Tips for Investing in the New "King Coal"

June 21, 2011
Dave Fessler

It's important to understand the production origins of any commodity, as this knowledge can provide you with a better understanding of where and how to invest.

This article published with permission from InvestmentU.com.

When it comes to commodity investment, it’s critical that you know your history.

Poll any American about the origins of coal, and you’ll likely get the answer that it was first mined here. Perhaps they were paying as much attention in history class as I was. More likely schools never touched this subject in the first place.

But it’s important to understand the production origins of any commodity, as this knowledge can provide you with a better understanding of where and how to invest. America was a little late to the coal party. Production actually started in Europe, more than 200 years ago.

The Industrial Revolution began in Great Britain in the eighteenth century. Its spread to other parts of Europe — eventually to North America – and was largely due to a new, cheap and readily available fuel: coal.

Coal: Fuel for Industrial Revolutions Since 1805

The United Kingdom’s western valleys are the heart of the massive South Wales coalfield. It provided the fuel for England’s industrial steam engines, railroads and steamships.

The longest continuously operating coal mine in the world was the Tower Colliery in South Wales. Opened in 1805, it operated for 203 years until it closed in 2008.

Coal is found just about everywhere in the world. The graph below, courtesy of the World Coal Association, shows where the largest oil, coal and natural gas reserves are.

You can ignore the figures for natural gas, since this graph was produced prior to the development of shale gas fields. The biggest coal reserves are in the United States, India, China, Russia, Africa and the Asia/Oceana region.

In terms of consumption, the picture is a little different. In the graph below, from the Energy Information Administration’s International Energy Outlook, you can clearly see that since 2000, China has been gobbling up coal at a frenetic pace.

By 2030, China alone will be consuming half of all the coal produced in the world. Where’s it all going to come from? One nearby country (besides Australia) is shaping up to become a major supplier of coal to China.

The Two Types of Coal

Coal is generally classified into two types: soft coal and hard coal. Soft or low-rank coal is either lignite or sub-bituminous. It represents about 47 percent of all the world’s mined coal. Both are used for power generation, and some sub-bituminous is also used to manufacture cement.

Hard coal is either bituminous or anthracite. Today, anthracite represents only about one percent of all coal mined, with bituminous making up the rest (52 percent).

Bituminous is further divided up into coking coal (used in iron and steelmaking), and thermal or steam coal, used in power generation and other industrial processes.

Most of the world’s coal trade is in thermal or steam coal. It represents about 70 percent of world coal exports.

The top three exporters of coking coal are Australia, the United States and Canada. They’re expected to hold those positions through the next several decades.

Care to guess the top exporter of thermal coal? I’ll give you a hint: It’s none of the above.

The answer? Indonesia. The country is loaded with thousands of low-cost surface mines.

Indonesia’s Bumi Resources: The Top Producer of Thermal Coal

While Indonesia has been in the coal business for some time, it’s jumped to the forefront of the coal scene in a big way in just the last decade.

In 2010, Indonesia produced 325 million tons of thermal coal. Of that, 265 million tons were for export. Most of it landed in India, China, Japan, South Korea and Taiwan.

The country’s — and indeed Asia’s – biggest thermal coal producer is Bumi Resources (PINK: PBMRY). Bumi is under the watchful eyes of the Bakries, one of the most politically connected families in the country.

Bumi’s first quarter revenue was up 21 percent to $1.23 billion. Profits grew by 16.5 percent to $113 million. Higher coal prices as a result of strong demand from all of its customers made up for lower production due to heavy rainfall in the vicinity of its main mining operations.

For 2011, Bumi expects its output to rise by 10 percent, and analysts are forecasting 2011 net profits of $498 million.

Investors wanting additional exposure to a strong Asian coal player might want to consider adding a few shares of Bumi Resources to their portfolio. China’s demand isn’t expected to decline any time soon

Dave Fessler is the Senior Analyst at InvestmentU.com.See more articles by Dave here.