Despite statistics released by the U.S. Energy Information Administration (EIA) supporting an increase in the long term usage of coal as a form of energy, both delivered coal prices and coal stocks have experienced declines over the past year. This article seeks to explore the potential investment opportunity presented by cheaper 'toxic rock'. It reflects not only the challenges and potential benefits of investing in coal but also aims to inform investors how exposure to the coal industry can be achieved.
A rocky ride for coal demand in the past year has lowered coal prices to attractive levels. Several factors are exerting downward pressure on the average delivered coal price. This includes: lower demand for coal to generate electricity, lower natural gas prices causing utility companies to switch from coal to natural gas power plants, and concerns regarding an energy cap that seeks to limit carbon emissions.
However, coal is cheap, easy to extract and ample in supply. The World Coal Association states that coal currently provides 29.6% of global primary energy needs and generates 42% of the world's electricity. It is widely expected that demand for coal will rise in the long term. Population and income growth are the main drivers of demand for energy and are expected to increase in the coming years. A larger population coupled with higher levels of income result in an increase in the production and consumption of energy.
Furthermore, demand for the coal in the long term is supported by current statistics released by the U.S. Energy Information Administration (EIA). The EIA expects coal consumption to increase from 139 quadrillion Btu in 2008 to 209 quadrillion Btu in 2035 (See chart 1). Primary drivers for an increase in expected demand of coal are Asian countries, more significantly China - the world's largest energy consumer, consuming close to half of the world's coal. China's annual coal demand is expected to reach 3.9 to 4.3 billion tons by 2025. Despite China's attempt at adopting a more diverse energy diet, investing heavily in renewable energy resources such as hydro, wind, solar and biomass power, it still relies significantly on coal fired powered plants to provide approximately 80% of its electricity.
However, China is not alone in its preference for coal as the main provider of energy. Australia, Poland, India and South Africa use coal as a major fuel to generate electricity. India is expected to increase its use of coal fired power plants from 99 gigawatts in 2008 to 172 gigawatts in 2035, representing an increase of around 60%. South Africa, the world's fifth largest coal producer relies on coal to produce 93% of its electricity needs and coal is the country's third largest source of export revenue. Environmental conservation efforts such as the proposed U.S. Waxman-Markley Energy Bill, aka the American Clean Energy and Security Act, gives rise to the use of clean-coal technology. Clean-coal technology seeks to reduce harsh environmental effects by using multiple technologies to clean coal and contain its emissions. Acceptance of this bill will increase preferences towards the use of clean-coal technology, inevitably raising demand for coal. These facts point favorable towards the demand for coal and is supported by analysts at UOB-Kay Hian Ltd - The largest listed securities company in Singapore, engaging in stock broking, investment trading, commodities and research services, who believe China's "strong demand and supply tightness should continue to support coal price uptrend in 2012."
Coal Supply 'Stuck Between A Rock and Hard Place'.
China relies largely on domestic energy resources to develop its economy. Coal represents China's largest form of energy resource. The Chinese domestic market for coal is more than three times the entire international coal trade. As a result, a minor shortage in supply of coal would increase the world's coal prices. On the domestic front this shortage could be caused by china's inadequate rail capacity, resulting in a dramatic increase of road transportation via truck which is costly and already strained. This is likely to increase production costs and remain a constraint to further expansion.
Australia - The largest exporter of coal has recently approved the use of a carbon tax, to be implemented in mid-2012, with a smooth transition within three to five years to a cap-and-trade system. As a result any coal mine expansion plans are expected to be axed, further pressuring coal supply. The notion of a shortage of coal is frowned upon given the widely held misconception that current coal reserves will last for another century, mainly due to poor reserve estimates as countries seldom update their estimate of coal reserves. Indeed, the previous update which occurred in 1997 resulted in significant downward revision in the amount of coal in the ground deemed as recoverable.
The US has experienced peak extraction of the high quality coal such as anthracite since the early nineties. Higher quality coal produces more energy and is easier to mine. The Energy Watch Group - A German organization that undertakes studies about the actual worldwide availability of fossil and nuclear energy resources and the possibilities of renewable energy developments with the aim of enhancing energy policy decisions, has estimated that China will experience peak coal by 2015. In addition to the factors limiting supply, the vast reserves of the world's coal are mainly of the lower-quality bituminous coal, more difficult to mine in terms of time and cost, further giving rise to the importance of a long-term investment in coal.
Getting Your Hands Dirty With Coal. . . The 'Pure Play'.
'Pure play' involves investing in a company devoted to one line of business or a company whose stock price is highly correlated with the specific business. For example - Investors seeking exposure to the coal market could purchase shares in Peabody - The U.S. largest coal mining company in terms of revenue, thereby, making a pure play in the coal mining business.
An exchange traded fund or ETF, can also be used as a pure play on the coal mining business. ETFs are passive investments that track an index, a commodity or a basket of assets like an index fund and trade on an exchange. ETFs can be purchased via a single transaction. The advantages of this include cost effectiveness since there is only one transaction per trade. Furthermore, ETFs require minimal management as their aim is to track an index rather than outperform it; therefore, risk and management fees are lower. An ETF such as Market Vectors Coal ETF (KOL) or PowerShares Global Coal ETF (PKOL) provides investors with exposure to a global universe of listed companies engaged in the coal industry. Some of the top holdings in these Coal ETFs include Peabody Energy, Alpha Natural Resources and CoalCorp Mining. Coal ETFs will not only provide exposure to the coal industry but help investors achieve diversification as a result of lower systematic risk.
Coal to Stand the Test of Time
Given that 2011 was difficult for coal stocks, evident by dramatic falls in a number of coal mining company stocks such as Peabody which is down almost 60% as of Jan 2012 from its 52 week high of $73.95, therein may be the entry point for investors with a long term outlook. The challenges the coal industry faces in the long term will be determined by the expansion rate of environmental conservation efforts, improvements in the production and mining in the coal industry and the adoption rate of renewable energy resources.
Despite these challenges, the benefits of coal such as; ample supply, cheapest form of energy, ease of extraction and contribution towards the labor market should not be underestimated. The expected tightening of supply and rising demand of coal coupled with a more positive macro outlook only strengthens the appeal of coal as a long-term investment. In any investment portfolio, an allocation towards a stable investment should always be considered - Commodity investing is no different. Investors seeking a stable commodity that will stand the test of time; may 'call to coal' as a way to maintain some stability in a portfolio. A long-term investment in coal could help maintain investors' portfolios in the black for years to come and may emerge as the 'black gold' of our generation.
About the author
Yasin Ebrahim is a freelance journalist researching developments in the alternative investment field through exposure in traditional and social media. His background in risk and investment management coupled with leading industry qualifications; Financial Risk Manager (FRM), Chartered Alternative Investment Analyst (CAIA) provide him with a sound background to explore alternative investments.
© Capital ME 2012
