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Mark Anthony, is an IT professional and who had a scientific research background before joining the information revolution. Visit his blog: Stockology (http://stockology.blogspot.com/)
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  • The Darkest Star In The Commodities Boom 9 comments
    Mar 3, 2012 6:58 PM | about stocks: AAPL, ACI, ANR, BTUQ, PCXCQ, SWC, PAL, UNG, KOLD, USO
    In 2008 I wrote an Editor's Pick article The Brightest Stars in the Commodities Boom, Part I, and Part II. By luck I correctly called the topping of JRCC as well as the general coal mining sector at the time, on the exact day. Please read those old articles again, as they contain good principles of how to determine the rally potential of specific commodity sectors.

    As every one focus on the brightest spots in the market, let me talk about the darkest star instead. Physicists say that the darkest matter also shines brightest when it glows. A savvy investor would notice what others ignore, and would appreciate the beauty of Cinderella before she is invited to a royal party and be admired by all.

    The darkest star is literally dark in color. This sector is also at its darkest moment now. It will soon glow from the darkness and become the brightest star. I am talking about coal.

    While the Dow and S&P index hit multi-year high, and famous adult toy maker AAPL reaches half a trillion dollar, the US coal mining sector is at its darkest moment. Coal mining shares PCX, ANR, ACI and BTU are at or near multi-year lows. US coal price is at two year low and natural gas price is at the lowest in 10 years.

    Pessimistic views are rampant. Fellow SA contributor Peter Epstein wrote about the bearish views and quoted pessimistic views from mining executives themselves. But I am bullish. I believe this is the best time to invest in coal mining stocks. An incredible US coal rally, unlike any of the previous ones, is coming imminently.

    How dare I differ from the opinions of coal mining executive? Do I know something that experts in the coal business don't know? Well, back in late 2008 I urged management of PAL and SWC, the only two North America palladium mining company, to utilize their cash at hand to acquire palladium stockpile at the low price of $200 or even $165 per ounce. I told them to produce from a European palladium mine with 99.9% purity ore grade and below $200 production cost. The mine is called Swiss Bank Vault. I told them when a commodity is sold below production cost the low price could not last long.

    No one listened, instead PAL made secondary public offerings at rock bottom stock price, hurting their share holders. The PAL to SWC share price ratio used to be 2:3, now it is 1:5. Had they listened they would have turned the $80M cash into $280M as palladium rallied to $700+ an ounce, and they would not have diluted their shares. Therefore savvy investors generally have a broader view than near-sighted executives who know little beyond their own company. It is no wonder that the executives often predict the market wrong.

    Let me say it again, commodities can not be sold below production cost for long. If the price is too low, money losing producer will have to cut production or go out of business, leading to tighter supply and price recovery. On the opposite, when price is too high, producers will rush to produce more (if they can), leading to price collapse. It keeps going up and down in repeated cycles, like seasonal changes.

    The US coal market is such, as I discovered, that it only takes a small percentage of supply/demand imbalance to tilt the market either way, causing extreme swings of coal mining share prices in relatively short period of time, providing excellent opportunity to reap huge profits from such big swings.

    Most US coal miners are now un-profitable. Some have started to cut production. That gives us the confidence that we are at or near the bottom. The downside of the sector is limited and will be over soon. So what will continue to keep it down? What about the up side potential?

    US coal price is dragged down by several domestic factors. Warm winter cut electricity demand; abundant natural gas production depressed the price of both natural gas and coal, as utility companies switch to the cheaper fuel for electricity generation.

    Are these bearish factors exaggerated? First let's look at some numbers. In fuel energy equivalence:

    1 ton of coal = 4 barrel of oil
    5.6 mmBtu gas = 1 barrel of oil (1 mmBtu is about 1000 cubic feet)

    Today Brent crude oil is $125 per barrel. US coal is $60 per ton. US natural gas is $2.50 per mmBtu. Thus coal is priced at $15 per barrel of oil while natural gas is priced at $14 per barrel of oil. Isn't $15 or $14 per barrel ridiculous, when the Brent crude oil is $125 a barrel?

    The so called natural gas glut due to shale gas over production is exaggerated. The EIA gas storage data was 3805 BCF and 3850 BCF, respectively for Thanksgiving Day 2010 and 2011. That was little build up in a year, indicating balanced supply/demand. Currently the storage is about 700 BCF above average. It was entirely due to a warm winter, a one time event. 700 BCF is worth about 9 days of US natural gas consumption in the winter, not a big chunk in terms of annual demand.

    Do you know that USA is still a net natural gas importer? We import from Canada. Canada has oil sand, which is cooked using natural gas to produce crude oil. Due to extreme price disparity between crude oil and natural gas, Canada is better off keeping the natural gas to itself to produce more oil sand. We imported 371 BCF in January, 2011, by Nov. 2011, the import dropped to 246 BCF, losing 125 BCF a month, or 1500 BCF a year. If the imports from Canada continue to drop, the pathetic 700 BCF extra storage people talk about will be gone before you notice it. Good for Canada as its LNG export to Asia now fetches $15 per mmBtu, when the US gas is selling for only $2.50.

    The new US shale gas wells are said to have very steep decline rate, with a production drop of 65% to 85% within the first year. Current low natural gas is un-profitable for shale gas producers. As they reduce the rigs drilling wells, the glut may turn into a shortage soon.

    Japan boosted its LNG import in January, 2012 by nearly 30%, and boosted coal import by 7.9%. Japan pays $15 per mmBtu for the LNG. Europe is paying $12 for the LNG. There is no glut of natural gas. There is a shortage of LNG vessels so all the countries desperate for energy needs will have to turn to coal importation instead.

    There is no coal glut in the US, either. Based on EIA data, US coal stockpile is smaller than it was the same time last year. The stockpile was 243M tons in Oct., 2010, and 209M tons in Oct., 2011. Restocking alone would require 34M tons of coal. So much for the 50M ton less US coal demand that coal mining executives were worried about.

    50M tons of coal is a significant number to tilt the supply and demand of the US coal market of about 1 billion tons a year. But it is a small number compare with the big scheme of things globally. US exported nearly 110M tons of coal in 2011, a record year, beating 2010's 82M tons and 2009's 59M tons exports. At this pace of rapid increase US could easily add another 35M tons coal exports this year, to 145M.

    India is projected to import 140M tons of coal this year versus 114M last year. So here comes another 36M tons extra demand from India.

    But the biggest story is China who has a giant and rapidly growing coal demand. China's coal production and demand saw double digits growth for more than ten years and it is not slowing down any time soon. Last year China produced about 3.78 billion tons of coal and imported 182 million tons, thus become the world's No. 1 coal importer only 2 years after it became a net coal importer in 2009.

    Chinese government agency predicts a 30 to 40 GW power shortage this year, worse than 2011. China has enough installed fire powered generation capacity. The problem is government control of electricity price makes power plants reluctant to buy coal to generate electricity at a loss. They will have to wise up and let the free market determine the prices. China needs 200M tons of extra coal just to plug the hole of 40GW power shortage. (0.55 kg coal is needed to generate 1 KWH of electricity)

    The Chinese demand growth is not slowing down any time soon. The numbers are still small comparing with the Chinese population. China generated 4.7 trillion KWH of electricity in 2011, versus 4.1 trillion KWH in the US. Averaged over the population, each Chinese enjoyed an average of 390 watts constant electricity power, barely enough to light a bulb and run a computer at the same time.

    But China's coal production growth may slow down or even slide in 2012. According to BP, EIA and World Energy Council, China's coal reserve is roughly 100 billion tons. That is not a lot of coal comparing with 3.5+ billion tons a year production.

    I predicted that China has reached or is near Peak Coal production. There are a few signs that China has reached Peak Coal. Industry users have been complaining about inferior quality of coal: the same amount of coal containing less amount of heat. Coal miners would not intentionally produce inferior coal: They would always dig the best qualify coal first to fetch good money. They only turn towards low quality coal as the mines begin to deplete and the low hanging fruits have been picked. There are reports of whole villages in Shanxi collapsed as the ground itself collapsed due to hallowed out coal mines underneath. How long can they keep digging?

    Peak Labor also plagues the Chinese coal mining industry. The method of coal mining has not changed dramatically. To produce 10% extra coal, you would need to dig 10% more coal wells, utilize 10% more equipments and electricity, and hire 10% more miners to do the job. As the Chinese coal mining industry expanded rapidly over the decade, there was never a shortage of young migrant workers from the poor rural villages willing to take up the dirty and dangerous job for a very moderate salary. The army of coal miners kept expanding rapidly.

    But the unlimited expansion is coming to a sudden end. China's One Child policy is finally taking its toll and ending the much talked about demographic dividend. After the Chinese New Year break at the end of January, 2012, when factories throughout China reopened and wanted to expand their business, they found they could not find many migrant workers to hire! "Yong Gong Huang"(labor source scarcity) became a new buzz word in Chinese blogosphere. Worst hit must be the coal mining industry. I saw job ads of up to 10,000 yuan ($1600) per month for freshman coal miners! Typical city jobs for migrant workers pay about 2000 to 3000 yuan. There must be a coal miner shortage.

    As the reserve depletion and labor shortage limits growth of Chinese domestic coal production, the authority also realized the need to limit growth and preserve the resource for longer. Inner Mongolia, whose coal production reached 979 million tons in 2011, announced that it will cap the production below one billion tons before 2015, which means little more growth allowed from the 2011 production level. Shanxi province announced that they will limit 2012 production to 850M tons, which is a drop of 22M tons from the 2011 level.

    Inner Mongolia and Shanxi alone accounted for the entire Chinese coal production growth from 2010 to 2011. If these two provinces do not see higher production in 2012, China will see little production growth.

    As China's coal demand continue to grow aggressively while domestic coal production is limited by reserve depletion, labor shortage and the authority's conscious decisions to limit production to preserve the energy resource longer, China must rely more on coal imports.

    The outlook for US coal market can not be better and there can not be a better entry opportunity into the US coal sector but right now. Coal mining stocks like JRCC, PCX, ACI, ANR, BTU, etc. are at their lowest levels since 2009. During the US coal rally from 2007 to 2008, I reaped only a small profit but missed the big part of the JRCC rally, from $3.56 to $62 in only ten months (+1700%). I regretted ever since then.

    But the darkest star in commodities is going to grow brilliantly soon!

    I am so happy that history repeats itself and I can try to do my best this time around in the US coal sector, are you ready to do the same?

    Full disclosure: At the time of writing, the author continues to hold a core position in palladium mining stocks SWC and PAL and is heavily invested in coal mining stock JRCC, PCX and others. I have no position in AAPL yet but am looking for good entry price to short it.

    Disclosure: I am long JRCC, PCX, SWC, PAL.

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Comments (9)
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  • rjj1960
    , contributor
    Comments (1359) | Send Message
     
    Great job here, nice to look at a time frame longer then 30 seconds. This week was brutal for the coal stocks so your article is well timed. Thanks and keep up the clear thinking.
    3 Mar 2012, 06:54 PM Reply Like
  • jmartz101
    , contributor
    Comments (187) | Send Message
     
    Great article I got in to BTU on Friday but am a little nervous on that trade.
    4 Mar 2012, 02:26 AM Reply Like
  • Titan06
    , contributor
    Comments (303) | Send Message
     
    great article, i agree "when a commodity is sold below production cost the low price could not last long." so the question is when exactly will we see a rally in natural gas prices. i think within the next 6 months just look at the rapid decline in gas rigs. Company's are losing money and switching to oil.

     

    http://bit.ly/z1Csqi

     

    http://reut.rs/w8qbYf
    4 Mar 2012, 02:51 PM Reply Like
  • The Linch Scale
    , contributor
    Comments (41) | Send Message
     
    Agree with your article 110%.
    5 Mar 2012, 12:49 PM Reply Like
  • Energy-Trader
    , contributor
    Comments (612) | Send Message
     
    Unfortunately, the supply/demand equation for thermal coal here in the United States for utilities is out of whack. There are 69 days of inventory on hand, vs the 45-50 that we see in the "normal" market place. I'm a big bull on Coal and especially companies like BTU that have been building out their asset base in Australia and Mongolia to feed the demand out of China. But you have to be careful here, and not try catching a "falling knife". As previously mentioned by "Titan" above, one of the keys going forward will be nat-gas prices.

     

    I enjoyed the article.
    Thanks!
    6 Mar 2012, 05:24 PM Reply Like
  • Titan06
    , contributor
    Comments (303) | Send Message
     
    69 days of inventory are because of a warm winter. a hot summer and a surplus quickly becomes a deficit . As for natural gas prices take a look at this chart. Almost every single gas well is unprofitable and thus we see the massive decline in rig count. its only a short matter of time before we see a rally in gas prices in my opinion, prices simply can not stay this low with production decreasing rapidly

     

    http://bit.ly/yq2OYj
    6 Mar 2012, 06:01 PM Reply Like
  • Mark Anthony
    , contributor
    Comments (3601) | Send Message
     
    Author’s reply » The US coal inventory is actually LOWER than where they were the same time last year:

     

    http://bit.ly/x8YkGN

     

    There is no coal glut. Power plants had 168M tons of coal at hands in Nov., 2011, way below Nov., 2010 and Nov., 2009 figures.
    6 Mar 2012, 06:39 PM Reply Like
  • cleveland1
    , contributor
    Comments (185) | Send Message
     
    If coal is so cheap compared to oil, why aren't there more consumers of coal?
    8 Mar 2012, 10:58 AM Reply Like
  • vorgriff
    , contributor
    Comments (167) | Send Message
     
    Great article, Mark

     

    Any preference on coal companies? I'm long BTU.
    8 Mar 2012, 10:02 PM Reply Like
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