St. LOUIS () -- In speaking to Resource Investor, President and CEO of Sprott Resource Corp. [TSX:SCP], Kevin Bambrough, says worldwide shortages and growing steel demand will continue to squeeze the coal market sending prices higher and higher.
RESOURCE INVESTOR: Today on Resource Investor Podcasts, we're going to discuss the red hot coal market. With us is Kevin Bambrough, President and CEO of Sprott Resource Corp., a company that invests directly and indirectly in natural resources, managed by an all-star team of resource investors from Sprott Asset Management. Welcome to our show, Kevin.
KEVIN BAMBROUGH: Thanks very much for having me, Jon.
RESOURCE INVESTOR: First off, the coal market has really turned red-hot in the last 6 months. Prices of thermal coal have gone from $40s to $80s and metallurgical coal is now approaching $300 in some transactions. What's the story behind the rally?
KEVIN BAMBROUGH: Well it actually started probably late summer. Things started to really tighten up in Asia and the price of thermal coal in China sort of led the charge ahead. Australian coal followed right behind and actually broke out to its all-time high probably in the late summer, early fall, and that's when we became extremely bullish on coal. From there, we've just been hit with a litany of problems over the last, probably, two months.
One of the main problems started in China with huge snow falls - a record snow fall across China - and created what they stated as the worst power crisis in the history of China. They actually had production problems with coal mines - amongst all other types of industry. The government declared a state of emergency, basically, and banned the exports of coal. I should note that China was really one of the largest exporters of coal a few years ago, providing about 15% of the world's seaborn trade of coal. Slowly over the last few years they've exported less and imported more where they basically became flat last year imports to exports. About 58 million tonnes though was still exported from China, and shutting the tap off and banning those exports in mid-January really set the market on fire.
Right on the heals of that though, in Queensland, Australia, there was a major torrential rain fall over there that lasted a couple of weeks flooded out some of the largest producing mines in the world. If you know about Australian coal in the Queensland area produces about 50% of world's seaborn trade of metallurgical coal, which is used in steel. So a bunch of those companies all declared force majeures - BHP [NYSE:BHP; LSE:BHP; ASX:BHP], Xstrata [LSE:XTA], etcetera.
And if that wasn't enough to really get the market going, shortly there afterwards in South Africa, they ran into a lot of problems with a power shortage so bad because of a lack of coal, that they actually had to shut down some of the coal mines because they didn't have the power to run the coal mines because of a lack of coal. You know, well, obviously quite ironic. They're still operating and they've told companies that you have to operate at about 90% of power. So the exports out of South Africa stopped, got or suffered force majeures.
What this has done has sent the price of thermal coal from - like you said - in the $50s last year out of Australia to actually - the latest spot deals have now been done at $150 out of Australia. A mind-boggling price considering that metallurgical coal, which is a premium product, only received $95 from most suppliers last year. And as you've mentioned, the price of metallurgical coal is now upwards or towards $300 with some small spot deals being done in that neighbourhood this week.
RESOURCE INVESTOR: That is pretty amazing. So would you say that the market is more supply driven now than demand driven?
KEVIN BAMBROUGH: Most certainly. It is definitely at the point now where at least from where I sit, steel makers are not - there are going to be some steel makers that will have to stop steel production because of a lack of coal. And that'll really drive the price - it could drive the metallurgical price of steel anywhere. You've got only about 12% or so of the price of stainless steel comes from coal. So on the margin, it could really send prices higher. And this is at a time, actually, where steel prices are being raised all over the world. The steel market is surprisingly tight despite the fact there's talk of a recession.
If you want me to comment a little bit on the steel market, in the U.S. they consume about 130 million tonnes of steel and only produce about 100. So there are about 30 million imports. And the U.S. steel price is up strong, but it's actually one of the cheapest steel prices in the world. And such that they can't afford to import at these prices. So I'm bullish that actual steel production in the U.S. is actually going to have to rise and that their consumption of coal will have to go up. They're going to have to - as the dollar falls off here like it has, it really drives up cost in the U.S.
RESOURCE INVESTOR: Sure, sure. Now prices of coal are set in a similar fashion to that of steel, with large producers like BHP and Xstrata signing deals with larger buyers. Now where do you think prices between these large players will be set?
KEVIN BAMBROUGH: Well, typically what we've seen happen over the years - what we're seeing right now with the spiking transaction prices in the market - usually sort of the one-year term contracts are done at a bit of a discount of that price. Now where that could go this year is anybody's guess. There's some, I mean Xstrata was asking for $210 as a starting negotiation a few weeks ago before a lot of these problems actually developed. Now we've seen the prices really move up. There's a chance that we're going to see some transactions in the coming weeks on a spot basis maybe get done in the mid-$300s, $350. So I'd say obviously conservatively, there's a good chance that we're going to see it in at least the low $200s for a lot of coal companies to set the price. There's a chance that some coal companies might get to mid to high $200s for the year.
It's a shame - obviously, as these prices run up it's very tempting for a lot of coal companies to sign contracts and take advantage of the higher prices because it's taken the market by surprise and moves so fast - so I wouldn't be surprised if there are quite a few coal companies that have already put to bed a large amount of their next year's production. We've seen some of that happen in the U.S. for some of U.S. large producers. But there are still a lot of companies out there that have significant tonnage on price that are going to reap some margins that they've never seen in the history of their companies.
RESOURCE INVESTOR: Yeah, yeah, exactly. Back to the relationship between metallurgical coal and steel. Because they have such close ties, if steel prices were to fall, could this also derail the coal rally?
KEVIN BAMBROUGH: I think first of all, steel prices aren't going to fall. I mean today, we had Posco [NYSE:PKX] and I believe - was it Arcelor Mittal [NYSE:MT] - raise prices. Japanese scrap steel prices went to a record today. As I said, in the U.S., it's the lowest in the world but still a very high price and heading higher. The fact is it's a very tight market and there's going to be a lower production of steel, in my opinion, because of the shortage of coal. On the margin it isn't that significant of a steel price, and there's such a shortage of coal that you can't stop this market.
The other thing to remember is that metallurgical coal, it doesn't need to be sold as metallurgical coal if you don't want to. You can always - basically metallurgical is high quality thermal coal that's been washed and processed so that it can be used as metallurgical coal. And when you wash, you basically reduced your tonnage of the thermal coal when you try to produce a met product. So really, the price of met is typically set off the price of top thermal coal, because the producer always has an option of selling the met as thermal - and selling more tonnes at that price.
With the move that China made, and the force majeures from Australia and South Africa, I have no doubt that there is a serious, serious, serious shortage of thermal. I mean for the price to go from $50 now to $150 for thermal coal, the market is clearly as tight as it can be. We've got - Taiwan was recently out looking for spot deals concerned that they're not going to get any coal from China for the next two months because of their restrictions on exports. So many countries like Taiwan - 70%, 60% of their power comes from coal. And if the exports don't come in, the lights go off. It's that simple. You see the chaos that's happened in South Africa.
We've had similar problems in many countries where they basically start once their energy markets get tight, they ban exports. And that's going to create real instability and reason for concern, and I think long term, the countries like Japan are either going to look to diversity and have more suppliers and build up larger inventories in order to protect themselves from these shocks that can happen in the marketplace.
RESOURCE INVESTOR: Sure. Now what do you think about the looming U.S. recession and resulting global economic slowdown? Could this act as a bearish element much like what the market's saying with oil. Could this affect coal in a similar way?
KEVIN BAMBROUGH: For us, as I said, U.S. inventories of steel have already been driven down to a record low. It's probably the lowest it's been in over 30 years. Steel producers and consumers have lowered their inventories in anticipation of the slowdown as it really has been a slow moving train wreck. But when you look at history and you look at how much slow down actually occurs, the slow down isn't large enough to really effect the supply dynamics that are in place in this market. As I said, the U.S. was already importing 30 million tonnes and the price is so low right now in the U.S. on a world scale, it shouldn't really affect the market. If anything, I said domestic steel production should be rising in this environment.
RESOURCE INVESTOR: Sure. Moving on to your recent transaction though. Sprott Resources just invested $31 million in PBS Coals Corp. in exchange for a 37.5% interest - really giving you an in to the soaring metallurgical coal market. Now what's the next step on the agenda for this investment? Can you give us an update of the on-goings at PBS Coals?
KEVIN BAMBROUGH: Well, sure. We basically started negotiating this transaction back in September. As I mentioned, it's amazing how the markets change because the price of thermal coal in the U.S. around that time was actually - I think the week I went down to visit them first - was between $42 and $44, and it's recently spiked up to hit $80 and we've heard of rumours of spot deal done even higher in the U.S. So we've almost had a doubling of the coal price, which prices everything in these markets. You've got U.S. producers that were struggling; a lot of them were barely making any month with the coal environment we saw last year.
But now the U.S. dollar's come off; it's put pressure on Australia and Canadian producers, and with the strong Canadian dollar I decided it was a good time to look south of the border. I actually transferred the money to do this purchase, the $31 million, when the Canadian dollar hit $1.07, which was a very timely transaction because by the time the transaction closed we were back to par and I made a $2.4 million forex gain on the transaction.
The 22.4% that I actually acquired indirectly into PBS Coals for $31 million basically gave PBS an applied market cap of around $140 million. As a producer of nearly 3 million tonnes last year, 70% of which is metallurgical coal; so if you can image say 2 million tonnes, the margin expansion that we could see this coming year could be enough to make in cash flow what I paid for them.
In a public market, I think this would be an incredibly valuable company. They're cashed up now and we've taken down the debt such that they're in a position to grow production over the coming years for 5 million tonnes eventually, 3 and then say 3 and a half, almost 4 million tonnes hopefully of metallurgical production in a couple of years out would be the goal there. And if they were able to get a public listing in this environment, I think we'd be richly rewarded and the return to Sprott Resource Corp. investors would be phenomenal.
RESOURCE INVESTOR: Sure, sure, absolutely. Well unfortunately, that's all the time we have today. I thank you for speaking with me today. Once again we are speaking with Kevin Bambrough, President and CEO of Sprott Resource Corp. on Resource Investor Podcasts.
KEVIN BAMBROUGH: Thanks very much.
