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When I think of coal…two questions pop in my mind:

1) How much coal is out there?

2) How is the coal mining industry going to survive in an ever increasingly emissions-conscious world?

Supply

To answer the first question, I did a little digging, no pun intended. It turns out that the world has plenty of coal, enough to last us for the next 120 years at current rates of production. This is a tremendous surplus compared to that of oil, which has only another 50 to 60 years. To top it off, almost every country has coal reserves; however, so far only a few have been able to access them.

The coal-rich countries with recoverable resources are Australia, USA, China, Russia and India. At the global level, most coal producers use it for their own needs, only a fraction, 16%, of the global coal produced is exported. One exception is Australia, which exports about 75% of its production. Mining specialists believe that we could enjoy coal-produced electricity for even more than 120 years if new technology allows for more efficient exploration and mining techniques. One such technique is Underground Coal Gasification (UGC), which is a “green” method of extracting with coal. It is meant to convert underground coal to a combustible gas, meaning that the gasification process takes place underground. This process should allow countries with hard-to-reach coal deposits to take advantage of them, and it is considered environmentally friendly.

Environmental Concerns

My second concern is quite often debated equally passionately among advocates on both ends of the spectrum. Let’s face it: when one thinks of coal, images of heavily polluted cities and underpaid third-world miners often enter one’s mind. However, like it or not, the world is heavily dependent on coal, since it is the main source of energy. Although 37% of world’s electricity comes from coal, some countries use more coal than others.

For example, Australia and China get about 80% of their electricity from burning coal. Considering just those numbers, it is hard to imagine that the world is going to divert from it any time soon. However, there are proposals out there meant to curb the nasty carbon emissions that contribute to climate change and the dreaded global warming.

One of them is the “cap-and-trade” program implemented by the European Union in 2005. The idea of the program is to incentivize polluting companies to pollute less by giving them carbon permits which they can sell for profit to companies that cannot meet their pollution quota. The idea of “you pollute, you pay” sounds good; however, implementing the program brought about a wave of criticism. The Institute for Energy Research found out that surprisingly “European emissions rates under the cap-and-trade policy increased by 3.5 percent. During that same time, U.S. emissions increased by 0.7 percent.”

The report states that many permits were misused: “Many companies got free permits, and because those permits were based on future estimates of emissions levels, there were too many free permits. As a result, companies made large profits by selling unneeded permits and not passing their savings on to their customers.” Therefore European taxpayers were hit twice: first by footing the bill for the cap-and-trade program and then by not receiving a share of the profits from selling the permits. To top it off, the cost estimates to run a trading system for carbon emissions can run anywhere from 5 to 80 billion dollars annually, depending on the loftiness of the goals.

As expected, there is acrimonious discord in Australia regarding how much electricity companies pay for carbon emissions. Australian Coal Association (ACA) executive director Ralph Hillman said that the “ACA supports putting a price on carbon, but not one that causes Australian mines to close and shift production to other countries with no reduction in global greenhouse gas emissions.”

His statement is in line with what critics of carbon-reducing measures argued for years: it may be futile for developed countries such as Australia or the USA to implement costly carbon-emission control technologies, while China intends to expand its coal-fired electricity sector, has not made any attempts to reduce pollution and seems unconcerned with climate change. However, if only the developed world adopts new technologies that prevent pollution, it could end up a zero sum game, meaning that developed countries will decrease their carbon emissions while developing countries will not, effectively forcing the developed world to pay for maintaining the status quo.

There are alternatives to “cap-and-trade” program, such as carbon capture and storage (CCS). The capture part of the process is the most expensive, about 70-80% of the total cost. So far, the US has allocated 3.4 billion dollars for CCS technologies, while Australia, the UK and the EU have also made commitments to fund coal-fired CCS plants.

Demand

Coal has enjoyed some good times in the last decade – as the global economy expanded so did the demand for coal. According to a paper published by researchers at MIT (Massachusetts Institute of Technology), “Coal is a low-cost, per BTU, mainstay of both the developed and developing world, and its use is projected to increase. “ This safe and abundant fossil is primarily used for electricity generation, steel production, cement manufacturing and liquid fuel. However, it does not stop there. Coal is used in fertilizers and also as a by-product for aspirin, soaps, plastics, fibers and so on. All of the above make coal an omnipresent resource. It’s future is safe: China plans to build 500 coal-fired plants over the next decade or about an electricity plant per week.

Trading Coal

The mining industry operates slightly differently than other industries; take tourism for example. It is very investment intensive, accounts for a significant portion of Australia’s GDP but hires only a few thousands workers. Therefore, chances are that you may not profit from coal’s golden era unless you invest directly. I admit that it is challenging to sit on the sidelines and watch large mining companies turn in record profits. Rio Tinto’s (RIO) profits were up 162% in 2010, while Swiss Xstrata’s profits were up 337% in 2010 from the previous year. In 2011 BHP Billiton’s (BHP), the fifth largest company in the world, posted half-year profits up 72% from last year. If you haven’t already done so, it may be the time to take a closer look at the Australian mining sector. There are many ways to get your feet wet: trade coal futures contracts, an Australian mining company stock, an ETF or an index.

There aren’t any coal futures contracts on ASX; however, in the USA, coal futures contracts are traded on NYMEX, and the symbol is QL. Producers and electric power companies do most of the trading for hedging and risk managing purposes. Coal futures contracts are also traded on Intercontinental Exchange (ICE). There are two different contracts available on ICE: European (Rotterdam) and South African (Richards Bay). It may be hard to find a brokerage house that will allow you to trade coal CFDs (contract for difference, a sort of an over-the-counter derivative). The good news is that S&P/ASX 300 Metals and Mining Index (AXMM) is derived from S&P /ASX 300 Index, and as the name implies, it only includes companies from the mining and metals sectors, such as BHP Billiton (BHP), Rio Tinto (RIO), Newcrest Mining Ltd (NCM), Iluka Resources (ILU), Alumina Ltd (AWC) or OZ Minerals Ltd (OZL).

It would come as no surprise to Australian investors, but as you can see from the chart below, the S&P/ASX 300 Metals and Mining has significantly outperformed the ASX300 over the past 10 years.

#FOTO:1091:400#

If you’d rather invest into a specific company, the most important coal mining companies in Australia that are traded on ASX are Riversdale Mining (RIV), New Hope (NHC)and Coal & Allied Industries (CNA). Some other major companies are either not publically traded or traded on other exchanges.

When researching mining companies, Allan Trench (Adjunct Professor of Mineral Economics at Western Australian School of Mines) recommends to stick to larger mineral markets, such as gold, copper, iron ore, uranium or thermal coal and make sure that the shares of the stock you are interested in are liquid enough.

He also places emphasis on the importance of understanding the magnitude of a mineral discovery: “For example if a company makes a world-class copper-gold discovery, the value of such price runs into the billions of dollars. Conversely, however, if the company discovers a small to mid-size nickel, copper or gold deposit, the value of such discovery may only lie in the hundreds of millions. Which size is the company targeting?”

For more info about the mining sector and companies, please make sure to check the following links:
http://austresources.realviewtechnologies.com
http://www.asx.com.au/research/resources-sector.htm
http://www.asx.com.au/research/asx-australian-resources.htm

>>Back to the newsletter to view other articles – June 19th 2011

 

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