Monday, December 27, 2010

Looming Peak Coal in South Africa and the World

South Africa is about to reach Peak Coal, or has already passed it. Mean while the world will reach Peak Coal soon, said Cal Tech scientist David Rutledge. Mr. Rutledge surveyed coal production history of major producing counries all the way back to 1880, and applied the math model pioneered by King Hubbert, who accurately predicted the 1971 Peak Oil production in the USA, using his math model. Rutledge concluded that previous estimates of global coal reserves were outdated and too optimistic. He believes that there were roughly 662 billion tons of ultimate recoverable coal reserve on earth, among which 59%, or 400 billion tons, still remain underground. To put the numbers in prospect, the world produces and consumes about 7 billion tons of coal a year. China is responsible for about half of that number, or about 3.5 billion tons.

South Africa produces 242 million tons of coal last year. David Rutledge predicts that South Africa's production will peak in 2011 at 253 million tons a year. Peak Coal in South Africa has huge implication to the global economy and to the supply/demand of a critical natural resource that the world can not be without, especially as we move towards alternative energy solutions. South Africa is responsible for 85% of the world's platinum production and 40% of palladium, two noble metals used extensively as catalysts to cut air pollution from automobile emissions, and as catalysts to produce synthetic fuels and used in fuel cells, among other things.

Peak Coal in South Africa also means Peak PGM for the world, just as the world has an increasing demand of PGM metals for the environmental and alternative energy needs.

I discussed previously that mining of Platinum Group Metals (PGM), platinum, palladium and rhodium etc., is extremely energy intensive. Based on reports available from South African PGM mining companies like Anglo Platinum (AGPPY.PK), it costs roughly 1x10^10 joules of energy to produce just one troy ounce of PGM metals. That is the direct energy cost. If you include the indirect energy cost, the energy required to build and replace the mining equipments, build and maintain the mine and provide for the mining workers etc, the total energy cost to mine one ounce of platinum or palladium could be five times higher, or roughly 5x10^10 joules.

The 5x10^10 joules total energy cost to produce one ounce of platinum or palladium is equivalent to 13,890 kwh of electricity, or 7.64 metric tons of coal, or 30 barrels of crude oil, or 160,000 cubic feet of natural gas, or 0.556 miligrams of mass. At their recent prices in the US market, these energy commodities would be worth $472 in electricity, or $955 in coal, $655 in natural gas, or $2730 in crude oil. (Calculated using $0.034 per kwh electricity, $125 per ton of coal, $4.09 per thousand cubic feet of natural gas, and $91 per barrel oil.)

Remember in early 2008, electricity shortage almost knocked out the electricity grid in South Africa. The PGM and other mining industry was forced to shut down for 5 days, causing a market panic that sent platinum price to $2300/oz and palladium to near $600/oz.

Has ESKOM, the nation's semi-governmental electricity company, fixed the electricity supply problem in that country? Not by a long stretch! So far ESKOM has not even touched ground to start building any new power plant, even though there has been lots of talks. They promised in 2008 to quickly return three mothballed coal fired power plants back to service in a few months, but the first of the three mothballed power plant did not return to service until October, 2010.

The problem is that ESKOM is financially crippled due to the low electricity tariff in South Africa. Based on their latest annual report, ESKOM burned 122.7 million tons of coal and generated 215940 GWH of electricity, or roughly 0.57 kilograms of coal to generate each kwh of electricity.
Cost of electricity generation was 0.282 rands per kwh, half of which is fuel, mostly coal cost. So ESKOM paid roughly 250 rands per ton for coal, or US$25 per ton, using last year's exchange rate. Current international coal price runs as high as US$125 per ton. Imagine what kind of craps (discard coal) ESKOM burns to generate electricity as they could only pay a fraction of the going market price of coal!

ESKOM is vulnerable to lose its domestic coal supply to international buyers who have insatiable demands and who can pay much higher prices. Look at India with an economy growing at 8% and who faces peak hour electricity shortage of 14%, and who will boost coal import from 80 to 100 million tons next year. The increased will mostly come from South Africa. China is also approaching peak coal. China begins coal import from South Africa just as Asia tops Europe to become South African coal's biggest buyer. China experiences such acute coal shortage in major cities recently that they inadvertently cut power supply to critical oil refineries, resulting in a diesel shortage that crippled the truck transportation, leading to skyrocketing vegetable prices while some produces are left rotting in the fields unharvested.

Let's look at South Africa's coal again. Last year's 242M tons of coal production was mostly used by ESKOM (123-million tonnes), Sasol (40-million tonnes) and export (66-million tonnes). ESKOM's expansion program can use an extra 50M tons while Sasol's new project requires an extra 20M tons annually. And we are also talking about insatiable international demands from India, China and Europe. There is no way South Africa can meet all these coal demands.

Some one has to yield! Who is least capable of affording high coal price, namely, ESKOM, must yield! ESKOM must drastically cut electricity supply and aggressively boost electricity price to stay in business and keep the country's electric grid up and running.

We are not talking about events a few years down the road. These events are rapidly unfolding in front of our eyes now. I have been monitoring coal price and see how it rallied from $90/ton in August, 2010 to now $125/ton, a 40% surge in just 4 months.

What's the implication if ESKOM has to take those drastic measures? The country's energy intensive PGM mining industry will crumble! Simply put, platinum and palladium will have to be produced at much higher cost. The production volume has to be cut dramatically. The PGM mining companies will demand much higher metal prices to compensate for the increased cost to stay in business.

That, of course is bad news for the world, but music to the ears of wise investors who put their money in physical precious metals, palladium and platinum. These two metals, particularly palladium, are the ultimate alternative energy investments as I discussed.

Full disclosure: The author is heavily invested in palladium and owns large long positions in North America's only palladium mining company, Stillwater Mining (SWC) and North American Palladium (PAL). The author is also heavily invested in coal mining company PCX and is looking to buy other coal mining stocks.


MontyHigh said...

Yet another great post. I'm wondering whether futures contracts or futures options might be better than North American miners for palladium and platinum.


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