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The Queensland flood is coming to your neighborhood

The news this week that about one-third of Australia's coal production has been halted by massive flooding in the state of Queensland is an opportunity to look at the coal supply situation in Asia and the impact it could have on global energy prices in the next few months.

For several decades now, China has been the epicenter of rapidly increasing global coal production. In fact, it is hard to understate the significance of the China's coal industry's contribution in recent years to the world's economic growth. With total coal production of circa 1 billion metric tons in 1990, Beijing was able to grow its coal industry to the point where it might (the numbers aren't in yet) have produced on the order of 3.2 billion tons including a 10 percent or nearly a 300 million ton increase in production during 2010 alone. Now this is a whopping amount of energy. The utility of coal and oil of course are not the same for the world's transportation systems run on the liquid fuels derived mainly from oil, while the world's coal production mainly goes to generate electricity, heat buildings and make coke for steel.

If one assumes each ton of coal is roughly equivalent to 4.8 barrels of oil, then Chinese coal production last year was on the order of 15 billion barrels of oil equivalent or half the world's oil production.

In November, however, the Wall Street Journal reported that the word out of Beijing was the meteoric growth of coal production was likely to come to a halt possibly as soon as this year or next. This of course makes perfect sense as nothing can continue growing at 10 percent or 300+ million tons per year indefinitely and knowledgeable outside observers were saying that this unprecedented surge in growth had to end soon. Mines were getting deeper, coal seams thinner and transportation of this much coal from the mines was overloading the rail and road networks.

The problem, however, is that if Beijing is to continue growing its economy in the vicinity of 8-10 percent a year, then it has only a limited number of choices. It can increase its production of nuclear and hydro generated electricity; it can replace old inefficient generating stations with new high-efficiency ones; or it can increase imports of foreign coal, liquefied natural gas, or oil. While China is making major efforts to increase production of wind and solar power, these are still minor producers by the scale of Chinese energy consumption.

Reports say mines accounting for 40% of the world’s coking coal have been shut down by the flooding.

While the first alternatives, hydro, nuclear, and more efficient plants are the best long-term solution, they will take many years to build and China's energy shortage is already upon them. Coming up with anything close to the equivalent of 300 million additional tons of coal by replacing inefficient generating stations and building new non-coal-fired power plants each year is clearly impossible over the short term.

Importing coal, however, can be accomplished relatively quickly provided there is enough coal available. For the Chinese hard currency currently is not a problem. Finding a source of supply for coal in the quantities the Chinese will need to maintain their accustomed growth is going to be a challenge. In 2009, only about 16 percent, 940 million tons, of global coal production was exported with the rest being consumed in the producing countries. Until recently, China was not a major factor in the coal import market and was actually exporting coal. Now this is changing and Chinese demand for imported coal is increasing rapidly.

Interestingly, the adequacy of Chinese domestic production is a matter of controversy. In an effort to hold down inflation, Beijing mandated a cap on coal prices to keep the electric industry from passing on higher fuel prices to consumers. The coal mines seem to be balking at the price ceiling and new coal contracts are not getting written in sufficient quantity to cover the needs of the power industry. While coal industry officials maintain there is plenty of coal, power plants in some areas say the coal shortage is reaching critical proportions.

Recent reports from Australia say that mines accounting for roughly 40 percent of the world's coking coal have been shut down by the flooding and it may be several months before production is back to normal. Australian steam coal production is also affected and the problem is exacerbated by the same rains hitting nearby Indonesian mines slowing coal production there.

With much of Asia's coking coal supply shut-in, prices for coal and steel are going to increase rapidly. With imports severely restricted for the next several months some Chinese steel mills may be forced to shut down and imported steam coal shortages are likely to result in more reductions in China's power generation. Some are already saying that this situation could add to inflationary pressures and that shortages could markedly slow China's economic growth this winter.

How this is all going to work out is difficult to foresee. Should the coking coal shortage slow China's economic growth significantly, then it is possible that Beijing's demand for oil could slow too. The other side of the coin however, is that China has a history of increasing oil imports to make up for coal and power shortages by keeping factories running with emergency generators. This is fact is what appears to have happened last fall when Chinese oil imports surged to new highs.

With the global oil markets tight and prices rising, any new source of demand could easily have an outsized impact on oil prices in the next few months, right down to what you pay for gasoline at your local pump. As the global energy markets become tighter and tighter, a flood on the other side of the world is enough to trigger off a shock wave that will be felt everywhere.

What do you think? Leave a comment below.

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