Citigroup analysts said steel production cuts would push coking coal into a deep and persisting surplus, with global steel production expected to fall 4.2% in 2009.

The analysts added there was further downside risk if the global economy continued to deteriorate.

“The sharp deterioration in demand has accelerated a normal seasonal destocking cycle,” Citigroup said.

“Steel production cuts do not happen overnight, particularly if cold shutdowns become more pronounced. We now believe the recovery will be delayed into late 2010.”

The analysts pointed out supply constraints are becoming increasingly less relevant as demand flags.

While infrastructure would continue to limit supply some other factors would also affect production, they said.

“Firstly, lower prices will slow project development, especially among smaller mining companies,” Citigroup said.

“Secondly, consolidation of ownership among miners and downstream integration by steel mills are both expected to continue. Long-term concerns about hard coking coal availability have not gone away.”

The US over the past year has jumped on the export bandwagon as a swing supplier, with US exports expanding 80% to 16 million tonnes during the boom. However, with the slide in prices and the economies of shipping out of the US, Citigroup expects export markets will no longer be profitable for US producers.

If US exports were to revert to historical levels of 15-20Mt, this would halve the projected surplus, Citigroup said.

In Russia, domestic rail problems and lower margins are likely to reduce Russian supply.

Citigroup pointed out the threat of China flooding the market with exports was “nowhere near as severe for met coal markets as it is for thermal coal”

Citigroup expects demand for semi-soft and PCI coals will likely be even more heavily impacted than premium hard coking coal, with PCI prices anticipated to revert to a $US2 premium over semi-soft.

Citigroup said there were two main issues that would support prices – new infrastructure in Queensland and the motivation of the majors.

“The financing issues surrounding infrastructure (especially rail) developments in Queensland may act as a support for coking coal prices,” Citigroup said.

“If prices fall to a point where miners cancel expansion plans the Queensland government will not finance infrastructure expansions.

“Further, private capital for infrastructure from the coal miners, or elsewhere, will not be forthcoming either.

“The major players in this highly consolidated industry are highly motivated to achieve only a modest price reduction. Teck, having recently acquired Fording, will be keen to make a return on their investment pay, and to repay the debt incurred. BHP Billiton also seems likely to aim for price stability.”

On the flipside, factors that may push prices lower include an oversupplied market, steel cost pressures and competitive pressures.

“Chinese steel producers should be at an advantage to their overseas competitors given lower domestic coal prices in China,” Citigroup said.

“This should encourage Japanese steel mills to demand lower seaborne prices.”

The downward action will likely lead to a delay in price settlements.

“Neither producers nor consumers see it in their interest to settle annual prices in such a turbulent market,” Citigroup said.