Growth in Coal Demand Will Come From
Emerging Markets
June 13th, 2012 by Investing Daily
By: Elliott Gue
The US boasts the world’s largest reserves of steam coal and is a leading producer of this commodity,
though the majority of this output is destined for domestic consumption.
Source: BP Statistical Review of World Energy 2011
In 2011 US shipments of steam coal to international customers ranked sixth in the world, trailing
Indonesia, Australia, Russia, South Africa and Colombia.
Source: World Coal Council
As US coal exports account for 10 percent or less of global demand, supply and demand conditions in the
international market for steam coal have little influence on North American prices. In the near term, US
producers have limited scope to ramp up international shipments of steam coal and alleviate the domestic
supply glut. The nation’s operating export terminals have a total capacity of 173 million short tons per
annum–equivalent to roughly 16 percent of the industry’s annual output.
Source: Reuters
Moreover, shipments of metallurgiucal (met) coal–the kind used in steelmaking–usually command a
higher price than the varietal burned in power plants; steam coal accounts for only two-third of US coal
exports. Although the industry’s long-range plans include several export terminals on the West Coast to
take advantage of Asia’s demand for met coal, these projects remain in their nascent stages and won’t
ameliorate the current supply overhang.
A similar situation prevails in Canada, where met coal accounts for 90 percent of annual exports.
In short, investors shouldn’t assume that supply and demand conditions in the North America prevail in
international markets. The US steam coal market hinges on domestic demand for electricity, while the
seaborne market for this kind of coal depends on growing power consumption in emerging markets such
as China and India.
The coal-to-gas switching that’s plaguing US coal producers hasn’t come in to play in most international
markets because the price of natural gas is often four to five times higher than in North America.
The world’s top 10 countries in terms of coal-fired generation capacity account for 80 percent of the
world’s installed base. China, home to the largest fleet of coal-fired plants, makes up more than 40
percent of the world’s total capacity.
Source: International Energy Agency
Of the major coal-consuming nations, China and India will drive the seaborne market in the near term and
long term. The insular US market depends primarily on domestic production and has little capacity to
ramp up exports, while the weak EU economy will weigh on Germany’ electricity demand in the near term.
Over the long term, environmental concerns will likely stymie the construction of additional coal-fired
power plants in Germany and other EU member states
In contrast, demand for electricity will continue to surge as China and India industrialize. Coal’s cost
advantages should ensure that the fuel remains the dominant feedstock in these emerging markets.
Liquefied natural gas prices in Asia hovered around USD15 per million British thermal units at the end of
May, while the cost of steam coal delivered Australia’s port of Newcastle amounted to less than $5 per
million British thermal unit.
Rapid economic growth and development in China and India has fueled growing demand for electricity,
as increased urbanization tends to increase power consumption.
Source: Energy Information Administration, World Bank
China’s electricity consumption grew more than twelvefold between 1980 and 2009, while per-capita
electricity demand increased ninefold. Over the same period, India’s electricity demand increased by
more than 6.5 times and per-capita power consumption quadrupled. These growth rates dwarf the 78
percent increase in total US electricity demand over these 20 years.
Moreover, China and India have a long way to go before per-capita power demand reaches levels that
prevail in the US and Western Europe. China’s per-capita power demand would need to increase by an
additional 150 percent to equal per-capita electricity use in Germany and by almost 500 percent to match
the US.
When you consider that China’s population is about four times that of the US, even a modest increase in
the Mainland’s power consumption implies a substantial upsurge in demand for steam coal and other
energy commodities.
Not surprisingly, China and India dominate the league tables for new coal-fired generation capacity.
Although Western investors often fret that the retirement of older, coal-burning power plants in the US
and Europe will weigh on global coal prices, Asia’s emerging markets will continue to drive growth in the
seaborne coal trade.
Investors should also disabuse themselves of the misconception that China’s coal-fired power plants are
older, less-efficient and more harmful to the environment than their counterparts in the US and other
developed countries. Whereas 8 percent of coal-burning plants in the US are less than 20 years old, 90
percent of China’s coal-fired facilities were built within the last two decades.
Roughly 75 percent of China’s electric power plants have a nameplate capacity of more than 300
megawatts, on par with the US and Germany. These larger plants usually operate at higher efficiency
rates and have superior environmental controls than smaller facilities. China’s base of newer, highly
efficient coal-fired power plants is testament to the country’s commitment to this oft-maligned feedstock.
Source: International Energy Agency
In each of the five-year periods depicted on this graph, the International Energy Agency (IEA) expects
China to add the most coal-fired capacity, with India following closely on its heels. Although the US will
build some coal-burning power plants, most of these additions will occur in the near term and will be
offset by the closure of older facilities.
Factoring in plant retirements, the IEA’s forecast calls for China to add 488 gigawatts of generative
capacity by 2035–a roughly 75 percent increase to its current base. Over the same time frame, India is
expected to grow its generative capacity to 225 gigawatts from 101 gigawatts. At this rate, India will
overtake the US as the second-largest consumer of steam coal within the next 15 years.
How will China, India and other emerging markets obtain the coal to fuel these power plants? Imports will
be a big part of the equation. Although China is the world’s leading producer of steam coal and India
ranks third, domestic production won’t keep pace with demand growth.
Over the past five years, China’s output of steam coal has increased by 38 percent, while demand has
surged by 41 percent. India’s production of steam coal has grown an impressive 33 percent, falling short
of the 50 percent increase in consumption. These supply gaps appear relatively minor, but the size of
these markets translates into substantial demand for imported steam coal.
Although investors tend to focus on China’s insatiable appetite for oil, iron ore and other commodities,
India’s demand for imported steam and met coal will likely increase at a much faster rate. Not only are the
country’s domestic coal reserves of relatively low quality, but the country has also struggled to grow
production because of government restrictions on land use. India’s transportation infrastructure also
makes it difficult to deliver this output to the marketplace. The government has effectively acknowledged
that these challenges will persist by siting most of its newly built power plants near the coast, a location
that facilitates seaborne imports.
In recent years, Australia and Indonesia have battled for the title of the world’s leading exporter of steam
coal. Together, the two nations supply about 45 percent of the global market for seaborne steam coal. In
coming years, I expect Australia’s efforts to expand terminal capacity to enable it to hold the top position.
According to the Australia’s Dept of Resources, Energy and Tourism, the country’s total export capacity
will increase to about 448 million metric tons per annum (mmtpa) from 333 mmtpa at the end of 2008.
Indonesia has grown its exports of steam coal considerably in recent years, benefiting from the
predominance of relatively inexpensive-to-produce surface mines that are located near waterways.
Meanwhile, the nation’s rapidly expanding economy has fueled an almost threefold increase in domestic
coal demand between 2000 and 2010, prompting the government to debate new laws that would restrict
exports.
Colombia, Russia and South Africa also have the capacity to export significant amounts of steam coal.
Although reserves of steam coal are more widely distributed throughout the world than the metallurgical
variety, rising import demand in emerging markets should support the price of seaborne steam coal over
the long term.
Based on these long-term trends, I expect coal remain the world’s leading source of electricity for at least
15 more years.
energy stock in the sector. The stock has pulled back significantly over the past year, stung by declining
coal prices and short-term concerns about Chinese demand.
However, Peabody Energy is well-positioned to navigate the current environment. The company in
October 2007 spun off its coal mining assets in Central Appalachia (CAPP), a region where rising costs
remain a permanent headwind, with the initial public offering of Patriot Coal (NYSE: PCX). Not only did
Peabody Energy monetize these mature assets in a bull market for coal, but the move also enabled the
firm to focus on building its exposure to growing its production in Australia.
Although the US market for thermal coal faces undeniable headwinds, investors haven’t given Peabody
Energy enough credit for its domestic asset base and substantial operations in Australia. Trading at only
0.8 times revenue, the stock has more than priced in any additional bad news. In fact, the shares
command a lower valuation than they did at the height of the 2008-09 financial crisis.
The key upside catalyst for the stock will be a turn in sentiment regarding Chinese steel demand, which I
expect to occur in the back half of the year.