China is buying up Russian metallurgical coal on the cheap and ditching pricey U.S. coal, import data from China's General Administration of Customs shows.

In April and May, Russia's share of China's total imports surged to nearly 40%, while the U.S.' share plummeted to less than 3%, according to the data.

In 2021, China imported about 19% of its coal from Russia and roughly the same amount from the U.S. But the European Union, Japan and South Korea, which were the major buyers of Russian coal, have switched to Australia and Indonesia as part of sweeping Western sanctions in the wake of Russia's invasion of Ukraine. Now Russian coal producers are offering deep discounts to redirect sales to China and India.

U.S. coal exporters had benefited from China's unofficial ban on Australian coal, and U.S. steelmaking coal exports to China skyrocketed in 2021. But since February, trade flow changes and growing supplies in China widened the spread between seaborne and domestic prices, shutting China's import window for U.S. met coal. Rail services issues in the U.S. also interfered with coal delivery to the seaborne market.

"Since the war in Ukraine, the trade flow has shifted," Jeffery Lu, managing editor for metallurgical coal and coke at S&P Global Commodity Insights, said in an interview. "Western sanctions could lead to fewer destination markets being able to buy Russian coal. Consequently, more Russian flows may be seen with China and India especially after August [when the EU sanctions will take effect]."

Together through coal

While Russia is aiming to sell more coal to China, export volumes are restricted by limited railway and sea freight capacity.

Russia is in talks with China to supply 100 million tonnes of coal in the coming years, Russian state news agency TASS reported Feb. 18, citing Sergey Mochalnikov, head of the Department of Foreign Economic Cooperation and Fuel Markets Development at the Russian energy ministry. If the two countries cut a deal, China could absorb half of Russian coal exports, according to Today Think Tank, a Shanxi, China-based consultancy under state-owned miner Jiangxi Fengkuang Group.

The closer ties between the two countries can already be seen in coal pricing. While Russian coal prices had fluctuated with international prices, they now track Chinese prices, Liu Lei, a coal analyst at the consultancy, said in an interview. Companies in the two countries have used the Chinese yuan to trade coal to bypass financial sanctions. China's coal tariff waivers also benefit Russian supplies.

However, the upside potential for Russia's coal exports volume is limited, Liu said. Major international container lines have halted cargo shipments to and from Russia. And Russian railway transportation is restricted by low capacity and poor infrastructure, according to Liu. China's met coal imports from Russia are expected to rise to 1.8 million tonnes per month, slightly higher than 1.7 million tonnes in May and April, Liu said.

Depressed imports outlook

China's met coal imports have not yet recovered to the level seen before the unofficial embargo on Australian coal in November 2020, and import demand could drop further.

There was no sign of the ban being lifted in the near term and imports from major exporter Mongolia are still limited. Cross-border coal truck volumes between Mongolia and China rose to 450 trucks per day from just 50-100 trucks in the first quarter due to COVID-19 restrictions, but that is still well below the historical average of about 1,000 trucks per day, according to Lu.

Customs data showed that China's imports from Canada remain resilient but mainly reflect volume from established long-term contracts, according to Liu and Lu.

"Despite increasing purchases from Mongolia, Russia and Canada, [Chinese buyers] are still unable to fill up the vacuum [left by Australian coal]," Hou Lei, coal analyst at consultancy Shanghai Metals Market, said in an interview. In the meantime, China is aiming to reduce met coal demand by eliminating outdated steel capacity, Hou said.

The government has required producers to cut crude steel output and retire old coking output capacity. It is also encouraging companies to export high-quality steel products and slash output of lower-end products. Given these efforts, China's import demand for met coal is likely to fall further in the longer term, Hou said.

S&P Global Commodity Insights produces content for distribution on S&P Capital IQ Pro.