Frequently asked questions

Why list a deliverable futures contract?

Globally, commodity and energy-related futures contracts are either deliverable or cash settled using an index that is representative of the physical market. There is not one example of a major commodity or energy-related futures market that is cash settled on the basis of an editorial index or similar based on the bids, offers and trades facilitated by a single OTC broker.

In the absence of a robust cash settlement mechanism, a deliverable coal futures contract is needed to ensure convergence between futures prices and the price of the underlying coal.  Market participants should take comfort from the delivery process being administered by an independent, appropriately licensed and supervised clearing house.

To maximise participation and liquidity in a deliverable futures contract it is important to have a well defined and widely quoted reference price, underpinned by a deliverable range that is as wide as possible.

Mirroring Australian coal exports to Japan, the destination for approximately 57% of Australia’s thermal coal exports in 2006-07, ASX’s coal futures contract (FOB Newcastle) will be quoted on the basis of 6,000 NCV; Ash of <=13 AR ; and Sulphur of <=0.6 AR. In order to provide easily quantifiable arbitrage opportunities between different grades of coal the deliverable range encompasses any thermal coal (within very reasonable limits) delivered FOB at Newcastle with formula-based adjustments for Calorific Value, Ash and Sulphur.

As with many other successful deliverable commodity and energy futures contracts, ASX will provide an Alternative Delivery Mechanism whereby matched buyers and sellers can opt to manage delivery directly between themselves.

In addition to an Alternative Delivery Mechanism, an Exchange for Physical (EFP) trading mechanism will exist, and no doubt be actively promoted by brokers, to service the needs of market participants wanting to buy or sell coal FOB (or even CIF) at other ports.

Why FOB Newcastle?

As the pricing benchmark for export coal in the Asia-Pacific, FOB Newcastle is the logical delivery point for a thermal coal futures contract. The needs of participants wanting to buy or sell coal FOB (or even CIF) at other Ports will be best serviced by a futures market (including an EFP mechanism) or OTC basis market with reference to the futures benchmark.

What about port constraints?

One benefit of a deliverable futures contract during periods of port constraint is that the marginal price of the constraint will be transparent. Increasingly, third parties are offering trade finance and total-return swap-like products to acquire coal from producers in order to meet delivery obligations pursuant to forward agreements (and, in due course, futures transactions). For producers this will translate into additional competition for their thermal coal and improved terms of finance.

How many futures contracts are likely to go to delivery?

The charts below illustrate the number of ships loaded, export tonnage and the frequency distribution of ship size at the Port of Newcastle.  Most thermal coal exported from Newcastle is forward sold through fixed supply agreements and this is unlikely to change with the introduction of a coal futures market.

The global precedence with other futures contracts is that between 1 and 5% of the underlying market typically occurs through the futures delivery process. This equates to between less than 1 and 4 ships (say 90,000 tonnes each) per month.

Coal Futures - Vessels loaded and export tonnes 

 

Source: www.pwcs.com.au

How will ASX facilitate the Delivery Process?

The futures delivery process mirrors (and formalises) the existing practices that occur between counter-parties.  Futures contracts will be matched on the basis of minimising the number of counter-parties matched. The three delivery scenarios are follows:

1) Where all coal delivered to a Buyer’s vessel relates to the Buyer’s futures contracts, and delivery is made by one Seller only.

In this scenario the Adjusted Settlement Value for the Buyer and Seller is calculated using ‘Outbound Delivery Documentation’.

Seller is “Primary Shipper” for Port Authority requirements. Any residual coal is responsibility of “Primary Shipper”.

2) Where all coal delivered to a Buyer’s vessel relates to the Buyer’s futures contracts, and delivery is made by one Seller only , and delivery is made by more than one Seller.

In this scenario the Adjusted Settlement Value for the: Buyer is calculated using ‘Outbound Delivery Documentation’; and, Sellers’ is the Final Settlement Value Paid by the Buyer, prorated by quality & tonnage on the basis of “Inbound Delivery Documentation”.

One Seller will be required to nominate as the “Primary Shipper” for Port Authority requirements. Any residual coal is responsibility of “Primary Shipper”.

3) Where not all coal delivered to a Buyer’s vessel relates to the Buyer’s futures contract.

In this scenario the Adjusted Settlement Value for the: Seller(s) is calculated on the basis of “Inbound Delivery Documentation” only; and therefore for the Buyer pays the sum of the Adjusted Settlement Value(s) for all Seller’s under the ASX Delivery.

Buyer is “Primary Shipper” for Port Authority requirements. Any residual coal is responsibility of “Primary Shipper”.

 

Where a Seller obtains ‘additional’ coal from another stockpile then Delivery Documentation must incorporate:

  • a single Certificate of Sampling and Analysis that includes the Inbound Rail analysis and the analysis for the Seller’s ‘additional’ coal obtained from another stockpile; and
  • a single Certificate of Weight that includes the Inbound Rail weight and the weight of the Seller’s ‘additional’ coal obtained from another stockpile.

In circumstances where all coal delivered to a Buyer’s vessel relates to the Buyer’s futures contracts, a loading tolerance of 10% above or below 1,000 metric tonnes of thermal coal per contract is permitted at the Buyer’s discretion.

In respect of the event of any failure to make or take delivery, the Clearing Participant is in default.

For more information please refer to the contract specifications and determinations published at www.asx.com.au/coalfutures.

How is the market likely to evolve from here?

The forward market for coal in the Asia-Pacific has grown significantly in recent years thanks to the standardisation of trading agreements and screen-based trading. Typically, the next phase of a market’s growth is to move from a bilateral search market to a centrally cleared multilateral exchange market.  This development will continue with the listing of futures contracts with counterparty risk novated to a clearing house.

The development of a coal futures market will be complementary to the growth of the OTC market, including liquidity on existing screen-based trading platforms. In other words, the ability for participants trading forward and swap agreements in the OTC market to efficiently lay-off their price and counter-party risks into a futures market will enable them to trade more swap and forward contracts in the OTC market.

Futures trading is likely to commence between a sub-set of producers, merchants, consumers and financial market participants. Given the physical location of market participants, intra-day liquidity is also likely to be spread across the Asia-Pacific and European time-zones. Non-futures users will benefit as futures users can more efficiently lay-off risks incurred through physical forward and other transaction structures. The catalyst for many firms to trade exchange-traded coal futures will come when bids and offers are frequently more competitive than those for comparable forward and swap agreements in the OTC market.

In the first instance, futures trading is likely to occur predominately in the OTC market via the EFP and Block Trading mechanisms which together with ASX’s screen based market are globally distributed and available 24hrs x 5.5 days per week.

EFP and Block Trades may be negotiated off-market and in turn registered with the ASX. These trading mechanisms provide OTC brokers with a powerful value proposition and incentive to facilitate futures trading between new and existing clients.

The following chart illustrates the expected evolutionary path of derivatives based on thermal coal in the Asia-Pacific.

 Coal Futures - Likely Evolutionary Path of Thermal Coal in the Asia-Pacific

Likely Evolutionary Path of Thermal Coal in the Asia-Pacific

ASX’s expectation is that liquidity and open interest will build steadily over time. It may take three to 10 years for a mature futures market to develop. It is not unrealistic to envisage the value of turnover in the futures market at a multiple of the physical export market within this timeframe.

As with other new futures markets, trading and open interest will commence slowly and build over time. The catalyst for many firms to trade exchange-traded coal futures will come when bids and offers are frequently more competitive than the OTC market.

Globally, the track record of futures contracts introduced to service coal markets has been mixed. Futures contracts that cash settle against indices that are representative of coal prices in Europe and Richards Bay (South Africa) are in many respects inferior to deliverable futures contracts. The obvious advantage of physical delivery is that it ensures convergence between the futures price and the physical price.  

Why list a thermal coal (FOB Newcastle) futures contract at ASX?

ASX operates the largest futures exchange and clearing house (by value) in the Asia Pacific. ASX currently operates delivery processes for several financial and commodity futures contracts. ASX’s futures markets operates 24 hrs x 5.5 days a week and are very accessible throughout Asia, Europe and North America. ASX has regional offices with business development staff in London and Chicago.

ASX already operates successful energy (electricity) markets in Australia, and will shortly introduce futures on natural gas and emission permits issued pursuant to the forthcoming Australian Emissions Trading Scheme. With approximately 75% of Australia’s electricity being generated by thermal coal, and export parity for an increasing mass of ‘uncontracted’ thermal coal production, ASX is uniquely placed to complement its electricity futures market with futures on coal exports (FOB Newcastle), natural gas and Australian issued emission permits.

What are ASX’s plans for introducing futures and options on Richards Bay?

ASX has for sometime been consulting market participants regarding the introduction of a deliverable FOB Richards Bay Futures & Options market. This contract would largely mirror the specifications of the FOB Newcastle Futures & Options.

Together,  futures & options contracts for thermal coal delivered FOB at Richards Bay and Newcastle will provide a single clearing house for market participants to manage their exposure to seabourne thermal coal across the Atlantic, Indian and Pacific markets. The benefit to accrue from listing two FOB contracts at ASX include spread trading and margin offset opportunities.