Indonesia was, until today, the world’s leading exporter of thermal coal. As I discussed in my post on November 15, the prices of both thermal coal (used for generating electricity) and coking coal (used for production of steel) had risen to record highs following the end of China’s shutdown, problems with the global supply chain, and China’s ban on imports of Australian coal.
Thermal coal spiked to as much as $250 a ton — 5x the price of the previous year. It has since settled at around 150-170 a ton, which is still the highest it’s ever been.
Usually this wouldn’t mean all that much. However, there’s been something interesting going on in Indonesia.
Under Indonesian regulations, coal producers are required to sell at least 25% of their coal domestically at a price of no more than $70 a ton. This in itself is problematic, because not all coal is the same. Indonesian coal is famously wet low grade coal bordering on lignite (brown coal) and usually sells at a $20-50 discount to the Newcastle benchmark price in the chart.
As long as coal prices remained under $100, this regulation made little or no difference to where the coal went because it has little impact on the local prices.
However, once coal prices jumped above $200, this regulation created a $70-100 difference between the “local price” and the export price. This obviously creates a strong incentive to export the coal rather than sell it domestically, and that’s precisely what seems to have happened.
Either the coal companies simply ignored the regulations and make windfall profits by exporting 100%, or the utilities themselves decided it would be more profitable to export their coals reserves for a 70-150% profit than produce electricity.
Either way, this regulation designed to prevent problems by flattening out distortions in the market created a perversely larger distortion in the market.
Some would say, “Oh, no, those horrible profit seekers broke the law.” The rest of us would say, “Gee whiz, legislating against human nature failed yet again.”
Indonesia’s pricing scheme is just more example of history repeating itself
You could go back to the cobra effect in India, the wool price scheme in Australia, the rice pledging scheme in Thailand in 2013 and the current one, and the CIAs paying for enemy ears in Laos to see how incentives never work the way instigators think they will.
The most amusing one is the Hanoi Rat Massacre, during which time the French colonists in Hanoi paid local Vietnamese to kill rats. The obvious problem: Vietnamese can smell money much better than French can smell rats. A new industry was born overnight: rat farms.
It’s hard to believe anyone would do something so idiotic without considering the consequences. But then again, we are dealing with governments here, and the Hanoi government didn’t have the benefit of the internet to see if the results of such a policy in the past.
The Indonesian government, on the other hand, had plenty of time to check the internet before implementing the precise same policy and buying rats off locals in Jakarta in 2016. You can’t make this stuff up.
Now that we’ve established the Indonesian government’s bona fides with respect to idiotic policies, back to coal…
Nobody knows quite how it happened that domestic power plants ran out of coal, and most public servants are wise enough not to be curious.
Rather than play the blame game, he authorities decided it would be more effective to simply ban exports for a month so that powerplants can replenish their stockpiles.
The problem here is that, as I said above, not all coal is the same. Some coal mines simply can’t sell their coal to local power plants because they don’t produce the correct quality. Coal fired power plants are generally calibrated to operate on a narrow band of coal quality. Operating outside of that band drops their efficiency and can unbalance the plant (which leads to shutdown).
With limited storage capacity, coal producers simply have to stop producing coal. This means it will take weeks or months for the supply chain to catch up, assuming that they don’t again encounter the problem of mysterious coal leakage. This is on top of China’s self destructive “ban” on Australian coal imports.
I’ve heard that Australian coal is arriving in China despite the ban, being transshipped in third party ports for an extra $10-20. It makes no sense from an economic standpoint, but these are politicians making rules, and they really don’t seem to care.
The net effect is that in addition to paying extra to import Australian coal, China will have to scramble to find other sources.
Simply put, these coal prices are going to stay high for several months.
Coal prices are going to remain high for months, or even years
This means that where possible, coal-fired power plants are going to switch to minimum output. Usually, coal fired power plants can’t switch on and off each day, but they can close down one boiler or one turbine. They do this regularly for maintenance, and I foresee a lot of maintenance being scheduled in the coming months.
When coal fired power plants shut down, the slack is taken up by natural gas fired power plants.
As you are probably aware, natural gas is preferred over coal because it is a much cleaner fuel. Coal produces masses of smoke, which is actual pollution, and carbon emissions are higher. This is important in Europe where offsets are traded.
Coal prices at 180 is close to $9 per million btu (British Thermal Unit) which is meaningless, except that natural gas at the moment is $3.74 per million btu — less than half the price.
Usually coal is half the price of natural gas.
You’d think that every electricity generator in the world would switch over immediately. However it doesn’t work quite like that. Generally they have long term contracts both for the coal and for the electricity supply. It takes time to unwind these contracts, renegotiate, or switch them to other suppliers. So the switch takes months.
Which works for us because we can benefit over the next few months from the switch.
Make a 200% profit with a call spread on natural gas liquefaction
One company I like right now is Cheniere Energy Partners, L.P. (CQP).
This owns and operates liquefaction facilities at the Sabine Pass LNG terminal located in Louisiana. The company, for a fee, liquifies natural gas to be shipped around the world. Generally, more liquefaction means more profits, and higher natural gas prices mean more profits.
There won’t be any short term changes with this company. They make long term contracts for the supply. Nevertheless, they don’t sell 100% of their capacity in long term contracts. This gives them flexibility to carry out repairs and schedule maintenance. It also means that they can make a few extra dollars when the world is desperate for natural gas.
This is probably the most boring company anyone would ever consider buying call options on — even more boring than Excelon, which we are closing out today.
And yet it’s strangely compelling.
In addition to a slight upside, it’s also paying out a dividend yield of 6.12%, which in a world of zero interest rates is absolutely whopping.
It’s PE ratio is 15, which is normal for a company paying out 100% of profit at 6%.
However, it won’t take a lot to nudge the shareprice up to a dividend yield of 4.5%, which I think is much more appropriate in this market.
It also has added upside for natural gas exports (in terms of fee revenue) now that the EU has classified natural gas as green energy. It’s that amazing? Last week it was a fossil fuel.
Right now it’s trading at 43.49, which is only up 30% over five years. Even if it only keeps paying out the same dividend and makes the same profit, I expect it to rise to $60 over the next 12 months. However, continued high coal prices should move sentiment towards LNG, and Cheniere will be one of the obvious beneficiaries. So I’m setting a target price of $65 for the end of the year, or $54 by June.
The best options to benefit form this rise will be the June expiry call options.
These are thinly traded, so it may take a few days for the market makers to come to the party.
I recommend buying the 44/46 CQP vertical call spread expiring on June 17. You should be able to open this for 0.65. If I’m right and the stock does jump up to $55, or anywhere over even $46 by June 17, this position will be wroth $2 ($200 per contract) or $8000 for a 40-contract position.
So place an offer consisting of +40 CQP June 44.00 call contracts and -40 CQP June 46.00 contacts at a price of 0.65 ($65 per contract) and make it good for the week.
Then take profits on Excelon.
Take 110% profits on Excelon
Back in October I recommended buying January 2023 calls on Excelon to profit from rising electricity prices as crypto mining moves back to the US.
Excelon, as you’ll recall, is one of America’s leading nuclear-powered electricity generators.
At the time I said you could double your money in several months. Sure enough, ten weeks in the options are trading at 1.46, which is 117% higher than we paid for them.
Utilities such as Excelon are boring companies and most traders steer clear of them because almost nothing makes them move. That’s been great for us, so take profits. We may jump in again if the price dips.
Specifically, place an order to SELL TO CLOSE 30 call option contracts with strike price 65.00 expiring on January 20, 2023 with a limit of 3.7. If you don’t get hit at that price, lower it to 3.5 and leave it in the market for the week. The trading symbol is EXC230120C00060000. The hyperlink is Yahoo Finance.
The rest of our portfolio is fairly flat with Moderna the big loser and Arena showing early gains. Hold on to them for the moment. There’s good news coming out of France about a possible new variant of concern to keep the vaccinations rolling out.
Update January 6: Profits taken
The Excelon January 2023 65.00 calls traded as high as 3.95 before closing at 3.7. At my recommended sell price of 3.70, that’s a juicy $6000 profit in 4 months. If you sold higher, well done.
Update January 25: Cheniere calls not opened
The vertical call spread I recommended on Cheniere (CQG) never traded within our buying limits because the stock price nudged up immediately after our recommended buy on January 5.
Nevertheless, there’s still money to be made soon. I’ll keep you posted.
