Why coal is the fuel of the future

The floods in northern Australia have been horrendous to watch.

I spent some time in Brisbane about ten years ago. I know that natural disasters occur around the world all the time. But it brings it home to you when it happens to a place that you recognise.

As well as being tragic on a human level, the floods in Queensland, along with other bad weather stories around the world, highlight how vulnerable the global economy is to disruptions in our supply chain. We've seen food prices surge to dangerous levels, for a start.

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But the damage to Queensland specifically highlights our dependence on one particular commodity coal...

Coal prices are rising

As the Australian edition of the Daily Reckoning notes, Queensland accounts for a huge percentage of Australia's exports. This includes more than half the country's coal exports. "Australia is the world's top exporter of metallurgical coal (steel-making or coking coal) and the world's second-largest exporter of thermal coal (power plants)."

As a result, the price of coal is likely to be higher this year than it would otherwise have been. Obviously this is a temporary factor. Eventually thankfully life will get back to normal in northern Australia.

But prices have been rising anyway. The price of thermal coal is up by around 40% over the past 12 months for example. For all the talk of doing away with fossil fuels and investing in solar and wind power, the fact is that lumps of dirty old coal are one of the main fuels powering the global economy.

And that's not going to change in the foreseeable future. There was an interesting article in last month's Atlantic magazine on this topic. James Fallows was looking at why 'clean coal' is "the only way to stop global warming".

The idea behind 'clean coal' is that you find ways to minimise or capture the carbon dioxide the key 'greenhouse gas' given off when burning coal. Either you burn the coal in such a way that much of the carbon dioxide remains in the ground ('gasification'), or you catch it then bury it ('sequestration') after burning the coal.

Now, I'm not going to get into the whole climate change debate here it's irrelevant, for two main reasons. For one thing, governments have decided to make controlling carbon dioxide emissions the main focus of their 'green' policies. So as an investor, you have to position yourself for the way things are moving, regardless of your personal views.

More importantly, this is also about pollution control on a much more basic level. In Britain, we don't notice pollution because it doesn't impact on our day-to-day lives. In China, it's still a proper health hazard. So they're going to forge ahead with finding ways to use coal in less damaging ways, whatever we in the West say about it.

Why we can't just stop using coal

But if the problem is that coal is dirty, why can't we just stop using it? Because, as Fallows points out, it's impossible to picture an energy future that doesn't involve coal.

Why not? Because for one thing, it's a lot more geopolitically convenient than oil. The US has the most coal reserves in the world. Russia, China and India are next. Each of those nations is a leading economic and political power. Each has every reason to favour a secure, indigenous energy source over any other.

We're also much further away from 'peak' coal than we are from 'peak' oil. And for another, coal simply provides far more energy than most other sources. Coal-burning plants provide almost half of the electricity consumed in the US. Natural gas is a distant second at around 23%, nuclear is on 20%, and renewables (including hydroelectric power) form the rest. As for China, coal supplies a massive 70% of overall electricity demand.

Keep an eye on coal miners

What does all this mean for investors? For one thing, it means the future's bright for coal miners, regardless of competition from the likes of natural gas. We've been fans of the sector for some time my colleague David Stevenson tipped a couple of small Aussie miners back in October 2009 which have both soared since. Now is probably not the best time to buy in, as many of the biggest stocks in the US have rallied as a result of the floods. But it's worth keeping an eye on the sector.

Moreover, if you have an appetite for risk, clean coal technology is an area to watch. We'll be revisiting the sector in a future issue of MoneyWeek magazine. For other plays on the future of energy, check out this week's edition of MoneyWeek, out tomorrow. My colleague James McKeigue looks at how to profit from energy efficiency technologies that allow us to make better use of existing resources. If you're not already a subscriber, subscribe to MoneyWeek magazine.

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