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May 24, 2008

The Panda Vs. The Polar Bear
by Kurt Kasun

Last week the Bush administration declared polar bears as threatened species, acknowledging that global warming jeopardizes the species' livelihood as a result of rapid Artic sea ice depletion. The polar bear serves as a symbol for those who view climate change and global warning as the most important issue of our time. On the contrary, the panda represents China's seemingly insatiable appetite for consuming raw materials, with the world's resources being further strained by the unprecedented growing masses of people in India and other developing nations increasing their standard of living with their financial upward mobility out of poverty.

So you have the interests of those who want to limit carbon emissions pitted against one-third of the world's population, whose ideal pursuit of the life is modeled after the lifestyle experienced over the past century by citizens in developed countries, will undoubtedly lead to increased carbon use in the short term. There really is no contest here--the panda is going to devour the polar bear. I am merely speaking in symbolic terms because there is also contradicting evidence suggesting the polar bear population may be under no real threat at all.

In Kevin Hassett's Bloomberg commentary titled, "Polar Bears Threatening to Deliver Us $200 Oil," he captures the causes for concern associated with this ruling:

"The polar bear could, in theory at least, stop everything. Suppose someone wants to build a coal-burning power plant in Florida. Environmentalists might challenge the construction on the grounds that the plant will emit greenhouse gases leading to global warming and an increased threat to polar bears. It is hard to say how such challenges would play out. My guess is that it would heighten the pressure on the U.S. to adopt a cap-and-trade emissions program or a carbon tax."

Yesterday, the Wall Street Journal reported, "Congress is considering several measures that would impose a so-called cap-and-trade system, which would limit the amount of carbon dioxide companies are allowed to emit. Lawmakers this summer is expected to take up a bill sponsored by Sens. Joseph Lieberman (I., Conn.) and John Warner (R., Va.) that initially gives the power industry about half the allowances it needs and requires generators to purchase the remainder on an open market or cut emissions."

Such talk brings immense joy to the panda. Whatever limits the US Congress may impose that could result in lower domestic coal and other fossil consumption will more than be offset and graciously welcomed by the developing world. For environmentalists, this is "Whack-o-mole" times 10. For every coal plant we do not build in the US, 10 are being built worldwide. China and India are adding a coal-fired power plant every week. China in expected to boost power capacity by 40% in just three years. According to a Bloomberg article, "China is adding the equivalent of Japan's power capacity to meet the needs of the world's fastest-growing major economy. The country may increase spending on power plants and grids by at least 9.3 percent this year."

The developing world rejoiced at the twin errors US lawmakers made last week. The second blunder was deciding to no longer add supply to the US strategic petroleum reserve. This simply means more coal and oil for them at a lower cost. They will gladly absorb any decrease in demand in the developed world, as a result of climate concerns or otherwise. Our net incremental increases in carbon emissions simply pales in comparison to what we can expect as the result in growth from China, India and the rest of the developing world.

The widely-held belief that nuclear operators need greenhouse gas legislation to further in order to proceed with more plants is equally flawed. The world will be starving for energy sources in less than two years. The polar bear will be a distant memory as the supply for energy is no longer able to keep up with demand. No legislation is required. You are going to see more nuclear power plants sprout up all over the world than you could ever imagine. The problem is that we are five to ten years away from nuclear power having any meaningful impact; however, we are less than two years away from energy shortages. This will definitely get the US Congress moving. Remarkably, the problem might actually be worse in the US than in some other countries where you might expect it. A LA Times article written last week observes, "With so much resistance, coal plant construction has ebbed in the US. Be prepared for brownouts." This is not a US story (or a developed world story for that matter). The inevitable is beyond the control of environmentalists or any other group to hinder at this point. We in the US must learn that we are no longer in control of our destiny. In less than two years, we will be confronted full throttle with immense issues as figuring how to generate power, fuel our transportation needs, and feed our citizens. Accompanying spot shortages will produce intensely straining higher prices.

If you think China and India are going to actually limit their carbon emissions, you could not be more wrong. A month ago, Bloomberg reported that India has rejected a proposal supported by the US and Japan to curb global warming by replacing national limits on carbon dioxide pollution with targets for individual industries. Earlier in April, China had rejected a similar proposal. It is quite telling to further explore the concerns of Japan versus those of India. (Bloomberg)

The citizens of Japan are outright scared. A recent survey revealed that 80% of their population believes that they are not going to have adequate energy supplies over the coming decade. Japan is almost totally dependent on other nations for their fuel supplies. They are now becoming a leading proponent of clean coal technology. In early July, when the G8 next gathers to focus on climate concerns, Japan is widely expected to push for the "urgent deployment" of carbon capture and sequestration of carbon-dioxide generated from coal-powered energy plants. This is recognition that a continued reliance on coal over the near term is unavoidable.

If Japan represents the needs of a resource-dependent developed economy, India represents the needs of a resource rich, developing country. But, despite the fact that they have strong domestic coal supplies, they are in almost frantic search of even greater supplies. China, who also has significant coal reserves, became a net importer of coal earlier this year for the first time in their nation's history. The cute little panda is growing into a scary devouring beast. India is largely viewed to be less than ten years behind China in their growth curve. India can be considered another China forming in the winds. It is a cute furry tiger cub trying to catch up with the adolescent panda. Infants are known to have their growth spurts, too. Frank Holmes, in the most recent Weekly Investor Alert issued by US Global Investors, notes, "Stockpiles of coal at coal-fired generating stations in India continue to dwindle, with just nine days of forward cover on the ground, compared with the normal 22-day normal level this time of year." The Times of India recently presented a story titled, "Coal Shortage to Fuel Power Crisis," where they revealed that "the country is already facing about 14% power shortage at peak hours." Due to failure to secure supply and poor infrastructure, this number is expected to increase.

You can bet that India is going to eventually fix its infrastructure, gobbling up massive quantities of natural resources along the way. This might account for why India's coal and power generation companies are scouring the world for additional coal supplies. State-run NTPC, India's top power producer, for example, is looking to buy majority stakes in Indonesian coal mines to secure supplies. Power Trading Group, Tata and Reliance Power are also buying coal mines in Indonesia. Bloomberg reports that a coal India-led group plans to visit Mozambique to examine purchasing coking-coal mines. Coking coal is the type of coal that is required to make the steel, which will be needed to build out its currently skeletal infrastructure. The scale of resource consumption we are on the brink of is almost impossible to fully comprehend. There is clearly a resource race to secure both thermal and metallurgical coal underway. China just announced that it is "struggling to ensure steady fuel supplies to thermal power producers, because the price they pay is not fully in line with market prices," according to the country's top energy policy maker. (Reuters)

Coal producers around the world will be big winners. A tremendous opportunity still exists to invest in US domestic coal producers, which has clearly shifted out of their two-year consolidation pattern where environmental concerns largely weighed share prices down. But that was back when we lived in a US-centric world. Earlier this year, we saw prices for both met and thermal coal catapulted higher. Thermal prices have doubled in some parts of the world, while prices for met coal have tripled. What ignited the rise in the US coal stocks was largely caused by higher US coal prices related to a surge in exports from the US to Europe. This surge is expected to not only be sustainable, but to grow as we improve our port infrastructure and ability to export more.

This story just got even more bullish today for two reasons. First, with oil approaching $13O/bbl, natural gas and coal prices tend to rise with them. Second, and even more importantly, South Africa just announced that they might limit exports! (Bloomberg) South Africa has the world's second-largest coal exporting terminal. Supplies were already being re-routed from Europe to Asia, which accounts for Europe's new found reliance on the US for coal. This second issue is part of a larger problem for countries which import various forms of energy. As discoveries become harder to come by and reserves becoming increasingly depleted, energy-exporting countries are signaling that more of their coal, oil and natural gas are going to be hoarded for domestic consumption, especially as the economies of many of these countries continue their economic expansion.

As far as coal goes, this is the investment opportunity of a generation as exports begin to surpass levels last seen in the early 1970s. As news of South Africa begins to sink in, we should see prices soar. This is not at all priced in as analysts expected that we would experience a plateau in prices after the recent tripling in price. Getting back to India, Bloomberg just reported earlier today:

"Any further rise in global coal prices will be a cause for 'grave concern' to Indian importers, said R.S. Sharma, chairman of NTPC Ltd., the nation's biggest power generator. The company plans to import more than 5 million metric tons of coal in the year to March 2009, Sharma said in a phone interview from New Delhi. 'If a supplier the size of South Africa cuts exports, it's going to raise prices and hurt everyone's plans,' Sharma said. NTPC imports most its coal from Indonesia and Mozambique."

The prosperous prospects for the sector were summed up nicely by Dahlman Rose & Co's bullish domestic analysis of the coal mining sector when they wrote:

"The investment thesis for coal-mining companies is twofold, with support from the domestic power sector's current state of affairs and from a rebirth of the U.S. as a major player in both the international metallurgical and steam coal markets. We believe that export/global factors are supporting the overall thesis for now, and that fundamental issues in the domestic market are being masked and are yet to play out fully. We believe the recent run-up is supply/demand driven, not speculation. Coal's strength in the last several months, both the commodity and the equities, has occurred parallel to strength in other commodities that many blame on speculation more than fundamentals. While a popular investment strategy has been to be long commodities in a weak dollar environment, we believe the strength on the coal side is warranted. Our research indicates that coal supplies world-wide have continued to tighten even as supply becomes more constrained, and we see no relief in the near term."

US Eastern coal prices ended last week with a record advance as exports climbed.

In the new "Non-US-Centric World," the polar bear enthusiasts would be better served by redirecting their efforts from curbing greenhouse gas emissions to focus exclusively on developing new sources of energy. We are probably already beyond peak oil production and are rapidly approaching peak coal production. As coal and natural gas increasingly become part of the short term liquid transportation fuel solution their reserves will also rapidly diminish. With the growth of the panda, the tiger and the rest of the developing world, it will quickly become obvious to all that the concerns over energy supplies meeting demand, more than concerns over the environment and global warming, will necessitate and lead to developing new forms of usable energy. By focusing on producing energy innovations--fuel cells, wind, solar, and other renewables--rather than fighting the losing battle of fighting to curb fossil fuel consumption against the panda and the tiger, environmentalists are more likely to achieve their objectives in preventing man-made climate change.

As far as handicapping any sort of a timeline, I think that we are close to a tipping point. The only thing that is going to end this rally is a collapse in physical demand. Physical demand is the demand associated with the price consumers around the world are willing to pay to consume the product. We are seeing no signs of any appreciable decrease here. What you are about to witness is a massive flow of funds out of almost every other investable asset class into commodities. This represents investment demand. At some point investors/speculators will drive up the price of commodities so high that it will bring about a collapse in physical demand and a worldwide recession will result. I wrote about the time frame I expect this to occur in my commentary titled, "Commodity Boom You Ain't Seen Nothing Yet." For now, I intend to aggressively add to my existing coal mining positions in the both the core Global Megatrends Portfolio and in the Trading Portfolio.

Hint: You don't have much time to take advantage of this investment opportunity of a lifetime. In my research, I have identified five sectors which I believe stand to benefit the most. Coal (and other energy) is one group. To learn more about the other sectors you are invited to take a look at Global MegaTrends Portfolio.

*For more, I was just interviewed about coal on the Market Neutral podcast. Link: http://www.greenfaucet.com/market-neutral-kurt-kasun-coal-interview

Kurt Kasun
GlobalMacro

A contributing writer to GreenFaucet.com, Kurt Kasun writes a high-end investment timing service, GlobalMacro, which is focused on identifying opportunities that produce returns in excess of market with reasonable risk. He is strategically located in Washington, D.C., a key to maintaining contacts and relationships which help Kurt understand global policy and economic factors as they emerge. His investment approach has always been macro in nature largely due to his undergraduate studies at the U.S. Military Academy at West Point (B. S. National Security, Public Affairs, 1989) and his graduate studies at George Mason University (M.A. International Commerce and Policy, 2006).

Copyright © 2008-2009 Kurt Kasun

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