The cornfields of the Midwest aren't the only place where the weather is wreaking havoc on commodities prices. Let's follow a thread:
The media has, for months, been reporting on power outages in China since this past winter's severe storms. But far from improving, the situation may be getting worse.
An estimated 80% of China's electricity is produced by coal-burning power plants. China has taken heat for those plants because of the increased air pollution and greenhouse gases that go hand in hand with burning coal. With the upcoming Olympics - along with increased discussion of climate change in general (thanks Mr. Gore) - the attention on China has been intense. As a result, China has been working on changing things in the local coal industry.
For many years, small coal mines popped up everywhere as China's electricity demand grew. This isn't unusual - the "small mine" phenomenon is prevalent in China for gold and other metals. Small coal mines are defined as those producing less than 300,000 tons of coal annually. Considering that China produces around 2 billion tons of coal each year, 300,000 tons qualifies as small. Some of these mines are legal, many are not. More importantly, they are dangerous.
Last year, nearly 3,800 people were killed in mining accidents in China. The latest accident took 11 lives just this past Thursday. In a horrible case of irony, this accident came just one day after China's state media touted that safety in Chinese coal mines had improved. What exactly is the cost of coal in human lives in China? Well, in the first half of this year, it was quantified as 1.05 people dying per million tons of coal produced. In 2007, that rate was 1.485, and in 2005 it was 3.08. So yes, safety has improved, but I'm not getting on a plane and changing careers anytime soon.
In 2007, small mines combined to produce 38% of China's coal production - even after the government had spent the past three years closing down many small mines - a total of 116,000 in the last two years alone. The number of coal mines in China is now somewhere around 16,000. The government has plans to close all small coal mines by 2015.
Put this in a local, human perspective. You live in the center of China. Your electricity comes from a small, local, coal-burning power plant (likely unlicensed by the state). For years, you've been getting that electricity thanks to a few mines on the hillside that produce just enough coal to keep the lights on. Now, the central government has told you that you have to close the plants and buy coal from a bigger, state-run mine farther away. What do you think happens?
And then came May and the devastating earthquake. Coal inventory got tight and Beijing was looking at the calendar. Summer and the Olympics were coming. How to meet this increased electricity demand and showcase China to the world? Suddenly, there was a call for more coal and the instant reopening of the small mines. But there's a standstill. It seems that the mixed signals are confusing and annoying local officials; the "official" reopenings are not happening. Add to that the very real possibility of accidents occurring in reopened mines and the threat of closures and job losses, and you can understand why new mines might not be opening anytime soon.
A Survey Of Coal Inventories
The Wall Street Journal ran an article on July 10 by Sherry Su that contained the following statistics:
- Coal inventory levels at China's power plants normally consist of 15 days' worth of stock
- 541 coal-fired power plants averaged 11 to 12 days of stock (as of July 6)
- 181 plants had fewer than 7 days of stock
- 64 plants had fewer than 3 days of stock
- Coal shortage will likely reach 10 to 20 million tons in 2008, according to Yang Tao, a KGI Securities Analyst
Aluminum And Energy
There is a commodities story here. I promise.
Last week, 20 of China's top aluminum smelters announced they would be reducing their production by around 10% because of power shortages. Those 20 smelters produce most of the country's aluminum (70%), and the 10% reduction equates to about 3% of global supply. Bloomberg states:
"The energy used by China's aluminum smelters each week is enough to provide power for more than 2 million people for a year."
That's a lot of energy going to the smelters.
The reductions are expected to last for at least three months. The impact of the supply cut was predictable: Aluminum is now at all-time highs.
LME Primary Aluminum ($/Tonne, Cash Buyer)
Of course, this setback for the smelters is being spun as a positive - the reduction in power usage by the smelters means more electricity will possibly be available for the Olympics and therefore, this sacrifice is a form of support for the Olympics.
There is also the added effect that a decrease in supply and the resulting increase in price may allow the smelters to make a better profit on the aluminum they can produce.
Needless to say, aluminum prices reacted to the news by jumping up 6% during the day on Thursday.
On Friday, Reuters interviewed Wen Xianjun, the vice president of the China Nonferrous Metals Association (which, like many other entities in China, is state-owned), and he gave new estimates for China's aluminum production for 2008. "
I have adjusted down the estimate by 1 million tonnes. If power supply tightness escalates, the output could be even lower," Wen told Reuters by telephone from Beijing.
That is a reduction of 6.5% from the original projection and represents the official acknowledgement of the impact of those cuts by the top 20 Chinese smelters. But like so many things about China, the situation is more complicated. While these seem like drastic cuts in supply, they come in a market that is experiencing a period of tremendous supply growth. Chinese aluminum supply grew 37% in 2007. Even with all these problems, Chinese production will be up another 18% over 2007, to about 14.5 million tonnes of aluminum.
How can you profit from China's energy woes? Tom Lydon at ETF Trends has a good quick summary on how the aluminum ETFs are benefiting from the production cuts in China. But if you don't hold one of them, you may already be exposed to these developments through your other energy investments. You see, the last time China had a power crisis (2005), it saw an increase in demand for diesel generators for electrical needs - Aggreko anyone?
Chinese Inflation HAI - June 23, 2008
China power woes may worsen before Olympics Reuters - July 8, 2008 10:46 a.m. EST
Power loads rise in China China Daily - July 8, 2008 17:19
Illegal Power Plants, Coal Mines In China Pose Challenge for Beijing WSJ - December 27, 2006