July 5, 2018 / 6:21 AM / 15 days ago

EXPLAINER-What the failed Glencore-Tohoku coal talks mean for the market

TOKYO/SINGAPORE, July 5 (Reuters) - Electric utilities in Japan and other Asian countries are driving blind when it comes to coal prices after the failure of Japan's Tohoku Electric and Glencore to agree on an annual thermal coal contract that is used to set prices for the region.

Tohoku Electric, a major Japanese utility, and Glencore, the world's biggest exporter of seaborne thermal coal, abandoned the talks last month on their annual Australian supply contract.

"Both parties seem to have tried hard to come to a consensus but always had large difference in price expectations this year," energy consultancy Wood Mackenzie said in a note to clients.

Coal prices spiked as Japanese and Asian utilities jumped into the spot market to cover their needs after the talks broke down.

Companies that were relying on the talks to set a price for their previously delivered cargoes and future shipments under their April to March contracts now lack a reference for netting out prior payments based on temporary prices.

The collapse of this year's talks has raised questions about the industry's dependence on this method of setting prices.

WHAT WENT WRONG?

Japan's utilities, which buy about 40 percent of Australia's thermal coal exports, have a relationship with Glencore and its predecessors that goes back over 30 years.

The two sides typically sit down early in the year to negotiate fixed prices for annual supplies for April to March.

Those prices are published by media and used by utilities in Thailand, Taiwan and Malaysia for their own contracts.

However, during the talks this year, spot coal prices rose, making it difficult for the sides to settle on a contract.

"Because Tohoku already signed some deals with smaller suppliers when spot prices were lower, they were not willing to pay significantly more for coal from their biggest supplier, Glencore," said one source with knowledge of the matter who declined to be named as he was not authorised to speak publicly about commercial deals.

"Glencore had the opposite view. They were unwilling to agree to a supply deal significantly below spot market prices," the source added.

WHY DOES IT MATTER?

Without this year's deal, utilities need to find another reference price for their annual supplies or they can buy in the spot market.

Finding another benchmark is difficult because the coal market is more opaque than other commodities such as crude oil, where exchanges readily publish futures prices.

Rising prices have made going into the spot market expensive.

Spot thermal coal prices at Australia's Newcastle terminal have climbed by 32 percent from their 2018 lows, to over $120 per tonne, the highest since 2012.

But, buying from Newcastle supports Glencore, which exported 49.1 million tonnes of coal from Australia in 2017, a quarter of the country's overseas sales, according to government and company data.

WHAT'S NEXT?

Market participants are divided on the industry's next steps.

Some traders expect another Japanese utility to become an alternative negotiator for this year, or Tohoku will renew negotiations for another term contract as it wants to reduce its exposure to the volatile spot market.

Others expect the failed talks to mark a more significant change.

"Power market liberalization in Japan now demands that utilities have more flexibility in coal prices in their ability to pass-on fuel costs," Wood Mackenzie said.

National Australia Bank said in its July commodity outlook published this week that "spot prices for thermal coal may become increasingly important, given the breakdown of the traditional Japanese financial year contract mechanism."

Some Japanese companies are improving their ability to operate in the spot market.

JERA, a joint-venture between Tokyo Electric Power and Chubu Electric Power and one of the world's biggest fuel importers, has taken over the coal operations of Europe's EDF Trading and plans to buy its liquefied natural gas operations.

JERA President Yuji Kakimi said the company has reduced its coal requirements using long-term contracts to only a few percent from as much as 80 percent a decade ago.

Another option is to use spot price indexes. Japan's steel sector moved to this model last year after Nippon Steel & Sumitomo Metal ended their decades-old fixed price mechanism settled through talks with Australian miners for coking coal.

However, a senior official at Glencore said "that is not what we desire to happen."

Reporting by Yuka Obayashi in TOKYO and Henning Gloystein in SINGAPORE; Additional reporting by Aaron Sheldrick and Osamu Tsukimori; Editing by Christian Schmollinger

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