Coal: Investing Essentials

A primer on investing in the coal industry.

Aug 11, 2014 at 12:00AM

Coal might no longer be the energy source of choice in America, but its power is growing abroad. Emerging market demand for coal is expected to surge in the years ahead to produce cheap electricity and manufacturing steel. That's why investors might want to take a closer look at coal. 

What is coal?

Coal is a fossil fuel that is believed to have once been prehistoric vegetation found in swamps and peat bogs. These plants absorbed energy from the sun through the process of photosynthesis, but after dying they didn't decay and release their energy. Instead, the decaying process was interrupted and the energy ultimately locked into coal. This happened when silt and sediments built up and buried these swamps and peat bogs with the help of movements of the Earth's crust. Once buried, the plants were subjected to high temperature and pressure that caused a physical and chemical change that transformed the vegetation into coal.

Coal Pile

A pile of coal. Photo credit: Flickr user oatsy40.

There are a number of different types of coal, of which the most common is bituminous. It has two subtypes: thermal coal and metallurgical coal, which is also known as coking coal. Power plants use thermal coal to produce electricity, while metallurgical coal is used in making steel.  

How big is the coal industry?

Worldwide, more than 6,185 million tonnes of bituminous and other hard coals are produced each year. The top five coal producers are China, the U.S., India, Australia, and South Africa. Much of the coal production in each country is used domestically, with only roughly 15% of hard coal hitting the seaborne marketplace.

In 2012, the U.S. coal industry produced 1,016.4 million short tons of coal. Most of that coal was used to produce 39% of the country's electricity. However, a growing portion of U.S. coal is being exported as demand in emerging markets such as China and India is growing and outstripping internal production.

The coal industry in the U.S. supports roughly 175,000 jobs directly relating to mining, transportation, or power plant operations. On top of that, the industry estimates that more than 1 million jobs are indirectly supported by coal production and that coal adds about $100 billion to U.S. gross domestic product each year. Furthermore, on a global scale the coal industry supports about 7 million jobs.

How does the coal industry work? 

Coal is extracted from beneath the surface of the Earth, processed, and then sold. Thermal coal is typically sold to utilities. Power plants burn the thermal coal to turn water into steam, which is used to turn a turbine that produces electricity. Meanwhile, metallurgical coal is put into a coke oven to turn it into coke, which removes impurities so that it become almost pure carbon. The coke is combined with iron ore and minerals such as limestone to make steel. 

Open Coal Mine

Surface mining for coal. Photo credit: Flickr user Bert Kaufmann 

Because coal is separated into two subtypes, investors need to choose which type to invest in -- there are pure-play producers of both types, as well as more integrated producers. The location of a company's coal reserves is also an important consideration for investors. Low-cost coal mines in the Southern Powder River Basin of the U.S. can yield profits even when coal prices fall. Meanwhile, Australian coal assets located near export ports can be strategically important to a coal producer due to demand from Asia. 

What drives the coal industry?

Coal Pwer Plant

Coal power plant. Flickr user eutrophication&hypoxia

In short, demand for electricity and steel. Coal's market share for electricity generation, though, has been slipping in recent years as natural gas is used in more electric power plants. More than half of the United States' power came from coal in 2000, but it is expected to generate only about 32% of the country's electricity in 2040.

One reason coal's market share is slipping is because of its impact on the environment. According to the Environmental Protection Agency, electricity generation was responsible for 32% of U.S. greenhouse gas emissions in 2012, and coal accounted for 75% of that amount. Because of that the EPA has proposed strict rules governing coal-fired power plants, which could further diminish coal demand in the U.S.

Coal, however, fuels a greater percentage of electricity elsewhere. China, for example, is the world's largest producer and consumer of coal, accounting for half of the world's consumption. Nearly two-thirds of India's power comes from coal.

Looking ahead, global coal demand is expected to surge 48% between 2010 and 2030. Urbanization trends in emerging markets combined with the cost and reliability of coal have made it the fuel of choice for these emerging economies. Emerging markets also tend to be large consumers of steel, so metallurgical coal demand will be largely driven by these economies. 

While China and India produce a lot of coal domestically, neither can produce enough to meet the demands of their growing economies. Over the next three years alone these two countries are expected to increase imports by more than 100 million tonnes. This key demand will drive the coal industry, especially for American and Australian coal exporters, in the years ahead. 

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