Windfall Coming For Canadian Coal Cos In '08 - But What Then?
Dow Jones
April 09, 2008: 02:00 PM EST
money.cnn.com
VANCOUVER -(Dow Jones)- Arbitrage traders are starting to take short positions on Canadian coal producers, which are benefiting from news that fiscal 2008 coking coal prices will be triple what they were last year, thanks to a raft of supply-side problems that include massive flooding in Australia and transportation bottlenecks and delays.
"Everyone knew (new pricing) was coming, but now this is officially old news," said one arbitrage trader.
What's happened is this.
Shares in Fording Canadian Coal Trust (FDG) and a raft of smaller coal producers, such as Grande Cache Coal Corp. (GCE.T), spiked sharply Monday on news that South Korean steelmaker Posco (PKX) had settled on a contract price of US$305 per metric ton for fiscal 2008 - more than three times the US$98 contract price last year.
Historically, when a major contract like this is reached, the global benchmark will be about the same. Analysts across the board have called for a windfall year in 2008 for coal producers and have been ramping up their target prices for Canadian coal companies.
"This is great news for the coal producers. But now, the only thing that can happen from here is bad news - can they actually get enough coal to market given the transporation headaches and, really, how long will the spike last?" the arbitrage trader asked.
Following news of the Posco contract, Fording's share price hit a high of C$ 65.63 Tuesday, up 17% from Friday. The stock is trading Wednesday at C$64.00.
However, speculation that the price of coking, or metallurgical, coal - the stuff used to make steel - would spike higher in 2008 has been growing since January, following massive flooding in Australia's coal-rich Queensland district, which forced companies down under to declare force majeure on coal shipments.
Merrill Lynch reckons about 15 million tons of coal have been taken out of this year's market, thanks to flooding in Queensland's Bowen Basin. And it'll still take a number of months for companies to dry out these operations and re- wire machinery before restarting production and shipments.
And remember that back in January, Fording was at C$32.76 - about half what it is this week. At that time, the market believed the company was woefully undervalued, but the income trust, which benefits from the coal-rich Elk Valley mines in British Columbia, had announced a restructuring, in part because of its stagnant unit price.
This restructuring includes the possible sale of its 60% interest in the Elk Valley partnership. Teck Cominco Ltd. (TCK) holds the remaining 40% in that partnership but controls 52% of Elk Valley coal distribution through direct and indirect holdings.
Fording Restructuring Still On Pace Despite Good News
While the situation for Fording looked dire in January, things look decidedly different just three months later. Colin Petryk, director of investor relations at Fording, said income-trust distributions to unit holders would jump this year if it can also secure 12-month contracts around US$305 a ton. He said negotiations with its end users haven't been finalized, but agreed that, historically, once one major contract is settled, there is a global domino effect.
Having said that, he said the restructuring process continues but wouldn't be drawn on further details.
There has been speculation in recent weeks that U.S.-based Peabody Energy Corp. (BTU) had taken a slide rule to Fording's coal assets in anticipation of a possible offer, something analysts said Teck Cominco would welcome, if only because there could be asset transfers between Teck and Peabody if they became Elk Valley coal partners.
A Peabody spokeswoman wouldn't comment on the issue.
"But now the question is, who would take out Fording's assets at these prices? ," asked one trader, who added that any asset sale could be delayed until this price spike in the coal market subsides.
Analysts said just how long prices remain high is the million-dollar question at the moment.
"Our expectation is that prices will come down in 2009," said Salman Partners Mike Plaster. "However, supply is so limited, there's certainly a possibility that pricing could stay stronger for longer."
BMO Capital Markets analyst Tony Robson said he expects this extrordinary tripling of coking coal prices will lead to significant earnings moves in 2008 for Teck Cominco. However, he's pencilled in a US$140-a-ton price for coking coal in 2009, on the premise that supply will improve. That means the one-time windfall probably won't be repeated.
Another issue for both Teck and Fording in fiscal 2008 is contracts that are being carried over from last year. Analysts reckon that Elk Valley carry-over coal shipments will negate any price rises through the second quarter; transport delays and other issues mean operations are still meeting obligations at last year's $98-a-ton price.
What's more, in the following year as Australia's premier coal mines come back on line, the likes of U.S.-based Consol Energy Inc. (CNX) and Cleveland-Cliffs Inc. (CLF) are bringing additional coal supply back to market. And Peabody started three greenfield mines in 2007 which are ramping up to full production. These are all supply-side factors that could drive coal prices down next year, analysts said.
"Investors should know they can't pick the top of the market so the big questions of the day are: when do Fording distributions start falling off and when does the bad news start hitting over-valued share prices? And that's why we're starting to see short selling in the market," one arbitrage trader said.
Web Sites: fording.ca
teckcominco.com
-Brian Truscott, Dow Jones Newswires; 604-669-1595
brian.truscott@dowjones.com |
