Seven Things You May Not Know About Coal

Seven Things You May Not Know About Coal

By Marin Katusa, Chief Energy Investment Strategist

The days of tossing another lump on the fire to keep warm are behind most of us, but coal is still vital to keep our modern computers, air conditioners, and even cars humming. How much do you know about one of the world’s most indispensable commodities?

#1. Before turning into coal, layers of ancient swamp bed transition through another familiar carbon compound in as little as 9,000 years. That’s peat.

In the right conditions, high pressures and temperatures below Earth’s crust can turn organic material from ages-old swampy sediments into coal. But before that happens, the material passes through an intermediate stage that the Irish made famous. Peat is coal in the making, and as most everyone knows, it burns too. (For connoisseurs among us of the single malt, peat also helps give Islay scotches their distinctive flavor.)

There are also different kinds of coal itself. They vary in their content of water, carbon, and other ingredients, and in the time it takes to fashion them as well. The hardest coal, called anthracite, requires on the order of millions of years to form. That’s a long way from peat.

#2. A single percentage-point improvement in the efficiency of a coal-fired power plant results in a 2-3% reduction in CO₂emissions.

Facilities that convert coal into power currently generate 41% of the world’s electricity, according to the World Coal Association. At about 43%, the United States rates about average. But the world’s second-largest economy, China, depends on coal for 81% of its electricity; and with nearly as many people, India depends on coal for 68%. A few countries rely almost completely on burning coal to make power—South Africa (94%) and Poland (86%), for example.

Small surprise, then, that a lot of research has been devoted to reducing the carbon emissions and other pollutants that result from combusting coal. Once it’s mined, washing it to remove impurities can reduce ash by more than 50%, while also removing much of the sulfur that causes acid rain. Grinding lumps into powder makes the coal burn more efficiently as well as quickly. In smokestack exhaust, filters capture soot and more ash, and scrubbers capture mercury and more sulfur.

We’ve come a long way from Victorian London and its noxious yellow fog. But there are strong incentives to keep at it. The return on improvements is still significant, as you can see above.

Furthermore, coal’s vital role in power generation is likely to be around for a long time yet—most predictions even set it as increasing slightly in the next few decades. With all the talk about natural gas and alternative energies, coal still provides the always-on, baseload type of power that’s so hard to replace.

#3. Unlike many commodities, the prices we refer to for coal come directly from negotiations between producers and consumers.

In the oil sector, you’ll see prices quoted that benchmarks like West Texas Intermediate or Brent Sea Crude are bringing on the market. You may see a spot price and a contract price for uranium.

However, coal prices aren’t standardized like that. Instead, they’re set by whatever bargain a producer can drive with a consumer (or the other way around, for that matter).

To track the coal market, there are a few key negotiations we watch. For metallurgical coal, the most important contract price is that between Australian producers and Japanese steelmakers. There’s a much larger array of contracts for thermal coal—the kind power companies use to generate electricity—but most observers keep their eyes on Indonesian export prices.

#4. The world’s fastest-growing coal importer is… China? Nope: India.

This is a great example of tricky wording that’s possible with statistics. China and Japan both import more coal than India, and China’s rankings at the top tier of coal consumption and overall growth put it in the driver’s seat of increased global demand. But the world’s fastest-growing coal importer is India.

Just look at the last couple of years. From 2011 to 2012, India increased its production from 585 to 595 million tons (Mt)—but at the same time, it had to increase imports from 105 to 160 Mt in order to meet domestic demand. India has been on that track for several years now, and it isn’t expected to get off anytime soon.

The reason why is widespread inefficiency. New coal projects face delays in regulatory approval—and once they do get approval, they face challenges that range from resettlement to opposition based on environmental concerns. Then there’s inefficiency in moving coal where it needs to go around the country. By some estimates, half of coal transports are affected by rail capacity that isn’t implemented properly.

The result: power companies have to import coal just to make sure they can keep the lights on.

#5. The number of Indonesian billionaires has almost tripled since 2010 to 29.

Australia was the world’s largest coal exporter for a long time. It’s been overtaken by Indonesia, however, first in thermal-coal exports and now in total exports. The land above the Land Down Under exported 52% of the world’s coal in 2012, the latest year for which global figures are available.

Indeed, Indonesia has huge reserves of thermal coal, totaling 4.5 billion tons at the end of 2013. Plus, the country has one major advantage over Australia: location. It’s almost half the distance from the largest coal importers—China, India, South Korea, and Taiwan. And with friendlier regulatory hoops to jump through, Indonesian companies have been able to build basic infrastructure, such as conveyor belts, railways, and ports, more easily and quickly.

What do all these delightful facts have to do with billionaires in Indonesia? Most owe their wealth either directly or indirectly to commodities. The coal sector has created a marked change in Indonesia’s wealth, a nation of 247 million relatively poor people. A retail boom started taking off even as the rest of the world reeled from the 2008 economic crisis; segments of its real-estate market rose 30% just in the last year.

This may be a difficult trend to keep up, though. China is considering legislation to ban the import of coal with a caloric content (a measure of energy it contains) below 3,900 kilocalories per kilogram. This is the kind of coal typically burned in low-tech, “dirty” power plants—and the kind that most often comes to China from Indonesia. In contrast, most thermal coal from Australia, North America, and Russia rates above the 3,900 kcal/kg floor.

#6. The long-term picture sees the world needing an additional 500 million tons of metallurgical coal annually by 2030—a 200% increase from today.

Again, China is a major driver. In 2012 China’s steelmaking industry consumed 581 million tons of metallurgical coal (AKA “met” coal and coking coal), an increase of 8% in a single year even as signs emerged that its economy was slowing. China had to import 71 tons of it.

China is far from alone, however. Brazil has been busy building major infrastructure, stadiums, and housing in preparation for the 2014 World Cup and the 2016 Summer Olympics. Japan has plenty of rebuilding to do, and consumption of met coal is rising in India along with its needs for thermal coal. And let’s not forget South Korea: Home to the world’s second-largest shipbuilding industry, it consumes the most met coal on a per-capita basis on the planet.

In the face of all this demand, supply is markedly constrained. Only five countries in the world export significant amounts of metallurgical coal: Australia, Canada, the United States, Russia, and Indonesia. The global recession forced several producers to shelve plans to expand mines, and good, new discoveries are few and far between.

#7. It’s not just floods in Australia—labor issues and looming higher taxes on coal are putting pressure on coal prices as well.

The 2010 floods that inundated coal mines, washed out railroads, and shut down port facilities in Australia may have been news to the rest of the world, but Australians know they’re not that uncommon. It doesn’t take much to disrupt supply of a commodity that’s in high demand.

Expect labor issues to nag the industry as well. For example, thousands in Turkey have gone on strike to protest unsafe working conditions after an explosion in a coal mine killed more than 300 miners in mid-May. Australia’s top coal transporter Aurizon Holdings Ltd. is seeking to end more than a dozen union agreements after a year of negotiations with workers have fallen through. These are just a couple of examples.

Then there are the taxes that will only increase on the world’s two largest suppliers of coal.

Increased demand and tightening supply… sounds like a situation we investors like to get in on.

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On Thursday, May 22, we’ll publish the brand-new monthly issue of the Casey Energy Report, and most of it is about coal. We haven’t recommended coal companies in a while, but the sector looks so promising now that you’d waste an opportunity for great profits if you didn’t get in now. Our coal company pick for this month is a good-size coal producer with very limited downside and excellent upside potential.

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