The Case For Long-Term Investment In Coal

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Coal, which is primarily used as a solid fuel to produce electricity and heat coupled with applications in some industrial processes, can be a relatively attractive long-term investment. This article discusses the demand – supply scenario for coal and some attractive investment opportunities in the fossil fuel.

At the very onset, just to bring forward the demand scenario for long-term, the EIA expects coal consumption to increase from 139 quadrillion Btu in 2008 to 209 quadrillion Btu in 2035.

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World Coal Consumption in Btu

The growth in demand is much robust for non-OECD Asia, where coal consumption is expected to increase from 77.5 quadrillion Btu in 2008 to 144 quadrillion Btu in 2035 (nearly double). The biggest demand for fuel, going forward, comes from liquid fuel followed by coal.

Asian Coal Comsumption in Btu

I emphasize this at the beginning of my article just to focus on the fact that the primary demand drivers for coal consumption would be Asian countries. This region has huge economic upside potential and in the absence of any international agreement limiting greenhouse gas emission, the demand for coal will remain very robust.

The use of coal for generation of electric power is expected to be extensive for a country like India, which has a population of over 1.2 billion and a significant power deficit. Just to put things into perspective, the coal-fired electricity generation capacity in India is expected to rise from 99 gigawatts in 2008 to 172 gigawatts in 2035. The same holds true for China, where the coal-fired generation capacity is expected to double during the period 2008-2035.

In 2010, China and India accounted for 56% of the world’s total coal consumption (with the bulk of the consumption coming from China). The global coal consumption grew by 7.6% in 2010, with Asia Pacific countries accounting for 79.7% of the increase. What this tells us is that even if the Developed world goes through a long period of sluggish GDP growth; the annual coal consumption will remain robust aided by strong demand from Asia Pacific.

To add to the positives, the reserves-to-production ratio (R/P ratio) for coal is lowest in Asia Pacific (57 years), with the number being even lower for China (35 years). The global R/P ratio for coal as of end 2010 stood at 118 years (which is the highest R/P ratio for any fossil fuel).

R/P Ratio for Coal in number of years

However, I have to mention here that the R/P ratio for coal in the year 2000 was 210 years. Therefore, the decline in the ratio in the past decade has been very significant. This is an indicator of the fact that growth in consumption is not matched by increasing reserves.

Significant Decline in Global R/P Ratio for Coal

Also, a low R/P for Asia Pacific region effectively means is that much of Asia’s demand would be met by importing coal. This, in turn, would benefit large global players with significant coal reserves outside Asia.

The biggest beneficiaries would be players in Europe and Eurasia, which has 35.4% of the world’s proved reserves and an R/P ratio of 257 years and North America, which has 28.5% of the world’s proved reserves and an R/P ratio of 231 years.

On digging deeper into the reserves profile, I found that nearly 75% of the coal reserves are concentrated in six countries – United States, Russia, China, Australia and India. With increasing production cost and relatively poor investment in coal mining in the last decade, the scales seem to be largely tilted towards higher prices of coal on the back of all these fundamental factors.

From this perspective, I would consider long-term exposure to coal through some ETF’s and some stocks. With a slowdown in China, which accounts for 48% of the world’s annual coal consumption, I would use any decline in demand and price for coal as a buying opportunity. Listed below are some good investment options (in my opinion).

1) Market Vectors Coal ETF (NYSEARCA:KOL) – The ETF seeks to replicate the price and yield performance of the Stowe Coal Index (TCOAL). TCOAL is a rules-based, modified-capitalization-weighted, float-adjusted index intended to give investors a means of tracking the overall performance of a global universe of listed companies engaged in the coal industry. The ETF has a net expense ratio of 0.59% with total assets under management of USD323.8 million. The ETF helps investors get exposure to large Chinese companies operating in the coal mining industry

2) Yanzhou Coal Mining Company Limited (NYSE:YZC) – YZC is primarily engaged in coal mining, washing, processing, distribution and coal railway transportation is an excellent long-term investment option. YZC is currently trading at a PE of 5.9 with a dividend yield of 4.01%

3) Coal India Limited (CIL) - is a holding company, which produces around 81.1% of India’s overall coal production. I mention this stock as the Indian markets would be soon open to foreign individual investors and Coal India is an excellent long-term investment option

A case for long-term investment in coal looks convincing to me from the fundamental factors of demand and supply coupled with factors such as production cost, poor reserve estimates and the long-term growth story for Asia.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.