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US metallurgical coal companies may benefit if 'trade war' talk depresses dollar

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US metallurgical coal companies may benefit if 'trade war' talk depresses dollar

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A quenching tower releases steam at a U.S. cokemaking facility that provides the raw material for steelmaking. Recent tariffs announced by the Trump administration could be favorable for those selling coal to domestic cokemakers, while the potential weakening of the U.S. dollar if the tariffs cause a trade war could also benefit metallurgical coal sales abroad.
Source: S&P Global Market Intelligence

A weakening of the U.S. dollar as the world reacts to President Donald Trump's hints at a global trade war could benefit U.S. metallurgical coal producers, particularly in the longer term when international prices are widely expected to drift lower.

A closely watched figure among metallurgical coal producers is the value of the U.S. versus the Australian dollar. In Australia, the largest global supplier of steelmaking coal, producers sell their coal in U.S. dollars and pay their costs and expenses in Australian dollars.

"Their margins are squeezed when the U.S. dollar is weaker," said Seth Schwartz, president of Energy Ventures Analysis. "Their Australian profits go down."

In the past few months, the interplay between the currencies had a relatively light effect on metallurgical coal markets. After prices increased following a yearslong decline, producers are now selling for well above their production costs. At recent prices, producers are incentivized to produce until prices come down to a level where margins tighten and shifts in currency can be the difference in whether a mine is profitable or not.

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Schwartz said currency differences are always a consideration in competition between U.S. and Australian metallurgical coals but become more influential when the world benchmark price is around $150/tonne to $160/tonne. Daniel Scott, executive director of MKM Partners LLC, wrote in February that the coking coal market remains strong and is the best bet for investing in U.S.-based coal companies, even if the market is expected to moderate in the near term.

"Years of under-investment in the commodity has driven the current tight market conditions, with no spare capacity left to produce with modest capital spends," Scott wrote. "The price runs of the last 18 months have been driven by Chinese policy decisions and Australian weather and port issues, but it's clear that disruptions are here to stay in that market."

CSX Corp. Executive Vice President and CFO Frank Lonegro recently said his company, a railroad service hauling products and commodities including metallurgical coal, has enjoyed improved demand for U.S. metallurgical coal. He said the U.S. is a swing supplier in coal export markets, stepping up production when global demand fluctuates.

"We certainly have a quality advantage when it comes to metallurgical coal, but having a weaker dollar, which is not something I think anybody really anticipated, that's really provided some more temporal strength in the marketplace," Lonegro said at a transportation conference in late 2017.

Peabody Energy Corp., the largest coal company based in the U.S., uses currency forwards and options to hedge against potential currency risks for expenses for its metallurgical coal mines in Australia. In a recent regulatory filing, Peabody said that without such measures, the company's exposure in operating costs and expenses due to a 5-cent change in the exchange rate between the Australian dollar and U.S. dollar is approximately $90 million to $100 million in the next 12 months.

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The president and his administration, through U.S. Treasury Secretary Steven Mnuchin, have made comments — later softened — suggesting the White House prefers a weaker U.S. dollar because of the trade advantage it affords those who export U.S. products. However, conservative commentator Lawrence Kudlow and two economists who co-founded the Committee to Unleash Prosperity said in a Feb. 16 opinion piece that there is "little in this world that can bring our economy to its knees faster than a weak dollar."

"Devaluations and weak currencies do not create U.S. jobs. Instead, weakened currencies are accompanied by relative price changes leading to inflation in the devaluing country," the three wrote. "Looking forward, the administration should speak of a sound, stable, strong dollar."

Trump's March 2 tweet that "trade wars are good, and easy to win" caused concern about recent tariffs announced on steel and aluminum. While a tariff may generally be considered dollar-positive on its own and could lead to increased demand for domestic steel and metallurgical coal, it may also lead to retaliation from other countries that could hit other parts of the economy.

"A full-scale trade war is not good for global growth and risk sentiment, the imposition of trade tariff is also likely to be inflationary for the U.S. as domestic [consumers] will have to pay more for steel and aluminium and the risk of retaliations suggest that other sectors in the economy could end up getting hurt too," wrote Rodrigo Catril, a currency strategist with National Australia Bank Ltd Inc.