Mongolia will soon be one of the world’s key producers of coking coal, one of the two main ingredients for making steel. In 2011 the country overtook Australia as the single largest supplier of coking coal to China, the world’s biggest importer. As of late 2011 local coal mining firms were reporting lower prices than earlier in the year, as Europe’s sovereign-debt issues cast doubt on the strength of the global economy.

In general, prices for coking coal vary widely according to regional dynamics. Around three-quarters of Mongolia’s coking coal ends up in China. Prices have fallen in 2011 in China, as elsewhere in the world, and they are expected to continue to drop as long as the global economic outlook worsens. This decline is largely the consequence of a long upswing in prices over the past five years, which left room for some deflation.

ON THE WAY UP: The long-term future looks brighter. China’s ongoing building boom means steady rises in demand for steel and, consequently, coking coal. “China’s demand for coal is likely to last for the next 20-30 years and raw coking coal demand from China is expected to double,” George Lkhagvadorj Tumur, the managing director at Australia-based Hunnu Coal, a company that develops coal projects in Mongolia, told OBG.

Chinese plants were not producing at full capacity and steelmakers had been offering to buy the input at prices just north of $315 per tonne in 2011. Several had lowered their offers by $16-32 per tonne towards the end of the year. Market prices for coking coal in Shanxi, one of China’s main steel-producing provinces, were between $245 and $260 in early November 2011, down about $8-16 per tonne on international prices. Australian imports were selling in port cities for as low as $220 per tonne for lower-quality coal.

PROFIT MARGINS: Yet even at lower prices, Mongolian exporters are set to enjoy solid profits. A tonne of coking coal was valued at around $300 in November 2011, according to global averages, while production costs were between $70 and $90 worldwide. The massive coal deposits at Tavan Tolgoi (TT) in Mongolia are likely to come in at the lower end of that range, as the seams are located close to the surface, lowering digging costs. “By the time coal reaches the end-user, the cost becomes around $120 due to transportation and Customs fees,” Justin Kapla, the president of SouthGobi Sands, told OBG. Although TT is widely expected to provide high profit margins for its investors, total potential revenue will be uncertain until buyers are familiar with the mine’s output and quality.

LOOKING AHEAD: Long-term forecasts envision total coal exports to China at between 30m and 50m tonnes a year. The wide range in that prediction reflects uncertainties about the market but also the unreliability of statistics in Mongolia. While the focus is on China, part of Mongolia’s master plan is to build railroads that would allow coal to be shipped to Russian ports on the Pacific Ocean as well, and from there sent on ships to other countries. Most non-Chinese buyers will most likely come from Japan and Korea, both of which have a history of investment in Mongolia.

SPECIFIC ARRANGEMENTS: A handful of major coal-marketing firms have recently set up in Mongolia, after securing long-term contracts to ensure supply. For example, Trafigura, a metals-trading firm based in Amsterdam, said in November 2011 that it would work with the Beijing-based private-equity firm Origo Partners to export iron ore and coking coal, in addition to investing in specific mines and projects.

Similarly, in October 2011 the Chinese firm Winsway Coking Coal Holding, which ranked as the biggest foreign buyer of Mongolian coal in 2009, announced a 10-year supply deal with the Mongolyn Alt Corporation, a domestic mining company with an open-pit coal mine about 50 km from the Chinese border.

The arrangement obliges the Mongolian company to sell Winsway a minimum of 3m tonnes of coking coal each year, at a rate determined by quarterly reviews of markets prices. Winsway, which was founded in the British Virgin Islands, is engaged in operations in China and also trades on the Hong Kong Stock Exchange.