Resources Policy.Vol. 24, No. 1, pp. 59–75. 1998 1998 Elsevier Science Ltd. All rights reservedPergamon

Printed in Great Britain0301-4207/98 $19.00+ 0.00

PII: S0301-4207(98)00009-9

Trading practices in the coalmarket: Application of the theoryof bilateral monopoly to theAustralia–Japan coal trade

Peter ColleyConstruction, Forestry, Mining and Energy Union, 3rd Floor, 361 Kent Street, Sydney, NSW 2000, Australia

One of the better-known anomalies of the international coal trade is the wide disparity indelivered coal prices into major markets. This disparity is particularly noticeable in Japan,the largest market. In Australia, the largest supplier to Japan (and the world), the dominanttheory explaining the significantly lower delivered price for Australian coal relative to othermajor supplying nations has been the ‘bilateral monopoly’ theory. This postulates that anincreased surplus available from the trade due to savings in freight costs because of proximityis shared between Japanese buyers and Australian sellers. This article examines the applicationof the theory made by Bowen and Gooday (1993) which shows a roughly equal distribution ofthe surplus from the trade in the period 1980–1990. This examination shows that majorassumptions with respect to exogenously determined upper and lower prices within which bar-gaining between the parties occurs cannot be sustained. Small adjustments to the bargainingrange produce results which show an unequal distribution of the surplus which consistentlyfavours buyers over the period. The latter part of the article examines a series of tradingpractices and differences in the composition of capital which may explain the long-term differ-ences in bargaining power between the parties. 1998 Elsevier Science Ltd. All rights reserved

Keywords:coal, international trade, price bargaining

Introduction

The international coal trade is one of the largest andmost opaque of the resources sector. After a short pla-teau in the early 1990s, volumes traded are againincreasing and there appears consensus that the absol-ute volumes and proportion of global coal productionthat will be traded internationally will increase sub-stantially in the next decade (International EnergyAgency, 1997). The prospects for the coal trade andthe basis on which the trade is conducted are of keeninterest to nations reliant on coal exports for theirtrade performance, and to importing nations for whomcoal supplies are a significant component of economicgrowth and development plans.

This is particularly so in the Asia–Pacific region,where economic growth rates substantially exceedthose of Europe and the USA. The matter is parti-

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cularly acute for Australia, a developed nation on thesouth-east tip of Asia in the unusual position (for adeveloped country) of still relying on raw and pro-cessed mineral exports for half of its export earnings.Coal is Australia’s largest export earner, accountingfor around 10% of goods exports, and Australia is thelargest supplier to the international market, account-ing for about 140 million tonnes (mt) of the 479 mttraded in 1996 (International Energy Agency, 1997).

The international coal market has a number of fea-tures which render it opaque and far removed fromconventional concepts of free markets. Despite thesize and maturity of the trade, there is no formalisedmarket place, trading system or clearing house—thereis no equivalent of the London Metals Exchange. Ascreen-based trading system set up by Bain Refco inAustralia in 1989 was abandoned for lack of custom;it was apparently boycotted by major players. Aus-

Trading practices in the coal market: P Colley

tralian consultants Barlow Jonker made a furtherattempt in 1996 (Australian Coal Report, 1996) butwere again unsuccessful. Similarly, there is no futuresmarket for coal, despite the number of producingfirms and industries which have substantial riskexposure to the trade. Again, there has been specu-lation of a futures market being introduced (Reuters,1995) but it has yet to become a reality. A currenteffort by the New York Mercantile Exchange(Hutchison, 1997) will be confined to the US dom-estic market.

The largest part of the international coal trade isbetween Australia and Japan; the latter accounting forabout 28% of purchases overall and slightly under50% of all Australian exports (International EnergyAgency, 1997; Joint Coal Board and Queensland CoalBoard, 1997). Australia is easily the largest exporterto the world and to Japan. The terms under which thetrade between Australia and Japan is conducted aretherefore not only of considerable interest to the twonations, but to all nations and companies participatingin the international market.

Academic analysis of the trade has long sought todocument and explain its key features. Smith (1977,1982); Rogers and Robertson (1987); Tang (1993);Koerner (1993) have sought to analyse trading andpricing arrangements in the coal trade and in therelated iron ore trade.

The first part of this study focuses on the work ofBen Smith, whose bilateral monopoly theory of theAustralia–Japan coal trade remains the prime theoreti-cal explanation of the issue. More particularly, itexamines the application of that theory made byBowen and Gooday (1993). Using the same evidenceas Bowen and Gooday, but under altered assumptions,the conclusion is reached that the distribution of bene-fits from the trade has flowed disproportionately toJapanese buyers. Reference is also made to recenteconometric analysis which has reached similar con-clusions. The second half of the study is an examin-ation of the construction of capital within each of themajor parties and the subsequent evolution of tradingpractices, which may explain the situation of an ongo-ing unequal distribution of benefits from the trade infavour of buyers.

The bilateral monopoly theoryThe dominant view of the Australia–Japan coal trade,and indeed of most Australian trade with Japan, isthat it is of roughly equal benefit to both nations. Thepopular ‘Garnaut Report’ (Garnaut, 1989) argues thatthere is a natural complementarity in the Australia–Japan relationship, with Australia being a provider ofraw materials (and, maybe, some processed resourcesand knowledge-intensive service industries) andJapan being a provider of capital and high-technologygoods (with the rest of Asia supplying labour-inten-sive manufactured goods).

The Garnaut Report does not have a great deal to

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say about coal, despite it being Australia’s largestexport industry and the biggest component of tradewith Asia, including Japan. Six pages out of over 300present the basic data and conventional wisdom onfuture prospects: Japan is the big consumer but otherbuyers are emerging; the coking coal market is stag-nant but opportunity exists for Australia as a low-costproducer; steaming coal is the big growth sector.

Garnaut relies for his basic perspective on the coaltrade on work done by Ben Smith at the AustralianNational University in the late 1970s and early 1980s.This work has been influential in subsequent analysisand policy debate.

In ‘Bilateral monopoly and export price bargainingin the resource goods trade’ Smith (1977) presentedan abstract model of how resource trades such as theAustralian iron ore and coal trades might work. In‘Long-term contracts for the supply of raw materials’Smith (1978) examined the role of long-term con-tracts as a special case distinguishing the Australianresources trade from other markets. In ‘Bilateral com-mercial arrangements in the energy coal trade’(Smith, 1982) an application of the bilateral mon-opoly theory of 1977 was made to the Australia–Japancoal trade. The more recent work of Bowen and Goo-day (1993) of the government-based AustralianBureau of Agricultural and Resource Economicsadopts the Smith approach, suggesting that it remainsthe dominant view of how the trade is conducted.

The central thesis of Smith’s argument is that Aus-tralia and Japan enjoy a proximity which makes itmore beneficial for each to trade with the other thanwith more distant alternatives. For most of the post-war period the two nations have been the onlydeveloped nations in the Asian region, with Americanand European markets being much further away. Thegreater the cost of freight as a proportion of deliveredprice, the greater the incentive for trade based onproximity. Coal is a low value-for-weight commoditywith up to 30% of the delivered cost of coal beingfreight. It is therefore a good example for Smith’stheory.

Smith takes as his starting point that Australia isthe dominant supplier of coal within the region, andthat Japan is the dominant buyer. Each is held to bein a position to exercise monopoly/monopsony poweron their side of the trade. Smith then argues that thenatural result of this situation is for each to chooseto trade with the other in order to maximise the sur-plus from the trade. The surplus is maximised byreducing the cost of freight, and Smith (and sub-sequently, Bowen and Gooday) argues that the freightbenefit is shared between the two parties.

The theory helps explain why Australian coal,especially coking coal for steel-making, is landed inJapan at a price that is consistently below that of mostother major coal suppliers, even after allowing forquality differences. In 1995 the delivered price of UScoking coal was 20% more than Australian coal,whilst Canadian coal was 26% dearer (Tex, 1997).

Trading practices in the coal market: P Colley

According to the theory, this is evidence of Japanbenefiting from the lower transport costs betweenAustralia and Japan, with the corollary that the pricereceived by the Australian sellers is also better thanthe prices available in other markets for Australiancoal.

The bilateral monopoly theory thus says that, not-withstanding that the delivered price of alternate coalsupplies is significantly higher than the price for equi-valent Australian coal, the results are still highly ben-eficial for sellers as well as buyers. Specifically, theresults do not demonstrate any discrimination byJapanese buyers against Australian sellers. The differ-ence in delivered prices is simply the result of sharingthe benefits of trade based on proximity. The Aus-tralian producers sell to the Japanese consumers atprices higher than what would be available from alter-native consumers. The Japanese consumers buy fromthe Australian producers at prices lower than whatwould be available from alternative sellers.

Practical application of the theoryThe bilateral monopoly theory does not require thatthe distribution of surplus from the trade be sharedequally; the actual distribution will be a result of thebalance of power between the parties. Of great rel-evance to both market participants and to public pol-icy-makers is the issue of whether the balance ofpower in the Australia–Japan coal trade has beenapproximately equal or consistently in favour ofone party.

The work of Bowen and Gooday is an empiricalapplication of the bilateral monopoly theory, whichconcludes that ‘sharing of the gains from transportcost differences between markets has been roughlyequal throughout much of the 1980s’ (Bowen andGooday, 1993, p 48). Figure 1 shows Bowen andGooday’s work in establishing that the f.o.b. price(free on board-price at point of departure by ship fromthe producing nation) for Australian coking coal hasfallen between the alternative sources/markets thateach nation could seek. The upper limit of the bar-gaining range is the c.i.f. figure (cost, insurance,freight or delivered cost) for coal to Japan from theUSA (the assumed alternative source). The upperlimit has been adjusted downwards by US $4.41 onthe basis of alleged quality differentials (which willbe examined later) and also through the deducting ofaverage Australia–Japan freight rates over the period.The lower limit represents f.o.b. prices for Australiancoal to Europe; Europe being portrayed as Australia’salternative market. The results indicate a sharing ofthe benefits over most of the previous decade, thoughit appears that at both the beginning and the end of thestudy period the benefits have been disproportionatelyappropriated by Japanese buyers.

Application of the theory critiquedWhilst Smith’s bilateral monopoly theory is a sig-nificant contribution to explaining how the inter-

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national coal market works, the application of thetheory by Bowen and Gooday to outcomes in the Aus-tralia–Japan trade warrants closer examination. Thedetermination of the distribution of the surplus isclearly sensitive to both the upper and lower boundsand also the bargaining power of each party. Whilethere are clear potential gains from low transport costsfor both parties, there are two problems with theapplication of this theory which this research hasidentified. They concern the determination of thealternative prices which lead to there being a surplusavailable for sharing between the parties. It is arguedthat the application by Bowen and Gooday misunder-stands the role of the two parties in the global tradeand the interaction of the Japanese buyers withother suppliers.

Lack of exogenously determined world floorprices. For Bowen and Gooday to reach their con-clusions, ie, to demonstrate a roughly equal distri-bution of the surplus arising from the trade, actualprice outcomes between Australia and Japan need tofall roughly mid-point between the global price (orlower limit) and the upper limit of alternative sup-pliers—at least on average over time. If the actualoutcomes tend to fall towards the lower limit, thenthere has not been equal sharing of the surplus arisingdue to transport savings and genuine bilateral benefitshave not been achieved.

The bilateral monopoly theory requires that thereare prices determined exogenously from the Aus-tralia–Japan trade that determine the upper and lowerbargaining limits for the sharing of the freight benefit.With respect to the lower limit, Bowen and Gooday’schosen parameter flows from Smith’s 1977 postu-lation of a global market called Atlantea which is thealternative point of sale for all coal and has a globalprice that is not affected by the Australia–Japan price.Bowen and Gooday translate the hypothetical Atlan-tea as being the European market.

However, any analysis of the international tradeshows that Australia and Japan are not only dominantin their region but the dominant participants in theglobal trade. It is difficult to conceive that world coalprices would be as low in the absence of the supplierwho accounts for one third of all trade. Similarly, itis difficult to conceive that world coal prices wouldremain unaffected if the single largest market fortraded coal was not dominated by two collective buy-ers—the Japanese Steel Mills (JSM) and the JapanesePower Utilities (JPU). Any perusal of coal trade jour-nals such as the International Coal Report shows thatEuropean price settlements are affected by the out-comes of benchmark negotiations in the Australia–Japan trade. In many years the benchmark pricenegotiations between Japanese buyers and their majorsuppliers precede not only the settlement of sales intoall other major Asia–Pacific markets but also Euro-pean markets. Even where this chronological pro-

Trading practices in the coal market: P Colley

Figure 1 Bilateral bargaining range and price outcomes for hard coking coal. Source: Bowen and Gooday (1993)

cession does not occur, as in early 1995,1 it is stillunlikely that European price settlements are whollyunaffected by prices in the Asia–Pacific region. Alter-natively, if it is argued that the European coal marketis distinct from that in the Asia–Pacific region due todistance effectively creating two separate markets,then again it is incorrect to postulate Europe as theglobal market place determining global prices; theexplicit assumption of Bowen and Gooday.

The significance of this issue is that, if the lowerparameter to the model is affected by the outcomesfrom bilateral monopoly bargaining and is thereforelower than it would otherwise be (in the case of buy-ers exercising greater market power), then the calcu-lation of the mid-point in the surplus available to bebargained between the parties in the bilateral mon-opoly model is affected. The mid-point in the bar-gaining range will be increased if the lower parameteris adjusted upwards to discount the effect of monop-sonistic purchasing power.

Bowen and Gooday’s chosen lower parameter istherefore likely to result in an overstatement of theshare of the surplus accruing to Australian coal pro-ducers. It is in general implausible to postulate theexistence of an independent global price which wouldhold in the absence of the Australia–Japan trade andagainst which Australia–Japan prices can be meas-ured. It appears that Bowen and Gooday have applied

1In early 1995 the Australia–Japan negotiations took over 4months, with the result that European buyers, who normally lookto Japan to set a ceiling price for coal, had to conclude contractswithout that benefit. This exception proves the existence of theconvention rather than its absence.

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a key parameter which does not have the exogeneitynecessary for use on an unadjusted basis.

Lack of exogenously determined prices from alterna-tive suppliers.The second problem lies with theupper limit or alternative coal prices. This upper limitis the delivered price (adjusted for coal quality andAustralia–Japan freight costs) that Japanese buyerscould be expected to pay if they source coal fromother than Australia. For Smith and then for Bowenand Gooday, the alternative supplier is the USA.However, this is not a straightforward proposition.Firstly, there is the problem of Canadian coking coalexports to Japan. These are clearly the highest on adelivered price basis into Japan (some 26% higherthan the Australian c.i.f. price in 1995). These importscome from mines specially developed for (and fundedby) the JSM and do not have alternative markets(Anderson, 1987). Bowen and Gooday thereforeargue that they are a special case and should be dis-counted as a source of an alternative upper price.There is merit to treating the high-price Canadianmines as a special case—the Bullmoose and Quintettemines are an example of extreme supply manipulationby the JSM. However, this problem is hardlyaddressed by simply discounting them. If there is abilateral monopoly between Australia and Japan, thenthe calculation of the surplus available for distributionbetween the two parties that arises out of the tradebetween them must take some account of the pricesactually paid by the major buyers for alternative sup-plies.

The second problem with the determination of theupper limit price for alternative coal supplies by

Trading practices in the coal market: P Colley

Bowen and Gooday is that it is determined in negoti-ations which have the same buyer as in the Australia–Japan trade: the JSM. These negotiations occur at thesame time as well as with the same people. It is afrequent occurrence that price negotiations (or simplyrumours of them) between the Japanese buyers andUS/Canadian producers are used as a bargaining leverin the Australian–Japan negotiations (InternationalCoal Report, 1995). The International Coal Report’sdry summary of 1991 Fiscal Year price settlementwas:

All suppliers have been selling long enough to theJSM to know what happened this year is what alwayshappens. One producer is selected from the chorusline, bribed with extra tonnage, a two year supplyagreement or a reclassification of coals, enjoys anannual fling with Nippon Steel or some other stud,only to be cast off 12 months later, her beauty appar-ently jaded. It always ends in tears.

Last year it was MIM (and Westmoreland andConsol), previous years have seen KCC, Fording andWestar, Pittston, BHP-Utah again, all similarlyblessed. (International Coal Report, 1991, p 6)

In this context, it is not satisfactory to simply positthe US c.i.f. price for coking coal to Japan (whetheror not adjusted for freight and quality differences) asthe exogenously determined alternative price. Theeffect of this problem is that the upper limit to bebargaining range is likely to be lower than it wouldbe if it had not also been affected by monopsonisticbuying practices. This then further limits the amountof the surplus which is available for bargainingbetween the Australian and Japanese parties.

Further and finally, the upper price limit used byBowen and Gooday to validate the theory involvesmore than simply the deletion of the much higherCanadian prices; it has also been substantiallyadjusted downwards for quality differences. Bowenand Gooday cite only one source to justify the largeaverage discount of US $4.41 they apply to the upperlimit (Porter and Gooday, 1990).

The use of coal quality criteria in the adjustmentof price is the subject of lengthy debate amongst coalproducers though rarely has this permeated into aca-demic discussion. In one of the few economics andpolicy-oriented articles on the subject, Koerner (1993)used detailed econometric modelling of coking coalprices from Australia, Canada and the USA intoJapanese markets, adjusting them for several qualitycharacteristics. From his results he argues that coalquality differences do not explain the substantial dif-ferences in price. It is apparent that there is agreementthat US coking coals have some quality attributeswhich, on average, may warrant a slightly higherf.o.b. price (ie, before different freight costs are takeninto account) but these are nowhere near as high asUS $4.41.

This argument would appear to have been lent

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further credence by the buyers themselves in 1996. Ina departure from the benchmark pricing system theJapanese buyers unilaterally adopted a ‘Fair Treat-ment System’ (FTS) which, amongst other features,provided for greater price variance on the basis ofalleged quality differences (International Coal Report,1996). Here it is only useful to note that this newsystem, if it is based on quality differences, mustmean that previous benchmark prices did not fullyreflect quality differences. Either now or previously,there must be or have been a substantial arbitraryelement to the c.i.f. and f.o.b. price differences forcoal which was or is unrelated to quality concerns.

The model retestedFor the purpose of testing the effect of changed para-meters in the bilateral monopoly model as developedby Bowen and Gooday, Figures 2 and 3 are presented.In Figure 2 the upper and lower parameters remainas proposed by Bowen and Gooday, but the Canada–Japan c.i.f. price (reduced by the Australia–Japanaverage freight cost) is also given. As Canada sup-plied roughly 22% of Japanese coking coal require-ments over the period, and for reasons given earlier,it is important that the price of actual alternative sup-plies in the real world be given. However, it is notused in determining the division of the surplus avail-able for distribution between Australian sellers andJapanese buyers.

The extent to which achieved prices diverge fromthe price outcome that would have been achieved ifthe surplus were equally shared is shown. In only twoyears does the actual price meet or exceed that postu-lated by the model. Over the period examined, theaverage divergence from the mid-price in favour ofthe buyers is equivalent to 4.4% of the price receivedby the sellers. Statistical analysis of the data showsthat actual prices differ significantly from being equal(t = 3.02, p , 0.02). With profits for a large part ofthe Australian coal industry averaging 2.4% in the 10years to 1995, an average discrepancy of 4.4% in theprice received may be considered to be of significantrelevance (Coopers and Lybrand, 1995/1997).

On this limited basis there would appear to havebeen a dominance of the bargaining arrangementsover the 1980–1990 period by the buyers. Summingof the divergences from the mid-price for the volumeof hard coking coal traded between Australia andJapan yields the sum of around US $555 million in1990 dollars as the approximate amount of revenueforegone by Australian coal producers as a result ofunequal price outcomes. If the prices set in the hardcoking coal trade also affect the lower-quality cokingand steam coal trades between Australia and Japan,and the general coal trade with other Asian countries,then the cumulative revenue foregone is much greater.

The sensitivity of Bowen and Gooday’s con-clusions to quite minor adjustments in the bargaininglimits is shown in Figure 3. Here, the upper parameterhas been adjusted upwards by 5% to conservatively

Trading practices in the coal market: P Colley

Figure 2 Bilateral bargaining range and price outcomes for hard coking coal, with Canadian data and mid-point plotted. Source:Bowen and Gooday (1993); Tex (1995)

Figure 3 Bilateral bargaining range and price outcomes for hard coking coal, with US–Japan price adjusted for impact of monop-sonistic pricing. Source: derived from Bowen and Gooday (1993); Tex (1995)

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Trading practices in the coal market: P Colley

simulate the effect that monopsonistic buying prac-tices might have on the US–Japan coal trade. US coalexports to Japan have shrunk substantially over theperiod under examination (from 31% to 14% ofJapanese imports) whilst exports to Europe have beenincreased (from 49% to 57% of European imports),suggesting that American producers have perceivedprice-suppressing monopsonistic practices to be inoperation in the Japanese market (InternationalEnergy Agency, 1989, 1992). Australian producershave had less ability to switch markets due to theirmuch greater distance from Europe. The Canada–Japan c.i.f. price has not been adjusted upwards in asimilar manner given the special contractual arrange-ments that applied with major Canadian coking coalmines. In fact, the prices shown have been furtheradjusted downwards to reflect the quality differentialsdetermined by Porter and Gooday (1990).

In Figure 3 price outcomes under these slightlyrevised assumptions show an even greater divergencefrom the mid-price which would reflect equal sharingof the surplus due to transport savings over time. Theaverage divergence from the mid-price in favour ofthe buyers is around 7.4% of the price received byAustralian sellers, and further statistical analysis con-firms the data differ significantly from that whichwould reflect an equal distribution (t = 4.9,p , 0.01).Summing the effect of the divergences for the ton-nages of hard coking coal traded over the period givesrevenue foregone by Australian coal producers of US$942 million in 1990 dollars. This figure can be meas-ured against total turnover for the Australian coalindustry of US $5.9 billion (A $7.5 billion) in 1990(Australian Bureau of Statistics, 1992). These lostrevenues might provide part of the explanation as towhy much of the Australian coal industry has lowrates of profit relative to other Australian miningdespite clear competitive advantages into major mar-kets (Coopers and Lybrand, 1995/1997).

Econometric analysisEconometric analysis undertaken by Oczkowski(1993) at first produced results confirming Bowen andGooday’s work, but a significant revision of the meth-odology (Oczkowski, 1998) has produced resultswhich draw similar conclusions to that reached here.

Using a more highly specified model than that usedby Bowen and Gooday, and a much longer time per-iod, the recent study confirms that the distribution ofthe surplus between the parties has not been roughlyequal. The technique used is the generalised Nash bar-gaining framework of Binmoreet al (1986). Quantityis determined through mutual agreements between theparties to maximise combined payoffs and price bar-gaining is predicted to take place between two(reservation and often directly unobservable) pricelimits. Oczkowski examines data from over a 28-yearperiod (1962–1990, the majority of the time the Aus-tralia–Japan coal trade has existed) and finds that theproportion of the surplus accruing to Australian coal

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producers never reaches 50%. In the period examinedby Bowen and Gooday where they found the surplusto be approximately evenly distributed (ie, 1982–1988) Oczkowski determines that sellers obtainedapproximately 36% of the available surplus. Oczkow-ski’s view is that determining the upper and lowerprice limits only by reference to other observed tradedprices is inadequate; he argues that standard cost anddemand factors must be taken into account.

The view reached here is that, whether one usesthe methodology of either Bowen and Gooday or theeconometric analysis of Oczkowski, it cannot be con-cluded that the history of the Australia–Japan coaltrade demonstrates an approximately equal distri-bution of the surplus arising from bilateral monopoly.

Differences in bargaining power

The bilateral monopoly theory recognises that the dis-tribution of the surplus arising from the trade betweentwo monopolies will be affected by the relative bar-gaining power of each party. Bowen and Gooday donot attempt an analysis of each party. In this sectionof the paper that attempt is made. This leads to anunderstanding of why the distribution of the surplushas been, and is likely to remain, unequal.

Construction of the parties to the tradeThe bilateral monopoly explanation posits ‘Japan’ and‘Australia’ as two equally large or otherwise similarentities in the coal trade. This is acknowledged as anabstraction; clearly the trade takes place betweenfirms rather than between nation states. However, forthe abstraction to be of little consequence, the forma-tion of capital in each industry must have some simi-larities so that there is a basis for assuming that theunits which make up each national ‘party’ to the bilat-eral trade will act in roughly the same way. If thereare major differences in the capital formation of theindustry on each side, and these differences create thepotential for different behaviour in the market-place,then the abstraction becomes a misleading simplifi-cation. It is argued here that the ownership structureof each of the major parties is fundamentally differentand that these differences give rise to differingcapacities for action. It is therefore incorrect to por-tray each as having equal monopoly power on theirside of the market.

Ownership structure of Japanese coal consumersand tradersCapital formation in major Japanese industries hasseveral distinctive characteristics: it is on a very largescale, is extremely stable, and is characterised byinterlocking shareholdings amongst groups of majorcompanies.

There are eight major Japanese steel mills: NipponSteel, NKK, Kawasaki Steel, Sumitomo Metal, KobeSteel, Nisshin Steel, Nakayama Steel and Godo Steel.

Trading practices in the coal market: P Colley

Collectively they are known in the coal and iron oreindustries as the JSM (Bowen and Gooday, 1993).Their total revenues for the year ending March 1994were in the order of US $65 billion, many times thesize of Australia’s steel industry. In the power gener-ation component of the industry, there are nine majorpower companies and the Electric Power Develop-ment Corporation (EPDC—a joint venture of the nineprivate companies and the Japanese Ministry ofFinance). The total revenues of the 10 companiesexceeded US $134 billion in the year ending March1994, making them a significantly larger economicbloc than the steel industry.

There is a third group of companies within Japanwhich are key players in the coal trade even thoughthey are not coal consumers. They are the specialisttrading companies, orsogo shosha, for which Japanis renowned (eg, Kunio, 1982; Johnson, 1982; Yosh-ino and Lifson, 1986). These companies have played aprominent role in Japan’s post-war economic growth,being responsible not only for most internationaltrade, but also for a substantial proportion of domestictrade within Japan. It is the trading companies whichare the most common vehicle for Japanese overseasinvestments (Komiya, 1990).

In keeping with this trend,sogo shoshaare themain source of Japanese direct investment in the Aus-tralian coal industries, and are the nominal coal buyerin most cases (Parker, 1992). Their clients are theJapanese consumers rather than the Australian pro-ducers. The largest five companies, Itochu, Mitsui andCo., Marubeni, Sumitomo and Mitsubishi, each haverevenues that exceed Nippon Steel Corp. by a factorof six.

Ownership structure.The vast majority of theJapanese companies involved in the Australia–Japancoal trade are publicly listed joint stock companies.2

However, the ownership structure of Japanese compa-nies is extremely complex and quite different in bothcomposition and function from companies based inAustralia and other predominantly Anglo-Saxonnations.

Futatsugi (1986) estimated that fully 30% of thevalue of all shareholdings of Japanese public compa-nies are ‘cancelled out’ by cross-shareholdings, forc-ing up the relative value of shares and making newentry to the share registers more difficult. The issuingand holding of shares in Japan seems to be not somuch a means of raising capital, as is conventionalwisdom, but a means of establishing relationshipswith banks, suppliers and customers (Gerlach, 1989).

These general comments on Japanese companiesapply to the companies/industries under examination.

2There are notable exceptions such as Idemitsu Kosan, a privatelyowned oil company, and the Electric Power Development Co.(previously mentioned).

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Table 1 shows major shareholders for two steel, twopower and two trading companies (one of the largerand one of the smaller ones in each case). Sharehold-ings are concentrated in the hands of banks andinsurance companies. The exception is Nittetsu Shojiwhich, with a 46% holding by Nippon Steel, is effec-tively a subsidiary of the steel company.

A key feature of equity linkages in Japanese com-panies is their alignment alongkeiretsu lines, ie, inco-operative groups with no single leader or owner.Gerlach (1989); Futatsugi (1986) argue thatkeiretsufirms engage in a very high degree of inter-firm tradeand/or financing as well as cross-shareholding. In Fig-ure 4 the example of the Sumitomokeiretsuis given.Financial institutions are linked to heavy industriesand to manufacturers. Most importantly, there is amajor trading company in each group. (In Figure 4 itis Sumitomo Corp.)

The trading companies arenot the parent companyin any legal or actual sense; they are simply a keycomponent of a set of inter-company relationships.The most obvious way in whichkeiretsu organisethemselves is through the mechanism of ‘presidentscouncils’—monthly meetings of the chief executivesof keiretsumembers—though the level of interactionclearly goes beyond that. A combination ofkeiretsulinkages and a relatively inactive market for corporatecontrol in Japan, combined with extremely high price-to-earnings share ratios and a high value currency,means that there is very little opportunity for foreigninvestment in Japan. Daly (1993) states that the pro-portion of foreign ownership of Japanese equities fellfrom 2% in 1985 to 1% in 1990. It is not only hard tobuy shares in Japanese public companies; thekeiretsulinkages also make it difficult to establish new busi-nesses that can compete with existing participants inthe market.

This brief examination of corporate structure inJapan shows that the ownership of the major buyersand traders in the Australia–Japan coal trade is spreadamongst related companies and institutional investors,and is mediated through historical and cultural link-ages which ensure a tight and continuous managementstructure. Hostile takeover bids are unheard of, andforeign investment is negligible. This ownershipstructure creates a very strong sense of a sharednational interest and also instils in management anapproach that is long-term in its focus and thereforemore capable of a strategic orientation. By contrast,whatever strategic orientation may be possessed byAustralian coal producers, it is certainly not based oninter-company linkages or national co-operation.

Capital formation in the Australian coal industryThe common view that Australian coal suppliers andJapanese buyers can be portrayed as two distinctgroups delineated on national boundaries finds readysupport in a superficial analysis of the ownershipstructure in the Australian industry. Four companies(BHP, Rio Tinto, Cyprus Amax and MIM) account

Trading practices in the coal market: P Colley

Table 1 Major shareholders, Japanese coal-consuming and trading industries, March 1994 (% of total equity held)

Nippon Steel Corp. % Nakayama Steel %

Nippon Life Ins. 3.7 Nakayama Hoonkai (scholarship 9.0fund body)

Mitsubishi Trust & Banking 3.3 Toyo Trust & Banking 5.4Industrial Bank of Japan 3.3 Sanwa Bank 4.2Meiji Mutual Life Ins. 2.5 Industrial Bank of Japan 3.7Mitsui Trust & Banking 2.5 Mitsubishi Trust and Banking 2.9Dai-ichi Mutual Life Ins. 2.4 Yasuda Trust & Banking 2.8Yasuda Trust & Banking 1.9 Mitsuboshi Kaiun KK 2.7Sumitomo Life Ins. 1.8 Sumitomo Trust & Banking 2.7Fuji Bank 1.7 Nakayama Trading Co. 2.3Sumitomo Bank 1.7 Nippon Credit Bank 1.9

Tokyo Electric Power Co. % Hokuriku Electric Power Co. %

Dai-ichi Mutual Life Ins. 4.5 Toyama Prefectural Govt. 5.1Nippon Life Ins. 3.8 Hokuriku Bank 4.8Tokyo Metrop. Govt. 3.2 Nippon Life Ins. 3.9Sakura Bank 2.5 Industrial Bank of Japan 3.5Industrial Bank of Japan 2.4 Asahi Mutual Life Ins. 3.2Sumitomo Life Ins. 1.8 Long-Term Credit Bank of Japan 2.9Asahi Mutual Life Ins. 1.7 Hokkoku Bank 2.8Dai-ichi Kangyo Bank 1.5 Sumitomo Trust and Banking 2.6Mitsubishi Trust and Banking 1.5 Sumitomo Life Ins. 2.3Taiyo Mutual Life Ins. 1.5 Sogo Taxi 2.3

Itochu Corp. % Nittetsu Shoji Corp. %

Dai-ichi Kangyo Bank 3.7 Nippon Steel Corp. 46.2Sumitomo Bank 3.6 Tokai Bank 5.0Sumitomo Trust and Banking 3.6 Sanwa bank 3.1Tokio Marine & Fire Ins. 3.4 Mitsubishi Bank 3.1Nippon Life Ins. 3.3 Employees’ Stockholding Group 2.5Asahi Mutual Life Ins. 2.8 Industrial Bank of Japan 2.1Nippon Fire & Marine Ins. 2.6 Chuo Trust & Banking 1.5Bank of Tokyo 2.4 Nippon Steel Metal Products 1.4Sumitomo Marine & Fire Ins. 2.3 Taeko Tomita 0.9Mitsubishi Trust & Banking 2.3 Sumitomo Life Ins. 0.8

Source: Nikkei-Telecom Japan News Retrieval.

for 65% of exports and ten account for 85%(Australian Coal Report, 1997). However, this depic-tion is highly misleading. The structure of corporateownership of coal production is both more fragmentedand more volatile.

Of major interest for the application of the bilateralmonopoly theory is the high degree of foreign owner-ship and, more importantly, thetypeof foreign inves-tor. It is shown here that there are two major types offoreign investor—specialist resources companies andconsumers (including the traders aligned to them)—and that the presence of the latter category is a con-tributor to the lack of a coherent position amongstAustralian producers in the trade with Japan.

The Australian coal industry in 1996 had approxi-mate revenues of US $7.6 billion and assets of overUS $11 billion (Australian Bureau of Statistics,1997a, b). There is a clear trend towards an increasingconcentration of production into fewer managementunits. Numerous smaller, older mines have closedsince 1987, and there have been a number of corpor-

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ate takeovers which have also rationalised the indus-try. The more recent takeovers or changes of owner-ship have included Rio Tinto’s takeover of Coal andAllied (merging two of the largest producers), Shell’stakeover of Austen and Butta, the acquisition by Han-son subsidiary Peabody of Costain Resources’ Aus-tralian coal assets and Cyprus Amax’s seizure of con-trol of Oakbridge.

In seeming contradiction of the trend towards con-centration of production into a smaller number ofmanagement units, there has been anincreasein thenumber of foreign investors and the amount of equitythey control in the industry.

By mid-1993 approximately 40% of productionwas owned by foreign interests, as shown in Table 2.This tends to understate the level of foreigncontrol,as a controlling or substantial influence can be exer-cised where a company does not have majority control(Demsetz, 1988).

Of particular interest is the rapid increase in thenumber of investors with links to Japanese coal con-

Trading practices in the coal market: P Colley

Figure 4 Cross-shareholdings of the leading companies of the Sumitomokeiretsu, 1994. Note: for all linkages each shareholderis one of the top 10 shareholders. Arrows indicate direction of ownership.Source: Nikkei-Telecom Japan News Retrieval, updated from Gerlach (1989)

Table 2 Percentage of Australian coal production owned by foreign-based companies, 1992-93

Production share (’000 tonnes)

Country NSW QLD Total As % of total coalproduced in Australia

Japan 14 904 8 398 23 302 13.1Europe 16 626 11 968 28 594 16.1USA 6 559 11 772 18 331 10.2Other Asia 1 461 - 1 461 0.8Total foreign ownership 39 550 32 138 71 688 40.3

Source: Joint Coal Board (1990); Queensland Coal Board (1993) and updates received directly from JCB and QCB staff in mid-1994.

68

Trading practices in the coal market: P Colley

suming and trading companies. The NSW Govern-ment-based Joint Coal Board records 10 Japanesecompanies as being investors in the NSW industry in1989–90. By 1992–93 that figure had grown to 23companies (Joint Coal Board, 1990).

The answer to the contradiction between fewermanagement units but more diverse major investorslies in the ownership of the major companiesand alsoin the ownership structure of particular mines.

BHP is the largest company in the Australian coalindustry, closely followed by Rio Tinto Ltd. Both arepublicly listed companies, but are diversifiedresources companies rather than coal companies, andhave other coal assets in addition to their Australianholdings. BHP is nominally an Australian companywhilst Rio Tinto is based principally in the UK. Oak-bridge, the fifth largest company in the industry,recently came under the control of Cyprus AmaxMinerals, a North American mining company. Oak-bridge is now almost wholly foreign owned, with sub-stantial minority participation by Japanese coalbuyers/traders.

In order to enable some comparison with the share-holding structure of the Japanese buyers and tradersdepicted in Table 1, Table 3 presents details of thetop shareholders in three of Australia’s largest coalmine operators. Each company has a core controllingentity, with the remaining leading shareholders beinginstitutional investors.

But these major companies do not own all themines they operate. In many cases they are managerson behalf of a consortium or a joint venture in whichthey are a partner (for example, BHP in CentralQueensland Coal Associates [CQCA] and Oakbridgein the Bulga Joint Venture).

Consortiums and joint ventures create numerousopportunities and methods for foreign interests toacquire equity stakes. The small or non-existent directpresence of Japanese coal consumers and traders inthe share registry of BHP and Rio Tinto has not pre-vented them being significant owners in many of themining operations run by those companies. The larg-est example is Mitsubishi Development’s 13.33%stake in the CQCA mines in Queensland. MitsubishiDevelopment Ltd is the Australian subsidiary of Mit-subishi Corp., the largest Japanese investor in theAustralian coal industry and the fourth largestJapanese trading company. Another typical exampleis the 11.3% holding of EPDC and Japan Coal Devel-opment in the Blair Athol steaming coal mine oper-ated by Pacific Coal, a subsidiary of Rio Tinto. BlairAthol is the largest and most productive steaming coalmine in Australia, and EPDC (Australia) Ltd and JCD(Australia) Ltd are subsidiaries of the JPU and theJapanese Ministry of Finance.

The nature of foreign participation and the degreeof influence or control.An important issue for theoperation of the bilateral monopoly theory is therationale of foreign investors for investing in the

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industry, and the question of whatcontrolor influencethose investments enable that is beyond the conven-tional division between management and passiveshareholding. By examining this it is possible to dis-tinguish differing and conflicting interests amongstfractions of capital in the Australian industry that pre-vent ready recognition of mutual interests in the Aus-tralia–Japan coal trade.

There is a sharp distinction between foreign inves-tors which are specialist mining companies and thosewhich are consumers or traders of the final product.Without exception, the investors which are of Euro-pean and North American origin are transnational cor-porations who are specialists in resource industries:Rio Tinto and Hanson from the UK; Arco, Exxon andCyprus from the USA; Shell and Ruhrkohle from con-tinental Europe. The primary interest of specialistresources companies who have no investments in con-sumption operations is clearly to make profits outof mining.

By contrast, the investors who are Asian in origin(and overwhelmingly from Japan) are companieswhose primary commercial interests lie outside ofmining and often (in the case of trading companies)outside of the coal industry altogether. The rationalefor the involvement of consumers and traders in own-ership of mining companies is less clear, and certainlyconflicting. There is conflict between the interests ofthese companies as owners of coal mines (where pro-fits come from the sale of coal) and as owners of coal-consuming companies (which make profits by min-imising the cost of inputs) or trading companies(which make profits from commission on sales orfrom differences between buying and selling prices).Coal consumers and traders may have greater interestsin making profits elsewhere in the coal chain thanin production.

Smith (1978) contends that this is not a concerndue to the consumers and traders being minorityowners; that there is a lack of the vertical integrationthat provides opportunities for transfer pricing.3 Theconventional rationale for equity participation by con-sumers is to create firmer commercial relationships;to ensure greater stability in coal supplies (Takeuchi,1990). From the point of view of other investors, equ-ity participation by consumers is a means of ensuringsales and securing finance (Rogers and Robertson,1987). However, it is possible for prices to bemanipulated by more sophisticated methods thantransfer pricing, and minority equity stakes can playa crucial role in this. If such stakes are co-ordinatedacross the production industry, and further co-ordi-nated with long-term contracts (as discussed later inthis study) then aggregate supply may be influencedand prices manipulated to the detriment of otherinvestors (Colley, 1997).

3Transfer pricing is the setting of a price on a non-market basisbetween two related entities so as to shift profits from one to theother in an undisclosed manner.

Trading practices in the coal market: P Colley

Table 3 Major shareholders of leading Australian coal producers, 1994

BHP Ltd a %

Largest shareholdersBeswick Pty Ltd 17.9 Operating revenue (coal production US $1.86 b

only)ANZ Nominees Ltd 6.5National Nominees Ltd 5.2Westpac Custodian Nominees Pty 4.5 Coal sales from managed 47 mtLtd operationsAMP Society 3.4Chase Manhattan Nominees Ltd 2.5Perpetual Trustee Group 1.7State Auth. Superannuation Board 1.7Queensland Investment Corp. 1.4The National Mutual Group 1.3

CRA Ltd b %

Largest shareholdersTinto Holdings Australia 48.95 Operating revenue (Aust. coal US $0.60 b

production only)ANZ Nominees Ltd 6.30National Nominees Ltd 5.14Westpac Custodian Nominees Pty 4.17 Coal sales from managed 33.7 mtLtd operations (Aust.)AMP Society 2.93Queensland Investment Corp. 2.01

Chase Manhattan Nominees Ltd 1.77State Auth. Superannuation Board 1.52Pendal Nominees Pty Ltd 1.35MLC Life Ltd 1.29

Oakbridge Ltd b %

Largest shareholdersCyprus Amax Minerals Group 42.7 Operating revenue US $0.38 bTomen Corporation 25.0Nippon Oil (Australia) Ltd 23.0 Coal sales 10.1 mtBan-Pu Australia Pty Ltd 6.5Kawasho Corp. 2.8

aFrom Annual Report for the year ended 31 May 1994.bFrom Annual Report for year ended 31 December 1994. CRA became RTZ-CRA in 1995, when it became a dual-listed company with its largestshareholder, RTZ of the UK. In 1997 the name of the dual-listed entity changed to Rio Tinto.

A further issue concerns the degree of control orinfluence over coal production that can be exertedthrough minority investments by consumers and trad-ers. It is not argued here that Japanese minority inves-tors directly control a large number or proportion ofAustralian mining operations. There is evidence thatthe basic style of ownership exercised is passive; theinvestors generally take no part (on the sellers’ side)in the annual contract price negotiations betweenAustralian sellers and Japanese buyers, and thesenegotiations are often quite robust, as they were inearly 1995 (Australian Coal Report, 1995).

However, an equity role does not have to beasserted actively in order to have an influence; thecommercial realities of the situation are enough toinfluence the views and activities of the major share-holders and mining managers. It is not possible forthe Australian coal industry, or even individual com-panies within it, to act with the degree of cohesion

70

that is possible within Japanese steel, power and trad-ing companies. Put simply, capital formation in theAustralian coal industry is volatile at the controllinginterest level, and is fragmented by the need to servicethe interests of minority investors who have strategicinterests that may conflict with making profits fromcoal mining.

The popular construction of the Australia–Japancoal trade as a relationship between roughly equal andautonomous parties is therefore a misleading perspec-tive on the underlying structure of the participants inthe trade. The Japanese coal-consuming and tradingindustries are extremely large industries which are notsubject to the normal disciplines of the stock marketin the same manner as Australian and North Americancompanies.Keiretsulinkages amongst firms not onlymake the ownership profiles extremely stable, they actas a barrier to entry to other participants.

In sharp contrast, the Australian coal mining indus-

Trading practices in the coal market: P Colley

try is relatively small in size, despite its importanceto the Australian economy. There are few major oper-ators and a large number of foreign investors. Thereis evidence that the amount of foreign investmentindustry, and especially that of Japanese consumersand traders, has increased in recent years. The owner-ship structure is quite volatile, with numerous takeov-ers.

These substantial differences in the construction ofcapital within each of the national parties to the Aus-tralia–Japan coal trade makes it highly unlikely thatthere is equivalence in the coherence and capacity ofeach party that would enable a roughly equal bar-gaining power. In the next and final section, bar-gaining practices are examined. They are a practicaldemonstration of how the differences in the construc-tion of capital lead to practical differences in bar-gaining power and hence unequal outcomes.

Bargaining arrangements

Examination of actual market processes shows sig-nificant differences in bargaining capacity over time.The evolution of long-term contracts into annual con-tracts, current bargaining processes, the role ofJapanese trading companies and the distribution of theocean freight task all suggest a process that is domi-nated by buyers.

The role of long-term and annual contracts.Overthree-quarters of Australian coal exports are sold onthe basis of long-term or annual contracts: to the steelmills and/or electricity utilities of Japan, South Korea,Taiwan, Brazil, etc. The remainder is split betweensales by tender (eg, to India) and ‘spot’ sales, ie, one-off sales on the open market.

There are two features to this type of tradingarrangement which do not correspond well with thenotion of two parties of equal bargaining power. Thefirst, and most obvious, is the shift to annual contractsin place of long-term contractsexceptwhere it hasbeen determined by the buyers that long-term con-tracts are necessary to bring on new or additional pro-duction capacity.

Most Australian producers are now on annual con-tracts with the JSM and JPU. However, there aremajor new mines—sometimes managed by newentrants to the industry—that have been awardedlong-term contracts of 5–7 years’ duration. This is thecase with the Gordonstone mine managed by Arcoand the North Goonyella mine managed by WhiteIndustries (Tex, 1995). The awarding of long-termcontracts to new mines has occurred notwithstandingthat there are a number of Australian suppliers whohave a demonstrated record of reliable supply andwho have ample capacity to expand production(International Energy Agency, 1997).

There has been no reciprocal capacity on the part ofAustralian producers to either choose amongst majorJapanese consumers or to manipulate demand, sug-

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gesting that this aspect of the exercise of marketpower has been very much a one-way process.

The second problematic aspect of the contract sys-tem is its alleged role in reducing transaction costs.Smith (1978) argues that the contract system mini-mises information and transaction costs where thereis no open market. Very little coal is sold on the openor free market—a feature distinguishing the inter-national coal trade from other commodities markets.A significant consequence of this is that market infor-mation is not readily available as it would be in anelectronic or centralised exchange system.

The evidence of Parker (1992) is that the Japanesetrading companies perform an extremely detailed andcost-effective information and transaction service forthe major Japanese buyers. This means that the con-tract system is only necessary for this purpose for thesellers. Secondly, the reason there is so little in theway of a free or open market is because the majorbuyers and sellers do not choose that mode of trading.That is, there is circular logic involved: it is theactions of the major buyers and sellers in opting forcontracts thatcreatesa limited open market. Smith’sargument on this point had more relevance when theinternational coal trade was new and small; now thatthe trade is much larger it has less merit.

This means that the contract system, with respectto the issue of information and transaction costs, hasbecome one which ischosenby the buyers but whichis neededby the sellers. This in itself suggests a sub-stantial power imbalance in the relationship betweenbuyers and sellers in the Australia–Japan trade. Thecontinued use of contracts (and long-term contractson a highly selective basis) suggests that the con-tracting system continues because it enables the majorbuyers to co-ordinate their participation in the Aus-tralia–Japan coal trade on a strategic basis.

Co-ordinated bargaining practices.The annual con-tract system, when used in conjunction with co-ordi-nated bargaining practices, creates an integrated pro-cess that bears little relationship to the normaldynamics of open markets. This is a dominant featureof the Australia–Japan coal trade. The 48% of Aus-tralia’s export coal that is directed to Japan is effec-tively sold to just two buyers, despite the myriad ofactual contracts: the JSM and the JPU. Until the 1996Fiscal Year negotiations, both insisted on bargainingas a group, and in placing almost all of their purchasesthrough annual contracts.

This practice has been exhaustively documented byAnderson (1987) in his major study of the coking coaltrade of Canada and Australia with Japan. It is morebriefly described by Bowen and Gooday (1993, p 17):

In Japan, hard coking coal price negotiations betweenthe Japanese steel mills and the companies from Aus-tralia, the United States, and Canada normally pre-cede negotiations for the softer coking coals. In deal-ing with exporters from any one country, the Japanesesteel mills usually have two steel making firms coord-

Trading practices in the coal market: P Colley

inating the negotiations. One of these firms acts asthe leader and the results are accepted as binding bythe others. For this reason, these steel mills are usu-ally referred to in the trade literature as if they werea single entity, ‘the JSM’. The coking coal negoti-ations are followed by the steaming coal price negoti-ations, between a single company on behalf of theelectric power utilities (on the same principle) andcoal producers. Contracts for steaming coal withsmaller buyers from the Japanese industrial and thecement industry are usually negotiated after the aboveprocess is completed.

Anderson traces the adoption of the co-ordinatedpurchasing practice back to 1964, when it was for-mally adopted by the JSM for the purpose of buyingiron ore. The scheme was extended shortly thereafterto cover coking coal. It was emulated by the JPUwhen they entered the international trade in the 1980s.Anderson argues that the practice was part of an over-all approach by the steel mills to ensure that economicrents from the development of an internationally com-petitive steel industry were not dissipated through‘unnecessary competition’. That is, the procedure wasnot anad hocor unique response to a particular prob-lem; it was part of a broader strategy to secure com-petitive advantage for Japanese industry.

It has been argued by the Australian industry(Australian Coal Association, 1994) that they act ina similar manner and that the situation is one of co-ordinated negotiations on both sides. Discussionamongst Australian sellers certainly occurs, and thereis some attempt at combined positions. However, theactual negotiating framework shows significant dis-parities in the balance of power. Under the lead nego-tiator system insisted on by the JSM until 1996, allnegotiations took place in Tokyo, and occurred whendetermined by the JSM. Suppliers were required tomake themselves available whenever requested. Itwas extremely difficult for sellers to maintain a unitedfront when the JSM insisted on negotiating with indi-vidual sellers. For many years, the price that the JSMhas been able to negotiate with one producer becamethe ‘benchmark price’ that all other producers had toaccept (eg, International Coal Report, 1994).

Two recent contract rounds—for Japanese FiscalYears 1995 and 1996—demonstrated the limitedscope for power-sharing despite a significant changein market practices occurring. In the negotiationsleading to the JFY 1995 contract settlements Aus-tralian producers displayed a degree of co-ordinationnot witnessed for many years, which have often seenbitter recriminations amongst producers after one hasbeen the first to settle on terms considered unfavour-able by the rest. Australian sellers refused to acceptdeals negotiated by the JSM with Canadian and USproducers as ‘the benchmark’. The combination of atighter supply situation, and adverse public reactionto earlier price settlements (notably a series of majorstrikes and a concerted publicity campaign by the coal

72

mining trade union in Australia), led to a view that aprice rise greater than that considered appropriate bythe JSM (US $2 to US $3 per tonne) was warranted.A price rise of US $5.65 per tonne was eventuallyachieved—but at the cost of a reduction in contractedtonnage of 2 million tonnes or 5%.

In response to this greater focus amongst Aus-tralian producers on the achievement of a betterbenchmark price, the JSM introduced in 1996 the‘Fair Treatment System’ (FTS) which, as stated earl-ier, was alleged to reflect differences in coal qualities.Australian producers were required to negotiate witheach steel mill rather than a lead negotiator. With thesudden introduction of coal quality criteria in a differ-ent manner, the comparison of offers put and acceptedbecame much more difficult. Moreover, it was arequirement of the buyers that final settlements bekept a secret.

Despite the semblance of more one-to-one bar-gaining in the Fair Treatment System, it is the mannerof its introduction and the conditions placed on out-comes which demonstrate the high level of co-ordi-nation maintained by buyers which is not emulatedby sellers. The new system was introduced across theboard by all buyers on a unilateral and united basis; itwas not a negotiated change to the market structures.Sellers were put at a disadvantage by being prevented,at least officially, from exchanging information aboutprices. This stipulation of secrecy in price-setting isfar removed from any conception of transparency inmarket operations. Here it is enough to note that itcertainly does not reflect a bilateral relationshipbetween equal parties in the market place.

The role of Japanese trading companies.Therelationship between sellers and buyers is stronglymediated through the trading companies. The activi-ties of these companies are a central feature of thetrade rather than a peripheral aspect. They are heavilyinvolved in investment in production, which has beenpreviously discussed. Here, discussion focuses ontheir role in trading practices.

Japanese industry has unmatched strength, because ithas powerful trading companies known as sogo sho-sha. The trading companies are industrial organis-ations unique to Japan, organisations whose existenceis almost unparalleled elsewhere. (Ozawa, 1979, p 30)

The sogo shoshaare the giants of the Japaneseeconomy. There are no equivalents to them in Aus-tralia. They were instrumental in pre-war Japan asdomestic traders and in the post-war period have beenthe principal mechanism of Japanese participation inthe global economy (Kunio, 1982; Young, 1979).Their extensive role in the coal trade has been exam-ined by Parker (1992). He notes that, whilst tradinghouses are declining in Europe, they are a dominantfeature of the Pacific trade. However, whilst there areover 17 specialised trading companies involved in thecoal trade, the annual contract negotiations are under-

Trading practices in the coal market: P Colley

taken by the buyers themselves. Therefore, the tradinghouses simply act as purchasing agents for the mainbuyers, rather than as independent traders.

The amount of coal handled by various tradingcompanies tends to reflect their ownership stake inthe production side of the industry. The Tex Report’s1995 Coal Manualshows that Mitsui and Co. andMitsubishi Development market most of BHP’s coal,as well as being the major Japanese equity partnersin that company’s operations. It is the same withrespect to Tomen and Kawasho for the production ofOakbridge Ltd. The steel mills must use several trad-ers rather than just the one or two with which theyhavekeiretsulinkages because different trading com-panies have rights to market the product of differentmines based on equity stakes as described above. Sofor the steel mills to obtain sources from many minesthey must use a number of traders.

This relationship between equity stakes and volumeof coal traded is one of the more obvious linksbetween investment patterns and trading arrange-ments which are overlooked or accorded scant atten-tion in the bilateral monopoly theory and its appli-cation by Bowen and Gooday. The lack of freedomof choice amongst sellers to select their trading com-pany is also ignored. Only Japanese trading compa-nies are able to make contact with Japanese buyers;producers wishing to export coal to Japan must dealwith a Japanese trading company.

Control of the freight task.Coal into the Japanesemarket is exclusively sold on an f.o.b. basis. This isa standard practice in that trade, but not in other coalmarkets; coal into Europe is normally contracted foron a c.i.f. (delivered cost) basis. For buyers, it wouldbe expected that c.i.f. would be the critical cost, asthis represents the final price for goods at their pointof use, and that therefore they would call for contractor spot purchases on that basis. It would then be upto the seller/trader to determine the best mixture ofmining and freight costs that is competitive.

But in the Australia–Japan coal trade the JSMshifted from a c.i.f. to an f.o.b. pricing basis in the1960s (Anderson, 1987). This has enabled buyers to,at the very least, administer a major part of the logis-tical framework of the industry. Coal mines and coalports have limited storage space, and stockpiles havesignificant holding costs. In the short-term timeframethe control of shipping is an important point of tacti-cal advantage. Most contracts have a ‘plus or minus’component on the contracted tonnage, which is at thediscretion of the buyer. Where the buyer has exclusivecontrol of the freight task, it is possible to leave theseller ‘hanging’ as to whether their recent productionwill be taken (Smith, 1982).

Viewed at a broader level, freight is one of thecomponents of the coal trade that add value, with themost high value-adding component being the point ofuse. The problem for the Australian industry in havingno participation in the freight task is that its opport-

73

unities for profit-taking are restricted to the miningoperation. The distribution as well as the consumptiontask has been seized by the buyer.

This uneven distribution of the freight task betweenseller and buyer is at odds with the assumption of thebilateral monopoly theory that the way in which thebenefits of proximity are shared is in the form of adistribution of the freight savings in the trade.

ConclusionIt has long been agreed that trading practices in theAustralia–Japan coal trade do not reflect competitivemarket practices. The dominant explanation for thedeparture from the norm is the bilateral monopolytheory of Ben Smith. The contemporary applicationof the theory by Bowen and Gooday argues that Aus-tralian sellers and Japanese buyers have benefitedroughly equally from the trade even though Australiancoal is accorded a lower delivered price than coal pur-chased elsewhere by Japanese consumers.

This study has shown that Bowen and Gooday’sconclusions are highly sensitive to the determinationof the upper and lower limits of the bargaining range,and that alterations to those limits which would reflectmore accurately the impact of the parties on thoselimits results in a quite different distribution of thesurplus which significantly favours monopsonisticJapanese buyers. Revenue losses to coal producersarising from the unequal distribution of bargainingpower in the Australia–Japan coal trade over the dec-ade examined are estimated as at least US $555million in 1990 values. If the econometric analysisof Oczkowski is accepted then the revenue losses toproducers are far greater.

In seeking to determine why the distribution of thesurplus is continually unequal the capital formationof the parties to the trade and how they are con-strained in their actions has been examined. Japanesesteel, power and trading companies have a corporatestructure and coherence which enables them to act asco-ordinated parties to the trade whilst the formationof capital amongst the Australian producers preventsan equivalent coherency.

The specific trading practices which characterisethe trade have also been described. They include thelinking of long-term and annual contracts to co-ordi-nated bargaining and the role of trading houses asinformation specialists acting for one party only. Thetentative conclusion is drawn that differences in thestructure and character of capital in each nation leadsto unique bargaining practices and other tradingarrangements which demonstrate unequal bargainingpower and thence lead to an unequal distribution ofthe surplus from the trade on a long-term basis.

It is the author’s contention that these demon-strations of unequal power in the Australia–Japan coaltrade are explicable within the context of Japanesetrade and industry policy which has been dominatedby a national consensus to build the nation and to

Trading practices in the coal market: P Colley

ensure competitive advantage over foreign interests.However, that broader view has not been argued heregiven space constraints. The conclusion here is lim-ited to the observation that there has been no roughlyequal sharing of the benefits of trade based on prox-imity in the Australia–Japan coal trade and that thisis due to long-term differences in the character andstrength of the parties to the trade. Investors and pub-lic policy-makers with interests in coal mining needto consider the means by which bargaining power canbe equalised if there is to be a more equitable distri-bution of the surplus from the trade. This conclusionwill be of relevance not only to participants in theAustralia–Japan coal trade but to all nations and par-ties which are affected by coal prices determinedbetween Australia and Japan.

AcknowledgementsThe supervision of Dr Dick Bryan and the commentsof Damien Roland and an anonymous reviewer onearlier versions of this work are gratefully acknowl-edged.

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