By Nick Ristic
Background
Earlier this year, diplomatic tensions between Canberra and Beijing flared up over calls from the Australian government for an investigation into the origins of the Covid-19 outbreak. As we covered at the time, this was followed by China imposing restrictions on imports of Australian produce, in the form of an 80% tariff on barley purchases.
Since then, the dispute has continued to rumble on, encroaching more and more on dry bulk trade. In early October, we heard reports that power utilities and steel mills had received verbal instructions from authorities to halt coal buying from Australia, following a surge in buying activity in June and July. These rumors were not officially clarified, but we did see Chinese end-users reselling shipments which had not yet arrived and cutting back further purchases for fear of cargoes being prevented from clearing customs. Many of these diverted cargoes headed to India or Vietnam, while others continue to wait outside Chinese ports. Queues of Post-Panamaxes in particular have seen excessive waiting times, given they are heavily used in the Australia - China trade.
Despite this, we actually saw discharges of Australian coal in China tick up by 21% MoM in October to 6.4m tonnes according to cargo tracking data, though it is unclear how much of this had been waiting to clear for an extended period of time. This volume is however still down by around 12% YoY.
Tensions escalate
This week we heard further reports of unofficial bans, now emphasising restrictions on coking coal, with Chinese steel mills again receiving verbal notices from the Ministry of Commerce to stop importing Australian material. This time, there is a defined deadline: November 6th. Australian coal cargoes arriving before this date can reportedly be considered for clearance. Cargoes reaching Chinese ports after this date will not be eligible for clearance, according to some end users, though we understand that few Australian coal cargoes were booked since the last verbal ban.
Meanwhile, restrictions have now been placed on other commodities, which have a lesser impact on the dry market but are nonetheless valuable exports for Australia. Verbal notices were issued to traders telling them to cease purchases of wine, lobster, copper, sugar and timber.
The bigger picture
It is no coincidence that, during a time of frosty relations, the recent move on coal has targeted Australian producers, but politics is not the only factor at play. Rumours of import bans come against a backdrop of much wider restrictions on coal imports from all sources. As we have covered over the past few months, China has maintained monthly quotas on coal imports this year, which aim to support its domestic coal mining industry while allowing some trade to keep power utilities’ margins healthy.
This policy is responsible for the large slump in imports across all producers that we have seen in recent months. Relative to Australian imports, we’ve seen far more severe declines in volumes of low quality product from Indonesia, which is far more easily replaced with domestic supply. As a result of the quotas, we’ve also seen a significant arbitrage open up between Chinese domestic and seaborne coal prices over the past couple of months, as local production and transport has struggled to keep up with demand from utilities.
The Daqin Railway, which is largest coal transporting rail service in China and hauls material from producers in Shanxi in the north to the transhipment hub of Qinhuangdao, has suffered multiple accidents. This includes a derailment this week, which has added upward pressure to domestic prices. On a CFR basis, the price spread between domestic and Australian coal of similar specification pushed to a record $40/tonne in September, remaining elevated since.
Citing these points, Australian coal producers have remained somewhat upbeat, expecting sales to China to rebound at the start of next year when import quotas are eased due to pressure from power utilities faced with tight margins. They see the recent restrictions as a reaction to higher than anticipated shipments from Australia in Q3, rather than a long-term ban on trade. After all, this is not the first time trade with Australia has been restricted in some way.
Substitutes
In the short term however, Australian coal shipments are likely to remain depressed, and the availability of substitutes from other sources is already reshaping coal trade flows. While Australian cargoes are being resold into different markets, Chinese buyers are looking to other suppliers for high-spec coal. Over January - October, seaborne imports from Russia surged to 24.7m tonnes, an increase of around 40% YoY and 78% versus 2018. While Russian supply can compete with that of Australia on quality, it has historically been unable to significantly ramp up output. The majority of this increased volume has come from ports on Russia’s east coast, such as Vostochny and Shakhtersk on Panamaxes and Supramaxes.
But we have also recorded a jump in longer-haul coal voyages to China from Murmansk, mainly on Post-Panamaxes. Shipments from Murmansk are up almost ten-fold on 2019’s volume, totalling around 1.5m tonnes so far this year. The majority of these shipments made the seven-week voyage via the Suez Canal, but we also saw a handful of specialised vessels taking the Arctic route via the Northeast Passage.
If restrictions on Australian coal continue into next year, China will likely need to look for other sources to satisfy demand given the limitations on Russia’s production capabilities. This could translate to more long-haul trade from Canada and the US, but would also likely increase the flow of overland coal volumes into China from Mongolia.
Is iron ore next?
Naturally, worsening relations between Australia and China have prompted questions over whether commodities more critical to the Australian economy, such as iron ore and natural gas, will be hit next. We see restrictions on Australian iron ore as being highly unlikely, given how crucial the commodity is to Chinese economic growth and the absence of alternative suppliers to pick up the slack.
Today’s seaborne iron ore market is tight, owing to both strong Chinese demand and persisting supply issues in Brazil, which seems to be struggling to push output above 2018 levels. As such, Beijing is left with little alternative but to allow 60% of its iron ore needs to be sourced from Australia. Longer-term, supply from West Africa could change this dynamic, but projects in the region will likely not see their first shipments until 2025 at the earliest.