Coal

Coal is often seen as the poor relation in the energy market and the emergence of a
liquid commodity trading market in coal has been very sluggish. One reason for this
is that the market has traditionally sold bespoke long-term contracts to utilities.

These were very specific with respect to quality since many power station boilers
were designed to take particular quality specifications. This was more than just
sulfur and calorific differences, but would also include specifications for chlorine,
ash content, hardness (grindability), sodium, ash fusion temperature, volatile matter,
moisture and others.

Another issue rests with the transport of coal. Coal is an expensive energy product
to transport. For instance, although the cost of mine-mouth coal from an open-cast
area can be as low as $3/tonnes FOB, the delivered cost of that coal could be closer
to $30/tonne. While there is a competitive shipping market for seaborne trade,
railroads are often oligopolistic in nature.

Finally, the market has been traditionally oversupplied by a large number of
fragmented producers. This has led to extreme price competition and a market
traditionally seeing a backwardated forward market. As a result, annualized historical
volatility in this market is very low (10–15%). In addition, the lack of liquidity in
standard products means clear forward curves cannot be easily found.
The coal market is, however, slowly changing. Faced with the challenges of deregulation
and environmental constraints, utilities are moving to buying shorter-term,
more standard coal qualities. These forces have led to some industry and the
development of a coal trading market that is still in its infancy.
A reasonable international trading market exists and this is being complemented
by standardized contracts in the USA. ‘Hubs’ are developing in Powder River Basin,
Appalachia, Illinois Basin, Colorado-Utah and Pittsburgh Seam. Evidencing this
trend, NYMEX has proposed launching a coal contract based on the Big Sandy River
(Appalachia) in 1999.

Some early option and swap trading has taken place with indices being priced off
publications such as Coal Daily in the USA. However, liquidity in these products has
been very limited and, to date, they have not proved to be useful hedging mechanisms
for major producers or consumers.