Mining for Profits in the Most
Unloved Fuel Source

Dear Investor,

Scale is everything.

For instance, in the U.S., the top 100 utility plants produce roughly 230,000 megawatts of power at peak summer loads, according to the U.S. Energy Information Administration. That’s slightly less than one-quarter of a terawatt.

Now, scale that up to 1.5 terawatts … that’s what China is adding over the next 10 years.

In that time, the country of superlatives – where words like “biggest” and “fastest” are commonplace – is adding the equivalent of America’s 100 largest power plants … six times over.

And 70% of those new power plants will rely on coal.

Now, if China met this increasing demand for coal with its own production, everything would be copasetic. Alas, that’s not the case.

Government policies in China are constraining domestic production growth. So instead, China’s increasing coal needs are coming from imports … and in that, you’ll find an investment opportunity. I’ll tell you how to profit from a coal company that may be the next big takeover, but first, let’s look at why this fuel will thrive, despite its bad name.

A Dirty Fuel – That Isn’t Going Away

Not a lot you can say about coal is sexy.

The energy is dirty. The environmentalists hate it. Mine explosions in the U.S., China and most recently New Zealand routinely take the lives of the miners. And countries – including China – are trying to get industry, particularly power generators, to wean off the energy source.

Many are pushing for natural gas, a cleaner burning commodity in excessive abundance these days. (I’ve written in The Sovereign Individual about one of the top natural-gas stocks to own in China. Its shares are up nearly 50% since late-June, and it still has plenty of room to run. Learn more about this company by clicking here.)

Yet, despite the move toward natural gas – and despite the efforts to promote alternative-energy sources like solar- and wind-power – coal is not a commodity headed toward extinction. It remains a primary fuel source, and as China’s demand growth shows, one of the world’s commodities that has a bright future.

Rising Demand for Coal Imports

To be sure, coal is destined to play an increasingly smaller part of China’s energy mix going forward. Nevertheless, the absolute volume of coal that China will consume will rise, driven in large part by the country’s own version of Manifest Destiny.

That’s the philosophy I’ve written about previously, in which China is purposefully driving growth across interior provinces. It’s the urbanization now taking place across China, in second- and third-tier cities like Changsha, the capital of Hunan Province (where I’m traveling this week to research and report on the middle-class trends reshaping China outside of Beijing and Shanghai).

Coal is a huge part of this multi-decade push. It’s the fuel for the steel mills that supply the steel necessary for the apartment blocks and new factories rising in the city. And it’s the source of electricity powering the ever-expanding number of homes and assembly lines that are evident across Changsha and so many other cities just like it.

Of course, China’s isn’t the only country where you find rising demand for coal imports. The trend is evident across much of Asia, including Japan, Taiwan and Korea, some of the most advanced economies in the region.

In South Asia, meanwhile, India’s need to import thermal coal – the type used to generate heat and/or steam to drive the turbines that create electricity – surpasses even China’s.

And then there’s the steel industry in China and India, two of the fastest-growing producers of the metal. Australian mining giant Rio Tinto estimates China’s production growth alone will double between now and 2020.

As with power, coal – in this case, metallurgical coal – fuels steel mills. That will only add to the pricing pressures.

An Investment for the Long Haul
– and the Short Term

Though we’re talking here about coal over the next decade, it’s not just a long-term play. Coal has characteristics likely to make it a winner over the course of 2011. A key factor at play is China’s rising cost structure for domestically produced coal.

The West has long derided China for low wages, lax safety and disregard for the environment, among other gripes. But China has been addressing those issues. That process, along with other factors like domestic transportation bottlenecks, has effectively doubled its domestic coal-mining production costs in the past five years, according to Bank of America Merrill Lynch.

That puts upward pressure on prices of imported coal.

And it is clear Beijing has imports on its agenda. China in September agreed to provide Russia with a US$6 billion loan that will finance the development of large-scale coal mines in Russia. Russia, in turn, will increase annual coal exports to China for at least the next 25 years.

Meanwhile, China, recognizing that domestic production won’t be enough, is trolling through Mongolia and Australia looking for additional imports.

For investors, the message is simple: own exposure to coal.

You can do that in the U.S. if you don’t want to venture overseas. The U.S. has several quality coal companies including Walter Energy, which just recently acquired Canada’s Western Coal. (Walter itself is a likely takeout candidate because of the quality of its metallurgical coal.)

Or you can own exposure to coal directly in Asia – through markets in Australia and Indonesia, the world’s largest exporter of thermal coal. You can even play the dry-bulk shipping companies that haul the seaborne coal to China; that demand is set to ramp higher.

Ultimately, if China builds just half the power plants it needs to fuel the growth and urbanization happening there, coal – dirty, nasty, environmentally despised coal – will clean up well inside a portfolio.

Until next time, keep a global view…

Jeff Opdyke
Editor, Emerging Market Strategist
Blog: http://globetrotter.sovereignsociety.com/