Coking Coal Sees First Swap Transaction

In the closing days of August, Credit Suisse (NYSE:CS) and an unnamed coking coal market participant completed a 60,000MT transaction that allowed the Credit Suisse’s counterparty to swap exposure to floating coking coal prices for exposure to a fixed price. While few details of the swap were disclosed, the transaction represented the first of its kind for the coking market which is seeking to hedge growing price volatility for both producers and consumers.

The swap – a financial transaction between two parties to exchange a fixed price for a floating price at some fixed date or dates in the future – is a six-month tenor transaction that provides coal traders protection for profit margins on cargo traded as principal, and gives customers fixed prices when buying at floating prices under contract.

The market for coking coal swaps are expected to grow quickly, despite mixed feelings amongst coal market participants. Credit Suisse Global Head of Freight and Iron Ore Kristian Thunes said “We believe steel mills will find this a very valuable risk management tool, especially since coking coal prices have been quite volatile in recent years, and would expect coking coal swap volumes to increase rapidly.”

The price of the swap was settled against Platts Australian Coking coal index, which stood at US $289/ton FOB Australia the Friday following the trade. Indexed based pricing is an attempt to provide standardization of pricing, and the growth of these kinds of instruments will help provide some transparency for coal traders whose role is to smooth out some of the volatility in prices.

A recent Reuters’ article cited a Hong Kong trader as saying that “Index pricing is a natural progression – obviously there is a lot of resistance to it, as there was in iron ore [after it introduced their swaps four years ago].”

An informal survey of several steelmakers conducted by Platts identified some of this resistance centered on the complexity of the trading swaps and concerns over trading swaps being decided against an index set by a person, rather than a system or platform.

But as more buyers have entered the marketplace in the last 10 years and higher quality coking coal has become scarce, traders, producers and consumers are looking for ways to reduce the financial burden of holding high-priced coking coal stocks. The price of coking coal has begun to climb over the last year from below US $200 per ton to recent spot trade highs around US $285/MT FOB Australia for premium coals.

In the same Platts survey, another merchant coke maker said the swaps “can only be positive…It’s an extra option, and the forward pricing will give us a different perspective.”

Thermal Swaps

Following Credit Suisse’s transaction, CME Group‘s NYMEX exchange announced it will list two new thermal coal swap futures, an Australian and a Chinese contract. The Australian future floating price will be based on the API 6 index, an Australian coal export benchmark published by Argus and IHS McCloskey, and the Chinese future on the arithmetic mean of the IHS McCloskey/Xinhua Infolink South China CFR Marker 5,500kc NAR. The new swap futures became available for trading on the NYMEX trading floor on 12 September 2011 and will be available for clearing through CME.

Argus Media (NYSE:GCI) chairman and chief executive Adrian Binks said the new contracts “will help expand risk management and trading opportunities for thermal coal in Asia-Pacific” and will be based on the same methodology for the API 2 and API 4 indexes it jointly produces with McCloskey Coal. The API 2 and 4 indexes are currently the benchmark prices for more than 90 percent of world coal derivative prices.

Despite some resistance to these floating prices, the same Reuters interviewed broker noted that “more and more Indonesians are proposing moving towards floating prices. The Chinese may get there – it isn’t going to be easy. Index pricing started in Europe five years ago. Two years ago no Indians would buy South African coal on the index but now 90 percent are doing so.”

The introduction of the new coking and thermal swaps will likely provide greater transparency of pricing in a market which is becoming much more globally integrated than it was 10 years ago. Prices for both thermal and coking coal remain very high today on the backs of growing demand, and any mechanism which may help alleviate any other price risks are likely to be adopted within the industry.

Securities Disclosure: I, James Wellstead, hold no direct investment interest in any company mentioned in this article.