China will again generate significant volatility in the global coal market in 2017 as government strives to balance smooth and cheap coal supply to households and steel mills with environmental concerns about coal use, according to Fitch-affiliated market analyst BMI Research.

The country will continue its shift to cleaner sources of coal through heightened consolidation of ‘dirty’ mines, while increasing production from ‘cleaner’ mines to remain on track to attain self-sufficiency.

After a policy shift provoked a supply shock in 2016, prices rallied. Authorities are now aiming to keep coal prices more stable in 2017.

Government has announced plans to cut coal capacity while ensuring a stable coal supply.

In January, the Chinese government cancelled 85 coal-fired power plant projects, owing to environmental concerns. The 85 plants were valued of $62-billion, spanning 13 Chinese provinces and were either planned or under construction. This was in addition to 18 projects cancelled in 2016, taking the total to 103. It eliminated 120 GW of future coal-fired capacity, 54 GW of which were already under construction.

In December 2016, government announced a five-year target to cut 800-million tons of coal-producing capacity by 2020.

After strong consolidation in the coal mining sector in 2016 in light of these imperatives, government had to urge miners to restart production and eased restrictions after thermal and coking coal spot prices drastically increased and hurt the Chinese steel industry. In September 2016, Chinese State-owned coal miners agreed to increase coal output in an attempt to mitigate the sharp rise in prices.

“Thermal coal prices at Qinhuangdao port eventually reached a peak of $104/t in November 2016 before retreating to $86/t in January with mine restarts. “Similarly, Australian coking coal prices retreated to $168/t in January from a peak of $273/t in December 2016.”

BMI says, once the winter heating demand peaks some time this month, it expects government to resume its capacity reduction drive once again, putting prices under pressure and generating volatility in the coal market to achieve domestic outcomes.

Chinese authorities will be cautious with their coal sector consolidation policies in 2017 so as not to repeat the coal price rally of 2016. Unlike policies aimed at reducing output, BMI expects government to focus on shutting down idle, outdated and inefficient mines. Thus, capacity will be reduced mainly by consolidating smaller mines that were not in production in the north-east of China.

Meanwhile, countrywide output will not be reduced as larger producers in the western regions of Inner Mongolia and Xinjiang ramp up output in light of current high prices.

“We estimate China [will] produce 3.3-billion tons of coal in absolute terms in 2017,” National Development and Reform Commission director Xu Shaoshi said.

BMI forecasts coal production to decline for the fourth consecutive year in 2017, but says the decrease will be “much less dramatic” than in 2016.

Closing redundant mines reduces the fixed costs per unit of output, which increases miners’ profitability. Along with an improvement in coal prices over the years to 2021, this will stabilise production from 2018 onwards, adds BMI.

Despite falling prices since the peaks of November and December 2016, mines are still profitable at current price levels.

“With China’s aim to attain coal self-sufficiency and coal consumption expected by the authorities to reach 4.1-billion tons by 2020 from 3.9-billion tons in 2015, we do not expect policies to encourage output cuts in the coming years as in 2016. “The Chinese government expects 3.9-billion tons of coal production in 2020 up from the 3.7-billion tons produced in 2015.”

Nevertheless, risks remain as to how private miners will react in the face of low prices in the coming years, whether they reduce output to increase prices or leave the market altogether owing to financial woes, notes BMT.