An increasing number of physical deals are taking place bilaterally in the CIF ARA and South African Richards Bay thermal coal markets, resulting in a significant shift away from the traditional screen and voice-brokered traded environment, numerous sources told S&P Global Platts Friday.
The move was particularly apparent in the CIF ARA market, where recorded deals transacted over January and February had slumped more than 76% in year-on-year comparisons, S&P Global Platts records show.
Only seven 50,000 mt multi-origin cargoes -- some of which had US optionality -- had been transacted for delivery into Rotterdam or Amsterdam over January and February 2017, at an average price of around $86.55/mt.
This represented both the lowest number of reported deals transacted for the period and the highest average price since Platts records began in 2013. It was also a sharp contrast to the 30 reported deals concluded during the same period during 2016, when prices had averaged $45.86/mt.
Although several sources said some decline in trading activity was to be expected given lower natural gas prices and the ongoing move towards renewable power generation in the region, the magnitude of the reduction in screen trading suggested other factors were at play.
Numerous sources said thermal coal buyers were moving towards cheaper, non-SCoTA -- Standard Coal Trading Agreement --specification coal in recent months, as prices had surged to multi-year highs towards the end of 2016. As such, fewer reported deals were being transacted via brokers.
Coal originating from South Africa, Colombia and Russia was heard to have been sold under bilateral agreements.
"I assume they're mixing it up with SCoTA coal they already have on contract... this shaves some pennies off I guess," one London-based broker said of the move.
In addition, the strong backwardated structure had also been keeping buyers out of the market or pushing them into the bilateral space, as none were keen to transact for and store volumes given the lower prices in April and May.
"Most are not buying full cargoes because they don't want to build stock [given the backwardation], so there's been some smaller cargoes trading," a London-based trader explained of the trend.
Uncertainty over the direction of prices in the key Chinese market was largely cited as another factor hindering trade, as high demand at the beginning of the year threatened to falter, potentially sparking a decline in prices that was yet to emerge with any momentum.
Liquidity in CIF ARA futures shrinks
This low activity in the physical CIF ARA market had also potentially sparked a significant fall in liquidity in the financial market, where thermal coal derivatives traded over January and February were down more than 58% on the year, according to Platts calculations.
Over January and February, derivative trading of 256 million mt was only a fraction of the 620 million seen during the same months in 2016, while the percentage of this volume cleared had dropped from almost 100% in 2016 to around 85% in 2017.
"Less than 5 million mt of swaps trading on a day is fairly common now," a trader with a large investment bank noted. "It was probably triple that this time last year."
With the exit of larger players -- particularly Citadel -- from the financial market at the end of 2016, several players have noted the steady rise in popularity of smaller lots, particularly through the ICE trading screen, which has taken a significant share of the market.
"You can trade direct on webICE and there's no broker fee," a London-based fund trader explained. "Coal is an over the counter swap/future which means brokers match trades and put them through a clearing house. If you can go straight to the clearing house, you can save about 1 cent per tonne, which is quite a chunk of money over a 5,000 mt calendar swap for example."
This was echoed by a northwest Europe-based financial trader, who added: "Nobody wants to pay for a service that doesn't add much value, the Cal [contract] is such a standardized product -- not something exotic like spreads -- so it doesn't make sense to pay a broker for that and a lot has moved over to ICE as a result."
"Smaller utilities and banks prefer [to transact 1,000 mt clips on the ICE screen] as it keeps names out of the market and gives it a bit of direction," a trader with a large producer said. "Traditionally, you would see one bid for 5,000 mt, but now you see five bids for the same amount of volume, so it adds liquidity for smaller players and makes the market bounce around a lot with less volume."
A London-based trader said it was unclear whether the 1,000 mt trading pattern was a recent development in the coal market, or whether it had been exposed due to the withdrawal of the larger players.
"I think a lot of this is to do with the loss of the market makers... with them gone, the less volatile underlying market (with no negative gamma either) and the 1,000 mt clips has made the market go quiet."
However, a Switzerland-based trader noted that many clearing houses had recently reduced the initial margin required to trade.
"This helps the smaller traders because it leaves their cash flow higher, but it's still harder than it was a year ago because the exchanges have raised margins quite a few times in the last several months," the source said.
While the limited amount of trading was positive for utilities and banks, several traders cautioned that it was becoming difficult to hedge larger positions, keeping the speculators looking to take large positions out of the market, creating a cycle of diminishing liquidity, which in turn reduced price volatility.
"I get the sense the market is supported, but it's not being pushed," one Switzerland-based trader noted, adding that the situation was unlikely to change in the short term given the uncertainty in the Chinese market, which kept larger players from taking positions. "If they don't decide what to do, we are stuck in this limbo."
