Asia's Development Will Continue to Drive Energy Needs
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There are a host of negative issues in China and Asia but in the long run the demand for oil and natural gas is set to increase. With the Fukushima disaster and the continued declines in HSBC's Flash China PMI index, there is a large amount of negative news. The unknowns hidden in China's shadow banking system and debt problems in other countries like South Korea show a host of underlying issues which pop up sporadically. In the face of all of these negative aspects Asia's energy demand still has room to grow.
China recently surpassed the US in total energy consumption. China's main energy source for electricity generation is coal and has recently become a net coal importer. Japan has announced their plans to remove all nuclear power by 2040. Whether Japan actually achieves such a goal is yet to be seen. A reduction in Japan's nuclear energy industry is almost guaranteed. Their precarious situation as a small series of Islands which are forced to import most of their raw materials means that they will be leery to place all their electricity needs on natural gas. Renewables will always have some relevance, but they are still not significant enough to replace base load generation.
The decline in nuclear power is very positive for the coal markets. It would be very unwise for Japan to place the majority of their growth only in natural gas. Fracking is still not completely understood and the lack of long term data suggests that even at $8/Mcf, only 31% of horizontal wells would break even or make money. The higher prices for fracked natural gas and the environmental concerns make it very risky for Japan to place their new power generation solely on this source. They face stiff competition for natural gas resources from China and Russia. Coal is a major part of the world's energy mix and the recent events in Japan and continued development in Asia mean that it will remain so.
The EIA expects energy consumption to increase over the coming decades. The majority of growth is expected to come from non-OCED countries. The per capita energy consumption of many non-OCED countries like China is far below American standards. China just recently passed the U.S. in energy consumption while their population is far below America's. China and Asia have a host of issues but as they continue to develop their energy needs will continue to grow.
Larger diversified coal producers like Peabody Energy Corp (NYSE: BTU) offer an opportunity to take advantage of the long term rise in coal. With assets in America and Australia they are exposed to both sides of the Pacific. The slow growth in ODEC is a negative factor for the long term status of their U.S. operations though the possibility of exporting always exists.
Alpha Natural Resources, Inc. (NYSE: ANR) is focused in metallurgical coal and this gives them a large degree of exposure to the Chinese manufacturing sector. With the recent down trend in the Chinese PMI one can expect the company to under preform in the short term as the world's factories decrease production.
Arch Coal, Inc. (NYSE: ACI) has the highest total debt to equity ratio of any of these companies at 1.60. Depressed coal prices and declines in emerging markets mean that a prolonged downturn could send the company into bankruptcy. In the short and medium term the coal industry does not appear to be a great investment. The larger more diversified players like Peabody have been able to stay profitable but they will not be able to change the short term prospects of the entire coal market.
Over the long term there are a number of positives for the coal market. Growth in the emerging markets will continue to drive energy demand. Japan's nuclear mishap is a very positive factor for non-nuclear energy sources. In the short term there are number of negative factors and declines in the Chinese PMI should not be forgotten. Investors ought to be aware of the long term picture and not get overwhelmed by the short and medium term negatives.
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