Trading surges in Indonesian sub-bit coal swaps

By Jackie Cowhig

LONDON, June 13 (Reuters) – A surge in interest in Indonesian sub-bituminous coal swaps beginning in April has convinced some major coal players that the swaps could become the world’s biggest coal derivatives market.

“Indonesian sub-bit is fast emerging as an important supply source in the Pacific,” said Zenny Tran, coal team leader at Singapore-based brokers Ginga, which has pioneered the development of sub-bit spot trade and swaps.

Sub-bituminous swaps began trading very slowly in 2010, but in the past two months liquidity has risen markedly as Asian consumers have largely turned away from high-priced standard coal in favour of cheaper, low-grade fuel.

An increasing amount of demand from China and India and most of the output growth in Indonesia, already the world’s biggest thermal coal exporter, are expected to be for sub-bituminous coal, which is substantially cheaper than bituminous.

“The physical seaborne traded Indo sub-bit market is probably more than 100 million tonnes a year, which is more than exports out of South Africa’s Richards Bay, and lots of this is traded on the spot market to India, China, Korea, Taiwan and South East Asia,” Tran said.

“This makes a great fundamental for a derivatives market to develop from,” she added.

Thermal coal is divided roughly into standard-grade bituminous and so-called sub-bituminous, which is a low-energy, low-sulphur and high water-content coal.

Sub-bituminous coal has around two-thirds the energy content of standard coal, and although on the surface it appears cheaper, more of it must be burned to generate the same amount of electricity.



Standard coal prices of around $120 a tonne are nowhere near 2008’s record of over $180 a tonne FOB Newcastle, but they are high enough to have caused a big shift in buying patterns this year.

The rise in physical sub-bituminous prices from $82 to $89 a tonne after China scooped up a string of cargoes in April helped draw in new players, said an official at brokerage Spectron, which has recently started to broker sub-bit swaps.

Around 280,000 tonnes of sub-bit swaps traded in May, up from almost nothing in 2010 and roughly a trade a week in the first quarter. The current activity still is far less than the daily trade in API2, API4 or Newcastle swaps, but the rapid growth suggests this will escalate, the brokerage official said.

Utilities, traders and banks who are long-established players in the liquid API2, API4 and Newcastle swaps markets, said they have been drawn to sub-bit swaps by the rise in physical prices this year as well as by a desire to get in early on a nascent market, which seems to have the scope for rapid growth.

“Sub-bit swaps have the potential to be huge, bigger than the APIs because of the sheer volume of underlying physical trade. It will be the largest coal market in the world,” said an Asia-based trader with a major European utility.

“From April there was a marked rise in interest. Bid/offer spreads closed right in, more participants got involved and the number of trades rose sharply,” he said.

“Sub-bit swaps are nowhere near an API scale yet, but trades rose in April from one a day to four trades in five minutes. The players are wide-ranging too — banks, traders mostly but producers and end-users are showing interest,” he said.

“Vitol is getting set up, Societe Generale is getting set up, Mercuria has been keen from the start, but we’re also seeing J.P. Morgan, Peabody, Credit Suisse, Morgan Stanley, Louis Dreyfus, Trafigura, J. Aron and Macquarie regularly,” he added.

Traders and brokers are now aiming to entice Indonesian producers and Asian consumers into the swaps market.

“We’re extremely interested in sub-bit swaps; we see the potential,” said one major international physical coal trader.

“There is interest from producers and consumers but they may want to see more liquidity first,” he said.

Indonesian producers have embraced the idea of linking physical coal sales to the Australian Newcastle index and using Newcastle swaps to hedge, but Asian end-users have been slow to use derivatives.

Numerous funds and institutions in Asia and elsewhere, meanwhile, either want to or have started to dabble in sub-bit swaps alongside Newcastle swaps to get some exposure to coal without taking or making physical delivery.