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The Daily Reckoning

Coal use points to growth

A decreased supply of coal, due to flooding, and an increased demand, from Japanese reconstruction, has caused prices to rise

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Luckily for China, it sits atop the third-largest amount of recoverable coal reserves in the world behind the U.S. and Russia. The country ramped up its coal production from 645.9 million tons of oil equivalent in 1999 to 1,552.9 million tons in 2009. Despite this increase, production couldn’t keep up and the country became a net importer of coal in 2009. Production jumped over 15 percent during 2010 but the country was still forced to increase coal imports by 42 percent in order to meet demand, according to the China Daily.

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There are two types of coal. Thermal coal is burned in furnaces to create electricity and metallurgical coal, also called coking coal, is used to create concrete and steel. China’s coal reserves are light on the latter, which has required China to rely on countries such as Australia, Indonesia and Russia for supply.

These imports are playing a vital role in China’s infrastructure boom. The U.S. Energy Information Administration (EIA) estimates that Australia’s total exports to Asia, which also includes Japan and India, will increase 64 percent to 394 million tons by 2035. This accounts for 94 percent of Australia’s total exports.

Coal exports from Indonesia, Asia’s second-largest source of coal, are expected to rise 26 percent over the same time period, according to the EIA. In 2009, China signed a 25-year, $6 billion loan-for-coal agreement with Russia that will supply the country with 15-20 million tons of coal.

The Chinese government made it clear that it wants to wean the country’s power grid from coal. That’s proven to be a difficult task. China’s 12th Five Year Plan calls for big improvements in energy efficiency and the development of additional sources including natural gas.

Massive projects such as the Three Gorges Dam have sought to increase capacity of alternatives, but hydroelectric, nuclear and other renewables combined make up only 10 percent of total power. In addition, low water levels due to a drought in Southern China have reduced current hydroelectric capacity.

The ongoing disaster at the Fukushima nuclear plant in Japan has delayed but not squashed China’s nuclear ambitions. The country has plans to build more than two dozen plants by 2020, accounting for 40 percent of new nuclear facilities around the globe.

Only time will tell if the effort will be successful. The EIA forecasts that China’s power generation from coal will increase by 2035 but will only account for 62 percent of total power generation at that time. However, the EIA says that absolute coal consumption will nearly double as the economy continues to grow and electricity demand remains strong.

With coal’s short- and long-term status atop China’s energy mix intact, we think some domestic coal producers stand to benefit. To participate, we’ve taken positions in several coal producers including Shenhua Energy and Yanzhou Coal which we believe offer tremendous potential for the China Region Fund (USCOX).

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