Coal Trading: The Basics

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American Coal Council & Doyle Trading Consultants, LLC

COAL TRADING
Introduction

The Basics

Forecasting the price of coal has always been more of an art than science. In recent years, there have been so many
new supply, demand and volatility drivers thrown into the equation that forecasting has become synonymous with
guessing.
Liberalized power markets have created unpredictable electricity demand fluctuations.
Compliance with NOx regulations in states east of the Mississippi has thrown a wrench
into the classic dispatch model.
Natural gas prices have ventured into uncharted territory.
Generators have reduced the size of their working inventories.
After decades of productivity gains, coal miners are faced with stubbornly increasing
costs and the gradual depletion of their premium reserves.
Coals possible role as the feedstock for a future hydrogen-based economy has huge implications.
Potential legislation on mercury and/or greenhouse gas emissions add yet another layer of uncertainty.
Combine these factors with the familiar unknowns weather, force majeure and transportation glitches and we
have a commodity that continually confounds the experts. This uncertainty has tremendously magnified the risk
profiles of coal producers and coal consumers. At the same time, investors and creditors are demanding stable and
predictable operating results.
To provide market participants with a higher degree of control over their businesses, an over-the-counter (OTC) and
futures market in coal have developed, providing a wide array of trading tools designed to manage risk.

Background
For trading to occur, there must be companies on both sides of the fence who want to reduce price risk. In the past,
coal producers hoped for higher prices and experienced pain when the market gave them low prices. Conversely, coalconsuming utilities hoped for lower prices. However, when the market gave the utilities high prices, they felt little pain
because they were permitted to recapture the price hike by raising their electricity rates. Since it takes two to tango,
coal trading never developed.
Traditional risk management strategies were renditions of the old adage: dont put all your eggs in one basket.
Strategies used by many producers included expanding into various regions (Central App, Northern App, Illinois Basin,
PRB, Colo./Utah, international), diversifying sales (domestic and export), diversifying accounts (utilities, industrials,
metallurgical) and diversifying spot/term. Strategies used by utilities included diversifying supply regions, diversifying
the number of suppliers, diversifying transportation providers (if possible) and varying the length of contracts. While
these strategies mitigated some types of risk, price risk remained mostly unchecked.
In the 1990s, three events contributed to the partial de-coupling of the price of coal from the price of electricity:
1) Deregulation of our nations wholesale electricity and transmission markets.
2) Deregulation of the retail electricity market by many states.
3) The sale and/or transfer of many coal-fueled power plants to independent energy merchants and/or to the unregulated
subsidiaries of utilities.

Price Volatility
This de-coupling of the price was not enough of a reason, however, for coal trading to develop. Price volatility
also had to be present. In recent years, coal has shown the propensity to rise and fall dramatically.
Price volatility does three things. First, it makes the natural longs (producers) fearful that the price will drop.
Second, it makes the natural shorts (consumers) fearful that the price will increase. Third, it attracts speculators,
who want to profit by taking on risk, providing two-way markets and marketing risk management products to
the shorts and longs.
What causes price volatility? The inability to predict the outside forces that impact supply and demand: hot
summers, cold winters, nuclear utilization rates, rainfall, mine disasters, transportation congestion, environmental
regulations, bankruptcies, consolidation, price of natural gas, price of petcoke, price of synfuel, price of emissions
allowances, security of Colombian coal supply, mining regulations, electricity curves, reserve depletion, new
technologies, labor disruptions, stockpile management, political climate, bonding costs, etc.

COAL TRADING
An art or
a science?

Brokers
OTC brokers play an essential role in coal trading. They bring buyers and sellers together by continually searching for the highest
bid and the lowest offer. In effect, they conduct a non-stop auction. The names behind the bids and offers are always
anonymous until the two parties are matched up. The broker knows, in advance, each companys approved credit list. Each
party pays the broker a few cents per ton for each trade executed. Brokers never take positions and are always unbiased
market participants. Brokers are typically well-versed in risk management techniques and can assist market participants
tremendously in understanding trading nuances.

Standardized Contracts
The American Coal Council (ACC)

Liquidity can only occur after the market


participants agree on standardized contract
language. Each product traded OTC or on the
futures exchange has pre-established
specifications, terms and conditions. This
enables the buyers/sellers to execute a trade
within seconds. This also allows the buyers/
sellers to reverse their positions with ease.

PRB Historic Prompt Quarter Sept '00 - Oct '03

is the pre-eminent business voice


of the American coal industry. The
Association is dedicated to
advancing the development and

Price $/ton

13.00

Prices nearly
tripled in five
months!!!

11.00
9.00
7.00

PRB 8800
PRB 8400

5.00

utilization of American coal as an


economic, abundant and

Jun-03

Sep-03

Mar-03

Dec-02

Jun-02

Sep-02

Mar-02

Dec-01

ACC Conference Services

Jun-01

Trading Instruments

Sep-01

FAX: (602) 485-4847


info@americancoalcouncil.org

Mar-01

Even if the standardized product is not exactly what a consumer/producer uses/produces, it is usually close enough to be used
as a hedge. Often non-standardized products are traded OTC. This will usually result in the best price for the buyer/seller
although, due to the non-standard nature (quality, volume or location differentials), the product is unlikely to be re-traded in the
market.

Dec-00

environmentally sound fuel source.

Sep-00

There are standardized contracts for PRB


3.00
(8800 Btu and 8400 Btu), CSX (12,500 Btu,
1% Sulfur, 12,500 Btu, 1.2# SO2) and the
Nymex look-alike (12,000 Btu, 1% Sulfur,
Tim e
Big Sandy River). There are also proposed
contracts for Northern Appalachian qualities.
(Standardized terms and conditions can be accessed at the Coal Trading Associations web site: www.coaltrade.org.)

Forward and spot contracts in all of the major products are traded in the OTC market. There is a quoted market for put and
call options, as well as a market for basis trades (differences in time, quality and/or product). On the New York Mercantile
Exchanges Clearport Trading System, only the Capp contract is traded. Capp stands for Central Appalachian and represents
a 12,000 Btu, 1% Sulfur coal loaded in the barge on the Big Sandy River.

American Coal Council


2980 E. Northern Ave., Ste. B4
Phoenix, AZ 85028
(602) 485-4737

www.americancoalcouncil.org

5765 Olde Wadsworth Blvd., Ste. 18


Arvada, CO 80002
(303) 431-1626
FAX: (303) 431-1606
lbernson@americancoalcouncil.org

Benefits of Trading
Nymex/CSX 1% Historic Prompt Quarter
Sept. '00 - Oct '03
50.00
40.00

Prices doubled in
eight months!!!

35.00
30.00

Nymex
CSX 1%

25.00
Jun-03

Sep-03

Mar-03

Dec-02

Jun-02

Sep-02

Mar-02

Dec-01

Jun-01

Sep-01

Mar-01

Dec-00

20.00
Sep-00

Price $/ton

45.00

Time

First and foremost, trading provides the market with the


ability to precisely measure and manage price risk with the
overall objective of predictable cash flow and stable earnings.
Trading increases price transparency tremendously by
providing curves that go out two four years. Trading can
reduce weeks and weeks of contract negotiations to a oneminute transaction. Trading provides participants with the
ability to easily reverse a position. Trading requires several
departments in the company (treasury, legal, procurement,
sales, operations, production, and risk management) to focus
on the measurement and management of price risk.

Prognosis for Coal Trading


The credit crisis suffered by the energy market in 2001 and 2002 resulted in the exit of many energy marketers that had been
providing speculative liquidity to the coal trading arena. While their absence has slowed the development of coal trading, it has
also brought many companies with natural short and long positions into the market to provide liquidity. Nymexs Clearport has
enabled OTC brokers to offer clearing services to companies whose credit does not meet the stringent criteria of the major
OTC players. Speculators are now returning to the coal market and are finding a much greater number of companies with
natural positions who are using the OTC and futures markets to reduce price risk. Financial institutions will add yet another level
of liquidity as price indexes spur the development of a financially settled swap market.

Doyle Trading Consultants


provides the energy and financial
markets with expert advice on the
coal industry and the trading of
coal and emissions.
Doyle Trading Consultants, LLC
1815 DS Road
P.O. Box 23254
Glade Park, CO 81523
(970) 256-1194
Mobile: 917 363 3719
Two Park Avenue
29th Floor
New York, NY 10016
(646) 840-1300
btubaron@aol.com
www.doyletradingconsultants.com

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