Coal and Treasuries

It was the best of times for the developing world, and the worst of times for the developed world. In the developing world, they built savings. In the developed world, they groaned and sagged under the weight of debt. In a world where the credit of developed nations had always been believed, the serial monetizations and bailouts set loose an emerging incredulity–driving developing nations into gold, commodity currencies, and land. In the aftermath of the financial crisis the developing world, measured at about 4.5 billion people, lumbered forth with its insatiable demand for energy. Mostly coal. In the developed world? They replaced their lost demand, lost credit, and the loss of cheap energy the best they knew how: with paper.

OECD demand growth for oil faltered years ago, as far back as 2004 when oil went above the “unthinkable” price of 40 dollars a barrel. In the developing world the escalating price of oil did not so much delay, as divert, energy demand to the powergrid. To an extent that’s hard to measure, but certainly evidenced by power generation buildout and growth in electrified transport, the rising price of oil sent a confirmatory signal to the Non-OECD: stay on your coal trajectory. Of course, overall demand for all types of energy in the developing world took off ten years ago. Indeed, in 2008 for the first time ever, energy demand in the Non-OECD eclipsed by a hair all energy demand in the OECD. Roughly speaking, we can think of the OECD as the oil users, and the Non-OECD as the coal users. Gaze upon the chart below:

When the developing world faced higher oil prices, it guided its development toward power generation. But when the developed world, already married to an oil based infrastructure, faced higher oil prices it guided its development towards growth in credit. The United States is the number 2 user of coal, behind China, at 565 mtoe per year. And Germany is the number 7 user of coal at 85 mtoe per year. But coal demand growth in the OECD is largely halted by infrastructure. Most of the powergen additions in the OECD the past 30 years have been natural gas fired. Take a look at the growth of coal demand over the past 20 years, meanwhile, back in the developing world.

While the United States has little room for growth in coal demand, it does indeed have room to reduce coal demand as the depression rolls onward. It should not have been a surprise to anyone following the latest failed recovery in the housing market, the continued crash in the commercial real estate market, and the predictable fall-offs in auto production (since cash for clunkers) that US electricity demand is going nowhere. Thus, when CSX Railroad announced last week that shipments of coal to US utilities would not be strong this year it was confirmatory to the macro trend. Although natural gas is “more expensive” on a per unit basis, it generally takes a much bigger spread to get utilities to actually favor coal over natural gas as the latter can be burnt with lower regulatory costs.

The expansion of the FED’s balance sheet and the explosion in government debt issuance, therefore, may have eased the pain of the US industrial and consumer collapse–but they’ve done nothing to revive real demand. And the coming tail-off in electricity use even from low levels is yet another sign that the 2009 stimulus package as well did not come back to Washington in the form of higher industrial activity–and higher tax receipts. Indeed, tax receipts on both the state and federal level are awful and this accounts for recent declarations from Illinois, New York, and California that they are essentially broke. In all that empty commercial real estate across the country, where no shoppers roam and no sales tax is recorded, the thermostats are turned down and the lights are turned off.

Meanwhile, there is every indication that the FED is going to have to extend its quantitative easing as the supply of Treasuries continues to ramp higher while US savings and international capital flows are simply not enough to supply the necessary bid, in US Treasuries. Moreover, it’s likely that a great deal of last year’s bid in US Treasuries was simply the FED’s monetization of the mortgage-backed securities market (MBS) coming back in the form of Treasury demand. The FED in a program of ongoing duration started purchasing 1.3 trillion of MBS starting last year, with the intent to continue through the end of March 2010. Should they not extend the MBS purchase program, I would expect Treasury prices to fall. Foreigners have already been avoiding the longer end of the bond curve, or simply reducing Treasury purchases overall. | see: Debt Burden Now Rests More on US Shoulders. Additionally, there is the problem of duration, in that Treasury has been funding a large portion of US deficit spending with shorter duration bonds. That means a larger number of bonds mature in shorter timeframes. Thus, in 2010, the US not only has to float a large new supply of Treasuries but it has to find buyers for its maturing supply of Treasuries. | see: The $700 Billion U.S. Funding Hole; Desperately Seeking A Very Indiscriminate Treasury Buyer.

Surprisingly, or perhaps perversely, 2010 sees an accelerated continuation of the 10 year trend in developing world coal demand and developed world credit growth. For all of its reflationary firepower, the OECD has at best eased the acute phase of deflation while sparking strong inflation in the Non-OECD. Here in the developed world we continue to see asset price deflation in real estate, though notably, our purchasing power has started to fall in the aggregate in both the US and in Britain. (In China, inflation threatens to rage. ) The problem for the OECD is that energy demand in the Non OECD does not translate well to demand growth for US Treasuries or UK Gilts. Coal prices are strong however because US utilities may not require more coal but pan-Asian utilities continue to build capacity, and the trajectory higher continues.

In January 2009 I asserted that the 27 year bull market in US Treasuries had ended in the blow off panic spike (in prices) just that December. I maintain that view now. And, while Washington may at times entertain thoughts of choosing a deflationary pathway out of the crisis–call it a liquidationist urge, if you will–the voices that beckon to inflate our way out of the crisis will always win out out in the end.

The developing world is clear-eyed enough to know that it cannot depend on developed world demand, to keep its factories running. This is why alot of direct trade occurs now within the Non-OECD that is designed to both trigger domestic demand and which also facilitates resource for resource deals which lock up supply. It’s in the developed world however that the lack of sobriety has reached epidemic levels as we keep trying to replace both energy inputs and production–with credit. When the growth in private credit could no longer carry the weight and failed, we embarked on a mad dash to do the same with sovereign credit. Were the OECD and especially the United States building new power generation or electrified transport with this credit, we could at least expect to get some return on the investment. But alas, we are hellbent still in trying to revive consumer demand. Thus, for all the growth in government debt, we are doing nothing more but pouring water on concrete.

-Gregor

charts by www.gregor.us using data from BP Statistical Review 2009

  • http://twitter.com/howardlindzon howardlindzon

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  • http://twitter.com/howardlindzon howardlindzon

    stop sharing all the good stuff :)

  • http://yzerfonteinchronicles.blogspot.com weskus

    I like it… here's some confirmation if you need it… http://bit.ly/4XDjsJ

  • http://yzerfonteinchronicles.blogspot.com weskus

    I like it… here's some confirmation if you need it… http://bit.ly/4XDjsJ

  • doc_faustroll

    Nicely done Gregor,

    I really appreciate the insights on Coal 2.0. Your take on coal consumption is one of the best macro views that I have seen in the macro analysis of recent vintage. I think you have discussed the developing world energy consumption at other times, emphasizing the smaller footprints and the larger numbers. I think I remember you making the point about how it is easy to miss the cumulative effect of “smaller but more.” Perhaps it is not so hard when one looks at the charts above to at least see the macro effect. It still may be hard for OECD members to see how this is a secular trend of many, many small footprints? Is there data that breaks down large scale coal consumption in power plants and industrial use versus smaller and even individual coal consumption in the developing countries?

  • doc_faustroll

    Nicely done Gregor,

    I really appreciate the insights on Coal 2.0. Your take on coal consumption is one of the best macro views that I have seen in the macro analysis of recent vintage. I think you have discussed the developing world energy consumption at other times, emphasizing the smaller footprints and the larger numbers. I think I remember you making the point about how it is easy to miss the cumulative effect of “smaller but more.” Perhaps it is not so hard when one looks at the charts above to at least see the macro effect. It still may be hard for OECD members to see how this is a secular trend of many, many small footprints? Is there data that breaks down large scale coal consumption in power plants and industrial use versus smaller and even individual coal consumption in the developing countries?

  • http://twitter.com/ianrmc Ian M

    nice work Gregor….perhaps some hint of why Copenhagen failed then, given the growth of coal usage in the developing world?

    I'm curious what data/metrics you are looking at when you talk about “the latest failed recovery in the housing market.” Even with the expiry/reinstatement/whatever of the tax credit, housing activity is well above the 2008 nadir, and prices haven't collapsed into a new down leg, according to most of the data I've seen. I'm not trying to be confrontational, just curious.

  • http://twitter.com/ianrmc Ian M

    nice work Gregor….perhaps some hint of why Copenhagen failed then, given the growth of coal usage in the developing world?

    I'm curious what data/metrics you are looking at when you talk about “the latest failed recovery in the housing market.” Even with the expiry/reinstatement/whatever of the tax credit, housing activity is well above the 2008 nadir, and prices haven't collapsed into a new down leg, according to most of the data I've seen. I'm not trying to be confrontational, just curious.

  • Anon

    I think you should write about the BTU content of the coal that's being mined in the US. Electricity demand may be down, but we need to burn more coal to generate the same or lower amount of electricity.

    West Virginia's coal mines are of the highest energy content. The best coal in WV has been largely
    mined already. What's left is the less energy dense stuff. Not all lumps of coal are created equal. The stuff in the powder river basin is not as good as the appalachian coal.

    We'll continue to see increases in coal production because we need MORE of the lower quality
    coal to generate the same amount of electricity.

  • Anon

    I think you should write about the BTU content of the coal that's being mined in the US. Electricity demand may be down, but we need to burn more coal to generate the same or lower amount of electricity.

    West Virginia's coal mines are of the highest energy content. The best coal in WV has been largely
    mined already. What's left is the less energy dense stuff. Not all lumps of coal are created equal. The stuff in the powder river basin is not as good as the appalachian coal.

    We'll continue to see increases in coal production because we need MORE of the lower quality
    coal to generate the same amount of electricity.

  • Archibald Stirling

    Coal Facts

    Just sit down for a minute. I wish to share an epiphany I had with this site since it has helped me understand coal.

    China must build the equivalent of the Australian Coal Mining Indusrty Each year for the next 5 years just to match demand.

    Surprisingly they have done just this for the last 8 years given theri production statistics.

    Unfortunately, China cannot repeat this growth phase in the future given, resources, safety, and logistics issues.

    India and China became coal importers in 2008 and 2009 respectively.

    Vietnam will be an importer within 3 years.

    Indonesia will use half of its output for domestic consumption within 5 years.

    Mozambique coal is years away until infrastrucure is built.

    Where is the new coal supply to come from to meet 250-300 million tonnes per annum increase. If you have any ideas could you please explain.

    US Coal to be deilivered in Asia will mean a significant upward price in Australian Coal prices. $40-$45 per tonne is an estimate used in the industry. But with higher oil and transport costs associated with higher oill prices these could double.

    China builds the equivalent of the Australian electrical grid each month and French Grid every 3 months.

    Over 70 percent of electricity production in developing world will be coal based.

    There is potentially massive upside risk to coal producers shares in the coming 3-4 years.

    Sometimes one gets lucky in life. In 2006 I got lucky with ZINC. Confronting you is an investment bet that will potentially change your life.

    Its not enough to know a market is undervaled, one must act. For an investment to matter it must be material and impact on your life.

    Once the stock market stabilizes you will have an opportunity like no other in your life. Shares will be ripped higher by massive dividends and eventual market understanding. At $USD 150-$200 pet tonne most Thermal Coal miners will be on 3-5 PE Rations in 2012.

    You work out the effect on your wealth and on the upside risk to Thermal Coal Producers.

  • Archibald Stirling

    Coal Facts

    Just sit down for a minute. I wish to share an epiphany I had with this site since it has helped me understand coal.

    China must build the equivalent of the Australian Coal Mining Indusrty Each year for the next 5 years just to match demand.

    Surprisingly they have done just this for the last 8 years given theri production statistics.

    Unfortunately, China cannot repeat this growth phase in the future given, resources, safety, and logistics issues.

    India and China became coal importers in 2008 and 2009 respectively.

    Vietnam will be an importer within 3 years.

    Indonesia will use half of its output for domestic consumption within 5 years.

    Mozambique coal is years away until infrastrucure is built.

    Where is the new coal supply to come from to meet 250-300 million tonnes per annum increase. If you have any ideas could you please explain.

    US Coal to be deilivered in Asia will mean a significant upward price in Australian Coal prices. $40-$45 per tonne is an estimate used in the industry. But with higher oil and transport costs associated with higher oill prices these could double.

    China builds the equivalent of the Australian electrical grid each month and French Grid every 3 months.

    Over 70 percent of electricity production in developing world will be coal based.

    There is potentially massive upside risk to coal producers shares in the coming 3-4 years.

    Sometimes one gets lucky in life. In 2006 I got lucky with ZINC. Confronting you is an investment bet that will potentially change your life.

    Its not enough to know a market is undervaled, one must act. For an investment to matter it must be material and impact on your life.

    Once the stock market stabilizes you will have an opportunity like no other in your life. Shares will be ripped higher by massive dividends and eventual market understanding. At $USD 150-$200 pet tonne most Thermal Coal miners will be on 3-5 PE Rations in 2012.

    You work out the effect on your wealth and on the upside risk to Thermal Coal Producers.

  • http://www.marketfolly.com marketfolly

    just wanted to say great post! have been watching treasuries more closely myself as of late.

  • http://www.marketfolly.com marketfolly

    just wanted to say great post! have been watching treasuries more closely myself as of late.

  • Paul Lessard

    Gregor, I think your excellent piece shows that China must be very worried about the future price & supply security of coal. That is yet another reason for them to be investing so substantially in solar & wind power etc.

  • Paul Lessard

    Gregor, I think your excellent piece shows that China must be very worried about the future price & supply security of coal. That is yet another reason for them to be investing so substantially in solar & wind power etc.

  • gregor.us

    I like to test the boundaries of what's good for me, or not. :-)

  • gregor.us

    I like to test the boundaries of what's good for me, or not. :-)

  • gregor.us

    Thankyou.

  • gregor.us

    Thankyou.

  • gregor.us

    Have not seen breakdowns like that, faustroll. You might try WRI dot org, and you might also look at latest books on Coal by Richard Heinberg. In general I am pursuing coal more because I think its neglected. I am making notes on your questions. :-)

  • gregor.us

    Have not seen breakdowns like that, faustroll. You might try WRI dot org, and you might also look at latest books on Coal by Richard Heinberg. In general I am pursuing coal more because I think its neglected. I am making notes on your questions. :-)

  • gregor.us

    My latest newsletter was titles Copenhagen Confirmation, and yes, there is a dovetailing between developing world coal use and OECD's woeful financial condition that pretty much ensures, right now, that no global climate agreement (or one that would do much or “hurts” much) is forthcoming.

    Everything I see in housing data from Case-Schiller, to stuff from outfits like Altos to my own 10 year collection of resources confirms for me that its only the low end which has the govt support that provided a data kick to the overall market. What I see is that everything above that is generally not selling at the Ask, and has been transacting at 6-12% below the Ask since September. Vacancy rates, shadow inventory, etc. And of course, there is no wage growth either in real or nominal terms. My view has been the current leg down is much gentler. But I think it could get nasty again–especially if the FED exits the MBS market. (which I don't expect them to do–I expect them to reverse the previous schedule, and start a new MBS program).

  • gregor.us

    My latest newsletter was titles Copenhagen Confirmation, and yes, there is a dovetailing between developing world coal use and OECD's woeful financial condition that pretty much ensures, right now, that no global climate agreement (or one that would do much or “hurts” much) is forthcoming.

    Everything I see in housing data from Case-Schiller, to stuff from outfits like Altos to my own 10 year collection of resources confirms for me that its only the low end which has the govt support that provided a data kick to the overall market. What I see is that everything above that is generally not selling at the Ask, and has been transacting at 6-12% below the Ask since September. Vacancy rates, shadow inventory, etc. And of course, there is no wage growth either in real or nominal terms. My view has been the current leg down is much gentler. But I think it could get nasty again–especially if the FED exits the MBS market. (which I don't expect them to do–I expect them to reverse the previous schedule, and start a new MBS program).

  • gregor.us
  • gregor.us
  • gregor.us

    I agree it could be ferocious. Thankyou.

  • gregor.us

    I agree it could be ferocious. Thankyou.

  • gregor.us

    Cheers, MF.

  • gregor.us

    Cheers, MF.

  • gregor.us

    Yes I think they are worried on two levels: mostly on supply, but also on degradation of the landscape and the air.

  • gregor.us

    Yes I think they are worried on two levels: mostly on supply, but also on degradation of the landscape and the air.

  • rower32

    great great great analysis! thank you!

  • http://twitter.com/phoneranger Drew Robertson

    FWIW we calculate that there are about 400 unit trains of coal inventory sitting at North American utilities. Maybe China will take off that surplus. But not fast enough for CSX et al.

  • http://twitter.com/phoneranger Drew Robertson

    FWIW we calculate that there are about 400 unit trains of coal inventory sitting at North American utilities. Maybe China will take off that surplus. But not fast enough for CSX et al.