The first index-priced term deal to supply South African coal to China has been done by an international company active in physical coal trade and for around 2 million tonnes a year, sources close to the seller said The seller, which declined to be identified for reasons of commercial confidentiality, said Chinese forward demand for South African coal has been increasing.
"There's going to be a lot more South African coal shipped to China going forward," one source said.
A deal that is indexes against benchmark prices allows sellers to use coal derivatives to mitigate price risk.
The significance of the first such deal is that if more Chinese counterparties adopt indexing, it will encourage many more sellers to weigh the margins offered by China and India against those offered in Europe, traders and producers said.
"If index-pricing starts to be possible into China, then selling South African there will be a no-brainer," one of South Africa's largest exporters said on Monday.
Expectations of rising prompt demand from China have pushed benchmark South African prices to $100 a tonne FOB Richards Bay from $85/T a month ago.
Although spot demand is rising, some importers are looking much further ahead - a big change from the past year when most deals were for no further ahead than the next month.
China is expected to import around 6 million tonnes of South African coal in 2010, out of total South Africa exports of 70 million tonnes .
China began ramping up coal imports from outside the Pacific region in late 2009 - from Colombia and South Africa - to meet booming power demand in its southern coastal regions but has historically bought on a fixed price basis, delivered to port.
Chinese traders said, however, that index-pricing on an FOB (free on board) basis would require buyers to protect against moves in freight rates.
There are no freight derivatives to cover shipping routes from South Africa into China for hedging purposes, so buyers would need to secure physical freight at a known, fixed price, they said.
Firms in China that buy on a floating, indexed basis to sell onward at fixed prices risk being squeezed by spot market moves if they do not hedge, as some of India's largest traders have found.
Chinese firms in theory could use existing coal swaps to mitigate price risk, but in practice this could be problematic, said a coal broker active in the Chinese market. In the iron ore market, for example, firms are not forbidden but are discouraged from using swaps.
China's coal miners are aware of the potential for price volatility. A trader source in China said domestic coal mines are increasingly unwilling to provide longer-term, fixed-price contracts as they anticipate further price upswings.
MID-TERM DEMAND RISING
Chinese importers are currently signing deals for delivery over a period of four to six months on expectations of higher demand and prices next year, a seller source said.
China's Qinfa Group failed to find the 1 million tonnes of Indonesian 5,000 kc/kg coal it sought last week due to supply shortages, a producer said.
But high prices are more of a factor behind the lack of fresh 2011 term deals than supply, according to Chinese and Australian traders.
China's demand for imported coal from South Africa in the next four to six months is also rising due to delays in shipments from Indonesia, its biggest coal supplier, and to wet weather in China, Indonesia and Colombia.