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Coal – that black rock that is pulled from the ground. It's not as sexy as oil, or new like ethanol, but it's a large part of the energy market. Do you know anything about it? Should you?

Maybe.

Coal -- a fossil fuel -- was formed from plant matter trapped under rocks and dirt for millions of years; kind of like oil. The heat and pressure of layer on layer of new dirt compressed that plant matter into what we call coal (heck, diamonds too).

Until the '60s, coal was the main source of energy on planet earth, and it's only been since then that coal has been outstripped by oil.

coal_chart

Even today, we burn more coal than natural gas, more than nuclear, more than anything but the other black gold made out of dead dinosaurs. It's not sexy, but it's a very, very big business, and to ignore it in favor of uranium trading and oil futures is simply foolhardy.

But for the most part, commodity investors DO ignore it. The coal futures market is still in its infancy, and coal is not part of any major commodities index. So, if you’re smugly holding a broad-based commodity fund and think you have exposure to the fast-growing coal market, think again.

A Big Player

Coal is the world’s second-biggest energy source for two reasons: first, there’s a lot of it, and second, a lot of it is easily accessible to the industrialized world. A full quarter of the world's coal supply can be found in the United States. The vast majority of this coal is put right on rail cars and hauled off to the nearest power plant to turn into electricity: that’s the fate of 92% of all coal in the U.S. The remaining 8 percent is used in higher value applications, mostly turning into ultra pure “coke” that's used in making steel.

China

Like so many primary economic inputs these days (copper, oil, zinc, trees), China is the big fat soot-stained elephant in the coal boiler room. China boasts 35% of the world’s coal reserves, and uses more of the big black rock than the U.S., EU and Japan combined. In fact, consumption keeps rising -- 14% in each of the past two years. India is right behind China, and coal plays an increasing role in fueling that economy too. , and with its fast-growing population, it will be eating a lot more coal in the future.

Why coal?

Well, for one, it’s dead cheap on a per-BTU basis. In 2005, the average price for a million BTUs of coal was $1.54. Natural Gas? $8.20. That's an unbelievable gap for the same energy, even if it separates the cleanest fuel and the dirtiest one. The price gap scared the natural gas industry so much that they launched a sophisticated, Hollywood-run ad campaign to disparage coal’s image (Face It: Coal Is Filthy.) That’s right – those ads with the beautiful, soot-stained models are not funded by some high-end environmental group, but by a coalition of natural gas firms.

Coal is so cheap that, if you've got a booming economy, it's easy to see how using anything else can start looking like a luxury.

The second reason people love coal is simple abundance. When the President talks about “America's Energy Security,” the sooty subtext is coal. We've got vast amounts of it. It's easy to get. We don't import it. Terrorists can't use it as a chokepoint.

So what's not to love? Almost everything else.

The inconvenient truth (sorry Al) is that coal, as it's used today, is terrible for the environment. From black lung to the stained buildings of London, coal's legacy is one of pollution and disease. Just mining the stuff creates sulfuric acid. Burning it makes it worse, and coal fired electric plants are the single largest emitters of CO2 on the planet. And even if we don't burn it in a plant, it can burn on its own – the Centralia, Pennsylvania mine fire started in 1962 and is STILL burning.

Clean Coal

A slogan any ad wonk could love, Clean Coal remains a dream more than a reality. The problem, at the end of the day, is that medieval alchemists never figured out how to turn lead into gold. When people talk about clean coal, what they really mean is “keep all the bad stuff out of the air.” But the bad stuff has to go somewhere: all that sulfur has to be disposed of; all that carbon has to be taken care of. This has led most environmental groups to label the “clean coal” movement as nothing more than greenwash.

Are they right? Sort of. There's little question that keeping the bad stuff out of the air and into a tank is a step in the right direction. And much of the research on how to deal with greenhouse gases is being driven by clean coal research dollars. The story of coal in 2007 is about the folks working the problem. In fact, when you hear about coal these days, it's almost always as part of an environmental story (and thus a political story) about the need to reduce greenhouse gases. But the reality is that we're just at the beginning of a clean coal economy.

Black Gold?

As ugly as it is, there is money to be made here. 80% of coal is sold on the long-term market, usually in contracts for delivery over a year or more. The rest is sold between the spot and OTC market. NYMEX started offering coal futures in July 2001, and now has three different coal futures available, each with a different delivery point. [NYMEX ClearPort: QL, QX, QP] ICE started offering contracts in 2006. None of these feature anything like the volumes you find in the oil market, but they are growing.

A more rational approach for most investors is to look at the coal companies themselves: Consol Energy Inc., Peabody Energy, Yanzhou Coal Mining, Cameco, Arch Coal, Inc., Massey Energy Company, etc. Understand, however, that for the most part, these are old (old) economy companies, and fundamental value, balance sheets and capital budgets are going to drive your decisions.

A third way to “get in on” coal is to look to the companies that are working to make it a greener fuel. The problem, as is often the case with big-market innovation, is that there are no pure plays to speak of. General Electric, Bechtel, Siemens – these are not companies one buys for their upstart innovation programs. There's only one newsworthy company that gets any traction off clean coal, and that's Fuel Tech (NASDAQ: FTEK). They do exactly what you'd want your pure play to do in coal – they clean up emissions and work on pre-combustion technologies that help coal burn cleaner. The problem is that everybody knows that Fuel Tech is the poster child for coal, so it pops on Cramer recommendations and politics more than it does on any real focus on fundamentals.

Coal remains the most boring, sizzle-less steak on the energy BBQ. It just happens to be the one we'll be eating until we move to Florida and live off grapefruit. Its main role, most likely, is to keep a check on the prices of other energy sources: if natural gas and oil get too expensive, folks will turn to coal no matter how many soot-faced models are splashed onto billboards across America.

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Coal in the News

TXU Corp (TXU) plans to build two clean coal-power demonstration plants in Texas. Wall Street Journal, March 12, 2007

TXU, bought out by private-equity groups, decides nuclear is better. Wall Street Journal, April 10, 2007.

Duke Energy Corp (NYSE:DUK) receives permission to build only 1 of the 2 proposed coal-fired power plants. Is also required to spend $ on energy-efficiency programs to help stem growing demand.

Source: Coal: The Black Gold?