Aug. 9th ,2011
White Gold, Black Gold and China’s
China has an ongoing energy crisis. Severe electricity power shortage spreads throughout most of China since spring time 2011. The power shortage occurred long before the summer peak power consumption season. Meanwhile, city residents complain about high food prices while desperate farmers had to destroy their harvest corps because no one is coming to their fields to buy their food produces. The reason: even though the prices of produce may be dirt cheap at locations of harvest, the cost of transporting them and distributing them into the basket of city dwellers is prohibitively expensive. The transportation bottleneck in China is just another facet of the energy crisis in China: There are not enough trucks and diesel fuel to transport the goods around the country, because diesel fuel is also needed to generate electricity.
Meanwhile, highways connecting Inner Mongolia to Beijing is severely congested — tens of thousands of coal carrying trucks, lined up one after another on a parking lot stretching hundreds of miles, barely moving. China desperately needs the coal supply from the Mongolian coal mines, roughly 800 million tons a year, transported by trucks. But the coal trucks barely move.
China has close to 1.4 billion people. The world population is about to break the 7 billion mark. Rapid economic development in China and other emerging markets means more energy is consumed to produce and transport all the goods and food to feed the world’s population. But we are quickly approaching the limit of how much planet earth can supply to feed the population of this world, both in terms of fossil fuels and in terms of other natural resources.
Every investor needs to understand the physics of the limit of growth. The goal of any investment is to grow fortune. Economists believe that sustainable growth is always possible given enough incentive of demands. But in a world of physical limits, sustainable growth is NOT possible. How do you grow your share of the fortune when there is a limit of growth for the world as a whole? A while ago I pointed out the fact that the most successful investor in the world, Mr. Warren Buffett, actually saw his fortune SHRINK by 75%, in the last 13 years, in real terms. You should pause and think: Why couldn’t Mr. Buffett grow his fortune in the last 13 years? What chance do we, the small potatoes, have, in beating Warren Buffett and do better than him in growing our own investment fortune?
Opportunities exist if you recognize how resource constraints are limiting the growth of China and the world. Let’s look at some numbers. According to BP World Energy Review 2011: China produces and consumes more than half of the world’s coal in 2011: China produced 1800.4 MTOE (million tons of oil equivalent) of coal out of the world’s 3731.4 MTOE, and consumed about as much. One ton of average coal is equivalent to 0.55 tons of oil in energy content. So in real tonnage, China produced and consumed 3.3 billion tons of coal per year. That number had been increasing annually at 10% pace in recent years!
China’s domestic coal production cannot catch up with demand growing at such a pace. It has to import! China only begin to import significant amount of coal in 2009. By 2010 the net coal import reached 150 million tons. The staggering growth is sure to continue in 2011, to 233 million tons according to Citigroup.
This year China faces a power shortage of 30GW, or even 40Gigawatts. It costs about 0.55 kilograms of coal to generate one kilowatt-hour of electricity. So 30GW shortage means a need of an extra 145 million tons of coal per year to fill the gap. That’s more than the 125 million tons of coal that South Africa’s ESKOM burns in a year to generate electricity!
Looking around the world, you have to wonder where China can get its coal in the next few years. The global international coal market is only roughly 1 billion tons per year. At 3.3 billion tons per year basis, one year of China’s demand growth at 10% pace is big enough to consume 1/3 of the world’s total available exports. The world doesn’t have any spare coal export to meet China’s growing demand, unless major coal producers drastically ramp up their production and exportation.
Figure in India, a developing economy with a population soon to exceed China, and one which is growing almost as fast as China. India also has an insatiable appetite for coal. It is also facing a severe domestic coal shortage and is looking around the world for coal. India produces 400 million tons of coal per year but consumes 555 million tons, numbers that are much lower than China’s, meaning a much bigger potential for demand growth. The Indians are flying around the world to sign coal contracts just as the Chinese do. So where can the Indians and the Chinese find extra coal supply?
Let’s turn attention to South Africa, the only place that foreign importers can hope to buy more. According to a recent report on the operation of ESKOM, south Africa’s national electricity company, they buy domestic coal at prices much lower than international market price, and collect electricity revenue at electricity prices much cheaper than any other countries. In last year, ESKOM burned 125 million tons of coal, paid 35.8 billion rands for the fuel and collected 91 billion rands from electricity tariffs. Using 0.55 kilogram of coal per kilowatt-hour electricity, and one US dollar equals to 6.70 rands, I calculated that ESKOM is paying less than $43 per ton of coal, and South Africa is paying an average of US$0.06 per kwh of electricity. Actually the subsidized big industry is paying way much less, at about 0.25 rands per kwh, or 3.73 US cents.
The coal price ESKOM is paying is not competitive against potential international importers, who are now paying more than US$120 per ton (FOB price, meaning buyer pays for shipping) for South African coal. The country has such a crumbling electricity supply infrastructure that this year, before the arrival of the winter season, which is July in the southern hemisphere, ESKOM could not afford to shut down the power generators for routine maintenance on a rotational basis.
With ESKOM’s power generators working overtime without proper maintenance, burning lowest quality coal that frequently clogs up the equipments, and more over they probably will not be able to get supply of even such lowest quality coal for much longer because the Indian and the Chinese importers are eager to pay a much higher price to buy lower quality coal, how long will it be before the country’s electricity grid crumble down once more, triggering a panic rally of prices of precious metals platinum and palladium like in early 2008? South Africa is the world’s major producer of PGM metals, producing 85% of the world’s platinum and 40% of palladium.
Mining and production of PGM metals is extremely energy intensive. According to data from major platinum producers, it costs roughly 1×10^10 joules of energy, or 2778 kwh of electricity to produce just one troy ounce of PGM metals. That’s only direct energy cost. Count in exploration and development of mines, mining equipments, and labor cost etc, the total direct and indirect energy cost could be 5 times higher at 13890 kwh. If fair cost of energy is US$0.15 per kwh, then the fair cost of PGM metals should be at least $2100 per ounce.
So the best way to leverage on China’s energy crisis due to shortage of the black gold, the coal, is surprisingly in metals that South Africa produces: the white gold, platinum and palladium. Coal shortage means platinum and palladium shortage one way or another: either South Africa keeps price of its electricity low and it leads to a crumbling electricity grid, which collapses the country’s PGM mining industry, or ESKOM has to pay fair market price for coal and charge big industry fair electricity cost, bringing the PGM mining industry out of business unless they ask for much higher prices for platinum and palladium.
How to play platinum and palladium? Buy the physical precious metal, or the physical metal backed ETFs, PPLT and PALL. As for mining companies, I would not recommend South Africa based PGM mining companies — they are restrained by the country’s electricity grid. Instead you should look in North America: Stillwater Mining (SWC) and North American Palladium (PAL) are the world’s only primary palladium producers. Located in North American and being the world’s only PGM producers with the capacity to grow production, they are best positioned to take advantage of a situation created by China, India and South Africa.
Now turning attention back to China’s coal needs. South Africa alone cannot satisfy China, nor can Australia. The only country with the capability to supply China’s extra coal needs, is the USA. Currently U.S. coal is traded at far below international market price, and major U.S. coal mining companies see their stock prices plummet, like PCX, ACI, ANR, JRCC, etc. I think that is buying opportunity.