a big loss if they had not had long-term purchase agreements sufficiently. In the current competitive climate, except the case of 2008, the difference in purchase price among the power generation companies reflects the price differential between spot prices and contract prices. Therefore, it is essential to maintain a proper proportion of long-term contracts in order to secure a stable and economic coal supply in the long-term perspective. Especially, it should be pointed out that it would be very difficult to raise again the proportion of long-term contract after the proportion has already dropped. Ch 6. Countermeasures against changes in the Future 137

160 Figure 6-2 Long-term/Spot Purchase ratio for Power generation companies in Korea Source: Lee, Y.J(Korea Sout-East Power Co), A Consultation Paper, 2011 Figure 6-3 Long-term/Spot Purchase Prices for 5 Power Generation Companies in Korea Note: Prices are based on 6,080kcal/ton, CFR, and average purchase prices from each country Source: Lee, Y.J(Korea Sout-East Power Co), A Consultation Paper,