Coal prices bounce back this year, but not for good

By Nina Chestney

LONDON (Reuters) - A rally in thermal coal prices over the past few months, after years of decline, should continue into next year but a cloud still hangs over the market in the form of weakening global demand due to more clean energy and increased energy efficiency.

All major benchmarks for thermal coal have risen above $60 a tonne in the past few weeks, an increase of around 50 percent since record lows earlier this year, due to output cuts, supply disruptions, and increases in demand in some parts of the world.

Many analysts expect prices to keep gaining for the rest of this year and into some of next year, but they will then likely go back into decline because the overall trend is one of global demand falling and production cuts could be difficult to enforce when prices are on their way up.

The coal market has been oversupplied for years, which dragged prices down by around 80 percent between 2008 and early this year, forcing producers to cut back investment into new capacity and close unprofitable mines.

China, the world's biggest coal producer, is restricting output to reduce a supply glut, lowering output by 280 million tonnes this year as part of a wider plan to close 500 million tonnes of production in three to five years.

Analysts at Citigroup expect Australia's thermal coal, the Asian benchmark, to rise further as the Pacific Basin market tightens due to Chinese output cuts and weak Indonesian exports. Falling European demand may also divert more coal to Asia.

"Adding fuel to the fire would be if rainfall due to La Niña was larger than expected, affecting production in Australia and Indonesia, quickly tightening the market," they said.

"Prices could even surge by 25 to 50 percent, or up to $90/tonne based on current prices."

In late 2010/early 2011, a strong La Niña drenched coal production areas in Australia and Indonesia, disrupting output and driving up prices to around $145/tonne from $90/tonne.

CLOUD OVER COAL

Demand for coal from India, Bangladesh, South Africa, Russia, South Korea, Indonesia and Australia is forecast to rise into next year as coal remains a cheaper alternative for producing energy but U.S. and European demand in particular will wane, mainly due to cheaper gas.

"We remain bearish on the thermal coal market ... Demand has deteriorated further, led by the seasonal decline of our EU Coal Burn Index. The profitability of coal-burning power stations in Europe (rather than gas), is now negative," said Georgi Slavov, global head of energy, iron ore and shipping research at Marex Spectron.

In Europe, demand is falling due to environmental regulations. In EU some countries, such as Britain, cheaper gas is squeezing coal out of the market. This is expected to continue and could drag European coal prices down around $40-50 a tonne, analysts said.

"In a counter-intuitive way, the market is showing persistent tightness whereas coal demand is falling in most parts of the world," said Guillaume Perret, director of coal, iron ore, steel and freight consultancy Perret Associates.

"We think the current rally is overshooting, in a similar way as prices overshot on the way down in January 2016. It is not fuelled by a genuine increase in demand but rather by a short- to medium-term delay for spare supply capacity to adjust to demand," he added.

(Editing by David Evans)