Analysis :Metallurgical coal costs to fall further in 2016

  • Tuesday, March 01, 2016
  • Source:ferro-alloys.com

  • Keywords:Mg magnesium metal
[Fellow]Cost savings well and truly remain the focus of global metallurgical coal producers in 2016. Last year, in US Dollar-terms, we estimate that seaborne hard coking coal costs fell by a record amount (i.e. 18% y/y), as the industry's push towards "pre-boom" level...

Cost savings well and truly remain the focus of global metallurgical coal producers in 2016. Last year, in US Dollar-terms, we estimate that seaborne hard coking coal costs fell by a record amount (i.e. 18% y/y), as the industry's push towards "pre-boom" levels of productivity was added to by falling currencies and energy prices.

In the chart below, we have plotted our estimate of the seaborne hard coking coal Business Costs curve in 2015, along with average price levels. For the calendar year, we estimate that prices sat ~77th percentile of the seaborne curve (n.b. the percentile was lower on the global cost curve), which indicates a level of industry profitability below what would be expected under steady-state conditions, but not so disastrous as other commodities.

In the same graph, we have also plotted our estimate of the industry variable cost curve in 2015. CRU believes this cost curve is useful in determining true "floor prices" when prices are falling and the industry is in "survival mode".

Why is understanding variable costs useful?

A relatively large proportion of costs are fixed in nature (i.e. ~40-70% according to our analysis of different mines) and, therefore, this money will need to be spent in the short-term irrespective of the volume of production or whether the mine closes down completely, whereas variable cost are incurred depending on the level of production. Fixed costs include labour and rail and port infrastructure (e.g. take-or-pay fees) and variable cost will include roof bolts, fuel and other supplies. Therefore, in a low demand environment, owners of mines are often willing to sell material for a period of time at a level that is below the total costs of an operation, but above variable costs, as this provides coverage of the fixed cost expense.

As a result, while prices can drop into the total costs curve, in desperate times, they should sit above, or close to, the 100th percentile of a variable cost curve, and this is demonstrated in the graph above.

Looking at the graph below, if the start of 2016 is anything to go by, operators are likely to see costs fall further still in 2016. We expect that met. coal miners will find operational cost savings more difficult to come by, but the macroeconomic environment is providing further cost relief. Key macroeconomic variables - the oil price and currencies - have plunged further since the end of 2015 and, below, we have re-run our 2016 cost curve at prevailing spot levels for oil prices and currencies, as of the end of January 2016, to demonstrate the impact. Given our developing view of the macro-economic environment, we believe the cost curve below represents well costs for 2016 as a whole.

Further cost reductions to come in 2016

In the chart below, we have shown more granular detail to demonstrate how, and why, we expect costs to change in 2016 compared with 2015. For simplicity, we have grouped our mine-by-mine costs sample into average country-level costs.

The key drivers of cost changes presented above are currency movements and fuel:

Currencies: the US Dollar has strengthened further in 2016 and oil exporting countries, such as Canada and Russia, have seen their currencies strongly devalued due to the collapse in the price of oil. This automatically reduces the US Dollar spend on locally denominated costs, such as labour, inland transportation, power and a share of consumables.

Fuel: the aforementioned fall in the price of oil has further reduced prices of fuels used in mining and coal transportation. The reduction in oil prices is expected to decrease costs by $1.0-2.5 /t y/y in 2016, but will especially help those producers with large truck and shovel fleets and open-pit operations. 

 Author:Stephen Duck, Senior Consultant Adam Parums, Senior Consultant at CRU

  • [Editor:tianyawei]

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