Why King Coal is set to take back its throne
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Associate Editor
David Stevenson Oct 09, 2009
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Coal was reckoned to be on its way out just a decade ago. But now it's making a big comeback. How do you cash in? David Stevenson reports.
"A couple I know experienced a rude interruption on a recent Saturday night," says Rich Karlgaard in Forbes. The two were at the local cinema, enjoying the latest thriller, The Taking of Pelham 123. But they never got to see the end of the film. Halfway through, "the cinema lost its electricity. The cause: a 'rolling brownout' caused by California's heat wave and excessive use of air-conditioning." To put it another way, there just wasn't enough power to go round.
Rolling brownouts are short-term voltage cuts used by energy providers as emergency measures to stop complete blackouts. They're a growing headache in the Golden State. And the problem would be far worse, but for US power suppliers being able to rely on that most basic of fossil fuels: coal. Old-fashioned, and often viewed as the dirtiest fuel on earth, coal has a faintly Dickensian image, conjuring up visions of grim factories with grimy chimneys churning out smog. Yet coal is still the key raw material for US power generators. Coal accounts for almost 50% of the country's electricity production, more than twice the amount derived from natural gas (see Two hot plays on natural gas) and nuclear combined. And despite talk of 'renewables', these supply just 9% of America's needs, with hydro providing the vast majority of that.
Volatile oil prices and nuclear energy fears have further reinforced coal's stranglehold over US power production. "In terms of cost and energy security, coal has all the advantages, its proponents argue," says Elizabeth Rosenthal in The New York Times. "Coal reserves will last for 200 years, rather than 50 years for gas and oil. More importantly, dozens of countries export coal – there's no cartel – so there's more room to negotiate prices." And on top of that, a quarter of the planet's coal reserves lie within US borders.
America is mulling over ways to lessen its coal dependence. In June, law makers passed the Waxman-Markey bill, which would harshly tax US utilities relying on coal, nuclear and natural gas. The money raised would subsidise the 9% of power supplied by renewables. But while this may sound good on paper, in reality it's just a recipe for more brownouts. The alternatives just can't provide enough power. Hydro is mostly tapped out – just about every dam that could be built has been built, says Karlgaard. "At best, solar, wind, batteries, geothermal and cellulosic ethanol combined will meet 20% of our needs by 2025. The smart money would bet on 10%. Coal gets a bad rap, but walking away from clean coal technologies while chasing windmills will be economic suicide. There's no way the US economy can enjoy future prosperity without the big three electrical energy sources of natural gas, nuclear power… and clean coal."
It's not just America. Coal is the most widely-used fuel for electricity generation in the world, responsible for 42% of global production. What's more, outside the US, the percentage of power generated by coal will rise steadily. For example, last year, Italy's main electricity producer, Enel, said it was converting its plant at Civitavecchia, near Rome, from oil back to coal, so providing half the company's overall generation needs. By 2014, Italy is set to increase its reliance on coal from 14% to 33%.
The International Energy Agency (IEA) reckons Europe's electricity needs will rise by 15%–36% by 2030, which means 400GW (one gigawatt = a billion watts) of new EU power plant capacity is required. Across Europe, up to 50 coal-fired plants, each with 50-year shelf lives, are expected to be built during that time. The IEA also expects that in 20 years' time roughly 60% of EU-generated power will be derived from fossil fuels.
And that's the 'old', slow-growing economies. Emerging economies are even more demanding. Between 2002 and 2007, Chinese power output grew at double-digit levels. China gets about 80% of its power from coal, and has recently been building new coal plants at the rate of 70GW-100GW a year. It's already added about 400GW of new coal generation capacity since the start of 2004. That's about 25% more than the combined total of all US coal power plants, which took 60 years to build.
Yet future power demand in China and India is still set to climb strongly. In the long run, says the IEA, this all adds up to coal use doubling in the next 30 years. In short, it may be old-fashioned, but coal is here to stay. So how do you cash in?
The cheapest coal miners
There are plenty of quoted miners, and while the 'spot' (ie, market) thermal coal price has dropped sharply from mid-2008 (see main chart), many of the producers' stock prices have picked up recently. For example, four months ago we tipped low-cost US coal producer Peabody Energy (NYSE: BTU) at $30. The price has since risen to $38. On a forward p/e of over 16 times, Peabody's clearly not as good value now as it was then. While we wouldn't put you off topping up your holding, there are better plays out there.
For example, Alan Heap and Alex Tonks of Citi have just upped their forecast for next year's hard coking coal price from $140/tonne to $200/tonne, but they reckon Australian coal export growth "will be constrained by the slow pace of port and rail infrastructure growth development". That gives an opportunity to get into Aussie coal stocks. Two that still look cheap are thermal and coking coal producer Centennial Coal Company (AU: CEY) and its eastern Australia rival Gloucester Coal (AU: GCL).
Centennial, operator of the Cook Colliery, exports worldwide. Despite rallying over the last few months, the share price is still lower than a year ago. At A$3.13 and a market cap of A$1.18bn, it sells on 11.3 times forecast earnings for the year to June 2011. The prospective yield is set to rise to 4.5%. Gloucester is smaller, with a market value of just over A$500m, but it's also cheaper. The consensus view for the year to June 2011 is a p/e of eight and a forward yield of 6.2%. Again, while the stock has rallied in 2009, it's only up 10% on a yearr ago.
Indonesia is another big coal supplier to consider. The Citi team reckons that "at current prices, Indonesian material is likely to be more attractive to Chinese buyers". The Indonesian Coal Mining Association sees national coal production rising 8% next year, while the country's second-biggest producer (which has a listing in Germany as well as Indonesia), PT Adaro Energy (GR: A64), is looking to buy BHP Billiton's local Maruwai coal mining project. On 13.2 times next year's forecast earnings, Adaro isn't as cheap as its Australian rivals, but is worth watching as a long-term bet.
Profiting from clean coal
That's all very well for coal miners. But hang on, you say, what about the 18 billion-plus metric tonnes of CO2 already entering the atmosphere every year from using fossil fuels, trapping heat and raising global temperatures? Won't extra coal burning mean ecological disaster? Maybe not. "Coal accounts for over 40% of all energy-related CO2 emissions worldwide, with the US and China together responsible for half," says Armond Cohen of the Clean Air Task Force. "Fortunately, recent evidence of a willingness jointly to develop and deploy new technologies that reduce carbon emissions offers real hope."
Carbon capture and storage (CCS) technology allows carbon dioxide to be separated from fossil fuels, liquified and stored in underground reservoirs. Indeed, it could represent the future for coal, says Hsi Chan on Theticker.org. "Dirty fossil fuel power plants may be a thing of the past, as researchers race to develop cost-effective CCS technologies to reduce CO2 emissions. According to the Intergovernmental Panel on Climate Change, current CCS technology could reduce emissions from coal power plants by 80%-90%."
The third-largest utility in the US, Duke Energy, has became the nation's first electricity producer to announce a joint CCS project in China with Huaneng Group, the biggest Chinese utility. Furthermore, "the 30-year-old coal-burning Mountaineer generating station in West Virginia has just become the first commercial power plant to capture and bury some of the carbon dioxide it spews", says Peter Gorrie in the Toronto Star. "The experiment is a tiny step with giant implications for what we're increasingly told is the only technology that could save us from the worst of climate change."
The only trouble is, CCS is pricey – very pricey. It cost $100m at Mountaineer to process just 1.5% of the plant's annual greenhouse gas emissions. And the energy needed to operate CCS for the whole plant would cut efficiency by about a third and raise costs by 50%.
That could change as the technology improves. US Energy Secretary Dr Steven Chu has channelled $3.4bn into CCS research. And Brussels could soon hand out "hundreds of millions of euros of EU funding" to develop the technology, says Reuters. But the only listed pure play on commercially ready, large-scale carbon capture is the tiny Canadian TSX Venture Exchange-traded HTC Purenergy (CVE: HTC), with a market capitalisation of just C$31m.
HTC provides CCS solutions and churns out CO2 capture research, "including breakthroughs in designer solvents, absorption efficiencies and heat duty reduction". Furthermore, HTC says it has "licensed, internationally developed, and acquired a range of CO2 technologies to create a world-leading, carbon-capture product offering". The company has a global licensing agreement with Doosan Babcock Energy/Doosan Heavy Industries, the world's largest boiler maker, under which Doosan has a licence on all HTC's technology for commercial-scale, coal-fired power plants.
At C$1.68, the shares are clearly high risk. The firm has no debt and C$8.7m in cash, with net tangible assets of nearly C$19m – but so far has racked up C$8.7m in development losses. Yet "the company offers the most cost-effective version of large-scale CO2 capture available today", says Khurram Malik at Jacob & Company. He has a 12-month 'speculative buy' target of C$4. We wouldn't bet the house on it, but as long as you only invest money you can afford to lose, HTC could end up being a very profitable play on the future of coal.
Of course, another cleaner alternative to coal is natural gas, which is the world's second most widely used energy source. Eoin Gleeson looks at the state of that market and ways to play the commodity. See: Two hot plays on natural gas.
• This article was originally published in MoneyWeek magazine issue number 456 on 9 October 2009, and was available exclusively to magazine subscribers. To ensure you don't miss a thing, and get instant access to all our premium content, subscribe to MoneyWeek magazine now and get your first three issues free.
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