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Coal price surge coincides with hedge funds\' growing interest

Date: Tuesday, July 22, 2008
Author: Chris Flood

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Coal prices have doubled over the past year to record levels and could spike even higher as a power crisis in China combines with supply problems in leading exporting countries to tighten the market further.

The surge in prices coincides with fresh interest from hedge funds and other investors looking to gain exposure to the commodity thanks to greater liquidity in the previously opaque over-the-counter coal market.

"Coal has the strongest fundamentals of any commodity play," says Adam Knight, co-head of commodities at Credit Suisse.

"We are seeing an increasing number of investors looking for direct exposure to coal instead of via coal-linked equities."

The price gains have come on the back of rising consumption in China, which relies on coal for almost 80 per cent of its electricity generation. Several regions are rationing power supplies as coal shortages become acute.

"The Chinese power crisis is likely to be a major driver of the global coal market over the next few months," says Francisco Blanch, commodity strategist at Merrill Lynch, who warns that prices could hit $250 a tonne in the next three months.

The one-year forward contract for the Asian coal benchmark, known as API-4, has risen by almost 124 per cent over the past year to trade at about $153 a tonne yesterday, after reaching a record $179.50 this month.

China produces a huge amount of thermal coal, but most of this output is consumed domestically. The country's energy market is distorted by government price controls that have reduced the incentives for coal producers to lift output.

The effect is that China's net exports of coal have sunk by more than half over the past four years and the country even became a net importer in April, putting a significant strain on supplies in Asia. Emmanuel Fages, of Société Générale in Paris, warns that export supplies from China could tighten further, especially during summer when electricity consumption peaks.

Many traditional exporting countries, such as Indonesia, the world's largest exporter of thermal coal, South Africa or Poland are increasingly relying on domestic coal supplies for power generation, tightening the international market.

"Coal is the cheapest form of energy for power generation, which is reflected by the large amount of new build plans for coal in many countries," says Mr Knight.

The market had been expecting record prices would trigger an improvement in supply, but there has been virtually no response and supplies from the main coal exporting nations have fallen this year.

European utilities could began to feel the impact soon as Poland and Russia have reduced their coal exports to Europe, exacerbating the shortages created by South Africa.

"High and rising coal prices over the past nine months have led to utilities in Europe running inventory well below average levels," says Mr Knight: "There is not much time for restocking before the start of this winter."

The benchmark for seaborne thermal coal delivered into Northwest Europe, known as API-2, has surged more than 100 per cent in the past 12 months.