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Coal Rides China’s Industrial Strength

Bloomberg reports that “China’s industrial-company profits swelled 42.1 percent in the first five months from a year earlier.” The article cites a 43.1% increase in coal companies’ profits year-over-year. While U.S. coal stocks have been volatile the past couple of weeks, China’s strong demand for coal continues. Coal producers with mines in Australia should continue to do very well. The best coal names with mines in Australia include BHP Billiton (BHP) and Peabody Energy (BTU). The driver of coal demand isn’t U.S. utilities anymore but the fact that China has become a net exporter of coal to a net importer of coal, and this has been going on all of 2007. On June 18th, Goldman Sachs analyst Michael Molnar downgraded the sector to “Cautious” from “Neutral,” writing in a note to investors that “massive overproduction” in 2006 will likely continue into the end of this year, forcing coal producers to cut prices in 2008.

However, coal demand also follows steel production so coal supply should be kept in check as steel production remains high. In the Bloomberg article, ” Tangshan Iron & Steel Co., a unit of China’s second-biggest steelmaker, may report an 80 percent increase in first-half profit from a year earlier, the company said previously.” The World Coal Institute says, “Global steel production is dependent on coal – around 68% of total global steel production relies directly on inputs of coal. 592Mt of coking coal and Pulverised Coal Injection (PCI) coals are used in global steel production, which is 12% of total hard coal consumption worldwide (see overleaf for more information on PCI).”

Some risks to watch out for is if China cracks down hard on air pollution ahead of the Olympics. China is currently behind its target number of days of clean air to prepare for the Olympics. Much of it is industrial pollution from coal. Also, keep an eye on steel inventories and production as coal demand could slow on the back of lower steel demand.

**Disclosure: I own shares of BTU as of this post (6/27/07)**

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