Coal used to make steel is set to drop to the lowest price in two years,
eroding earnings at BHP Billiton Ltd. (BHP) and Rio Tinto Group (RIO), as European demand wanes and China shifts supply
contracts to Mongolia
from Australia.

The contract price may drop 11 percent to $200 a metric ton in the three
months to Dec. 31 from $225 a ton this quarter, according to seven analysts and
industry officials in a Bloomberg survey. The spot price in China fell 25
percent from the end of June to $177 yesterday, the lowest this year, according
to data compiled by Bloomberg.

A deepening debt crisis in the eurozone has dragged down demand and prices
of commodities, forcing the world’s largest steelmaker ArcelorMittal (MT) to shutter or idle plants in the region.
Slowing economic growth in China, the second-biggest importer of metallurgical
coal, has increased chances of output cuts at mills and further shrinkage in
demand for the fuel.

“Steel demand in Europe is very weak and consumption has slowed dramatically
in recent months,” said Tim Cahill, an analyst at J&E Davy Holdings Ltd. in
Dublin. “It’ll get worse in the second half as government
spending slows and banks stop lending to home buyers. Unless the U.S.,
Europe, China pump in serious stimulus, global steel demand will remain
subdued.”

Rating Cut

The EU produced 14.73 million tons of steel in June, the lowest for that
month since 2009. Moody’s Investors Service cut the corporate family rating of Tata Steel Ltd. (TATA)’s European unit, which contributes
two-thirds of the steelmaker’s output, saying further signs of weakness in the
region’s steel industry will lead to slower recovery in Tata’s operating and
financial profile. The outlook remains negative, Alan Greene,
senior credit officer at Moody’s, said today in a report.

Possible higher supplies will also put pressure on prices after the BHP Billiton
Mitsubishi Alliance, the world’s biggest exporter of steelmaking coal, resumed
operations last month at its Queensland mines, pruning the risk of shortages.
The venture supplies about 18 percent of global coking coal, according to a
March 22 Goldman Sachs Australia Pty report.

“If BHP Mitsubishi mines are successful in bringing on significant output
quickly, prices will possibly decline below $200 a ton,” said Jim Truman, a
coal market analyst at Hill & Associates in Morgantown, West Virginia.
“All steel companies will benefit and almost all coal miners will lose
revenue.”

Lower Earnings

Full-year profit at BHP, slated to report earnings this month, may drop
24 percent to $17.9 billion, according to the average of 20 analyst estimates
compiled by Bloomberg. Credit Suisse AG analysts, revising down commodity price
forecasts, cut their full-year profit estimate for BHP by 7 percent, according
to a July 12 note.

Analysts trimmed 2012 profit estimates for Rio on lower commodity prices and
slowing growth. Rio today posted first-half net income of $5.9 billion, beating
the $5.04 billion average of 11 estimates compiled by Bloomberg.

Kelly Quirke, a Melbourne-based spokeswoman for BHP Billiton, declined to
comment on falling coking coal prices, its impact on the company or plans to
cut output, as did Karen Halbert, a spokeswoman for Rio Tinto.

About 44 percent of Alpha Natural Resources Inc.’s revenue last year and
more than 10 percent of BHP’s sales in the year ended June 30, 2011, came from
coking coal. The fuel made up about 10 percent of Anglo American Plc’s revenue
last year.

Below $200

Should benchmark prices fall below $200 a ton because of receding demand in
China, the world’s biggest steel producer and consumer, coking coal suppliers
including BHP, Rio Tinto, Teck Resources Ltd. (TCK) and Alpha Natural
will start cutting output to support prices, said Kuni Chen, an analyst with
CRT Capital Group LLC in Stamford, Connecticut.

While spot prices have fallen below $200 a ton for the first time since
August 2010, the drop may not lead to settlements at these levels in the next
quarter, according to Doyle Trading Consultants LLC, an energy
research firm specializing in coal.

“When there are major volume commitments at stake, negotiations are much
different than spot market transactions during periods of very weak demand,”
Doyle Trading said in a July 26 report.

Global steel demand growth is forecast to slow to 3.6 percent this year from
5.6 percent in 2011, according to the World Steel Association. China may
consume 648 million tons of steel this year, compared with 657 million tons
forecast in March, because of the slowing economy, Australia’s Bureau of Resources and Energy
Economics said in a June 27 report.

Wait-and-Watch

“To buy or not buy coking coal now is a million dollar question, which
doesn’t have an easy answer,” said Jayant Acharya, director at JSW Steel Ltd. (JSTL), India’s third-largest producer.
“The industry is in a wait-and-watch mode. Prices look weak and may fall
further.”

Chinese steelmakers may lower production this month and next to remain
profitable as the slowest economic growth in three years drags down sales.
Immediate-delivery prices of benchmark hot-rolled steel sheets in China fell to
3,652 yuan a ton
on Aug. 7, the lowest level since November 2009.

“Steel prices in China are falling faster than raw material prices, which
can lead to closures of some of the high- cost capacities,” said Mark Pervan,
the head of commodity research at ANZ Banking Group in Melbourne.

Japan Demand

The slow pick-up in demand in Japan, the biggest coking coal importer, has
further dashed the hopes of miners. Japan’s crude steel production in the first
six months of this year was little changed from a year earlier at 54 million
tons, belying expectations demand will spurt as Asia’s second-biggest economy
rebuilds itself after the Fukushima nuclear disaster last year.

Contract coking coal prices surged to a record $330 a ton in the June
quarter last year, after heavy rains in Queensland disrupted output at mines
and choked shipments. Prices declined for four straight quarters after that
before climbing back in the three months started July 1.

As much as 87 percent of the 275 million tons of global seaborne coking coal
trade is distributed among Australia, the U.S. and Canada, according to David
Radclyffe, managing director for equity research at Nomura Holdings Inc. in
London, giving suppliers a hold on prices. Australia supplies 57 percent of the
market, he said.

Mongolia is likely to provide the strongest new competition being next to
China and because of the size and quality of its reserves, Australia’s Bureau
of Resources and Energy Economics said in a July 2 report.

“China benefits from its proximity and availability of cheaper coal from
Mongolia,” said Helen
Lau, a Hong Kong-based analyst with UOB-Kay Hian Ltd. “Mongolia will
continue to replace Australian coking coal in China.”