The return of King Coal

How will you heat your home or fuel your car 10 years from now? The North Sea is running out of oil and gas. Global oil reserves are dwindling. Most of what remains sits beneath unstable countries in the Middle East.

There is plenty of natural gas in Russia and Central Asia. But how secure is Britain's supply now the Kremlin can turn the taps off at will? Alternative energy, for all its promise, faces costly development and planning problems. And how can we return to nuclear power when no one has worked out where to dispose of the waste, nor how much it will cost?

Yet while the world frets about oil and gas supplies, the answer to Britain's energy problem may be literally underneath our feet.

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Coal, lying in thick and sometimes untouched seams, is present in just those countries which need it. There is enough in proven reserves to last the world 164 years at current rates of use. Natural gas will last perhaps 67 years at most. Proven oil reserves will last only 41 years, perhaps less now that China and India are getting rid of their bicycles and starting to drive cars just like we do.

Few people in Britain these days use coal at home, however. Only the oldest power stations run on it. Coal is still seen as old-fashioned, dirty, a stain on the environment, a byword for industrial accidents and industrial strife. Britain's deep coal mines were 'uneconomic' in the words of Mrs Thatcher. Yet now, 20 years after the British deep-mined coal industry was dragged like a cantankerous old horse to the knacker's yard, coal has a future again.

Coal may forever be associated with dirt and grime. But huge progress has been made in making it no worse for the environment than other fuels. Modern techniques include washing it and sorting out impurities before the coal is pulverised. Once the fuel is burned, the sulphur dioxide gases it releases (and which cause acid rain) are removed through special units installed within cooling towers.

These 'wet scrubbers' spray a mixture of limestone powder and water into the hot gases. By a chemical reaction this produces a dust, which then falls within the chimney. It is then collected and used for making builder's plaster.

More dust is removed by giving it an electrical charge rather like static on nylon clothing. This attracts the dirt onto special plates. Overall, modern clean coal technology can remove 99% of pollutants.

This is not to say that coal is clean everywhere it's used. Far from it. China's huge coal industry is as Dickensian as anything seen during Britain's industrial revolution, and not just because of the pollution caused by its aged plants. China produces 35% of the world's coal, but it accounts for 80% of its mining deaths. More than 7,000 miners die in China each year, and the figure is only gradually falling.

Globally, coal is used in power generation and steel manufacture, particularly in China and India. Their generators and mills demand high quality foreign coking coal in particular. But the adaptability of coal, largely forgotten in recent decades, is also being explored anew, because of its newly-found competitiveness. For investors, this offers huge potential. Coal is dramatically underpriced compared with competing fuels like natural gas, whose price moves up in line with oil.

Compare the market value of Peabody Coal (the world's largest coal firm) with ExxonMobil (the biggest oil firm) in terms of the energy value of what they own. The price of Exxon's proven oil reserves are $3.16 per million British thermal units. The equivalent coal deposits at Peabody are worth just 7 cents per million BTU. That's barely more than 2% of the value of oil!

Such an enormous discrepancy has spurred new technologies that allow us to substitute coal for oil and natural gas. But some coal-fuel processes are 60 years old and more. The Nazi war machine made use of synthetic fuel derived from coal. And before the advent of the North Sea fields in the mid-70s, we all used coal gas for domestic heating and cooking.

If oil prices remain above the critical threshold of $50 per barrel, there's even a good chance we will soon be flying in coal-powered airliners. Indeed, if you have flown from Johannesburg International Airport in the last seven years, your aircraft ran on a mixture of kerosene and liquidised, pulverised coal.

Coal-rich and oil-poor, South Africa became a pioneer of this work during the apartheid era. Sanctions blocked imports of oil, but it required transport fuel at any cost. Now Sasol, the South African chemical firm that leads the world in coal-oil production, is to offer a new version of its aviation fuel, 100% derived from coal, for international approval later this year.

Soaring oil prices now mean the rest of the world is getting interested, too. The US Air Force spends $4.5bn a year on jet fuel, and is already showing interest. Defence Secretary Donald Rumsfeld, recognising that many USAF scenarios involve bombing its own traditional oil suppliers in the Middle East, has ordered his forces to explore alternative fuels that don't require foreign oil. In September the USAF will conduct its first test flight with a synthetic fuel derived from natural gas, using technology similar to coal-to-oil.

Coal markets are fragmented by quality and locality. But it is clear that global coal prices have been rising for years. Since 1997, steam coal used for power generation has risen by 30% to $35 a tonne in the US. Over the same period, however, oil and natural gas prices have quadrupled. So coal is now increasingly competitive for electricity generation.

Growth in demand has had knock-on effects in hitherto declining industries too, stoking a resurgence in railway freight, shipping and ports. This is not likely to prove a flash in the pan. Coal prices are expected to double by 2020.

Outside Britain, demand for coal is growing fast. Every two years, according to the International Energy Agency, China is adding more power generation capacity than France has in total. About 70% is coal fired. China's steel boom is also being powered by high quality coking coal, though much of this comes from abroad.

Britain's coal industry, however, may play Cinderella during this party. Although we have 220 million tonnes of proven coal reserves, enough to last many decades, the main issue is getting at it.

Open cast digging, the method of choice in the vast spaces of Australia, Canada and much of the US is an impossibility in the UK. On planning grounds alone, deep-mined coal is hamstrung, too. But it also suffers from decades of neglect and a lack of miners. With few exceptions, it will remain easier and cheaper for UK power stations to import foreign open-cast coal than for us to reopen flooded and abandoned mines.

One of those exceptions is Richard Budge, the mining entrepreneur once known as 'King Coal'. He plans to reopen the Hatfield Colliery in South Yorkshire next May. Budge is the former head of RJB Mining, now known as UK Coal. It took over the rump of the British coal industry after privatisation in 1994.

Oil prices don't have to remain in the $70-$80 band for coal to have a future. With its new clean image and increasing adaptability, coal is going to muscle in so long as oil prices remain above $50. With no geopolitical risk, and increasingly attractive economics, there is huge potential in coal.

By Nick Louth for The Daily Reckoning. You can read more from Chris and many others at www.dailyreckoning.co.uk.