One of the things that many environmentalists liked about the outbreak of the novel coronavirus pandemic is that it reduced carbon emissions. After all, after the stay-at-home orders were issued and the economy was shut down, people were using much less fuel for either travel or other commercial uses. In addition to this, many oil and gas companies cut back on the development of new fields, which could result in oil consumption being lower than previously for an extended period. However, a recent report from Rystad Energy shows that they may have been overly optimistic here. This is because the shutdowns may have the effect of increasing the demand for coal in some emerging markets. One way that investors can play this is by investing in the VanEck Vectors Coal ETF (KOL) over the medium term. We will discuss the reasons why in this article.
Making The Case For Coal
It is highly unlikely that anyone reading this is unaware of the impact that the outbreak of the novel coronavirus pandemic has had on energy prices. As we can see here, the price of Brent crude has fallen from $66.25 at the start of the year to $41.68 per barrel today, which is a 40.06% decline, and while prices have certainly come up quite a bit from their lows, they do still remain well below where they were at the start of the year:
Source: Business Insider
This has also had the unfortunate effect of reducing the production of both oil and natural gas. In the United States alone, production has declined by two million barrels of oil and four billion cubic feet of natural gas per day year to date. The reductions internationally have been even greater.
One thing that many nations around the world have been attempting to do is reduce their carbon emissions due to concerns of climate change. One of the ways that they are attempting to do this is by converting their old electricity-generation plants from coal to natural gas due to the fact that natural gas produces much lower carbon emissions than coal does. Several emerging nations in Southeast Asia such as Vietnam and China have been among them.
In order to accomplish this though, these nations need to actually obtain the natural gas for their power plants. The coronavirus-induced plummet in oil prices may have made this job more difficult to accomplish. Vietnam may actually be a perfect case study of why this might be difficult.
As is the case with many emerging markets, Vietnam is growing its gross domestic product at a much faster rate than developed markets. In Vietnam’s case, that rate is about 7% per year. Naturally, this kind of growth requires the growth of energy infrastructure in order to feed the energy demands of the new industrial and commercial users, as well as from the members of the emerging middle class that wants to upgrade their lifestyles. According to Rystad Energy, this growth will require Vietnam to increase its power generation capacity from 54 gigawatts today to 130 gigawatts by 2030. This is a 140.74% increase over the next decade. As might be expected, this new infrastructure will increase the country’s demand for natural gas.
There may be some readers at this point that mention that the country can meet this expected demand growth using renewable sources. This is unlikely because renewable energy generation technologies do not yet have the reliability to sole power an industrialized economy. Vietnam does plan to increase its renewable energy generation ability, but the demand for natural gas from the electric generation sector alone is still expected to grow from 7.2 gigawatts today to 19 gigawatts by 2030.
Vietnam has some of the largest natural gas reserves in the world. According to the most recent estimates, the country has approximately 24.7 trillion cubic feet of proven reserves, which puts it at 29th largest in the world. This would be another reason for the country to base its power generation around natural gas, as it makes no sense for the country to import resources as it attempts to industrialize itself. Indeed, that was the nation’s plan. Rystad Energy expected that output would reach ten billion cubic meters by 2025, 60% of which would come from new projects. Unfortunately, the cuts from energy companies due to the COVID-19 pandemic have delayed the development of many of these projects. Rystad Energy says that 200 billion cubic meters of the country’s undeveloped resources will no longer be developed in the near term.
This ten billion cubic meters of output would not have been enough to meet the country’s expected sixteen billion cubic meters of demand. It was expected that the country would make up the difference by imported liquefied natural gas from the United States and Australia:
Source: Rystad Energy UCube, GasMarketCube
As a result of the postponements due to the COVID-19 pandemic, Rystad Energy only expects the country to produce seven billion cubic meters by 2025. This means that it has to import an even greater quantity of liquefied natural gas to meet its demand. This could prove difficult.
One of the reasons for this is the impact that the COVID-19 pandemic has had on liquefied natural gas projects around the world. The sector was already suffering from an oversupply of the compound before the pandemic, and the global economic shutdowns have made the problem worse. This has resulted in the developers of liquefied natural gas projects having difficulty obtaining long-term contracts for the output from their projects, and the presence of these contracts is necessary for these projects to make economic sense. This is why we have already seen the LNG Canada and Pacific Oil & Gas’s Woodfibre LNG project get delayed by at least one year. We have also seen Royal Dutch Shell (RDS.A) withdraw from the Lake Charles II project and Woodside Petroleum (OTCPK:WOPEF) delay the deployment of the second train at the Pluto LNG project. This all means that the medium-term supply of liquefied natural gas will likely be lower than what many were expecting prior to the outbreak of the pandemic.
The medium- to long-term story for liquefied natural gas continues to look quite strong though as countries all around the world seek to reduce their carbon emissions. The developing nations of Southeast Asia such as Vietnam are expected to have the highest growth in demand, although China and India will both likely boost their demands at reasonable rates. As we can see here, the global demand for liquefied natural gas is expected to increase at a 4% compound annual growth rate over the next five years:
Source: Wood Mackenzie, GasLog Limited (GLOG)
Rystad Energy’s concern is that the delay or deferment of projects will make it difficult to produce enough liquefied natural gas to meet this demand. Thus, these countries may need to import greater quantities of coal in order to meet their growing energy needs because they already have the coal-fired power plants in place and there are no other viable alternative sources of electricity that can be ramped out quickly enough to meet their needs.
About The Fund
The obvious way for an investor to play this is by investing in the VanEck Vectors Coal ETF (KOL), which is one of the only exchange-traded funds that is focused on the coal industry. At first, it might be expected that the fund only invests in coal miners, but this is not correct. According to the fund’s website, the fund is designed to track the MVIS Global Coal Index, which tracks the performance of coal operators (production, mining, and cokeries), coal transporters, producers of coal mining equipment, as well as companies involved in coal storage and trade.
As of the time of writing, the fund contains 26 positions. Here are the largest:
The first thing that we notice is that this is a global fund that contains companies from all over the world. This is nice because it provides a certain amount of protection against regime risk. Regime risk is the risk that a national government or some other authority takes some action that proves to be negative for a company. In this case, governmental restrictions on the use of coal due to climate change concerns is the obvious example, but it could also include something like the nationalization of a mine or the imposition of an unfriendly tax regime. The fact that the fund invests in companies all over the world helps to reduce the damage that the actions of any individual government can have on the fund as a whole.
As might be expected, the recent performance of KOL has been rather disappointing. The financial media, politicians, and many others have been predicting the demise of the coal industry for many years. As we can see here, the fund is down 45.96% over the past year and 38.44% over the past five years:
This could, however, present an opportunity if Rystad Energy’s analysis is correct. The coronavirus-induced project delays could force emerging markets to turn to coal to meet their growing needs for energy due to an insufficient supply of anything else. This would prove beneficial for the fund and lead to profits for investors.
In conclusion, the coronavirus has had a devastating effect on the energy industry, including on the development of various liquefied natural gas projects. This could unfortunately lead to a shortage of that compound as emerging markets continue to grow their economies and their energy needs at a remarkable rate. This could ultimately prove to be beneficial for the coal industry, as they will need to switch to other sources for power and they already have the coal-based infrastructure in place. The VanEck Vectors Coal ETF is one of the simplest ways for investors to take advantage of this, but it also boasts a significant amount of diversification that could make it a good option.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.