The bull run for coal used to fire power plants appears to be about to hit a Chinese wall.
Beijing this week effectively cancelled restrictions on coal production at Chinese mines, providing a boost to domestic supplies as it seeks to reverse thermal coal price hikes that may have gone too far for its liking.
China's National Development and Reform Commission said Thursday that domestic mines could operate for 330 days of each year, relaxing a restriction that had until recently been set at a maximum of 276 days of production.
"Chinese production and inventory of thermal coal are on the rise," Goldman Sachs noted.
Thermal coal prices have risen 50% this year, as production from China dipped 11% over the 10 months to the end of October compared to a year earlier. The government of President Xi Jingping ordered output restrictions to boost coal prices and support state-owned mines that had plunged into the red and run up significant debts after coal prices hit 10 year lows in January this year.
"China's coal production restrictions have turned coal markets on their head this year," wrote analyst at Wood Mackenzie in a report. "The Chinese government is trying to strike a balance between restoring its crippled coal sector to some measure of health while maintaining the push to reduce coal sector overcapacity without damaging downstream users such as the electricity utilities."
The increase in Chinese coal stocks, and easing demand for seaborne imports, was highlighted by recent reports that China Coal Group Corp, one of the nation's two biggest producers, had cut 10 renminbi ($1.45) off its spot price effective from November 3. The cut is the first since May this year when the government implemented the 276-day working rule. Cutting spot prices in November is unusual as thermal coal producers typically renegotiate benchmark prices at the end of the year so are incentivized to maintain higher spot prices.
"The strong pricing rebound is unlikely to be sustained as the Chinese government relaxes its working-day curtailment policies to manage prices," Fitch Ratings noted Thursday.
Not all coal prices are likely to head south in the near term; the cost of coking coal, used in steel production, has risen almost 300% this year to above $300 a ton in recent weeks, a price last seen in 2011 when floods in North Queensland closed key mines.
Continued strong demand and weak supply following years of cost cutting by miners will leave the market undersupplied for much of 2017, according to Goldman Sachs.
"We use the Queensland floods of 2010-11 to model the relationship between global inventory and the hard coking coal scarcity premium relative to its equilibrium price," the bank noted on Nov. 14. "Our revised inventory path, reflecting a greater than expected delay in Chinese output and a likely trough in global inventory in the first quarter of 2017, leads us to upgrade our 2017 quarterly price forecasts to US$350/$330/$250/$165 per ton but we leave our 2018 forecast unchanged at US$125/t."
A slower decline in metallurgical coal prices will cushion the blow of faster falling thermal prices for diversified mining companies, including BHP (BHP) - Get Report , Rio Tinto (RIO) - Get Report and Anglo American (AAUKF) , all of which produce significant amounts of coking coal, and have also benefited from a spike in iron ore prices.
BHP shares have climbed 65% year to date to 1,254 pence ($15.46). Rio Tinto is up 48% to 2,926.5, while Anglo has led the way higher climbing 261% to 1,080.5