What are Coal Futures?
Coal futures were developed as a way for coal producers, marketers and utility companies (coal consumers) to limit their exposure to the risk of price fluctuations in the coal market.
A coal future is a standardized contract traded on several exchanges around the world. As per the contract, buyers agree to purchase a standardized quantity of coal at a pre-specified price at a specific future date. Sellers of the contract agree to deliver the quantity at that price on that date. These coal contracts have a standard size, grade, price movement and expiry date so that they may be traded freely on an organized exchange.
What is Coal?
Coal is perhaps the most essential rock on earth owing to the fact that it generates almost half of the world’s electricity.
Coal is formed over millions of years by numerous biological and geological processes acting together.
In peat bogs and swamps, intense pressure, high temperatures and tectonic movements act on rock deposits containing layers of vegetation, slowly turning it into peat and then eventually into coal.
It is thanks to this million-year process that coal is such an efficient fuel source. Since the vegetation trapped inside rock deposits is unable to decay normally over the years, it ends up storing all its energy in the deposit—causing coal to be a powerful source of energy.
Coal is obtained from the ground through underground shaft mining or by open pit mining at the ground level. Usually, the lesser the moisture in the coal, the greater the energy it can produce. Low rank, moist coal makes up around 47% of the market, with hard coal comprising the rest. Both can be used to produce power, but hard coal is preferred when making high-quality steel since it emits extremely hot temperatures that are most effective for removing impurities from the metal.
History of Coal
Coal has a long history as an energy source. The Ancient Greeks, Romans and the Chinese all mined and burnt coal for energy.
However, it was many centuries later— in 1748— that coal was first commercially mined in Virginia in the United States.
With the advent of the steam engine in the 1700s, coal began to be used on a wide scale as a fuel—since it was cheaper than wood and there were vast natural supplies.
Coal has been instrumental in ushering many key historical breakthroughs, but its greatest contribution was bringing about the industrial revolution. In the 1800s, coal began fueling factories—making large scale industrial production— and hence economic growth— possible worldwide. By the dawn of the twentieth century, coal had replaced wood as the main energy source around the world.
Today, coal provides for nearly 30% of the world’s energy needs and is responsible for generating around 40% of the world’s electricity and 70% of the world’s steel.
Coal’s biggest use is in supplying cheap electricity to homes and industrial plants. When coal is used for generating electricity, it is pulverized and then burned in a boiler furnace. The heat from the coal turns the boiler’s water to steam and this steam in turn spins the turbines of generators that create electricity.
Coal’s second most important role is in steel production. Metallurgical coal (coking coal) is used in smelting iron ore at blast furnaces since it produces extremely high temperatures that drive away impurities from the metal and turn it into high-grade steel.
Small amounts of coal are also used in making cement and heating commercial and military facilities.
Where is Coal found and refined?
According to the World Coal Association, global coal reserves will last for another 112 years at the current consumption capacity.
While the United States has the world’s largest reserves of coal in the world, China has been the world’s leading producer of coal since early 1980s. It currently produces nearly half of the world’s coal. In 2012, total world production of coal was 7830 Mt, with China leading the production with 3540 Mt, followed by USA at 935 Mt and India at 595 Mt. Almost 70% of the coal produced in the U.S. in 2012 originated in five states: Wyoming, West Virginia, Kentucky, Pennsylvania, and Illinois.
The world’s leading exporters are Indonesia, Russia, Australia and USA. In 2012, the U.S. exported a record high of 125.7 million short tons, mostly to European and Asian countries.
How is Coal Used (United States)?
Coal’s two biggest uses are in the electricity and steel sectors.
Over the past 60 years, coal has been the single largest source for electricity generation in the U.S. In fact, coal-generated electricity forms nearly 40% of total electricity production in the country. In 2012 alone, nearly 80% (close to 800 million short tons) of the coal mined in the U.S. was used to generate electricity by US power plants.
Coal is also used extensively in producing high-grade steel in the US, with around 13% of the total coal production currently used by the industry.
However, in recent years, with increasing regulations and environmental concerns regarding carbon dioxide emissions, coal’s use in fuel production in the U.S. has declined. The demand for electricity has also fallen since 2007 and existing electricity producers, specially in the eastern U.S., are beginning to gravitate towards lower-priced natural gas.
However, the decline in U.S. consumption of coal is being made up by emerging nations such as China, which have significantly upped their consumption thanks to the fact that coal is a cheap fuel source that is useful in powering China’s bustling factories.
Asia is now the biggest coal market and presently accounts for 67% of the global coal consumption, with China and India emerging as the world’s largest importers of coal.
Who Invests and Trades Coal Futures?
As with other futures, coal futures too are traded by two categories of people: hedgers and speculators.
Hedgers are usually the consumers and producers of coal, who have an actual stake in the delivery of coal and hence, use futures as an instrument to “hedge” or mitigate the risk from price fluctuations.
While coal producers can lock in the sale price of their coal by using a short hedge, buyers of coal (companies who need to use coal in their businesses) can lock in the purchase price of the coal by using a long hedge. Futures can greatly help these hedgers balance their cash flows and plan production more efficiently.
The other category of traders are professional investors, also called speculators. They don’t have any vested interest in coal as a commodity and are only trading futures in order to earn profits from price fluctuations. They buy coal futures if they believe coal prices are set to soar and sell those futures if market data or their analysis leads them to believe that coal prices will fall in the future.
Coal Futures Contracts
Coal futures are traded on the New York Mercantile Exchange (NYMEX) in the U.S. There are various types of futures referring to the location where the coal is from. For instance, Central Appalachian Coal Futures (symbol “QLD”) are listed monthly for 5 consecutive years and are settled physically. A single future contract is of 1550 tons and is quoted in dollars and cents per ton. The coal deliverable under these contracts has to meet certain minimum requirements for Btu, ash, sulphur and moisture.
International Coal Futures Trading
European, Australian and South African coal futures are traded on the Inter Continental Exchange (ICE). These contracts are quoted in U.S. dollars and cents per ton.
ICE futures comprise three contracts for the world’s busiest coal centers: Rotterdam in Europe, Richards Bay in South Africa and Newcastle in Australia. All three contracts are financially settled upon the price of coal delivered to the three locations. The Rotterdam Coal futures serve mainly Atlantic coal market participants, the Richards Bay Coal futures serve the Atlantic and Pacific coal markets and The Newcastle Coal Futures serve the Asia-Pacific coal market.
ICE clears over one billion tons of coal contracts every year—which is estimated to be around half of the market.
How to Trade Coal Futures: Brokers and Costs
To buy or sell coal futures, you need to open a trading account with a reputable broker who handles futures trades. TD Ameritrade, CME Globex and Etrade are some well known online platforms for trading futures.
Most brokerage will charge the National Futures Association fees, which is roughly around $0.02 per side, along with a commission (which can range from $0.025 to $3 and more, per contract per side). You will also have to pay an exchange fee, which will vary depending on the exchange and the specific contract you are trading. Be sure to look at the fine print and add up all the fees into your cost.
Coal Futures Trading comes with its own risks. The coal market has witnessed great price volatility since 2001, due to regulations, emergence of more efficient fuel sources, and depleting coal reserves. In 2001, coal prices jumped 200% whereas in 2008, coal prices soared 300%. These sudden spikes in coal prices can go against traders’ positions and cause heavy losses. Due to the high leverage of these futures, the loss on a trade may exceed the amount of the initial margin and even the entire account balance.
Furthermore, the high volatility of the coal attracts many speculators seeking high profits. This increasingly endangers the equity investments of hedgers.
Lastly, most coal futures are limited in their liquidity and it may not always be possible to offset a coal contract in the market. So while coal futures represent significant opportunities, traders will do well to keep the accompanying risks in mind— in order to truly profit from their contracts.