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Why Coal Prices Will Soar

By Chris Mayer, editor, Capital & Crisis
Thursday, June 17, 2010

In 2001, consensus opinion had the population of Beijing, China hitting 14 million by 2040. It topped that by 2003. Today, it has about 22 million people.
Also in 2001, experts thought Beijing would have – gasp! – 1 million cars on its roads by 2010. It also topped that figure in 2003. Today, there are nearly 5 million cars on the road.
China is now the world's largest car market and is quickly becoming the world's largest market for a number of consumer goods. It's also the world's largest market for mobile phones.
On a recent trip to Beijing, I saw these numbers come to life... and watched the unfolding boom serving China's new and growing disposable incomes. Besides busy shops and restaurants and 5 million cars on the road in Beijing alone, there is something more basic that underlines all of this. In fact, it is more fundamental to the entire story of Asia's new consumer.
It's energy. Yes, all those factories require power. But so do iPods and air conditioners. So do cell phones and computers. The modern consumer economy is a plugged-in economy that eats electricity like locusts devour crop fields.
As a result, China has added power plants as fast as they can make 'em. China adds more every day, accounting for about 80% of worldwide construction. The Economist reports that the capacity China adds in 2010 will exceed the entire installed base of Brazil. In the next two years, China will produce more power than the U.S.
Where does the power come from? About 80% of it comes from coal. Not just coal, but awe-inspiring amounts of the stuff. Consider that in 2000, China used about as much coal as the U.S. Here we are 10 years later, and China consumes three times as much as coal as the U.S.
There are a couple of problems with coal. One won't surprise you, but one may. First, coal is a dirty fuel. You have to spend only a few days in Beijing or any of the big cities to see what burning so much coal does to the sky.
This creates many health problems in China, and the Chinese know this. Hence, there has been a lot of money flowing to alternative modes of power generation — like wind and nuclear.
The other problem with coal, which might surprise you, is that China may have a hard time making more of it. This line of thinking comes from Richard Heinberg at the Post Carbon Institute.
As he points out, China is now burning some 3 billion tons of coal per year. In the last decade, it added 2 billion tons of production. That's quite a feat. But as Heinberg points out, it gets much more difficult from here.
"Imagine building mining and transport infrastructure three times the size of the entire U.S. coal and rail industries in just 10 years," Heinberg writes. "That's what it will take for China to maintain 7% growth rates." Heinberg calls his 7% assumption "conservative," as China's growth rates to date have been much higher.
Another limiting factor is water, of which the Chinese are already relatively poor. As Heinberg points out, "A typical 500-megawatt coal-fired power plant uses about 2.2 billion gallons of water each year to create steam for turning its turbines – enough water to support a city of 250,000 people."
China will be pressed to produce the coal it needs domestically. In fact, after being self-sufficient in coal for years, China has begun to import coal. This year, it will import 150 metric tons, which is double last year's total. It may seem a molehill compared with what it burns, but that molehill is about 60% of Australia's coal exports – and Australia is the world's largest coal exporter – and growing.
"This means if China imports double again next year – not an unrealistic scenario – China will need to import more coal than Australia can currently provide," Heinberg notes. "One more doubling of import demand and China will be wanting to import 600 million tons per year, about the total amount of coal exported by all exporting nations last year."
This is fairly astounding math. And the first thing it makes me want to do is buy coal. It doesn't take a lot of brains to see that if this kind of demand scenario unfolds, it is going to drive up the price of coal everywhere.
And as coal is still the primary means of generating power in the world, it's going to have ripple effects throughout the energy chain. Natural gas-fired plants, for instance, will look increasingly valuable, especially as natural gas prices continue to wallow in the mud.
Another idea is to look at the engineering and construction firms (E&Cs).
The E&Cs are in the business of building the hardware you need to process and produce energy. They build coal-fired and nuclear plants. They build refineries and liquefied natural gas (LNG) terminals and biomass boilers. If you need more energy, you need an E&C.
E&Cs rise and fall with spending on energy projects. As oil demand (and pricing) has recovered in 2008 and 2009, this sets up strong capital spending for the next several years.
There are valid short-term concerns about China's overheated economy and property market. Sure, those concerns could depress prices for a while. But considering the extraordinary long-term demand picture here, I'm going to use any such correction to buy more coal, natural gas, and E&C stocks. I recommend you do the same.
Chris Mayer

Further Reading:

If China's demand for coal rises as fast as Chris suggests, it's going to mean big cash payments for investors in one small Canadian company. "The story is quite simple," Tom writes, "Strong demand for steel... tight supplies of metallurgical coal... giant deposits of coal in Canada... a simple business with a 9% dividend..." Get the details here: The Old Dump and Load Routine.
China has gone "oil crazy" according to natural resource expert Matt Badiali. And it's desperate for large new domestic oil deposits – like the "monster" resource they just discovered. Development has barely begun, so there's a pile of money in it for the right companies. Read the full story in Matt's two-part series: The Monster Oil Find Nobody Is Talking About and China's Giant New Energy Source.

Market Notes


So far our "income week" series has covered how to supercharge ordinary blue-chip yields and where to find guaranteed income investments trading like ordinary stocks. Today, we're looking for higher yields... as much as 20% a year.
Where can you find yields that high without taking on far too much risk? Mortgage REITs. Before you call me crazy for even mentioning the word "mortgage," understand that these companies never have to deal with foreclosures, defaults, and other risks associated with owning mortgages.
All they do is borrow money from Uncle Sam and turn around and buy government-guaranteed mortgages. They then collect the "spread" between these two rates. When the spread is large, like it is now, mortgage REITs turn into wonderful dividend-generating machines. Right now, they're paying between 15% and 20%.
The chart below shows Annaly Capital Management, the largest, most profitable mortgage REIT in America. It currently offers investors a 15% dividend yield. If the government raises interest rates, the spread will contract, the yield will shrink, and the stock will fall. But as long as the Fed's E-Z-Credit program is in force, investors can count on more giant dividends from Annaly and its fellow mortgage REITs.
– Tom Dyson

You can expect more big income from Annaly

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