President Donald Trump has made clear his intention of “bringing back coal.” He has rolled back environmental regulations and moved to repeal the previous administration’s curbs on carbon emissions from power plants.
Last week, adhering to a British-Canadian initiative presented at the 2017 United Nations climate change talks in Bonn, about 20 nations and regions (expected to grow to 50 by 2018) pledged to cease using coal as fuel for power generation starting in 2030. The U.S. and Germany refused to sign the accord, though talks regarding Germany’s decision will resume in Berlin.
Despite Trump’s rhetoric, the U.S. coal industry continues to shrink, mostly because of issues surrounding the fuel’s environmental ramifications, along with an aging industry infrastructure and a greater focus on renewable energy. Solar and wind are the fastest-growing U.S. sources of electricity.
And the U.S.’s partners in the Organization for Economic Cooperation and Development are also reverting to energy sources other than coal.
Further proof of the coal market’s demise is evident in its lackluster financial markets, specifically, trading volumes and open interest on futures and options. These instruments are used as hedges by producers and consumers, and as investment and trading instruments for investors, speculators, indices, exchange-traded products, known as ETPs, and hedge funds.
But lack of liquidity hurts market participants, making coal trading a challenging prospect. And the markets are not necessarily signaling that coal is an easy short, particularly when supply may not meet demand in certain regions.
The NYMEX division of the CME Group offers a slate of both thermal and coking coal contracts. The industry standard and reference-priced contracts, calculated by ARGUS-McCloskey, are the AP12 futures, based on coal imported by northwest Europe, and the API4, for coal exported from Richards Bay, South Africa. There are options on these futures as well as contracts based on the U.S. Powder River Basin, and hubs in Australia, Indonesia, the U.K and China. Yet, on any given day, most have zero volume and only a few hundred contracts of open interest.
Nonetheless, there was a 90 percent increase in volumes in September from the previous month to a total of 60,521,000 metric tons, according to the most recent International Coal Report. The volumes across both the coal futures and the options doubled from August. Options were also more active than the previous month, representing 25 percent of the overall CME coal volume. Open interest was down slightly.
These statistics may sound impressive, but they aren’t. Volumes on internationally coal futures and options this year have plummeted from levels approaching 500,000 in 2015 and 2016. Furthermore, as far as the option volume, all of the contracts were concentrated in AP12 options. Additionally, open interest has plummeted to a fraction of those in recent history. In fact, the NYMEX/Platts coking coal market was dormant in September: Not a single trade was registered and open interest was flat.
One could argue that seasonality is playing a role. Yet comparing the September month to earlier years rules that out. Or one could assume that Asia is still a strong producer and consumer, even as Europe and the U.S. are exiting the coal markets in favor of cleaner fossil fuels such as natural gas and renewable sources,. Yet the volume and open interest on coking coal from Australia — by far the biggest exporter — are also depressed.
The future outlook for coal prices is bearish as seen from its downward sloping forward curve, or backwardation, meaning future prices of coal are expected to be lower than current prices. This is a sign that long coal ETFs are not advisable due to the negative roll yield, which can eat away any profits should coal’s price rally.
Yet even with a backwardated market, coal is still financially less attractive than other more competitive energy sources. Crude oil, WTI, seems to have plateaued in the mid $50s per barrel, while U.S. natural gas will likely continue to be cheap due to abundant supply. And both of their forward curves are in backwardation, too.
With aging installed coal-fired generation capacity in the U.S., and low natural gas prices, companies are not willing to invest in repairing outdated facilities, or building new plants. As for trading opportunities, there are the occasional seasonal bets by trading calendar spreads on the more liquid futures contracts. Additionally, there are arbitrage opportunities between different U.S. coal prices or between other global coal markets.
India, for example, may soon face a supply shortage and thus, higher prices, as the country miscalculated the amount of hydro, nuclear and wind generation available and was forced to dip into coal inventories. At the same time, Platts recently reported weakness in South African, European and Russian coal prices. In addition, there are occasional opportunities to trade volatility, albeit withstanding low volumes and open interest.
The bottom line is that trading coal is not a wait-and-hold market or an easy short sell. It is for active traders who understand global physical trade flows that can withstand frequent lack of liquidity.
Shelley Goldberg is an investment adviser and environmental sustainability consultant. She has worked as a commodities strategist for Brevan Howard Asset Management and Roubini Global Economics.