Opening China's inflation floodgates

Queensland’s devastating floods have raised fears of a global coal shortage, and increased the difficulty faced by Chinese authorities as they try to battle mounting inflationary pressures without causing the economy to slow too severely.

The Queensland Resources Council, the industry body, estimates that flooding across central Queensland has already cost the state’s coal industry $1 billion in lost production. It could take several months before coal companies are able to pump the water out of flooded mines and resume full production.

Floods have also resulted in cuts to key transport links. The rail link to the Port of Gladstone, a key port for coal exports, has been disrupted. There are 18 vessels waiting to load coal from the port, with a further 12 expected in the next 10 days.

Some analysts are tipping that the floods will see the price of coking coal rise by more than 30 per cent in coming months, as steelmakers battle to ensure they have secure supplies.

Australia supplies two-thirds of the seaborne trade in coking coal, which is an essential ingredient in steel production. The floods are estimated to have hit mines that account for up to 40 per cent of the world’s coking coal, and there are already reports of Asian steel producers trying to buy coking coal in the US and Canada.

The cost of coking coal has soared to around $US253 a tonne, an increase of more than 10 per cent from quarterly contract prices before the flooding. But some analysts believe the floods will likely push prices to between $300-$330 a tonne. They estimate that the impact of the latest floods will be worse than the Queensland floods in early 2008, which saw coking coal contracts climb above $300 a tonne.

The price of thermal coal, which is used in power stations that produce electricity, has also risen. Thermal coal prices have now climbed to $US133.5 a tonne, up 9 per cent over the past two weeks.

Some of the world’s biggest coal producers, including BHP Billiton, Anglo American, Rio Tinto and Xstrata have declared force majeure, which means that they unable to fulfil their contractual obligations to supply coal because of events beyond their control.

Soaring coal prices and a reduction in coal supplies will exacerbate inflationary pressures in China, and could result in even worse disruptions to the electricity supply.

According to recent report in the Chinese publication, Caixin online, some Chinese power plants are already facing a shortage of coal supplies, due to the Chinese government’s policies aimed at stabilising coal prices.

Last month, China’s National Development and Reform Commission (NDRC) published a notice that instructed coal producers not to raise the key power coal contract price (the contract price used by large state-owned producers and power plants) in 2011.

The NDRC was concerned that an increase in the coal price would force power plants to raise the price of electricity, which would fan inflationary pressures.

But the NDRC’s notice has led to a thermal coal shortage in several provinces in Central and Northern China, which has caused a disruption to electricity supplies. Some coal producers have simply been unwilling to sign new contracts. Others have found ways of getting around the price control system. For instance, even if power plants have signed coal contracts, they may need to pay producers an extra fee before coal is shipped.

The NDRC’s notice to coal producers not to raise their prices came two weeks ahead of the move by the Chinese central bank to raise interest rates by 25 basis points. The central bank’s move, which followed a similar move in October, was aimed at curbing growing inflationary pressures. But it fuelled fears that the Chinese central bank is becoming vigilant about fighting inflation is about to start a series of interest rate hikes that could cause a severe slow-down in the Chinese economy.

Fears that a Chinese steelmakers may be forced to cut back production as a result of the Queensland floods has increased the risk that the Chinese economy could slow too sharply.