Cashing in on Commodities: The Short- and Long-Term Solutions to the Growing Global Energy Crisis

Jason Simpkins — Tue, 20 May 2008 11:36:42 +0000

Editor’s Note: This is the first installment of a new Money Morning series highlighting investment opportunities created by the global bull market in commodities.

By Jason Simpkins
Associate Editor

Crude oil is grabbing the headlines but it’s coal and uranium that together provide nearly half the world’s power.

So it follows that as worldwide demand for electricity skyrockets – as it will – the shares of companies that provide these two key fuels also will take flight.

And they make for almost-perfect partners.

That’s because coal represents the world’s short-term solution to the problem of a rapidly climbing global demand for power. It’s plentiful, it’s cheaper than other available alternatives, and a big percentage of the world’s power plants are set up to burn this fossil fuel.

Uranium, on the other hand, represents the long-term solution to potential fuel shortages – and it offers a solution to global warming, to boot. Uranium-powered commercial nuclear plants are cheap to operate, can run a long time, and when operated correctly cause little pollution.

**The New ‘Black Gold’**

India, a growing economic and industrial power, relies on coal for nearly 70% of its total energy supply. And the World Coal Institute expects India’s energy consumption to rise by as much as 8% to 10% annually through 2020.

Coal also is used to satisfy the Red Dragon’s energy appetite, providing 78% of China’s total power needs. Coal demand in China jumped nearly 9% last year – meaning the Eastern power now accounts for a full quarter of the world’s annual coal consumption, The Wall Street Journal reported.

Five years ago, China exported 83 million metric tons more coal than it imported. But last year, the nation’s surplus dropped to a meager 2 million metric tons. That means more than 80 million metric tons of coal (about 12% of the internationally traded market) has been taken out of global circulation.

Vic Svec, a senior executive at Peabody Energy Corp. (BTU), the world’s largest private-sector coal producer, referred to China’s ability to influence the price of commodities as a "butterfly effect." In other words, Svec told The Journal, "demand from Beijing can ripple back to Queensland, Australia, or Gillette, Wyoming."

Svec’s right. China’s recent development is part of the reason the highly desirable low-sulfur coal from the coal-laden Powder River Basin in Wyoming and Montana has climbed from less than $10 a ton last year, to nearly $15 a ton – a price gain of 50%.

Central Appalachian coal, the benchmark grade widely used by power plants, jumped from $40 a ton in early 2007, to nearly $90 a ton now, according to a recent report by the Associated Press. That’s price increase of 125% in just a single year.

Meanwhile, the weekly index for power station coal prices at Australia’s Newcastle port, a benchmark for the Asian market, averaged $126.45 per metric ton in the month of April, up nearly 40% from January. The port’s weekly price index rose to $133.63 per metric ton for the week ended May 9 – an 11-week high according to the globalCOAL NEWC Index. The index is up approximately 49% this year.

According to the Energy Information Administration, world coal consumption could expand by 74% from 2004 to 2030. And that will only drive prices higher.

While demand for coal is at an all-time high, the same can’t be said for coal supplies. Harsh weather conditions and infrastructure constraints in coal-producing regions have severely crimped supplies.

In South Africa, power shortages and flooding have closed down several key mines. With such setbacks, the price of coal coming out of South Africa’s Richards Bay Coal Terminal, the world’s largest, jumped nearly 90% last year.

Xstrata PLC, the world’s biggest exporter of power-station coal, said that first-quarter coal output fell 3.6% after floods and rain delays diminished supplies from Australian mines. Monsoon rains throughout the region also impacted archrivals Rio Tinto PLC (RTP), and BHP Billiton Ltd. (BHP).

Meanwhile, China, a leading producer and consumer, was devastated just a few months ago by the worst blizzard of the past half-century. Three weeks of snowfall killed at least 60 people and cost the country approximately $7.5 billion.

China had already closed a multitude of coalmines in 2007, after they were deemed unsafe. The subsequent weather problems only exacerbated that situation, forcing the closure of a great many more mines and prompting China to restrict exports. Major roads and railways also were shut down, creating traffic congestion during the thickly traveled Chinese New Year – and making deliveries highly problematic for drivers.

As the cold of winter gave way to the higher temperatures of spring and summer, yet another weather-related challenge emerged. This time around, the double-whammy of higher-than-expected temperatures coupled with sparse rainfall are straining thermal power plants: The warm weather is boosting the use of energy-intensive air conditioning even as those same higher temperatures have dropped the water level of the rivers that spin the huge power-producing turbines at hydroelectric dams.

If you’re looking to play surging coal prices, Money Morning Investment Director Keith Fitz-Gerald suggests taking a look at Yanzhou Coal Mining Co. (YZC). The China-based Yanzhou is nicely diversified in several ways:

First, it not only operates underground coalmines, Yanzhou also operates a railway transportation network for shipping coal.
Second, Yanzhou’s focus on low-sulfur coal products means it finds demand from large-scale power plants and from metal-producing companies all around the world. The reason: Low-sulfur coal can be combined with coking coal in a metal-production process known as "pulverized coal injection," or PCI. That combination gives Yanzhou a nice extra bit of industrial diversification.
Third, investors can add geographic diversification to the profit mix as they analyze sector plays.

Provided with these positives, it should be no surprise to investors that Yanzhou’s first-quarter profit more than doubled, climbing more than 112% on surging demand for the fuel and on the higher trading prices seen in the markets around the world.

Uranium: The Long-Term Play

If coal is the short-term solution to the world’s energy needs, uranium is the long-term play.

Uranium-fueled nuclear energy is rapidly re-gaining global acceptance as a clean, reliable alternative to such dirty-burning fossil fuels as coal and oil. In a twin bid to combat global warming and to keep up with soaring demand for electricity, countries are rushing to build nuclear power plants. There are currently 440 nuclear reactors in operation that combined generate about 16% of the world’s electricity. Another 25 are under construction, 38 are on order and 115 are proposed.

Also influencing the supply/demand equation for uranium: There are 284 research reactors in operation and 220 nuclear-powered ships and submarines patrolling the world’s oceans – key facts that many industry analysts forget to include in their calculations.

All those reactors, combined, soak up about 77,000 tons of refined uranium every year. But in 2006, however, only 50,000 tons of uranium was mined. That has forced some countries to run reactors at only 50% to 60% capacity, while others – such as India – have actually been forced to periodically take reactors off line because they lack the fuel to keep running them.

Once imbalances appear, they’re not easy to eradicate. It takes seven to 10 years to transform a uranium discovery into a fully operational mine. With that kind of lag time, it’s clearly almost impossible for supply to keep up with demand.

More than 40 developing countries have recently approached United Nations officials to express interest in starting nuclear power programs, the Washington Post reported.
China alone is planning to build 30 new plants in the next 15 years, a venture that will consume an estimated $50 billion in capital. And that country may require as many as 200 plants by 2050.

According to the Australian Foreign Ministry – with whom China has been negotiating – imports of uranium to China are set to increase from 2.5 million pounds per year to an unprecedented level of 44 million pounds per year. That would be an increase of 1,760%, and would represent close to one quarter of the world’s total uranium supply.

Japan hopes to have 11 more plants operational or under construction by 2010, and the United States and Europe are also jumping back onto the nuclear bandwagon. These new plants will only serve to widen the supply/demand gap.

Clearly, there are substantial dangers from nuclear power plants that are built – and operated – incorrectly. But there also are dangers from coal-fired plants. It’s just that – in an ironic twist – the nuclear fallout is virtually immediate (albeit long-lasting), while the environmental damage from coal takes longer to see.

That said, it’s also become clear that – with the enhancements to plant design and operation – commercial nuclear energy is the safest, cleanest, cheapest source of the massive amounts of electricity that will be needed to achieve three key objectives:

To fuel global growth.
To avoid a worldwide energy crisis.
And to battle the long-term environmental effects of global warming.

That is why uranium has become one of the most coveted and volatile commodities on the planet. Overall, uranium gained 28% in 2007, but that seemingly simple statistic masks a much-more-complex story.

At one point in June, uranium prices were up 84% for the year. But then a mass sell-off – accelerated by the U.S. Department of Energy’s decision to auction off as much as 200 tons of uranium from its own inventory – drove prices from $138 a pound down to $75 a pound in just three months.

So far this year uranium has skidded even more, reaching its current trading price of about $65 a pound. Despite the dip, however, the underlying fundamentals remain strong, meaning it’s probably the perfect time to start stocking back up on the yellow cake providers.

In a recent research note, analysts with the RBC Capital Markets Group of the Royal Bank of Canada (RY) said that the current spot price of uranium has been "driven to excessively low levels due to intense selling pressure and lack of buying demand, coupled with the typical illiquidity of the spot market."

The RBC analysts also said that "the long-term price, on the other hand, has not changed since May 2007 and we think this better reflects the market’s view of longer-term supply-demand fundamentals."

Prospecting for Profits Among Uranium Miners

So where should you look for profit opportunities? If you look at the charts, some uranium mining company stocks appear to move up and down in virtual lockstep with spot prices.
If you want a pure play on an increase in the price of uranium itself, Cameco Corp. (CCJ) is your best shot. It’s the largest producer of uranium in North America and – despite flooding at its Cigar Lake site last year – Cameco remains the world’s largest and most liquid uranium miner, making it vital to the global supply.

The company’s profit more than doubled in the first three months of 2008, surging 125% on its uranium and gold mining operations.
RBC also likes Cameco’s potential.

"We believe that Cameco will likely continue to be the best name among uranium producers, especially since the water-related risks at Cigar Lake have been reduced recently and it has a top-tier asset base that is in production," the group said. "Cameco’s contract structure should provide the company with increasing uranium price realizations over the next decade."
If you’re looking for more safety and diversification, Rio Tinto PLC (RTP) and BHP Billiton Ltd. (BHP) could fit the bill.

BHP Billiton is the second-largest commodities company in the world, mining steel, aluminum, copper, iron, nickel, titanium, diamonds and gold. It is also proprietor of the world’s largest uranium deposit, the Olympic Dam in Australia. When the demand floodgates are finally opened, it’s likely BHP Billiton will be riding the first wave of uranium into China.

Meanwhile, Rio Tinto, the third-largest mining company in the world, is another logical play. The company owns 68% of the Ranger Mine, which has produced more uranium than any other mine in Australia over the past decade. It also owns Canning Resources, which is the sole owner of two prospective Australian uranium deposits – the Kintyre Project and the Westmoreland Project.

Rio also owns slightly less than 70% of the world’s longest running open pit uranium mine, the Rossing mine in Namibia, Africa. The company has already started selling uranium to China from the Rossing Mine, so it already has business ties with the world’s largest market.

[Editor's Note: Global investing guru Jim Rogers has been a major commodities bull for several years now. Check out how you can obtain a free copy of his new best-seller, "A Bull in China." Next up in Money Morning's "Cashing in on Commodities" series: Gold.]