Glencore gets slugged by a thermal coal slump

Glencore’s decision to temporarily shut down its Australian coal production highlights the severe stress experienced by the thermal coal sector, and it could be years before the outlook improves.

Glencore’s unusual decision to shut down Australian coal production for three weeks might be something of a Band-Aid response to the glut in thermal coal markets that has been driving the price down, but it does highlight the stress the sector is experiencing.

The shut-down, which will reduce production (or defer it) by about five million tonnes is a clear signal that Glencore’s Australian mines are experiencing acute stress. It makes no sense to pour more coal into an over-supplied market while the mines are bleeding cash.

The temporary nature of the cessation of production, however, means that Glencore won’t impact the supply-demand fundamentals of the market. It means that it is only shaving the expansion of its own production to record levels.

Glencore, the world’s biggest thermal coal producer, had forecast that its global production would increase from last year’s 157 million tonnes to 168 million tonnes this year, with Australian production rising 16 per cent to 94 million tonnes.

While that increase in production has been contrasted with criticism by Glencore’s Ivan Glasenberg of Rio Tinto and BHP Billiton’s iron ore expansion strategies into a similarly over-supplied iron ore market, Glencore inherited a number of big coal mine developments when it acquired Xstrata 18 months ago.

An already difficult market for thermal coal has been made even more difficult by falling demand in China and China’s introduction of tariffs on imported coal against the backdrop of large-scale and widespread losses within its domestic coal industry.

Thermal coal prices are now in the low $US60 a tonne range, about half their level three years ago.

Glencore’s own assessment earlier this year (when the price was about $US10 a tonne higher) was that about 35 per cent of seaborne thermal coal supply was cash-negative and more than two-third of Chinese domestic producers were losing money. At current prices it would appear fair to assume that more than 40 per cent of seaborne supply is cash-negative.

Glencore, along with most of the other major producers, has shut down some mines and cut production at others in response to the slumping coal prices.

The producers are, however, trying to maintain production in their lower-cost and higher-quality mines and trying desperately to reduce their production costs to get the mines into cash-positive territory. They see demand for seaborne coal improving in the medium term and eventually absorbing the increases in supply that were locked in ahead of the end of the commodity price boom.

China’s efforts to reduce pollution and carbon emissions, diversify its energy mix and shift its economic strategies from investment to consumption and the displacement of coal by shale gas in the US will continue to weigh on the sector, although India’s expected growth demand is a positive.

In the absence of further and large-scale mine closures, however, it may take several years and considerable financial pain before the market is in a better balance and prices stabilise at profitable levels.