Investing in King Coal

By: Yiannis_G_Mostrous

China is both the world's largest coal producer and its preeminent consumer. In 2006, Chinese coal production totaled more than 1,200 million metric tons of oil equivalent, and output has been growing rapidly in recent years. China's coal production is nearly double what it was at the beginning of this decade.

It should come as little surprise that Chinese demand for coal will continue to surge in coming years. The country consumes vast quantities of both thermal coal and metallurgical (met) coal.

Editor's Note: As readers of my global investment letter The Silk Road Investor ( www.silkroadinvestor.com ) know, I've been recommending exposure to Asian coal stocks for sometime now. In this issue of Growth Engines , Elliott Gue, our in-house energy expert, shares with us his most recent take on the subject.

China's thermal coal market is exploding because of the country's rapidly rising demand for electric power. According to the Energy Information Administration (EIA), China currently generates 271 gigawatts (GW) of coal-fired power capacity. To meet growing needs, China will need to add nearly another 500 GW by 2030, tripling coal-fired capacity.

This massive increase in coal-fired capacity means rapid growth in coal demand. In 2004, China consumed about 22.7 quadrillion British thermal units (quads) worth of coal in its electric power plants. By 2030, that figure will be closer to 56 quads.

Despite China's strong growth in demand for thermal and met coal, the vast majority of its internal needs will likely continue to be met by domestic production. Because of its huge reserves, coal is the one commodity of which China has room to increase production.

This is also exactly why China will continue to aggressively expand its coal-fired power capacity in coming years. It has no other readily available, cost-effective fuel at its disposal. But just because it relies on domestic production for most of its coal needs doesn't mean the nation's rapid growth in coal demand won't have an impact on global coal markets.

Just a few years ago, China was exporting more than 80 million metric tons of thermal coal. As recently as 2002, Japan was importing more than 20 percent of its thermal coal requirements directly from China, and South Korea was another big importer.

But that's all changing. Chinese coal exports will total around 40 million metric tons next year, but it will also import about 40 million tons. China won't be a net exporter of coal in 2008.

In other words, as China's domestic demand for coal grows, there's less available for export to other coal-hungry Asian countries. Major importing countries will need to look elsewhere for their supplies. The loss of Chinese export supply has also put further upward pressure on Asian coal prices.

Beyond China

This coal growth story isn't only true for China. India is the world's third-largest producer of coal behind China and the US, producing some 398 million metric tons of coal annually. And like China, India has seen--and will continue to see--strong growth in demand for coal in coming years.

India has also seen rapid growth in coal imports in recent years. It imported 23.4 million metric tons in 2006 and is forecast to import closer to 30 million metric tons next year. That represents an annualized growth rate of more than 11 percent.

The gap between Indian production and consumption has become more pronounced during the past five years. This widening gap represents greater reliance on imports. The EIA estimates that by 2030 India's dependence on coal imports will be double what it is today.

Japan's and Korea's needs are also adding to the coal story. Neither Japan nor Korea has any real domestic reserves or production, so both countries are almost totally dependent on imports. Japan, the world's largest importer, will source around 115 million metric tons from other countries in 2007.

Japan needs to import a great deal of coal every year, and it's getting harder to find it. Japan has traditionally relied on China for a fifth of its thermal coal imports and as much as 14 percent of its met coal imports. But with China no longer exporting significant quantities, Japan has had to turn elsewhere.

South Korea's story is similar. It has plans to build a total of more than 7.3 GW of new coal-fired capacity in the next few years, and it already imports 63 million metric tons of coal per year. As new plants come on line, Korea's import demand--already growing at a 7 percent annualized pace in recent years--will pick up.

Bottom line: Demand for coal in Asia is growing rapidly, and China is moving from being an important net exporter to a net importer. This tight supply/demand picture is why international seaborne coal prices have remained firm even as certain regional markets--the US included--have seen coal prices fall.

By Yiannis G. Mostrous
Editor: Silk Road Investor, Growth Engines
http://www.growthengines.com

Yiannis G. Mostrous is an associate editor of Personal Finance . He's editor of The Silk Road Investor , a financial advisory devoted to explaining the most profitable facets of emerging global economies, and Growth Engines , a free e-zine that provides regular updates on global markets. He's also an author of The Silk Road To Riches: How You Can Profit By Investing In Asia's Newfound Prosperity .

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