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DEPARTMENT
OF TRADE AND INDUSTRY
UK
COAL OPERATING AID SCHEME
IMPORT
PARITY PRICE PANEL - RESPONSE TO CONSULTATION
1. INTRODUCTION
The Import Parity
Price Panel (IPP Panel) has been established to advise the Secretary
of State on certain contracts submitted as part of an application
for subsidy under the UK Coal Operating Aid Scheme. The Panel will
advise on what the price would be (the IPP) of imported coal of
equivalent quality purchased under terms comparable to those in
the UK coal contracts.
The Panel issued
a Consultation Document on 15 December 2000, which set out the general
methodology it intended to use to set IPPs, and sought views on
a number of specific issues. This Paper can be found at www.dti.gov.uk/support/coal.htm.
Responses were received from fifteen parties, listed at Annex A.
In addition the Panel has held meetings with the principal trade
associations representing UK coal producers, and with a number of
other parties with expertise in specific areas relating to the import
of coal.
This paper sets
out the main points raised in the consultation process, and the
Panel's conclusions on these issues. On one issue, highlighted in
Section 2, the Panel is inviting further comments. As previously
indicated, the Panel will undertake a detailed examination of all
contracts submitted to it, and the circumstances surrounding their
negotiation, including inviting representations from the applicant
for subsidy and usually also the customer for the coal.
The Panel's
Terms of Reference were set out in the Consultation Document (at
Appendix A). Some of the comments received would have required to
Panel to go beyond its Terms of Reference. We have been conscious
throughout of the need to comply as closely as possible with the
spirit of these Terms.
This paper covers
the topics in the same order as in the Consultation Document. Paragraph
references are to those in the original Document.
2. IMPORT PARITY PRICE PRINCIPLES
General
Many respondents
to the Consultation Paper have raised issues in relation to the
phrase "contracts to secure coal of similar quality and on
similar terms" in the Panel's Terms of Reference. The Panel
is also aware that the nature of many of the contracts which it
will be required to examine is such that some of the methodology
set out in the Consultation Paper may not be appropriate.
In particular,
this applies to specialised qualities including anthracite and coals
with unusual characteristics such as low volatile South Wales steam
coals. In examining contracts for the supply of such coals, the
Panel will be undertaking specific market research amongst traders
and users in order to derive an IPP which takes into account the
specialised qualities involved. In certain cases, the Panel may
come to the conclusion that there is no commercially credible non-UK
source of supply. If that is the case, then it will form part of
the Panel's advice to the Secretary of State.
In relation
to high specification, low ash industrial coals supplied in small
quantities to small businesses and public authorities, the Panel
has identified a number of sources of such coals based on plants
processing imported coals at various locations in the UK. When examining
a particular contract, the Panel will undertake specific research
into such sources to establish an IPP for an equivalent imported
coal delivered on the same terms.
In some cases,
a UK contract may be for general purpose steam coal that is available
from non-UK sources but the terms of the contract (e.g. very low
rates of delivery) are such that they are not normally applicable
to contracts for the purchase of imported coal. In these cases,
it will be necessary for the Panel to examine what the alternatives
were, or might have been. A possible import alternative would have
been the supply of residual power station fuel from a plant processing
imported coal primarily to produce high value products for premium
housecoal or industrial markets. Following this research, the Panel
will derive an IPP on similar contract terms. In extreme cases,
the Panel may conclude that there is no commercially credible import
alternative. Such a conclusion will then form part of the Panel's
advice to the Secretary of State.
Availability
of Longer Term Import Contracts (paras 2.3 to 2.4)
Two respondents
suggested that longer term import contracts (i.e. for more than
one year) could be available on fixed terms other than at prices
linked to an index of world market prices. Other respondents said
that import contracts were not available on fixed terms and that
it was not possible to compare long term UK contracts at these prices
with one year import contracts. On the other hand, one respondent
said that comparison with one year import contracts, revised each
year, was the only true comparison. If evidence is provided to the
Panel when it considers a long term UK contract that imports were
available for the same duration at fixed prices, the Panel will
take this into account in determining the IPP. Such evidence must
be documented, for example a quote in response to a tender, or a
firm offer to supply.
If no such evidence
is presented, the question then arises as to how a long term IPP
might be derived. The Panel has been advised that certain traders
would quote a fixed price for a long term contract if asked to do
so. It is clear, however, that such a price would be likely to be
different from the then current international price as it would
anticipate future price movements. When prices are low, therefore,
it would be significantly above the current market and when prices
are high, it would be lower. Given competitive pressures, it seems
unlikely that a customer would be prepared to pay significantly
above the prevailing market price for imported coal on the assumption
that it would rise much higher in future years. Similarly, when
prices are high, it seems unlikely that an overseas producer would
be prepared to accept a price well below the prevailing international
market price on the assumption that prices will later fall significantly.
For these reasons, the only long term contracts that are likely
to be concluded are at prices linked to an index of world market
prices. This is comparable in economic terms to a long term price
which is fixed in real terms.
The Panel is
therefore minded to conclude, in the absence of firm evidence that
prices for more than one year fixed in nominal terms (or linked
to the UK RPI) would have been available for contracts from non-UK
sources, that the IPP for a long term UK contract should change
for each year of the contract in line with the movement in international
prices. In such cases, the IPP for the first year under a long term
UK contract would be derived from the delivered price for international
coal at the time the contract was finalised, and for the second
and subsequent years of supply, the IPP would change in line with
international prices.
The Panel recognises
that this is not the only approach to this issue which merits consideration.
In particular, it can be argued that the IPPs determined at the
time that long-term UK contracts were finalised should remain for
the full length of such contracts (subject to indexation equivalent
to that in the UK contracts) on the grounds that the negotiated
prices will anticipate future movements (both up and down) in the
international price and will therefore reflect the anticipated average
of the international price over the duration of the contracts.
This matter
was raised in general terms in the earlier Consultation, but because
of its importance and in the light of the more specific proposals
now outlined above, the Panel wishes to provide the opportunity
for further comment before reaching a conclusion. The Panel would
welcome further views from interested parties on the methodology
that should be adopted for the determination of IPPs for long-term
UK contracts in cases where specific evidence of longer-term import
quotations is not available. Consideration of this issue is unlikely
to delay the Panel's deliberations and advice on IPPs for contracts
relating to first tranche subsidy applications.
Options
(para 2.5)
There was a
variety of responses to the Panel's request for views as to how
options in UK contracts might be valued in comparison with international
contracts. Views ranged from any attempt at quantifying the value
of an option as not being meaningful to a statement that options
can always be valued by the use of appropriate econometric techniques.
The Panel is aware that in UK contracts options are usually at the
buyer's call but that the producer is not always obligated to supply
in full. From the buyer's perspective, therefore, an option may
have some value.
The Panel has
concluded that longer term options have no quantifiable value at
the time they are negotiated given the volatility in world prices.
Depending on their terms, short term options can be valued by comparing
them with the alternatives that were perceived as being available
at the time of their negotiation. In considering a UK contract containing
an option, the Panel will assess its value taking into account the
terms of the option and, in particular, the extent to which the
producer is obligated to supply.
Coal
Price Indices (Paragraphs 2.7 to 2.18)
The Panel received
ten responses to this section of the consultation. Some respondents
thought the MCIS marker price was the most appropriate whereas one
considered the API#2 index to be the best indicator of the current
international coal price, and one thought that a basket of indices
should be used. Some made the point that small producers had to
accept an RPI-x formula imposed by large buyers, irrespective of
the cost of imported coal. Other respondents considered that the
UK price had been determined by large contracts, and their impact
in foreclosing the market to other suppliers, not by imported coal
prices as reported in various indices.
One respondent
made the point that existing indices were not in fact true indices,
as they are based upon the opinions obtained from market players
and not on actual contract tonnages, terms and pricing. The involvement
of trading entities may cause index distortion, and possible manipulation.
A further respondent
made the point that whilst coal price indices are a good guide to
the direction the market is moving, they are not such a good guide
to absolute prices, and the Panel should base its judgements on
actual quotations for supply.
Producers who
supply niche markets for particular quality coals considered that
there was no equivalent imported price quoted by any index for their
specialised products. Published indices for steam coals are only
appropriate for high volatile coals and an indexation approach would
be inappropriate for anthracite and low-volatile coals produced
in South Wales. The Panel agrees and will determine the IPP for
such products following specific market research. Such an approach
was favoured by a number of respondents.
The ideal situation
would be for purchasers of UK coal under contracts relating to subsidy
applications to disclose what import alternatives were available
at the time of negotiating and concluding the UK contract, and the
price that would have had to be paid for them. The Panel will require
firm evidence of actual quotations available at that time. In the
absence of firm quotations the Panel considers that the use of indices
set out in the Consultation Paper will apply. Following further
research and analysis of the basis of the indices available, the
Panel has decided that the MCIS Marker Price
is the most representative of current prices and therefore the most
appropriate starting point from which to assess the IPP for coals
other than specialist quality coals. Accordingly where no firm evidence
of a price for an import alternative is made available, the Panel
will adopt the MCIS Index for the appropriate period when compiling
the IPP.
Period
over which to apply an index (para 2.19)
The Panel had
suggested that where an index is to be used as the starting point
to derive an IPP, it should be the average of that index over the
three-month period immediately prior to the finalisation of the
UK contract. By finalisation was meant conclusion of the principal
terms, whether by way of a full contract, Heads of Terms, or exchange
of letters, whichever was the earliest. Two respondents felt that
three months was too long a period, and that particularly at a time
of price volatility, only the final month before finalisation should
be considered. Alternative views were expressed that three months
was too short a period, as price was often firmed up early in the
negotiations. Others agreed that three months was reasonable.
The Panel will
seek evidence as to the time at which the price of the UK contract
was established, but in the absence of specific evidence, reaffirms
that three months is the appropriate period to use.
Exchange
Rates (paras 2.20 to 2.21)
The Panel received
general support for its proposals on exchange rates. One respondent
said that the forward exchange rate should be the average for the
period of the contract rather than the mid point and another pointed
out that forward rates, which are freely quoted only for a year
ahead, are not available for the duration of some contracts. It
was also pointed out that the forward rate should not be used if
it was falling steeply at the time the contract was being negotiated.
The Panel agrees with these responses and will use the average forward
rate. For contracts of more than one year's duration, the twelve
month forward rate will be used. If the forward rate is falling
at the time of negotiation, the Panel will consider the rate of
fall and whether it was sustained over the period of negotiation,
and decide whether the spot rate should be used.
One respondent
said that the forward rate to be used should be that for the month
of finalisation of the UK contract rather than the average for the
three months up to finalisation. However, in comparing UK contracts
with contracts for international supplies, UK deliveries can commence
almost immediately, but it will be some weeks before imports start
to be delivered. The Panel, therefore, remains of the view that
an average for the three months prior to finalisation is appropriate.
The Panel was
also reminded that in some cases imports are quoted in sterling
terms (e.g. anthracite) and the exchange rate is not relevant.
3. PRICE ADJUSTMENTS
The Terms of
Reference require the Panel to take account of coal quality, and
to set the IPP on the basis of coal of equal value in use to the
purchaser.
Coal producers
made a general point that the cumulative impact of quality parameters
needed consideration, as well as the individual components. Certain
UK coals suffer from disadvantages against imported coals by being
on the high side in sulphur, chlorine, ash and moisture; and are
closer to the borderline of acceptability in other respects such
as ash characteristics and consistency. While each individual parameter
can be within agreed tolerances, the cumulative impact of these
being at the less desirable end of the scale can adversely affect
the price. The Panel recognises that this may be the case, and will
take into account evidence to this effect presented in relation
to individual contracts.
Calorific
value, ash and moisture (paras 3.5 - 3.7)
It was pointed
out that some coals, such as washed anthracites, are sold on the
basis of price per tonne, and that precise calorific value, provided
it is within the bounds of normal variation, does not matter. Moisture,
on the other hand, is significant, as are certain other properties
such as sizing and surface characteristics.
One respondent
indicated that individual power stations had expressed concern over
high ash or moisture content of certain coals, which could affect
the price. Another noted that the ash levels in imported power station
coals covered a wider range than had been indicated in the Consultation
Document, and that some higher ash imported coals had been bought
at discounted prices. One coal consumer emphasised the importance
of the quality and quantity of ash at individual power stations,
particularly in relation to sales of ash and costs of ash disposal.
The Panel notes
these points, and will reflect evidence brought to its attention
during the determination of IPPs.
Sulphur
(paras 3.8 - 3.10)
A variety of
views was expressed. One respondent said there should be no penalty
for high sulphur coal: if a generator was freely buying higher sulphur
UK coal, it must be assumed that it could achieve its planned generation
within its sulphur limits using that coal. Another emphasised the
disadvantages of lower sulphur coal in terms of precipitator performance
and other adverse effects on plant. One reply said that very low
sulphur coals could have distinct advantages for generators at non-FGD
stations. Coal producers drew attention to the pricing pressures
they had experienced on high sulphur coals, particularly where it
was necessary to sell coal through a third party to blend down the
sulphur level.
The Panel believes
that there is a price penalty for coals with a sulphur content significantly
above international levels. Where possible, a market-based approach
will be adopted through an assessment of the international price
for comparable high sulphur coals, although at present very little
is being bought in Europe. For coal sold to an FGD station, the
Panel will seek information on the additional costs of using high
sulphur coal. Where it is necessary for a producer to sell coal
for blending through a third party, the additional costs will be
taken into account in setting the IPP.
Chlorine
(paras 3.11 - 3.12)
Two respondents
felt that any penalty for high chlorine should be applicable over
0.4% rather than 0.5%. The Panel agrees.
Differential
Loss of Heat Content (para 3.17)
A number of
respondents commented on this matter, but only one felt that it
was a real issue, saying that there could on occasions be a material
heat loss between loading port and delivery to power stations, depending
on the particular circumstances. One respondent pointed out that
heat loss also applies to UK coals. In view of the limited information
presented, the Panel does not propose to take this factor into account.
Premium
for UK coals (para 3.20)
A range of views
was expressed, from those saying that there was no longer a premium
on UK coal, to those who felt that there was still such a premium.
One view was that there was a premium at times when international
prices were low, but that at times of high prices, UK coals sold
at a discount to the prevailing international price. The Panel continues
to believe that there are some largely unquantifiable advantages
in buying UK coals which may be reflected in prices at times of
market weakness, but that in the power station market the increasing
diversity of ownership has significantly reduced the scope for a
premium. The Panel will not as a general rule take this factor into
account.
Impact
on world market prices (para 3.21)
Only one respondent
commented on this issue, disagreeing with the Panel's view that
the subsidy would have only a small effect on world prices and suggesting
that the effect should be modelled once the extent of the tonnage
supported in each year is known. The Panel accepts that, particularly
at times of market tightness, there might be a temporary effect
on world prices if there were to be significant additional demand.
Over time, the impact would reduce as more production is made available.
The Panel will consider whether this factor should be taken into
account particularly for contracts signed since the market strengthened
during the year 2000, and if so, the techniques that may be available
to model the effect. The modelling exercise could be complex, involving
a large number of variables, and would have to take account also
of the extent to which contracts may have been awarded to other
UK producers as opposed to imports.
4. SHIPPING AND PORT ISSUES
Responses to
this section of the Consultation Document concentrated on the issue
of port capacity constraints. Comments ranged from support for allocation
on a first come, first served basis to ignoring the port capacity
issue for all but the largest contracts. One view was that the allocation
should be to the nearest port at which capacity was available at
the time a contract was let. Respondents made the point that port
capacity and choices may be limited by "take or pay" type
arrangements.
For specialist
quality coals and anthracite, port capacity was not an issue, as
these products would be imported in small quantities through a wide
choice of import terminals.
The Panel acknowledges
that some port capacity is unavailable or limited by previous contracts,
and that there may be further limitations because of "take-or-pay"
arrangements between ports and importing companies. The Panel does
not agree to allocation of capacity on a first come, first served
basis as that method would not recognise that some UK coal contracts
would not have been replaced by imports but by other UK producers.
Equally the Panel does not agree that it should always be the nearest
port at which capacity is available, because this ignores the fact
that earlier contracts may have used up some of the capacity, had
the subsidy not been available.
For small contracts
the Panel believes that there will always be capacity available
through low cost import routes. There will always be a degree of
flexibility at the margin at large ports and capacity at ports limited
to dealing with small cargoes will be available. For larger contracts,
the Panel recognises that the lowest cost import route may not be
available in full and subsequent large contracts may therefore need
to be allocated to higher cost routes. In coming to their judgement
on this issue, the Panel will take into account the extent to which
contracts may have been awarded to UK producers.
In its Terms
of Reference, the Panel is explicitly required to take account of
infrastructure limitations. In particular where transport infrastructure
would be insufficient for the full set of contracts under consideration,
a higher price must be estimated to take account of the costs which
would be incurred in expanding capacity or using alternative transport.
In order to
supplement the Panel's knowledge on port issues, external research
was commissioned from the research department of an internationally
recognised ship brokerage company, following a competitive tendering
process. This complemented the Panel's knowledge of port infrastructure
limitations, capacity and costs of use. The Panel will also keep
under review the available capacity at UK ports where Corus Group
currently import coal and iron ore, as the future plans for this
company are developed.
The report also
provided data on the differential in CIF (Carriage, Insurance and
Freight) rates between shipment costs to Rotterdam and the main
UK ports of entry for imported coal. From the information provided
the Panel are developing a methodology that is applicable in general
terms for converting the MCIS marker price to a CIF price at UK
ports for different sizes of vessel.
5. INLAND TRANSPORT
The majority
of respondents commented briefly on this issue. In the main, the
Panel's proposals were agreed, and the points made were ones of
detail.
Rail
transport
One response
argued that long-distance rail flows for imports may be subsidised,
that track upgrades to handle increased import flows are not fully
paid for by such imports, and that freight facilities grants distort
infrastructure pricing.
The introduction
of competition into the rail freight market was noted by one party,
with the expectation that this would lead to downward pressure on
rates.
The Panel has
had helpful discussions with EWS, Freightliner Heavyhaul and Railtrack.
We are well advanced in establishing a matrix showing the differentials
in transport costs between conveying imported and UK coal to the
principal customers. We have been made aware that the Rail Regulator
has been consulting on a change in the way in which track access
charges are levied on the operating companies, and that such a change
may be introduced during this year. This could well have an effect
on the rates levied by the operating companies on their customers,
and alter the differentials between long and short distance routes.
The Panel will keep rail rate differentials under review.
The Panel has
also consulted the three companies mentioned above on rail capacity
issues affecting movements from ports, and has formed a realistic
view of the location and extent of infrastructure and resource capacity
limitations. Where appropriate, these will be taken into account
in assessing IPPs. One respondent felt that in some cases the availability
of rail paths is more likely to be the cause of constraints than
port capacity, and that a "first come, first served" approach
to allocation of rail capacity should be adopted. The Panel agrees
that, for example, in considering movements from Scotland to England,
rail capacity is a greater constraint than port capacity. The Panel
will also keep under review the impact that changes in the operations
of Corus Group may have on the availability of rail capacity from
certain ports.
Road transport
For road transport,
some coal producers did not feel that the use of typical RHA rates,
in the absence of specific information on road rates, would be acceptable.
They felt that comparison with rates for similar journeys involving
coal transport, and in similar types of vehicle, would be more robust.
The Panel agrees provided that sufficiently authoritative information
can be obtained.
One producer
said that not all power stations were willing to accept deliveries
by road, and that the non-rail connected producer may have to go
through an intermediary's railhead at extra cost. Where this is
the case, the extra cost will be taken into account by the Panel
in assessing the IPP. It was also said that the cost of road transport
over longer distances limited coal sales options for non-rail connected
producers.
6. CONCLUSIONS
In the Consultation
Document the Panel had suggested that three factors would be most
significant in the determination of an IPP:
• The
estimation of a dollar price of imported coal in hypothetical
contracts that the purchaser would have purchased had he not signed
a contract for UK coal
• The
selection of the port or ports through which such hypothetical
imports would have been shipped, and the resultant costs
• The
estimation of transport costs between the ports and points of
consumption, and (where this not explicit) between the UK production
or loading points and the points of consumption.
One response
commented on this, saying that the first factor should be amended
to read "The estimation of a dollar price, taking into account
duration, quality and quantity, of imported coal…". This
is in line with the Panel's own proposed approach.
Views are invited
on the issue highlighted in Section 2, namely the most appropriate
methodology for setting IPPs for long-term UK contracts. Comments
should be sent to:
Arantxa Fernandez
Department of Trade and Industry
EPTAC 5C - Coal Unit
295 - 1, Victoria Street
London, SW1H 0ET
E-mail: arantxa.fernandez@dti.gsi.gov.uk
Annex
A
RESPONSES
TO CONSULTATION DOCUMENT
1. AES Drax
Power
2. BACM-TEAM, The British Association of Colliery Management
3. Betws Anthracite
4. CLG Energy Consultants
5. Coalpro-The Confederation of UK Coal Producers
6. Edison Mission Energy
7. Edwards Energy
8. FIM-Federation of Independent Mines
9. Hay Royds Colliery
10. Hugh M Lee
11. Moorside Mining
12. Naloo-The National Association of Licensed Opencast Operators
13. RJB Mining
14. Scottish Coal
15. Scottish Power
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