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La Nina wreaks havoc on global coal production

Tony D'Altorio
0 Comments|January 14, 2011

Interruption in supplies is forcing consumers – particularly in China – to look for alternative suppliers as far away as the U.S. and Canada

You may have heard by now about Australia’s flash flood that left 10 dead and 78 missing today. That tragedy is perhaps the tip of the iceberg in a country already struggling under the damages of too much rain.

In Spanish, La Nina – the name given to one specific global weather pattern – means “the little girl.” But instead of living up to its sweet-sounding name, the phenomenon seems to be throwing a temper tantrum.

Today’s La Nina, which consists of cooler waters in the equatorial Pacific Ocean, is the strongest since the 1970s. Already, it has caused droughts in some areas and floods in others.

So far, La Nina drenched countries from Indonesia to Columbia. But Australia has been hit especially hard, suffering its third wettest year on record in 2010.

And meteorologists believe it is here for a while longer. If so, it will likely send commodity prices even higher than surging demand has already sent them…

Australia’s coal production is underwater thanks to La Nina

Australia relies heavily on its coal production, its largest export industry. Yet La Nina had no pity as it flooded the rich, coal-producing, northeastern state of Queensland, which still remains largely under water.

Up to 10 million tons of the area’s essential coking coal now might not reach the market. And global coal producers – including BHP Billiton ADR (NYSE: BHP), Rio Tinto (NYSE: RIO) and Peabody Energy (NYSE: BTU) – have admitted they won’t be able to meet supply contracts.

The flooding also affected the surrounding infrastructure. Rails to ports such as Gladstone remains disrupted and ships continue lining up for fresh coal supplies… with no luck.

That’s all really, really bad since Queensland coal exports account for 40% of global coking coal capacity. And altogether, Australian coking coal – used to make steel – accounts for two-thirds.

Meanwhile, since February is traditionally the wettest month in Queensland, the worst may be still to come.

Flooding of coal producers sends coal prices higher

As already mentioned, La Nina has hit Indonesia – another large coal producer – hard too. Naturally, that fact and its implications have sent prices even higher.

Coking coal prices are set in quarterly contracts between miners and steelmakers. Most contracts on Australian coking coal for the first quarter have been set at $225 a ton.

But the flooding has pushed prices in the spot market higher than that. They’ve already exceeded $250 a ton and could still hit $300, a price last seen in 2008 due to flooding.

Meanwhile, the benchmark price of Australian thermal coal shipped from Newcastle recently hit a 27-month high of $133.50.

Higher prices for coking coal will likely push up the cost of steel as well. Already rising, steel prices are critical to the global economy as it filters into the cost of everyday goods.

And it’s contributing to inflationary pressures in emerging economies, including China.

Effect of the coking coal shortage on China

The coking coal shortage and ensuing price-hike could prompt Chinese steelmakers to lower production. It may even drastically affect China’s economy.

Over the past 10 years, coal consumption growth in the developing world has risen 7.5% per year. That means coal demand doubles every decade.

Most of that growth has come from China, with over 70% of its economy fueled by coal energy. A lack of thermal coal has already put pressure on its power sector since the fall.

Many small industrial companies have had to fire up their diesel generators for power.

This triggered a chain reaction on distillate prices around the globe, adding to the pressure brought on by a cold winter in the northern hemisphere. In the end, the Queensland flooding could end up increasing oil demand and hijacking those prices too.

What happens if China doesn’t get enough coal to continue firing its economic growth? Obviously, its leaders and anyone looking for strong, non-inflationary global economic growth don’t want to find out.

Coal investments to consider despite La Nina’s forecast

Investors can find a single silver lining in La Nina’s rain clouds. The interruption in coal supplies is forcing coal consumers – particularly in China – to look for alternative suppliers as far away as the U.S. and Canada.

That list includes:

  • Consol Energy (NYSE: CNX).
  • Alpha Natural Resources (NYSE: ANR).
  • Walter Industry (NYSE: WLT) – which recently bought Canada’s Western Coal and Canada’s Teck Resources (NYSE: TCK).
  • Market Vectors Coal ETF (NYSE: KOL) should profit as well. As of September 30, 2010, it invested over 72% of its portfolio in coal mining and production companies, nearly half of that in U.S. and Canadian companies.

That places it perfectly since weather forecasters increasingly believe this La Nina will mirror its hefty 1970s run… offering a rich seam of profits for investors in the right spot.

Disclosure: The author does not hold positions in any of the stocks mentioned  

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