Dear Reader,

Coal plays an integral role in keeping the lights on and buildings standing. Despite the green energy movement, more than 40% the world’s electricity still comes from coal-fired plants, and 70% of the world’s steel production requires metallurgical coal.

This graphic from the World Coal Organization reviews the types of coal and what they’re used for.

Like other mainstream commodities, coal has a spot price; but many trades take place off-exchange. For trades that do take place on an exchange, the two most common benchmarks are Central Appalachian coal, produced in the eastern United States, and Australian thermal coal, produced mostly in eastern Australia.

The price difference between the two comes largely from proximity to final destination. The coal spot market in Asia has taken off tremendously over the past year, with 67.7 million tons traded over 2013.

Major Players and Their Reserves

Total global reserves are over 860 billion tons, with anthracite and bituminous coals accounting for 404 billion tons (47%). At current production rates, the world has 109 years of reserves left.

Given a specific amount of resource, you might wonder how much of it is actually being produced. A common metric that reveals the number of years left at current production rates is the reserves-to-production ratio—a country’s total proven and probable reserves divided by its annual production.

It’s not just the quantity, but the kind of coal that matters. Calories quantify the amount of heat produced by complete combustion of the material—in effect, the amount of energy the material contains. In the case of coal, caloric level represents its quality, ash and moisture content, and its hardness. A major reason why anthracite and bituminous coals are more valuable resources is their high caloric content.

The following chart combines these two characteristics per country.

Coal Cycle

Once the downtrend in coal prices approaches the minimum level a company needs to make a profit, an unpleasant conundrum arises: Should it stop producing until prices pick up, or should it increase its production to try to maintain its revenue levels? Sometimes a company has to keep up production or go bankrupt—but if consumption doesn’t keep up with production, the excess supply can put even more downward pressure on prices.

The coal sector is currently in this exact situation. Major producers such as BHP, Glencore Xstrata, and the like have suspended operations due to poor economic conditions.

So let’s examine the demand in the coal market.

Major Coal Consumers

China is the 800-pound gorilla in the coal market, both in reserves and in consumption. There has been considerable outrage from the Western world over the air quality in China due to the lack of environmental regulations. I can confirm firsthand that air pollution there is bad.

The good news is that Beijing looks ready to pass laws to improve its air quality. The centerpiece is expected to be an import ban on low-quality coals with a caloric content of less than 3,900 kilocalories per kilogram. Such coals, like lignite, are used in lower-tech power plants.

China recently surpassed Japan as the largest importer of coal, even with Japan’s post-Fukushima scramble to replace the electricity that its nuclear power plants used to produce. Tokyo Gas, Japan’s largest municipal natural gas utility, said it has “strong interest” in building new coal-fired plants in order to diversify energy supply—a nice bump for coal demand in the country.

Japan continues to be the #2 global producer of steel. Annual production for 2013 accounted for approximately 7% of global supply, which means it’s a significant importer of metallurgical coal.

Japan gets most of its thermal and met coal from Australia: 72% and 52%, respectively. Indonesia is its second-largest supplier at 13% and 27%.

India ranks #3 in the world in differential between exports and imports for coal. With a population of over 1 billion, a population growth rate of over 1%, and a GDP growth rate of over 3%, its demand for power is relentless.

Of measured, indicated, and inferred coal in India, 232 billion tons of its total 264 billion tons fall into the category of non-coking coal. While lignite may be used for power generation in areas with relaxed environmental policies, the ability to export coal will be limited, likely requiring India to remain a net importer.

Like many of the Asia-Pacific countries, South Korea is and will continue to be heavily dependent upon energy imports. Of its total $150 billion in imports of oil, liquefied natural gas (LNG), and coal, oil represents about $110 billion and coal less than $20 billion. But thanks to the country’s growth rate, on a percentage basis coal demand has increased by 550% over the last 10 years.

The latest South Korean energy policy is aimed at raising coal briquette prices, a move to slow demand that suggests a shift toward LNG as the country’s main long-term power source.

The international coal trade is forecast to grow by 65%, from 24 quadrillion Btu in 2010 to 40 quadrillion Btu in 2040. To put those figures in perspective, one rail car holds about two tons of coal, or the equivalent of roughly 40 million Btu. If you were to fill rail cars with the 2040 forecasted demand all at once, the train would go around the Earth more than three times.

Supply-Side Economics

Indonesia is the world’s #1 producer and exporter of thermal coal. Currently, it exports nearly 80% of its production. However, the government has put a cap on coal production for 2014, as it’s trying to put future domestic interests ahead of international trade. The current reserves-to-production ratio stands at approximately 79 years.

A new Indonesian mining law introduced in 2014 banned the export of raw ore, which means all coal refining must be done domestically. The government has also stated plans to raise royalties from the 3-7% range (depending on type) to 13.5% for all coal types.

Port congestion has become an issue for the exporters; wait times have increased by nearly 30% to 6.7 days, in contrast to the one- to two-day average in other Asian ports. It’s one symptom that shows how reinvestment in the country’s port infrastructure is crucial to further development of its export market.

Just across the Timor Sea from Indonesia is Australia. The Land Down Under currently occupies the #2 spot of coal exporters, but it dominates the global forecast for coal production. Nearly 50% of coal reserves in Australia fall into the “hard coal” category, an advantage in coming years as environmental regulations get tougher.

The Australian government has big plans over the next several years to expand infrastructure that will add 80 million tons of port capacity, as well as to ramp up 65 million tons of production capacity. In total numbers, the export forecast is 327 million tons (23%) of the world’s steam, or thermal, coal. Metallurgical coal production is expected to be 259 million tons, which will account for 54% of global met production.

Russia holds the second-largest coal reserves in the world, with a reserves-to-production ratio of 443 years. Russian energy policy actually is going in the opposite direction of most of the West, by decreasing natural gas power generation and raising coal-fired generation.

Additionally, the coal industry in Russia has been restructured, leading to the privatization of coal assets. All coal mining is now carried out by joint-stock companies with private ownership.

There’s not a lot new to say about Colombia, the fourth-largest coal exporter in the world and the largest in South America by a considerable margin. Colombian reserves are 94% anthracite and bituminous coal and are the primary suppliers of coking coal for Brazil.

In contrast, South Africa shows potential to be a hot new region for coal with the discovery of the Waterberg area play. In 2012, the state-owned rail company announced plans to build Swazilink, a railway from the Waterberg coalfield in northeastern South Africa and the port at Richards Bay that would increase export capacity along with several feeder lines.

The United States, too, continues to be a major producer of coal; however, production has dropped off every year since 2007. Coal production for 2013 was down 27% to 744.8 million tons as tougher environmental regulations weakened domestic demand. Coal-fired power plants are subject to the Mercury and Air Toxics Standards (MATS), scheduled to take effect on April 16, 2015.

Tough domestic regulations don’t necessarily spell doom for the American coal industry as long as other countries in the world still operate coal-fired power plants. Nearly half of its reserves are the desirable anthracite and bituminous coals.

Future Supply

The growth forecast for total steam- and met-coal exports is 39% by 2040. Here’s a summary of expected exports by kind and country. New developments can alter the standings, however—among those just mentioned here, there’s the proposed air-quality legislation in China and Indonesia’s protectionist trend.

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