A Primer On Coal

By Chris Dumont AAA

Coal is the most widely used fuel source to generate electricity. In fact, about half the power generated in North America is from coal, and 90% of coal used in North America is to generate power. Internationally it, again, is the number one source for electricity, responsible for around 50% of the world's electricity generation. With this in mind, knowing what affects the price of coal, the types that are traded and the methods it is traded, investors will have the tools they need to better understand this commodity.

SEE: Futures Fundamentals

It is important to note that coal is used because it is the cheapest fuel source, not because it is the most environmentally friendly. The two rarely go hand in hand. Moreover, the price variation is so great that if compared to other fuels, the cost of coal is about one-fifth the cost. But even though it is so widely used, coal prices do not have that much of an impact on electricity prices. The price of electricity on the grid is determined by the most expensive power producer, and since coal is the lowest, it has little effect.

Along with being the cheapest, coal is also the most environmentally unfriendly fuel source and the single largest source of air pollution in the world. As a result, whenever there is talk about new laws regarding global warming, the price of coal usually rises, as it is the most affected. The price of other fossil fuels also has an effect on the price of coal. For example, if the price of oil and natural gas stay high, coal becomes even more economical, increasing the demand and thereby increasing the price of coal. However, even with an increase in the price of coal it remains the cheapest fuel source due to its economy of scale.

The most common way to transport it is by train, followed by trucks and barges. Because coal is relatively cheap, any additional transportation costs can increase the retail cost by a substantial amount. With this in mind, most coal plants are located in close proximity to the coal mines; however, new advancements have opened up more possibilities. One modern method is transporting coal via pipelines; however, as water is used for this, it can strain water resources from the vicinity and the added time to wait for the coal to dry can further make it cost prohibitive.

Types of Coal
The four types of coal are lignite, sub-bituminous, bituminous and anthracite. By getting to know the different types, and which types are traded, investors can better understand the coal market.

SEE: Commodities: The Portfolio Hedge

Lignite contains the lowest amount of energy out the four types of coal, made up of approximately 30% carbon. As the energy content is directly correlated to the amount of carbon the type of coal contains this is quite low and contains a lot of moisture. As it has such low energy content, it is rarely traded internationally and thus only used in power plants close in proximity. About 7% of U.S. coal production is lignite coal.

Having slightly higher energy content, sub-bituminous coal contains about 40% carbon. About half of the coal produced within North America is sub-bituminous.

The most abundant type of coal, bituminous, also has the second highest energy content. In comparison to lignite, bituminous produces about three times the energy content and contains around 70% carbon. This is about the only market for coal that is traded internationally, as it is more efficient to trade than the others. About half of the coal used in North America is bituminous.

Containing the highest energy content, anthracite coal is made up of about 95% carbon. However, it has a few disadvantages. First, it is hard to light, and its high price often makes it not very economical for electricity production. Furthermore, it gives off the same heat energy as bituminous coal, which does not give it that much of an advantage. It is the rarest type with only about 0.5% of the coal mined being anthracite.

Of the 50 states, 26 states mine coal as of 2010, producing 1,085.3 million short tons per year according to the U.S. Energy Information Administration (EIA). Wyoming mines the most coal, followed by West Virginia, Kentucky, Pennsylvania and Montana. Worldwide, North America produces the second most amount of coal, accounting for 15% of the world's production, with the United States producing 93% of North America's production. This amounted to about 1.1 billion tons. The only region that produces more is Asia, producing about half of the world's production, doubling from 22% in 1980 to where it is now.

There are two types of production, surface and underground. Between the two, surface is generally cheaper and requires less capital to acquire.

It can also be referred to as strip mining. This is where the coal is located near the surface. Often found in the Midwest and western United States.

Far more dangerous than surface mining, underground mining is reserved for the coal deposits located too far underground to be obtained.

Coal Trading
As with other commodities, coal can be traded on both exchanges and over-the-counter markets; however, it is not a heavily traded commodity. The only type of coal that can be traded is bituminous, and because of the difficulty in transporting it, location trading is almost non-existent. Another limitation on trading is the low correlation between electricity prices and coal prices. Furthermore, traders prefer volatility and there tends to be very little volatility in coal prices.

In relation to other commodities, 80% of coal produced worldwide is used in adjacent power plants, with the international market for coal being split into two regions due to transportation costs: a Pacific market and an Atlantic market. The Pacific market comprises of coal imports into Southeast Asia that include but are not limited to, Korea and Japan and China. The Atlantic market on the other hand consists of coal imports into the Europe, including Germany and Spain.

Investors who not looking to invest in the commodity itself on the futures market can choose to invest in coal ETFs, and/or stocks in coal producers. With coal demand rising, those ETFs and stocks may be a good addition to an investment portfolio.

Coal Reserves
The United States has close to 30% of the world's coal reserves, followed by Russia at about 20% and China at about 15% each. Totaling 275 billion tons of coal in the U.S., current domestic demand would amount to about 250 years of consumption.

The Bottom Line
Coal is an often overlooked opportunity for investors. However, with the right knowledge, investors can better understand coal and potentially gain exposure with the various investment vehicles available. One thing is certain: coal as a fuel source is not going anywhere, and demand, especially in Asia, will continue to rise.

SEE: A Beginner's Guide To Precious Metals

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