Seeking Alpha
Profile| Send Message|
( followers)  

By Eric

Coal has been mined across the world since the Bronze Age, becoming an important commodity during Roman times, especially in what is today Great Britain. However, the true Golden Age of coal began with the start of the Industrial Revolution in Europe and North America in the late 1700′s and early 1800′s. Coal was cheaper than wood for fuel and nearly as abundant, helping to power steam engines across the continent and get the world’s economy going into the industrial age. After the steam engine, coal became an important fuel source for the modern electric utility company, which can trace its start back to the early 1880′s. Once again, coal was an abundant fuel source that was easy to burn and turn into electricity, ensuring that the mineral became one of the most popular ways for mankind to power their homes and businesses.

Today, coal is primarily used as energy for power plants the world over, helping to generate roughly 40% of the world’s electricity. Although concerns remain over its relatively ‘dirty’ nature when compared to other fuel sources, the fact remains that coal is by far one of the cheapest and most abundant sources of fuel in the world today. Despite coal’s ubiquitous nature, there are very few options for investing in the product. Beyond exchange-traded futures contracts, investors can only buy up coal mining companies or obtain broad-based exposure to the industry via ETFs.

Physical Properties And Uses Of Coal

According to the World Coal Association, coal is the altered remains of prehistoric vegetation that originally accumulated in swamps and peat bogs. Over millions of years, thanks to incredible pressure and shifting tectonic plates, this vegetation slowly turned into peat and then finally into coal. Since the plants involved were unable to decay normally and instead had all of their photosynthesis energy trapped within them, coal has high a high energy density making it a perfect fuel source for power plants.

Currently, coal is broken down by the moisture content of the product which is inversely related to the carbon/energy content. In other words, the less moisture the coal has, the more energy it can produce. “Low Rank Coals” which are the most moist, make up 47% of all coal with 17% going towards lignite and 30% (of the overall coal supply) going to sub-bituminous. Both of these varieties are generally used in power production and feature a more brownish or Earthy hue.

Meanwhile, “hard coal," which makes up 53% of the total market, is split into two groups, Bituminous and Anthracite. Bituminous is also used for power generation but the metallurgical variety is a popular choice for companies making steel since this type of coal can get temperatures hotter which help to remove many of the impurities of the metal. The real prize of the coal world is Anthracite coal which makes up roughly one percent of total global supplies. This form of coal is dark black and generally sells for about two to three times its more abundant coal cousins due to its extremely high carbon content. Because this form is so expensive, it is rarely used in power generation and instead finds its way into more localized applications where it is prized for its low soot output.

Coal Supply And Demand

Demand for coal has soared over the last several decades as emerging markets continue to grow and require more coal to power their incredible economic growth levels. Coal is produced on every inhabited continent, but the main supply locations seem to be tilted towards the Asia-Pacific region where four of the top five producers exist. These countries, China, India, Australia, and Indonesia, combine to make up close to 60% of total world product with China producing well over 40% on its own. The other major producer of coal is the U.S. which produces just over 15% of the world’s total coal output, producing just over half a billion tons (oil equivalent) of the black rock in 2009. Interestingly, many of the world’s top producers of oil and other fossil fuels do not find their way onto the list, suggesting that coal deposits tend to form apart from oil ones. Below is a table highlighting some of the biggest producing countries of the product:

Country 2008 Production 2009 Production Percent Change YoY
China 1,425.6 1,552.9 9.2%
U.S. 596.7 539.9 -9.3%
Australia 220.3 228.0 3.7%
India 195.6 211.5 8.4%
Indonesia 140.8 155.3 10.6%
South Africa 142.4 140.9 -0.7%
Russian Federation 153.4 140.7 -8.1%
Poland 60.5 56.4 -6.6%
Kazakhstan 56.8 51.8 -8.6%
Colombia 47.8 46.9 -1.6%
Other Countries 297 284 -4.0%
Global Total 3,336.9 3,408.6 2.4%
BP Study

Price Drivers

As a global commodity, the price of coal is impacted by a number of factors, and is often subject to significant price swings in a relatively short period of time. The major price drivers of coal include:

  • Emerging Market Demand: Coal demand has surged in recent years thanks to rising electricity consumption levels in emerging markets across the globe. As these nations continue to industrialize, they will need more electricity to do all the things that we take for granted in the West, further adding to coal demand as a fuel for emerging market power plants.
  • Environmental Concerns: Although coal is used the world over, it has a reputation of being a ‘dirty’ fuel, spewing toxic by-products into the atmosphere and possibly contributing to rising CO2 levels. While there are some technologies that could potentially be useful to the industry– such as carbon capture– the axe of regulation or a carbon trading scheme in the U.S. or other markets beyond Europe could greatly curtail the demand for coal in both the short and medium term.
  • Use of Substitutes: Technological advancements have made possible the use of much more environmentally friendly ways to generate power such as solar or wind systems. While coal has virtually no chance of being unseated as the single greatest source of power for the foreseeable future, alternative fuel sources could slowly eat into coal’s demand causing the product’s price to plateau as more countries look to cleaner– but likely far more expensive– alternatives.

Investing In Coal

Coal has appeal as an investable asset for several reasons. First, the product has been an extremely important source of power for thousands of years and with supplies of coal dwarfing other fossil fuels, this trend looks likely to extend well into the future. Coal is also relatively recession proof, as no matter what happens, people will still need to heat their homes, and use electricity. Since coal is among the most popular ways to do this the world over, demand is likely to remain relatively strong for the foreseeable future.

Coal Futures

Coal is currently traded on the New York Mercantile Exchange under the symbol QL. The contracts are classified as Central Appalachian coal and trade in units of 1,550 tons and are quotes in U.S. dollars and cents per ton. Coal traded in this manner also must meet several criteria in order to qualify including;

  • Btu: Minimum 12,000 btu/lb., gross calorific value, with an analysis tolerance of 250 btu/lb below (A.S.T.M. D1989);
  • Ash: Maximum 13.50%, with no analysis tolerance (A.S.T.M. D3174 or D5142);
  • Sulfur: Maximum 1.00%, with an analysis tolerance of 0.050% above (A.S.T.M. D4239);
  • Moisture: Maximum 10.00%, with no analysis tolerance (A.S.T.M. D3302 or D5142);
  • Volatile Matter: Minimum 30.00%, with no analysis tolerance (A.S.T.M. D5142 or D3175);
  • Grindability: Minimum 41 Hardgrove Index (NYSEARCA:HGI) with three-point analysis tolerance below. (A.S.T.M. D409);
  • Sizing: Three inches topsize, nominal, with maximum fifty five per cent passing one quarter inch square wire cloth sieve to be determined basis the primary cutter of the mechanical sampling system. (A.S.T.M. D4749).

Trading terminates on the fourth last business day of the month prior to the delivery month. Trading is conducted in the current year and the next four years. Contracts for each new year will be added following the termination of trading in the December contract of the current year. The seller may not schedule delivery of coal earlier than the first calendar day and not later than a date such that there are a minimum of seven calendar days remaining in the delivery month. Furthermore, the seller may not complete delivery of coal later than the last calendar day of the delivery month. Coal futures are subject to NYMEX position limits.

Trading also is done for European and South African coal futures on the ICE. Those contracts trade in units of 5,000 tons and are also quoted in U.S. dollars and cents per ton. Both the European and African varieties as well as the American contracts are often used as tools by utility companies in order to hedge their expenditures so that they know how much it will cost to produce electricity in the near-term.

Coal Miners

Investors can also obtain exposure to coal by purchasing stocks of companies that are engaged in extracting and selling the compound. Like most companies, the profitability of coal miners depends on the prevailing market price for the products they sell. As such, mining companies tend to realize higher profits when natural resource prices are elevated—especially if significant portions of the cost structure are fixed in nature. Mining stocks tend to trade as a leveraged play on the underlying resource, meaning that the movements in price are often more significant than changes in the related commodity over the short term.

Unlike many of the largest mining companies, coal companies tend to be focused on coal production and exploration and rarely mine for other resources such as precious and base metals as well. As a result, there are a number of “pure play” mining companies and firms whose primary focus is coal:

  • Peabody Energy Corp (NYSE:BTU)
  • CONSOL energy (NYSE:CNX)
  • Alpha Natural Resources (NYSE:ANR)
  • Massey Energy Co (NYSE:MEE)
  • Arch Coal (NYSE:ACI)

There are also a number of international firms that are listed on American exchanges that could offer a higher return (but also a higher risk) to investors seeking higher levels of exposure to the coal industry. The most well known of this group is Yanzhou Coal Mining (NYSE:YZC), one of the largest pure coal mining firms in the world.

[see the holdings of the Market Vectors Coal ETF for a more detailed list of coal mining firms]

Coal ETFs

There are multiple ETFs offering exposure to coal as well, primarily funds that invest in companies that mine the valuable product. These two funds, which share a great deal of similarities, are:

  • Market Vectors Coal ETF (NYSEARCA:KOL)
  • PowerShares Global Coal Portfolio (NASDAQ:PKOL)

As mentioned above, coal is mined on every inhabited continent so very few economies are driven by coal exports. However, some countries do receive an outsized percentage of their exports from the product, and can be broadly accessed with the following ETFs:

  • IQ Australia Small Cap ETF (NYSEARCA:KROO)
  • Market Vectors Indonesia ETF (NYSEARCA:IDX)
  • Global X China Energy ETF (NYSEARCA:CHIE)
Source: The Ultimate Guide to Coal Investing