FALLS CHURCH, Va.– A little more than a month ago, Saudi Arabia hosted a roundtable discussion featuring Asian energy ministers. During these meetings, the Chinese representative–Deputy Commissioner of the National Development and Reform Commission Chen Deming–informed the participants that China will try to increase its use of domestic resources to meet its energy needs.

As I’ve noted here previously, the political leadership in China has made diversification of energy dependence away from oil a matter of national security. Given that China is not only a big consumer of energy but also a big producer, there’s scope for the country to achieve its objective.

Although China will have the opportunity to exploit its gas resources or continue to explore opportunities in the hydro, solar and bio energy areas, its main source of energy will remain coal for years to come. It seems that the Chinese leadership has realized that fact and has taken the necessary steps to ensure that its coal resources will be used wisely.

For starters, Chen was governor of the Shaanxi province–one of the largest coal-producing regions in China–and had experience on the subject before he was selected to essentially lead the national energy policy efforts. And the Chinese have been working on exploiting technologies to convert coal into oil, something that South Africa has been doing for a long time.

According to studies, oil prices above USD40 per barrel make such a conversion viable. Given that a good-sized conversion factory costs around USD3 billion, the Chinese are making sure that the viability of the project is satisfactory, given the big scale of such a project in China.

In a discussion I had with my colleague Elliott Gue, editor of The Energy Strategist, he confirmed the importance of coal. According to Elliott:

Coal is far and away the world’s most-important source of electric power and has been for decades. There are two good reasons for this: Coal is more abundant than oil or gas, and it’s cheap.

Coal is a greater pollutant than either natural gas or emission-free nuclear power. But new scrubbing technologies and plant designs can minimize that pollution. And there’s no way the world could replace all its coal-fired plant capacity in any reasonable time frame.

India and China both are heavily reliant on coal for their electricity needs. Coal accounts for about 80 percent of electricity generated in China and some 75 percent in India. And despite plans for a rapid ramp-up in nuclear, natural gas and renewable energy capacity in both countries, the Energy Information Administration projects that, in 2030, coal will actually account for 81 percent of China’s grid and nearly 60 percent of India’s.

If that’s the strategic part of the story, there’s a more tactical consideration that should also be positive for coal: Although China is a gigantic coal producer–second only to the US–its massive domestic coal production isn’t enough to keep pace with the country’s domestic demand.

There are a few reasons for China’s apparent problems in satisfying its coal needs shorter term, too, as the country’s power demand is growing by 14 percent this year.

China has seen low rainfall this year, meaning hydropower generation has been down. Thermal power plants (mostly coal fired) have been picking up the slack, taking their production growth up 18 percent and their power share to 85 percent or more at times.

Notice that China’s coal supply has been growing modestly at 8 percent per year, which, in turn, has made the country a net importer for the first quarter of 2007 and probably the rest of the year. At the same time, whatever coal exports China has are bringing in more revenue.

According to reports, Japan just agreed to new prices of USD68 per ton for April 2007 to March 2008 from USD52 ton, about a 30 percent year-over-year increase. China exported 20.6 million tons of coal to Japan in 2006, 19.2 million tons to Korea and 13.3 million tons to Taiwan

Furthermore, if demand for power in China remains strong this summer–one of the most demanding seasons of the year–industry experts have warned that the country’s ports, as well as vessel inventory, will have a hard time keeping up. The problem is that, although rail capacity has been increased, ports are able to handle only two-thirds of the new capacity. It seems there aren’t enough ships to make the round trips.

Given that only China’s flagged vessels are allowed to navigate the country’s coastal routes, with shipping rates approximately 35 percent lower in China compared to international routes, it seems difficult to add a significant number of new vessels to the trade in the near future.

I’ll be monitoring the Chinese shipping situation to determine if the SRI Portfolios should get some exposure to that theme. For the time being, I recommend more-traditional exposure to the long-term coal story in China though one of the country’s coal companies.

Incorporated in 1997, Yanzhou Coal Mining Co (NYSE: YZC) is one of the four largest coal producers in China. It derives two-thirds of its sales from the domestic market, while it sells mostly to Japan and South Korea in the export market.

The company is a leveraged play on Chinese coal because about 55 percent of its sales are on the spot market, which is entering a seasonally strong period, as noted above. The company also sells higher margin semi-soft coking coal, which is also up year-over-year.

The company has been expanding its operations, adding three new mines to its assets. With its strong balance and cash reserves, more long-term growth-oriented investments should be expected.

Yanzhou’s exposure to sport pricing raises the risks of investing in the company, given that its earnings will be affected more than others. On the other side, it will perform better if demand remains strong.

Of course, a slowdown in the Chinese economy—which I don’t expect to happen in 200–or a drop in coal prices are the two biggest risk factors. I’m adding Yanzhou Coal Mining Co to the Main Holdings Portfolio; one ADR is equal to 50 local shares.

Fresh Money Buys

If you’d like to add to your positions in Portfolio recommendations or allocate new funds, focus on the following markets, in order (for both countries and sectors): South Korea (banking), Hong Kong (real estate, publishing, infrastructure), India (pharmaceutical, banking), Malaysia (ETF), Russia (telecommunications, energy), Singapore (telecommunications, banking, industrial), Europe (oil, pharmaceuticals, industrials, communications equipment, media), Japan (industrials, banking), China (consumer, coal, power, oil, water), Taiwan (technology, telecommunications) and Macau.