Barry Melek Electric Train Sets

Coal Loads

TALK TO AN EXPERT: Bart Melek Makes The Case For Coal

In our latest conversation with BMO Senior Commodities Analyst Bart Melek, we discussed how the Great Recession of 2008/2009 ravaged demand for coal, and how that demand is once again picking up.

Rebounding demand associated with firming industrial activity and electric power requirements, higher cost of competing fuels and coal supply cuts bode fairly well for the U.S. coal market into 2011, Melek reports. This is good news for coal explorers and producers, particularly in North America where so much power consumption is fed by giant coal deposits from Powder River in the US to Alberta in Canada.

Resource Intelligence: The price of coal fell by almost 50% in 2008, as production was slashed due to a plummeting power demand with the so called Great Recession. How quickly will that pick up—and how quickly has it already picked up?
Bart Melek: 2009 was a very weird year for thermal coal, especially in the United States. What we have seen is very low natural gas prices. Relative to coal they were extremely low. At the same time we had industrial coal production in the US drop some 10%. That essentially meant you had the freedom to move from base loads to peak-load generation. That normally does not happen and what we have seen is the amount of power generated by coal drop to 44%, in I think August of last year, where normally it's about 50%. That was a problem and caused inventories to build up and prices fell.
More recently we've had natural gas prices jump from the summer lows and that relative price has moved higher, demand for coal power is returning and as such I think at this point, we are back to normal generation of power using coal. Ultimately supplies were cut as well in the US. Those inventories will eventually start unwinding and we think prices are going to firm up.

RI: What are the main drivers of coal demand?
BM: Electricity demand is the key driver of U.S. thermal coal demand, and last year was no exception. The sharpest decline in U.S. economic activity since the Great Depression dramatically reduced electricity demand in the U.S., down almost 4% over the course of the year. Since electricity supply and demand must always be in balance, demand declines automatically precipitate a decline in generation activity.

RI: Why does natural gas have such a notable effect on the price of coal?
BM: The two are to some extent alternatives, at least in terms of power generation. Coal is primarily used for power generation and if you have a low gas price you can use gas to fuel plants that generate electricity instead of coal. As non-coal prices rise, the incentive to use sources other than coal fall. So natural gas, especially last year, was very material in determining the future for thermal coal.

RI: With changing attitudes to global warming, what do you think the long term fundimentals are for coal? Will a greener attitude toward energy prevail, or will coal prevail as one of the cheapest forms of energy?
BM: Certainly, it is one of the cheapest sources of energy and frankly—for the US and North America in particular—half of our generated capacity is coal. These are very low, very difficult structural issues to change overnight. We will likely have higher power demand over time and we will have limited choice of what source of energy to use, so I think coal will continue to get used. At the same time, for environmental reasons I think coal development is not as robust as some would like and supply is constrained. Demand, like it or not, continues to move to the upside, because there is nothing else as plentiful and affordable to burn. We recently had an announcement from President Obama that carbon taxes are probably not on the cards at this point.

RI: I know you don't look specifically at companies, but what do you think is the first thing investors should look for in coal miners when assessing their project as an investment? Is size the central factor in finding the right deposit?
BM: I'm a cost guy. I think high quality deposits with close proximity to market are the best deposits for investors to be looking at.

RI: That would be because of the reduced cost of transportation. So location sounds like one of the top  factors that you look for, but interestingly coal is transported great distances these days—to China for example, and from China to the US, from time to time.
BM: Well, it has been happening recently, because of the really high price environment, but typically it doesn't happen.

RI: So are we seeing different kinds of increases or decreases in the price of the varying kinds of coal. For example you mentioned thermal and its prospects, but what about metallurgical coal?
BM: The price of metallurgical coal has been running high. It's a very small proportion of the total coal industry, but it is primarily used in and essential to the manufacturing of steel. China has been importing a lot more metallurgical coal than it normally does because of the relatively cheap ship freight rates, seaborne freight rates, because of the recession and a large supply of ships that came in recently. So metcoal [metallurgical coal] has done extremely well and has recently been trading on the spot between $180-$200. The steel industry is likely to recover globally. We remain fairly robust in China and that means the limited supply of metcoal that's out there is going to be quite valuable and we certainly have seen that typically coal markets, including thermal in the Asian sphere, have been performing better than in the West and that is probably due to the fact that there is a limited supply out there but also because the demand side is much stronger in the developing countries, especially in Asia and China.

RI: What are your price predictions for thermal coal in 2010 and beyond?
BM: BMO projects Nymex Central Appalachia thermal coal to average US$58.40/tonne in 2010 and US$65.90/tonne in 2011. Long-term prices are projected to be US$68.30/tonne, which BMO calculates is a level required to sustain the industry.

RI: China already has huge deposits and is one of the biggest coal producers in the world. Why are they shutting down mines lately?
BM: Firstly they have had some safety issues and secondly, a lot of their material isn't of particularly high quality and is more expensive to mine.

RI: What are the main factors that push the price of coal?
BM: Demand for power and the price of oil as well, I think, plays a big part in the price of coal. Energy broadly is more expensive and the price of coal reflects that today.
The other thing that affects the price of coal of course is the supply side. The availability and cost of it's competition, which are of course oil and gas. These factors are very much a regional issue, however. Much of the gas around the world isn't really shipped, but used locally. So if there is cheap local natural gas, that can be used as an alternative to thermal coal, but if there is no alternative, coal will be bought and used.

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