For years, the price action of coal has been as black as coal itself. That might finally be changing.
Until January, coal was in a brutal 5-year bear market. After hitting an all-time high of US$139 in January 2011, the price of coal (as reflected by ICE Newcastle) dropped… and didn’t stop falling. In January of this year, it hit a low of US$48.85, as you can see in the chart below.
Now it appears coal has finally carved out a bottom.
As we explained in January, falling demand from China and the U.S., the world’s two largest coal consumers, played a big role in coal’s decline. The shift toward cleaner energy sources such as natural gasalso pushed global coal prices lower.
But coal is still a vital energy source for billions of people around the world. India relies on it for 62 percent of its power production. Australia relies on it for 65 percent of its power. And although its share in power generation in the U.S. is declining, the country still relies on it for around 30 percent of its power. Despite its dirty reputation, coal is critical. And that means that its price couldn’t continue falling forever.
Since January, coal prices have made a steady comeback
The Australian Newcastle coal futures contract, a global benchmark, is up 20 percent this year. European coal futures are also trading at a one-year high.
In a sharp shift, some analysts are even forecasting higher coal prices for this year and next. BMI Research, an arm of Fitch Ratings, recently updated its 2016 average price projection for Newcastle coal from US$51/tonne to US$53/tonne. Newcastle averaged about US$51/tonne in the first half of 2016, and it’s projected to average US$55/tonne in the second half.
BMI estimates an even stronger average price of US$57/tonne for next year. That could rise to US$61/tonne by 2020. That’s not a huge jump – but it’s a big improvement after falling 65 percent over five years.
A larger-than-expected drop in the world’s coal supply is helping drive this modest turnaround. BMI expects global coal production to drop by 4.1 percent this year. But it anticipates that coal consumption will fall by less, by 2.1 percent. This 2 percentage point gap between production and consumption should help to support higher coal prices.
China, the world’s largest coal producer, is driving a lot of the supply cuts
China has banned the opening of new coal mines until 2019. The country’s main goal is to reduce its supply glut. But it also hopes to reduce its pollution levels and shift toward cleaner, renewable energy sources.
In February, China’s National Energy Administration announced it would halt 500 million tonnes of surplus coal production over the next 3 to 5 years. That equals 14 percent of China’s annual coal supply (or 6 percent of total global production).
In late June, the chairman of China’s National Development and Reform Commission said the country would cut coal output by 280 million tonnes this year alone – mostly by reducing by 54 the number of days coal mines operate during the year. At this rate, China may even exceed the 500 million tonne target it announced in February.
These cuts should significantly reduce China’s supply surplus. Every year, the country produces an estimated 2 billion more tonnes of coal than it needs for domestic use. That’s over half of the country’s total 2015 output of 3.7 billion tonnes.
Meanwhile, U.S. coal production has dropped to its lowest level since 1981
The U.S. is the world’s second-largest coal producer. But the drop in coal prices has made a greater percentage of coal production unprofitable. Over 50 U.S. coal companies have filed for bankruptcy since 2012, including Peabody Energy, the world’s largest private-sector coal producer.
Analysts expect more bankruptcies, which should reduce U.S. coal supply even further. The Energy Information Administration predicts that coal production in the U.S. will fall by 12 percent in 2016, which would be the largest percentage annual decline in nearly 60 years.
If Hillary Clinton becomes the next U.S. president, U.S. coal production may drop even more dramatically. Clinton has vowed “to put a lot of coal miners and coal companies out of business,” as part of her clean energy agenda.
Together, China and the U.S. produce 60 percent of the world’s coal. So continued production cuts in both countries should help coal prices recover. Indonesia, the world’s top coal exporter and fifth-largest producer, also expects production to fall next year. Smaller Indonesian mining companies are cutting output to survive the prolonged low price environment.
Asia will drive demand for coal over the coming years
The International Energy Agency (IEA) expects global coal consumption to grow by 0.8 percent per year through to 2020. The strongest growth will come from Southeast Asia, with growth of 7.8 percent per year.
Between 2020 and 2040, the IEA expects coal demand in southeast Asia to triple. It cites “economic factors, abundant supplies and the need for rapid electrification” as the main reasons for this strong projected growth. Indonesia, for example, has said that it plans to build 117 new coal-fired power plants in the next 4 years.
By 2040, the World Coal Association expects Asia to add power-generating capacity roughly equal to Japan and South Korea’s current capacity. Forty percent of that will likely be coal-fired.
There’s a simple reason for this: Coal is cheap. While many countries like the U.S. and China want to phase out coal because of pollution, it is still the most affordable way for developing countries – which don’t have the luxury of worrying about the environment – to generate power.
Given coal’s small but steady uptick this year, it looks like coal prices have found their floor. The price recovery may only be modest for the next few years, but that still represents a huge turnaround.
This means investing in coal mining companies is now more attractive. The Market Vectors Coal ETF (New York Stock Exchange; ticker: KOL), which we recommended in January, is the easiest way to gain exposure.