Towards a recognised steam coal price marker in Ukraine

IHS Markit was commissioned in late 2017 by DTEK to undertake a study of coal pricing methodology in Ukraine. In particular, it was asked to review and analyze the pricing for steam coal that are traded into or within Ukraine. To this end, in December 2017 IHS Markit reviewed price-setting processes elsewhere in the world in order to understand the best practices for price setting systems and how they may apply to Ukraine.

How coal is traded globally

• Coal is one of the main commodities that is traded on the world market, mostly without any restrictions.
• Most countries have moved towards market-based energy price settlement.
• All West European countries are now, or are transitioning to, free markets for coal sales and trading – deals tend to be short term in nature and spot/hedged and related to the API#2 index.
• In NW Europe only Poland has a substantial local coal industry. This works on a free market basis but co-operation or mergers between coal producers and generators are increasing the management of local markets for optimal joint profits.
• Turkey is free market but has set a floor to prices so that whenever spot import prices fall below $70, a variable tax of up to $15 a tonne is charged to importing generators. This is to protect local coal and lignite producers.
• Most of the rest of the world trades coal on a free market basis, largely spot but with some term (annual) business in Asia.
• China, which has the world’s largest domestic coal industry, is moving towards market management after finding price fluctuations on the spot coal market caused problems on both the buy and supply sides.

Indexation has enabled trading, forward pricing and increased transparency

• The international steam coal trading system that has developed since the early-2000s has made life considerably easier for companies willing to embrace it. On the buy side, buyers have found that by staying on index, they are less exposed to bad deals because they acted in accordance to market logic. They can also hedge their purchases forward so that their price and any further trading off it is protected. On the sell side, traders are similarly protected as long as they are selling at market price and can hedge in the same way. Effectively, indexation has allowed buyers and sellers to have a degree of certainty about forward prices without having to fix long-term deals with individual suppliers, which was the main trading system in use until the late-1990s/early-2000s.
• The new indices encouraged setting term deals to shadow spot price movements and drew in traders from other commodity markets, who were already used to the market instruments and practices that were used readily in other commodity trades.
• Within a few years of its birth in 2001 API#2, which is the main index for NW European trading, was easily the most traded index, while new indices were being added regularly by a number of players, as everybody sought the next API#2.
• This way of coal buying is now widespread in Europe and in Asia.
• However, in many parts of Asia, utilities remain locked in either state control, or governed by state-run power markets.

Ukrainian price-setting, NEURC Methodic[1]

• Prices delivered to Ukrainian power stations are based on the following parameters:
• Average API#2 price over the 12 months previous plus Average freight over the same 12 months.
• Freight is calculated by adding:
  • The average freight costs from ARA to Ukraine over the same 12 months, plus
  • The average cost of transit from vessel to stockpile.
  • The API#2 price is undoubtedly transparent, since it is openly reported.
  • For steam coal, a key issue with respect to using a NW European price plus freight from Rotterdam to Ukraine, as is the case now, is that there is little or no coal freight on this route, so the freight costs can only be estimated.
  • A second approach that could be used is take the indices based on the FOB basis for low volatile and high volatile coal  and add the transportation costs to the Yuzny port. With this approach, there is a risk of price increases due to trade in the Asian region.
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Main Conclusions

1. The pricing of steam coal is a fairly simple task because it is a widely and openly traded commodity, with major international hubs in NW Europe, South Africa, Southern China and Newcastle (New South Wales), plus many others.
2. Prices on the main indices tend to move together, meaning that the simplest approach to price-setting in Ukraine would be to adjust an agreed base price by the same proportion as one of the main indices. In this case, we suggest the NW European hub provides the best indicator of price movement.
3. Ukraine’s current system already uses the NW European hub in the form of the API#2 index but adds freight from Rotterdam to Ukraine. This is a valid approach to price setting, applying similar principles to the basic approach described above. However, the freight element of the calculation is neither regularly nor openly traded.
4. An alternative to the existing Ukrainian system is to take the NW Europe price as a starting point, calculate netbacks to loading ports, and then apply freights to Ukraine in order to reach a delivered Ukraine price. However, this can introduce too many uncertainties to the process since it assumes reliable estimates of freights from export terminals to Ukraine, which could not necessarily be sustainably achieved. In addition, this approach exposes Ukrainian prices to movements in the values on the Asian market, which tend to be much higher than those in Europe and are likely to become more so as the European Union steam coal market increasingly shrinks in importance.
5. Both of the above systems, however, expose the Ukrainian market to the volatility of the international coal market. For example, NW European prices today stand in the mid-$90s per tonne, 6,000kc basis, but in early-2016 they were at a weekly low of $42. Furthermore, during the commodities price boom in 2008, weekly NW European prices, same basis, peaked at $219, the all-time weekly high. Ukraine needs to be aware that price trends can be very damaging if there are no checks and balances in any price-setting system.
6. There is a limited global anthracite market, so few data points are available for comparison.
7. IHS Markit deliberately conducted this analysis without asking what it is to be used for in order to avoid considerations of acting in the interests of suppliers or buyers.