Coal's runaway rally makes crude oil-linked LNG competitive

 Thermal coal's spectacular rally in Asia is now running the risk of becoming a victim of its own success, with the fuel becoming uncompetitive versus LNG priced against crude oil.

Benchmark high-quality Australian thermal coal at Newcastle Port rose to a 13-year high of $168.71 a tonne in the week to Aug. 13.

The grade, which is preferred by Japanese and South Korean utilities, has now surged 264% since its 2020 low of $46.37 a tonne in September, hit at a time when demand was suffering as Asian countries locked down their economies to combat the spread of the coronavirus pandemic.

The Newcastle weekly index, as assessed by commodity price reporting agency Argus, is now closing in on the all-time high of $195.20 a tonne from July 2008. That was reached at a time when China was rapidly increasing imports, switching to becoming a net importer having previously been a net exporter.

Data from Refinitiv shows that the natural gas switching price in Japan, which is the price at which generating electricity from coal is equal to that from LNG, has been moving in favour of the super-chilled liquid fuel in recent weeks.

It is currently $10.01 per million British thermal units (mmBtu), while the Brent crude oil-linked LNG price is $10.28 per mmBtu.

This means that it is almost as cheap to use LNG to generate power as coal, which is a reversal from recent history.

At the end of last year the switching price was $4.71 per mmBtu, while the Brent-linked LNG price was $7.03, meaning that coal was substantially cheaper to use than LNG.

While spot LNG prices in Asia <LNG-AS> have also surged amid a scramble for cargoes amid strong summer air-conditioning demand, it's worth noting that the bulk of LNG traded in the region is still under long-term, oil-linked contracts.

Japan and South Korea are the two countries most able to switch between coal and LNG for power generation and are major importers of both types of the fuel.

Japan was the world's biggest importer of LNG, but is likely to be surpassed by China this year, while South Korea ranks third. Meanwhile Japan is the world's third-biggest coal importer behind China and India, while South Korea ranks fourth.

While the incentive price to switch to oil-linked LNG from coal is almost at parity in Japan, in South Korea it has already flipped in LNG's favour.

That switching price is currently $12.51 per mmBtu, while the Brent-linked LNG price is $10.28, according to Refinitiv data.

SWITCHING TAKES TIME

It's worth noting that just because the switching price moves in favour of LNG, it doesn't automatically follow that utilities will immediately change their generation mixes.

It usually takes several months for the switch to take place as oil-linked LNG prices typically move with a lag to fluctuations in the crude price, and coal purchases are usually agreed on a quarterly basis.

But if the current trends continues with flat to modestly lower crude prices and high coal prices, then in the coming months it's likely that some fuel switching will occur.

This is more likely to result in a softening in thermal coal prices, rather than movements in LNG prices and demand.

In effect, LNG in Asia is two separate markets: the traditional long-term, oil-linked contracts and the short-term contract and spot market.

About two-thirds of LNG supplied in Asia is on long-term, oil-linked contracts, while the balance is made up of short-term and spot deals.

Much of the spot buying is conducted by countries other than Japan and South Korea, including China, India and Pakistan.

Brent crude oil had rallied strongly from its pandemic lows, gaining some 300% to reach a 2021 high of $77.84 a barrel on July 6.

However, since then Brent has trended lower. It was trading around $70 a barrel in early Asian trade on Monday, amid growing market realisation that while demand is recovering in Europe and North America, it remains soft in Asia - the top-importing region - as several major importers continue to battle coronavirus outbreaks.

A softer crude price will only serve to make oil-linked LNG more competitive against thermal coal in coming months. (Editing by Kenneth Maxwell)

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