Dead Canaries in the Coal Mine

When I first took the helm of The Energy Strategist in October, I was bullish on oil companies, neutral on most natural gas companies, and generally bearish on coal, nuclear power, and most renewable energy companies.

As a result, I began to remove companies such as uranium miner Cameco (NYSE: CCJ) and coal miner Peabody Energy (NYSE: BTU) from the portfolios. Since last October, CCJ has muddled along, alternating between a 10 percent gain and a 10 percent loss (although it is down almost 50 percent over the past five years). BTU, on the other hand, has fallen by 43 percent, and is down more than 80 percent over five years.

The performance of these stocks may seem somewhat counterintuitive given the recently released BP Statistical Review of World Energy 2013. Global coal consumption set a new record in 2012, while nuclear power consumption suffered the largest decline in history.

coal consumption chart

It is instructive to look at the recent history of coal consumption to better understand why some suppliers have fared so poorly even as global demand continues to grow.

Following decades of slow growth, global coal consumption began to rise rapidly in the early part of the previous decade. Between 2002 and 2012, global coal consumption rose by 55 percent, from 2.4 billion metric tons of oil equivalents (btoe) per year to 3.7 btoe per year. But this increase was overwhelmingly driven by increased coal consumption in China, which rose by 1.1 btoe per year (87 percent of the global increase).

However, coal consumption fell in most developed regions over the past 10 years. Most European countries saw a decline in coal consumption, and the EU as a whole saw coal consumption decline by more than 7 percent. Coal consumption in the US fell by 21 percent. The 114 million billion metric tons of oil equivalent (mtoe) decline in the US was five times the decline in the EU.

The decline in the US primarily took place over the past five years as cheap natural gas displaced coal in the production of electricity. The switch happened remarkably fast; in 2008 natural gas was used to produce 20 percent of America’s electricity, but in 2012 the natural gas share exceeded 30 percent. (Although the Energy Information Administration is projecting coal to regain some ground in 2013 as a result of higher natural gas prices).

But a closer look at China tells the tale of why US companies have fared poorly even as global coal consumption climbed. While it is true that Chinese coal consumption increased by 1.1 btoe over the past 10 years, Chinese coal production nearly kept pace with an increase of 1.0 btoe. Moreover, China is in close proximity to two major coal exporters — Australia and Indonesia.

coal producers table

Thus, because of declining US demand, the US coal industry is faced with an excess of coal very far from the world’s leading coal market. India, another major coal importer, is also tough to access for US coal producers.

Following another 6.1 percent growth in coal consumption from 2011 to 2012, China’s coal consumption has for the first time exceeded 50 percent of the global total. Because of a large build-out of coal-fired power plants that is expected to continue for some time, Chinese demand for coal will remain robust for years. But US producers are in a poor position to benefit from the expected increase in demand. In fact, while coal exports from the US are on the rise, the vast majority of US coal export terminals are located on the East and Gulf coasts. Unsurprisingly, more than half of US coal exports are destined for Europe, which is not exactly expected to be a strong growth market in coming years.

Coal exports from the US to Asia are on the rise, but this will continue to be a competitive market given the proximity of Australia and Indonesia. Australia is the world’s top coal exporter, with nearly 90 percent of its total exports destined for Japan, China, or South Korea.

But the US does have the world’s largest coal reserves. At current market prices, the 237 billion metric tons of proved US coal reserves — amounting to 28 percent of the world’s total — is worth about $17 trillion. There will be an enormous incentive to extract that coal and get it to market. However, I think the US coal industry will continue to face serious headwinds in coming years — both political and economic — and I would therefore continue to avoid the sector except for perhaps short-term trades.

If one really wanted to invest in a coal company, Australian suppliers are in a far better position to exploit growing Chinese demand. While US coal companies have seen their share prices decimated, Australia’s largest coal producer BHP Billiton (NYSE:BHP) has fared better, suffering only an 8 percent decline over the past year.

Better market conditions in Australia have also led Peabody to announce that it will shift more  operations Down Under. Production in Australia already accounted for 43 percent of Peabody’s $8 billion revenue in 2012, but given the deteriorating conditions in the US, this percentage will continue rise.

Other US coal companies will likely need to follow suit if they are to survive. While the US will continue to burn coal for many years, coal’s days as a growth industry are likely at an end.

Fukushima Chain Reaction

While coal’s near-term future is going to be challenging, the outlook for nuclear power is mixed. In the short term, global fundamentals in the nuclear power sector will stay ugly, as they have been since the 2011 Fukushima Daiichi nuclear accident in Japan.

nuclear power consumption chart

In the past 50 years, the nuclear power industry has had two accidents that have significantly affected its growth rate. In 1986 a serious accident at the Chernobyl Nuclear Power Plant in Ukraine resulted in a number of fatalities, spread contamination across many countries in Europe, and left more than 1,600 square miles uninhabitable because of heavy radiation contamination. The Chernobyl disaster significantly changed the growth trajectory of the nuclear power industry as countries delayed or canceled plans to build nuclear power plants.

But over the subsequent 25 years, there were no other major nuclear power plant disasters in the world, and many countries faced difficult energy choices. Chernobyl began to look more like a product of shoddy design from a bygone era, and many countries began to reconsider nuclear power as a low-carbon source of reliable power.

The situation changed dramatically in 2011, when the Fukushima I Nuclear Power Plant located on Japan’s east coast was hit by a tsunami. The reactors were designed by General Electric (NYSE: GE), and the plant had DC batteries and emergency generators to keep the reactors cooled in case of a power failure. But the tsunami flooded the 4.7 gigawatt plant — the 11th largest nuclear power plant in the world at the beginning of 2011. The emergency generators were flooded and shut down. The back-up batteries provided power for less than a day, and once they were depleted cooling to the reactors was lost. Eventually three of the reactors reportedly suffered full meltdowns. A meltdown means that the nuclear fuel gets hot enough to melt, and this has the potential to melt through the casing around the reactor and release radioactive material into the environment.

Soon after the accident, radiation did in fact leak into the environment, and many countries quickly changed their positions on nuclear power. Within 10 days of the accident in Japan, Germany signaled a reversal of its direction on nuclear policy, suggesting that the incident would force governments everywhere to reassess prior support for nuclear energy.

German Chancellor Angela Merkel had been pushing hard for wider acceptance of nuclear power to reduce the country’s dependence on Russian natural gas, but within three months of the accident Merkel announced that all of Germany’s 17 nuclear reactors would be shut down by 2022. “After what was, for me anyway, an unimaginable disaster in Fukushima, we have had to reconsider the role of nuclear energy,” she explained.

With many countries reconsidering the role of nuclear power, global consumption has fallen sharply over the past two years. As Japan shut down the country’s nuclear reactors following the accident, its nuclear output plummeted and was the major reason behind a global drop of 4.2 percent for the year. But 2012 saw output fall in more than a dozen countries for a total decline of 6.9 percent — the largest ever experienced in the history of nuclear power.

The global growth rate for nuclear power is likely to remain sluggish for several years, particularly as Germany ramps down its output. However, for many countries the appeal of nuclear power is simply too great. Countries like China and India that want to provide affordable electricity to huge numbers of people are doing so with an “all of the above” strategy that includes nuclear power.

China, South Africa and Pakistan all bucked the global trend of declining nuclear power by notching double-digit increases in nuclear power consumption between 2011 and 2012. Other countries increasing nuclear power consumption during that time include the Czech Republic, Spain, Sweden, Argentina, Russia, India and Brazil.

A total of 64 nuclear power plants are under construction in 14 countries. One of these is in the US, but 26 are in China, and seven in India. Another 483 are planned or proposed globally, including 171 in China, 57 in India, and 26 in the US.

Thus, it seems probable that after the current slump, nuclear power will grow again. Uranium miners or engineering companies that specialize in nuclear power will benefit. (Growth Portfolio recommendation Chicago Bridge and Iron (NYSE: CBI) is the primary contractor on two reactors now under construction in Georgia, the first US nuclear power project in more than 30 years.)

A patient investor might live to see Cameco strong again after a losing streak that has halved its share price over the past five years. Energy Fuels (TSE: EFR) is the largest uranium miner in the US and offers great upside potential, but the downside risks in this penny stock will be unacceptable for most subscribers. 


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