Saturday, July 9, 2011

White Gold, Black Gold and China's Energy Crisis

China has a looming energy crisis. There is a severe, ongoing electricity power shortage throughout most area of China since spring time this year. The power shortage occured long before the summer peak power consumption season kicks in. Mean while, city residents complain about high food prices while tearful farmers had to destroy their harvest corps of vegetables and bananas, because no one is buying their food produces even at dirt cheap give away price of a few cents per pound. The reason: even though the prices of produces may be dirt cheap where they are harvested, the cost of transportating them and distribute them into the basket of city dwellers is no way cheap at all. The transportation bottleneck in China is just another facet of the energy crisis in China: There are not enough truck and diesel fuel to transport the good around the country, because diesel fuel is also needed to generate electricity.

China is a huge country with close to 1.4 billion people. The world population is now approaching the 7 billion mark. The rapid economic development in China and in other emerging market means a lot more energy is consumed to produce and transport all the goods and foods 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.

The reality of limit of growth is one that every investor needs to reckon with. The goal of any investment is the growth of fortune. Economists believe that sustainable growth is always possible given enough incentive of demands. But in a limited world, sustainable growth is not possible. How do individual investor grow his/her share of the fortune, when there is a limit of growth for the world as a whole? A while ago I pointed out thet fact that the most successful investor in the world, Mr. Warren Buffett, actually saw his fortune SHRUNK by 75%, in teh last 13 years, in real valuation term. It should make you pause and think about: Why Mr. Buffett could not grow his fortune in the last 13 years. What chance do we the small popatos have, in beating Warren Buffett and do much better than him in growing our investment fortune?

Great investment opportunities can be discovered if you recognize how resource constraints are limiting the growth of China and other emerging markets. Let's look at some numbers in China's on going power shortage. 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 coal in average 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 simply could not catch up with demand growing at such a pace. It has to turn towards importation. 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 30G, or even 40G watts. In average it costs roughly 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 amount of coal burned by ESKOM in South Africa to generate electricity!!!

But look at the world's major coal exporters you have to wonder where can China get its coal in the next few years. The total global coal export 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.

Don't forget India, a developing economy with a population that is about 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 traveling 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 just to load South African coal into ships waiting at the harbors. 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 1x10^10 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 crumling 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 physcial metal backed ETFs, PPLT and PALL. As for mining companies, I would not recommend South Africa based PGM mining companies: they are restrainted 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 advatnage of a situation created by China, India and South Africa.

10 comments:

MontyHigh said...

Thanks for the post. Wish you posted more often.

As far as buying platinum palladium, are there decent, liquid futures options (like for gold and silver futures)?

How about coins? What do you recommend for palladium and platinum coins?

Thanks much,

MontyHigh, www.worldofwallstreet.us

Anonymous said...

Bad timing??? SWC down 20% today. Due mainly to the merger, or other factors?

Ben said...

Hi Anthony,

Good post. I used to own SWC, but sold it off since it no longer is tied to PGM group metals alone.

What are your thoughts on SWC? Is it still worth the bet?

Thanks,
Ben.

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