Coal truths in the Japan aftermath
The devastating earthquake and subsequent tsunami that left over 27,500 people killed or missing has largely spared the Japanese steel industry. For Indian steel producers, whose margins have been squeezed over the last two quarters by rising coking coal prices, the uptick in steel demand from a Japanese reconstruction effort may lead to little respite from higher coking coal prices.
Coking coal prices, had ruled strong in the recent past, following the floods in Queensland, Australia that put many mines in that region out of operation, denting the margins of several Indian steel producers.
While the prices appear to have eased for now, supply-side challenges will again lend pricing power to miners. This may be bad news for players like JSW Steel, which depends wholly on external sources for metallurgical coke, while Tata Steel and SAIL depends on external sources for 70-80 per cent of their requirements. What does the reconstruction-led demand for steel bode for the sector? Does it shift the dynamic between miner and steel producer?
Unlike most other economies, Japanese steel production has a high degree of concentration and if a proposed merger between Nippon and Sumitomo does go through, the top player would control 40 per cent of Japanese steel production.
Most of Japan’s 132 million tonnes of capacity remains intact and has come on-stream following quick inspections for damage. However, they continue to operate with periodic shutdowns as a result of power outages.
As much as 10 per cent of Japan's power generation capacity has been disrupted due to damage to the Fukushima Daiichi nuclear plant and other coal and LNG based power generation capacity. This has lead to a raft of measures to conserve power, including curtailed schedules for services ranging from blast furnaces to train services.
While the Chinese steel-making behemoth, with over 600 million tonnes of production capacity, makes Japan’s 132 million tonnes per annum look small, the latter occupies a very important position in the steel cycle, owing to a qualitative advantage.
Producers such as Japan Steel Works (nuclear reactor domes) and Nippon Steel’s (among JFE, Kobe and Sumitomo) occupy important niches in the sector, aided in no small part by the dominant automobile and heavy industrial goods producers.The perception of Japan as an export-intensive industrial giant stems from the fact that, despite having next to nil natural resources, the country remains one of the most efficient and largest producers of steel and copper, among other metals that feed other industries.
Japan exported 43.4 million tonnes of steel in 2010 — 40 per cent of the domestic production that year. To produce this vast amount of steel, the company imported and consumed around 135 million tonnes of iron ore and 70 million tonnes of coking coal. The country is also the largest importer of hard thermal coal, consuming over 165 million tonnes in 2009.
Despite massive imports of raw material such as LNG, crude oil, coal and metal ores, the country’s sizable exports to China and the US in the form of heavy industrial equipment, automobiles (including parts) and electronics enabled the country to enjoy a trade surplus of around $85 billion in 2010.
Japanese steel producers produce and export high grade auto-steel and steel plates, as well as other products, to China, South Korea and India, among other nations. Any curtailed production in Japan may temporarily spell good news for China and Korea, which can step in to supply certain products. However, given the specialised niches several Japanese steel producers occupy, there are few global producers who can step into their shoes.
Disruptions in the global supply chain of automotive parts have resulted in cuts to automobile production in major markets such as US and the UK. The big question is how quickly can Japanese producers, led by their beleaguered energy segment, restore production; and whether it will be soon enough to avoid a spike in prices resulting from supply-side constraints. Such a price-spike could derail the ongoing and fragile recovery underway in several developed markets.
An estimated $300 billion of reconstruction spending guarantees a higher demand for steel. With an estimated 150,000 buildings to be rebuilt and rail lines, airports and bridges to be restored, Japan’s slack steel producing capacity (current utilisation rates of 80 per cent) across product lines will surely come in handy.
Hopes of other Asian steel producers capitalising on reconstruction demand hinge on how quickly Japan is able to get uninterrupted power on stream for steel producers. Reconstruction efforts expected to pick up from the middle of the year, may boost demand for construction products including steel which, in turn, will boost demand for inputs such as iron ore and coking coal.
With Chinese demand weakening over the last couple of months, spot-prices for iron ore have cooled from the peaks of mid-February by around 10 per cent. Similarly, damage to several ports and thermal-power pants has sent coal prices lower and those of coking coal have plunged from around $340 to $240.
SUPPLY CONSTRAINTS AND INDIA
The post-Japan disaster price corrections to iron ore and coking coal are likely to be temporary. Japanese demand for coal and iron ore are likely to bounce back when reconstruction efforts kick off by the middle of the year. Prices of iron ore and coking coal may receive a fillip then. There is a shortage of both quality iron ore and coking coal, with a handful of players from Australia, Brazil and Canada controlling supply.
China's domestic demand for coking coal is likely to exceed supply by about 56 million tonnes. While India is self-sufficient in iron ore, 60 per cent of domestic requirement of 60 million tonnes per annum of coking coal is met by imports, with demand expected to increase by 22 per cent over the next year due to capacity additions coming on-stream. India's coking coal reserves are of a low grade and need to be blended with higher grades, which are imported.
SAIL, JSW and Tata Steel have seen operating margins slip over successive quarters, thanks to coking coal prices which have risen 25 per cent over the last six months. Indian steel producers, whose coking coal bills account for a major portion of their raw material costs, are going to find themselves increasingly reliant on imports, which are going to get more expensive. SAIL and JSW (including Ispat), which consumed around 14 million tonnes and 7.4 million tonnes during the last fiscal respectively, will need around 21 million tonnes and 14 million tonnes of coking coal each.
Simply put, the global steel sector is a lot more fragmented than the supplying mining segment. Indian steel producers will become price-takers once demand strengthens over the latter half of the year. Additionally, demand for coking coal is expected to outpace supply over the next 24 months, a situation that will be exacerbated when Japanese reconstruction demand enters the equation.