Thermal coal takes the prize today—as the commodity with the biggest disconnect between the bullish market reality and the incredibly bearish sentiment amongst investors.
Producing stocks have seen a brief rally fizzle—with companies like Peabody Energy (NYSE: BTU) down 15% over the last month.
The sell-off isn’t surprising, considering how gloomy the prevailing media reports are. A Google News search for “coal” shows headlines like “opposition to coal export plans”, “coal is the wrong fuel”, and “end coal-fired power”. No wonder investors are heading for the hills.
But a look beneath the platitudes about the end of coal reveals a completely different picture.
Coal demand is surging. And not just in stalwart consuming nations like India—coal use is growing rapidly in a number of other surprising places.
At the same time production is falling. And just last month we saw one of the first glimpses of investor optimism in the sector—from a very high-profile endorser.
Suggesting that perhaps a resurgence in the sector is at hand? Below we look at what’s happening, the upside it could mean for coal investments, and how to play it for buyers who want to position themselves in front of this swelling wave.
Surprise Demand From Japan
This month, Japan’s Federation of Electric Power Companies said the country is making a move to coal. In a big way.
Coal consumption by Japanese utilities jumped 26% in October, year-on-year. To a record 4.78 million tonnes.
The big growth in imports comes as the nation continues to struggle for power. The majority of its nuclear fleet remains offline, forcing generators to look to alternate fuels.
It appears that coal is one of the go-to choices. A significant benefit for the global thermal coal market—considering that Japanese consumption previously appeared to be flat, or even declining.
Production Cuts From a Superpower
China is the world’s largest coal mining nation. But it wants to be more selective about its production going forward.
The country’s government announced last month that it will curb production from small mines—closing those with annual output below 90,000 tonnes, and denying approval for new projects less than 300,000 tonnes.
A move aimed at shoring up safety, and increasing efficiency in the sector.
This is going to have an impact on overall Chinese production. There are a lot of small mines in the country—most of which are losing money at current coal prices. Platts estimates that the majority of mines need a coal price around $80 per tonne to be profitable. Right at current levels.
If falling domestic output triggers more imports into China, it will be a shot in the arm for the market. Chinese imports had stagnated for most of the past year, after jumping 250% in 2011 to 2012.
India’s Incredible Imports
India continues to be the center of the thermal coal universe. With imports surging once again so far this fiscal year.
Accurate data on Indian coal shipments is difficult to come by—with different sources reporting disparate numbers.
But all observers agree on one point—there’s been a large-scale jump in imports since FY2014 began in April.
In October, the Indian Ports Association reported that coal imports at 12 government ports jumped 44% year-on-year between April and September. And just last month, analysts at India Coal Market Watch said that imports for the seven months to the end of October have grown 28%.
Even taking the lower figure, the data point to an increase in imports of over 30 million tonnes for the entire fiscal year. That’s a huge amount of new demand—equivalent to nearly 20% of export volumes from major producer Australia in 2012.
Signs of An Investor Turnaround
The one thing that’s been missing from the coal story is investor enthusiasm.
At least until last week.
That’s when we got news that Exhilway Global—the world’s largest provider of emerging market investment funds—is moving into coal. In a big way.
The firm has raised $200 million in a new fund dedicated solely to coal and iron ore. Managers have already identified a slate of projects, and plan to begin deploying capital imminently.
In fact, there are already plans to increase the fund to $500 million in order to take on additional positions in coal.
That’s a big vote of confidence from a big player. And perhaps a signal that downtrodden sentiment is finally turning up.
How to Invest in the Best Opportunity of 2014
The trends above—surging global demand, falling supply, and an influx of investment dollars—point to one conclusion.
Coal is a place investors should be in 2014.
The combination of depressed stocks and ravenous fundamentals is a formula for big profits if this boom plays out the way it is setting up.
So, what’s the best way to invest?
The Pacific/Indian Ocean region is the place to be—perfectly positioned to feed India, China and Japan.
Which leaves investors with a number of options—established, emerging, and one off-the-map locale that might offer potential for the biggest upside through the opening of a completely new producing district.
The Go-To Asian Supplier
Australia is the supplier of choice for higher-quality thermal coal around the Pacific sphere.
In 2012, Australian mines supplied 70% of Japan’s imports. Through the first half of 2013, Australia also supplied over a third of exports to big markets like South Korea.
The challenge for Australian producers is cost. The majority of mines are on the bubble at current prices—making little in the way of profit.
Production has thus been curtailing. But a rise in prices spurred by import growth in the region could change that.
If the market picks up, Australian producers are perfectly-positioned to feed it. Companies like Peabody Energy (NYSE: BTU)—which got 40% of its revenues from Australian operations through the first nine months of 2013—offer good exposure to the space.
An Emerging Supplier for India’s Coal Boom
India’s booing coal imports are bringing South Africa into play in Asia for the first time.
Traditionally, South African coal exports have headed west to Europe. But they’re now shifting east.
So far in 2013, 79% of South African thermal coal exports have sailed to Asian buyers like China, Japan and India. Signaling a shift in demand patterns that could be a major opportunity for investors.
Especially given that South African mines are some of the lowest-cost sources of supply in the world—producing coal for as little as $40 per tonne.
That leaves plenty of room for profit at current prices. And all the more so if India’s growing imports mean more tonnes being moved.
As we've discussed, this may be especially good for developers of new mines. Firms like Resource Generation (ASX: RES), which is currently arranging bank financing for its Boikarabelo project in the emerging Waterberg basin.
But even established miners like Sasol (NYSE: SSL) could benefit—with the company have supply that it could swing to Indian exports, if prices are right.
Asian Coal Buyers Are Betting on This Little-Known Spot
Madagascar. An island nation that might be the next supply source for Asia.
The country currently doesn’t produce any coal. But one of Asia’s biggest energy firms is working to change that.
That’s Thailand’s PTT. The state-owned oil and gas company is pushing forward development at its Sakoa field in southwestern Madagascar.
This will be the first development from the coal-rich Sakoa region. Meaning that PTT is blazing a lot of trail in building infrastructure like road and port facilities in this emerging district.
That’s great news for other license holders in the basin. Firms like Lemur Resources (ASX: LEM)—which holds nearly 180 million tonnes at its Imaloto project.
If Madagascar’s coal output hits tidewater, it’s a short sail to India. Meaning this upstart producer could end up being just what the Asian coal market needs.
This will yield big profits for investors as formerly neglected coal acreage at Sakoa becomes prized real estate. All the more so if current elections in Madagascar manage to install pro-business candidate Jean Louis Robinson—who led early-round voting in November.
All reasons that 2014 might be the year for coal here—and perhaps around the rest of the world.