COAL-It doesn’t glitter but its gold

Another commodity which has caught my imagination over the past couple of months since the time I have started to track it. I have been fairly fortunate enough by sheer coincidence. My foray in the commodities research concurred with the Bull Run in global commodity markets. Over the last 4 years that I have been in this market each year have been exciting and every year there has been a new commodity which has become darling of the market। . 2008 is the year for Coal and Natural Gas. I will take up natural gas in my subsequent articles in the current one let’s look at coal. After crude oil by far one of the most important commodity in this world when you look at the energy composition.

Introduction

Coal can be classified in two categories broadly thermal and coking coal (hard and semi soft). Thermal coal is used for electric generation purpose where as coking coal is used for crude steel production. The demand for both these categories is fairly high. We would be focussing on thermal coal in this article. Over the years despite the fact that coal is of strategic importance it has never really been talk of the town or coal prices never flew of the roof just the way crude or some of the other commodities did. Unlike Crude oil coal is easily available and is also in abundance. Recently coal has become the talk of the town and just like other commodities coal is also witnessing supply side issues. These days’ supply side issues are something that every commodity is going through but hold you horses the supply issues in coal are a bit different from other commodities. Unlike Crude oil coal story is not about lack to reserves and new capacities to meet demand. According to estimates current coal reserves are around 908 billion metric tonnes with current supply been at 5.9 billion metric tonnes coal reserves can last for nearly 153 yrs.

Supply

On the supply side there are two big issues lingering a) mine damages and b) infrastructural issues. Coal is produced across the globe but nearly 70% of coal comes for 4-5 countries US, Russia, China, India and Australia. Other important producers are Indonesia and South Africa. There have been supply side issues with some of these big producers. Flooding in Queensland has significantly caused damage in the Australian mining area and has constrained coal supply. The mines in Queensland were flooded during the early part of the year and it would take couple of years to restore the mines to its full capacity. In the case of South Africa wet weather had struck the first blow to the coal mining industry. Due to the wet weather in South Africa coal could not be delivered to the power plants and there were brown outs (brown outs is a phenomenon of low voltage) in South Africa. The power utilities company could not produce required amount of power as they don’t have enough stocks of coal with them. Due to this the mines are receiving just 90% of its required power and they are running below capacity. It’s sort of a vicious circle in South Africa. China was another country where weather issues have hampered the deliveries of coal to power plants. Another big coal exporting country is Indonesia the central government is Indonesia has decided to reduce the exports as they themselves require coal to meet their indigenous requirement; this is likely to create tightness in the market.

The other issue on the supply side is infrastructure bottlenecks in some of the major coal producing countries. For example in India itself there are logistics issues apart from quality issues. There are significant rail and port capacity constraints in big exporting market where the capacities have not increased in line with demand for coal. In one of the recent instance, Newcastle one of the biggest coal exporting ports ships were lying for nearly 3 weeks and coal could not be exported. It’s much more severe issue than the weather concerns hampering supplies as the latter is a short term factor but the infrastructural bottlenecks stays for long time. My guess is if the governments of exporting nations take a stock of the situation today and start working on it would take at least 2-3 years to ramp up capacities till then every now and then the supply issues will crop up.

China and India driving demand

According to the IEA, developing countries, should contribute 74% of the increase in global primary energy use between 2005 and 2030. China and India alone will account for 45% of the increase mainly due to the robust demand in China and India where most of electricity is produced by coal. Until recently, China was able to meet its domestic coal needs from its own production. In 2007 however, China became a net importer of coal while traditionally it has been one of the major exporters in the coal market into a net importer. In order to meet its energy demands, India is increasingly dependent on imports. This has also affected the coal sector as India’s economy relies heavily on coal, which accounted for around 39% of total primary energy demand. The Indian Government now plans to build a number of huge or so called “ultra mega” coal-fired power stations, each with a capacity of 4,000 megawatts (MW). Each of these 4,000 MW power stations is expected to consume about 15 million tons of coal a year. India has large coal reserves, they typically comprise high ash content and thus imported coal is needed to reduce pollutants.

Rising Cost

Rising costs should support thermal coal prices over the longer term driven by higher personnel and maintenance costs. Also, the declining quality of coal deposits and less favourable geographic locations of coal mines will support costs. Having said that coal is an efficient source of energy than crude or gas.

Coal vs. Crude

As mentioned above Coal is far more efficient as a source of energy than crude oil. With crude oil prices expected to remain high it is likely to help coal demand where we could see demand substitution setting in. If we try to compare coal and crude, 1 tonne of coal produces 7,100 kilo watts of electricity where as 1 tonne of crude oil produces nearly 6,500 kilo watts of electricity. Which means in volume terms it produces 600 kw more. Even in cost terms coal is cheaper 1 tonne of coal costs USD 120-160 depending on the place from where one imports. Where as in terms of crude oil assuming that crude consolidates and remains at USD 100. 1 tonnes of crude oil would cost roughly USD 600. Which means crude oil is 3-4 times more expensive than coal. Even if coal prices increase by 100% over the next 2-3 years coal would continue to remain cheaper than oil.

Looking at the long term Coal to me looks like a lucrative investment. Over the next couple of years I expect coal prices to increase anywhere between 50% - 75%. Though coal prices have increased by nearly 30% this year but I believe and my conviction in the market makes a case of further more upside. Coal continues to remain a cheap source of energy and the power of the commodity has not been factored in the price.