Needless to say, I too will take this opportunity to comment on some environmental matters, in addition to a few economics issues that are often overlooked but are of great significance. I want to emphasize at this point, however, that the really terrible thing about excessive global warming, if it is taking place, may turn out to be that it is NOT man-made. The problem then would be that an extraordinarily bad climate event would be economically and socially devastating regardless of the precautions that are taken. In fact, if an extreme range of unpleasantness seemed imminent, the lights in the Pentagon and similar establishments will burn very late at night, as Bruce Willis spin-offs in Armani military creations try to figure out how to keep the home-folks from occupying cheap seats in the losers club. (The same thing could happen with the wrong kind of oil-supply scene.)
A sort of caveat may be appropriate here. The physical destruction inflicted on New Orleans by Katrina was clearly worse that that suffered by some German cities that had been subjected to repeated bombing during World War II. But by the end of the Korean War (in 1953), regardless of the amount or type of damage that individual communities had experienced, most of them functioned satisfactorily – at least in the opinions of the American GIs who were lucky enough to be stationed near them. On the contrary, there is talk of it taking 20 years to rebuild New Orleans, assuming that the project is undertaken, and also assuming that the ‘Green City’ that former president Bill Clinton mentioned at the latest climate-warming talk-shop will have the approximate dimensions and population of the ‘old’ New Orleans. The interesting thing in this case, however, is that if the probabilities had been correctly calculated, and a modest amount of investment undertaken over the years, the kind of skillful engineering that has been practiced for decades in e.g. the U.S. and Holland could have turned Katrina into no more than a soggy happening.
I also want to use this chance to bring up to date several topics in my energy economics textbook (2000) and my book on coal (1985). Interestingly enough, I wrote another book on coal but never published it because I came to the conclusion that hardly anyone would bother to read it; however once the production of oil has peaked, or shows signs of peaking, and the future availability of natural gas is correctly appraised, a new coal book might find the readership it deserves – though hardly before. It might also be a good idea if, before examining this paper, readers examine a short, non-technical article by Murray Duffin (2004) in www.energypulse.net, and also the incisive comments on his work that are published at the end of the article.
Coal is formed from the remains of trees that have been preserved for millions of years under special non-oxidizing conditions where, after falling, they either did not rot or rotted very slowly. (More generally, it is possible to speak of the anaerobic decay of all kinds of plant life.) Top-grade coal requires a gestation period of tens of millions of years, and scientists have calculated that a coal seam 1 meter thick might have been compacted originally from a 120-meter layer of plant remains.
A good example of what this is all about is the coal rich state of Wyoming, in the western United States (U.S.). It has been estimated that the basis of coal seams in that region were formed tens or even scores of million years ago, and the dead vegetation was positioned in such a way that it did not rot or dry out. Perhaps 60 million years (= 60 my) of this arrangement led to the thickest coal seams ever found – up to 60 meters thick in some places – with a low sulphur content. High-value bounties such as this provided a strong incentive for further exploration: the U.S. has the world’s largest coal reserves, and is the second largest hard coal producer after China. The U.S. coal industry is also on average the most productive (as measured in output/man-years), even though ‘eastern coal’ – from east of the Mississippi River – is largely from underground mines. (Western coal production is generally an open-pit (or opencast) activity, where productivity is about 2.5 times as large as in underground installations.) About 72,000 persons are employed in the U.S. coal industry.
It is possible to distinguish a spectrum of coals, ranging from peat through anthracite. Peat, which is brown, porous, has a very high moisture content, and often contains visible plant remains, is the lowest class of coal, with an average energy content of 8.4 GJ/ton. (Here G signifies giga, which is a billion, and J signifies the basic energy unit joule. Thus, 1 GJ = 1,000,000,000 joules. The matter of energy units and equivalents will also be mentioned later in this paper.) Next we come to lignite, which can be regarded as the transition link to hard coal (= bituminous + anthracite coal). Lignite also contains a great deal of water, and its average heat content is 14.7 GJ/ton. Bituminous coals, on the other hand, are characterized by a low moisture content, while the moisture content of anthracite coal is extremely low. Where energy values are concerned we distinguish between sub-bituminous coal, with an average energy value of 25 GJ/ton, and bituminous coal, with an average energy value of 29.5 GJ/ton. Anthracite coal, which is jet black and difficult to ignite, has an average energy value of 33.5 GJ/ton. (Note here that thus far the short ton (= ton = 2000 pounds) is being used instead of the more common metric ton (or tonne or ‘t’ = 2205 pounds), and so 1 t = 1.1025 tons.)
According to Brendow (2004), coal accounted for 37% of global electricity generation in 2000, and it will reach 45% in 2030. The power plants in which this coal will be used will, on average, be technologically superior to those in use today, but from an engineering point of view they will remain relatively simple affairs. Coal is burned in a boiler, and hot steam under high pressure is produced. This goes to a steam turbine, whose mechanical work output takes the form of a rotational movement of generator shafts, which makes it possible to produce electricity. Students of thermodynamics and engineering dynamics know that energy losses cannot be avoided in this activity, but with a ‘combined cycle’ arrangement, some of the heat that might have been lost can be used to generate more electricity, which can sizably boost the overall efficiency of the installation. Brendow believes that by 2030 more than 70% of coal-based power generation will take place employing advanced coal combustion technologies. Obviously, for this prediction to hold, some gigantic financing problems will have to be solved.
In examining the energy literature on any level, we are constantly encountering the word ‘primary’. Primary energy is energy obtained from the direct heating of coal, gas, oil, etc, as well as electricity having a hydro or nuclear origin. Electricity obtained from the burning of substances such as coal is a secondary energy source. (“Primary energy” though is an American term. The IEA refers to ‘energy carriers’, which for them includes electricity.) Something that should be appreciated is that the energy content of the coal used to e.g. generate electricity is inevitably greater than the energy content of the electricity itself because the coal burning equipment does not possess an efficiency of 100 percent.
In some countries it is common to categorize coal as soft coal or hard coal. Soft coal consists of brown coals and lignite, whereas hard coal is bituminous coal and anthracite. In this system peat is regarded as a fuel type in itself, and is not particularly desirable any longer from a commercial point of view. Still another system divides coal into two classifications: brown coal and black coal. Brown coal is geologically young and high in water content, while black coal is considerably lower in water content, and contains much more carbon. Black coal ranges from sub-bituminous coals (which are usually dull black and waxy in appearance) to anthracite, and is divided into two general categories: coking or metallurgical coal, and thermal or steaming coal. (Coking coal will only appear en-passant in this discussion.) Brown coal is usually ‘consumed’ fairly close to where it is mined, while steam coal exports are exclusively high energy value coals.
The demand for coal (= hard coal + brown coal + lignite) grew by 62% over the 30 years before 2003, and the International Energy Agency (IEA) expects it to grow from that year by another 53% up to 2030. These figures make it very clear that coal is not on its way out – as many believe and/or hope. In addition, in 2030, one prediction has it that globally power plants will absorb some 74% of coal supplies as compared to 38% in 2000. The world might be a better place if we learned how to use less coal, but in some respects the electricity generating sector is not a bad place for growth to take place: that sector probably has more experience in suppressing deleterious emissions than any other, and is better financed to make the necessary investments.
It might also be useful to note that the average global power generation efficiency is approximately 33%, while state-of-the-art efficiency is almost 45%. Considering that most of the power plants in existence now will be scrapped or upgraded by 2030, the aggregate efficiency in that sector should reach at least 40%. This will greatly favor coal as an alternative to nuclear energy, although by my calculations, in a carbon-conscious world, nuclear energy will be a more economical source of electricity. On the other hand, on strictly private economical grounds, coal should be clearly preferable to gas at that time as a result of the greatly decreased availability of gas (due to depletion).
With regard to the efficiencies mentioned above, these are so-called ‘first-law efficiencies’, after the First Law of Thermodynamics. Calling this efficiency E1 we can write E1 = (energy transfer achieved by system)/(energy input to the system). It would not be easy to challenge this definition on intuitive grounds, however moving from a verbal assertion of the First Law to E1 is too complicated to be done here. It can be mentioned though that the First Law is the well known Conservation of Energy, which is usually stated as energy cannot be created or destroyed, and thus the total energy of the universe is constant.
It needs to be added that the icing on the thermodynamics cake is the Second Law of Thermodynamics, which happens to be a work of genius first proposed by the French artillery officer Sadi Carnot. One of the things it tells us is that there is an upper thermodynamic limit to efficiency, and technological progress involves no more or less than gradually raising the actual efficiency to that limit. It is difficult to say exactly what this limit will be for coal-based generating equipment, but Janssens and Cosack (2004), as well as others, indicate that 60% is the best that can be hoped for, although this will not be realized in the near future
The most important exporting countries for hard coal are Australia, China, South Africa and Indonesia. The exports of these countries total about 75% of seaborne hard coal, however the U.S. is still regarded as the global swing producer/exporter of coal, occupying the same position with that energy resource as Saudi Arabia does with oil. Japan is the most important importing country, although most of its imports are coking coals. It is forecast that Japan will account for 25% of total world coal imports in 2020. Coal consumption has declined in Europe because of environmental stipulations that favor gas, which at present is available in large amounts from the Norwegian North Sea, Russia, and North Africa – and perhaps eventually by pipeline from Central Asia via the Former Soviet Union and/or Turkey.
Steam coal trade in the Pacific region surpassed the Atlantic market in the early 1990s, and by 2000 was 20% higher. Today more than 100 firms/producers are active on the world market, which together with domestic markets gives the aggregate coal market the appearance of a competitive network – and according to some observers considerably more than an appearance. At the same time though, reading the chapters on perfect competition in your favourite microeconomics or price theory textbook will not provide you with an ideal introduction to the kind of logic needed to understand the conditions under which this important resource is produced, bought, sold and priced.
For instance, it is impossible to conceive of those 100+ firms operating at the bottom of their long-run cost curves as they would under ideal textbook conditions. Instead, equating supply to demand in the real-world coal market means the price rising at least to the bottom of the long run cost curve of the highest cost firm in the market, which in turn means that the ‘intramarginal’ (i.e. lower cost) enterprises will earn substantial economic rents (= profits greater than the amount needed to continue producing at the required level). The key explanatory factor for this phenomenon is, of course, a difference in the quality of coal deposits controlled by individual firms, which is a condition that cannot be eliminated in the short run, nor perhaps in the long run.
In the coal market, as everywhere else, there is a great deal of talk about replacing almost all long-term contracts by spot transactions. This kind of aberrant thinking comes from the present urge toward liberalization, and in some cases makes absolutely no sense at all. The ostensible justification is that spot prices respond rapidly to the existing market situation, rising when the market is tight, and falling when there are excess supplies, which is true. A problem here though is that enormously expensive investments are essential if markets like oil, gas and coal are to function in a manner that benefits households, small businesses and energy intensive large businesses, and many of these investments will not be forthcoming if the managers of oil, gas, or coal suppliers are constantly faced with highly volatile spot prices that provide mixed or misleading signals. With long-term contracts this volatility can be partially ignored.
Let’s put this a slightly different way. In finance theory, volatility is a common proxy for uncertainty. It can be easily demonstrated with some elementary algebra that e.g. in the neo-classical models featured in conventional economics textbooks, a high price volatility (and thus a high uncertainty) reduces physical investment. This is also common sense, and has to do with risk aversion. As it happens, although there is not a single world market for coal, nor a unique coal price, it is clear that coal has displayed a more stable price over recent decades than oil and gas, and as a result we have not had to entertain the kind of complaints about inadequate investment that we constantly encounter about the other two.
There has already been a reference to energy units, but that can be expanded on somewhat here, and also in the sequel. Several units are used to measure energy. Physicists seem to prefer joules, while engineers are often partial to British thermal units (Btu), or kilowatt hours. (Generally, joules are preferable outside the U.S.). Another unit is calories (or kilocalories). The transformation between joules and Btu has been carefully measured: 1 Btu = 1.055 x 103 joules. Since different coals have different calorific contents, a standard measure of energy content for coal can be extremely useful. This is the ton of coal equivalent (= tce), which is defined as a metric ton (= 1 tonne = 2205 pounds) of coal with a specific heating value of 12,600 Btu/pound. Consequently, more than one metric tonne of coal might be necessary to produce the heating value of 1 tce. For example, 1 tce = 1.4 tonnes of sub-bituminous coal, using the heating value of 9,000 Btu/pound given earlier. (Note: 1 kilogram = 2.204 pounds).
Consider also that in 1977 world coal production came to 3,400 million metric tons of raw coal, which was 2,500 million metric tons of coal equivalent (= 2,500 mtce), which in turn had the energy content (in Btu or Joules) of 33 million barrels of oil per day (= 33 mb/d). This last figure is obtained from the following equivalency between oil and coal: 1 tce converts to 4.8 barrels of oil, and 76 mtce/year is equivalent to 1 mb/d of oil. To a certain extent, tce is an artificial unit, since its heating value is almost certainly higher than the heating value of an average tonne of coal extracted during any given year, but even so it is extremely useful.
It was mentioned earlier that the average global efficiency of coal using power generation equipment is 33%. Thus a standard pound of coal equivalent functioning as an input in this equipment would have an energy output of only 12,600 x 0.33 = 4150 Btu electric = 4150 Btu(e). Readers should note the difference between ‘equivalent’ and ‘electric’.
One more thing can be looked at here. Coal is sometimes referred to as a backstop resource, where the expression ‘backstop’ (or even input into a backstop technology) was introduced by William Nordhaus in a brilliant article (1974), and involves the availability of a substitute to which no ‘scarcity royalty’ can be attached. For instance, at the present time coal has been described as a backstop for motor fuel since it can be transformed to synthetic oil (as Marlon Brando assured us at considerable length in the film ‘The Formula’), however hydrogen that is produced employing uranium or thorium in a breeder reactor probably comes closer to the strict definition, as perhaps does hydrogen obtained via electricity generated in wind installations. Of course, coal might not be as plentiful as some people believe, and even if it is it is not certain that using enormous quantities of ‘uncleaned’ coal is a good idea.
Some very simple algebra will obtain the equation
for the approximate time to exhaustion of a coal deposit X*. We can compare the difference between the static time to exhaustion (where g = 0) and the dynamic – where, e.g. the value of g is taken as 2.5%/year. The static value (= X*/X0) is approximately 260 years. Now, this can be very easily adjusted for growth by employing equation (3) we get Te = (1/0.025) ln [ (0.025 x 260) + 1] = 80.5 years for the ‘dynamic’ value, which is a sizable difference. Enough to make us wonder just how much coal the great grandchildren will actually have at their disposal. Of course, by remembering that the total (or ultimate) amount of the resource will increase, and the rate of growth used to obtain this equation was taken as continuous rather than discrete, this 80.5 years can be extended somewhat, but very definitely not enough to come anywhere near the static value.
THE WORLD COAL SCENE
This section begins with a short review of the coal situation in various parts of the world – “short” because the rapid change that often takes place does not justify a more thorough perusal. More important for me, however, is the suggested ‘commoditization’ of the world coal market, which refers to the irrational desire by various buyers and/or sellers to increase the use of ‘spot’ transactions while decreasing the employment of long-term arrangements. We have seen this sort of thing in other energy markets, and the results were not encouraging. Certainly, as Mr Zach Allen pointed out to me, large mines will not be opened if producers/investors have to accept being at the mercy of spot prices.
Coal in North America is dominated by the large production and consumption of the United States. Coal is the basis for slightly over 50% of U.S. electricity generation, and some of this electricity, together with the direct use of coal, heats and/or cools about 50% of U.S. homes. Moreover, the energy in U.S. coal reserves (measured in Btu or joules) is well in excess of the energy in Saudi Arabian oil. These are undoubtedly important (though apparently unspoken) reasons why the U.S. could not sign the Kyoto Protocol – aside from the fact that the world would probably be better off without the Protocol, the conference in which it was produced, and similar conferences in the future. Coal can fairly easily transformed into motor fuel, although – unlike natural gas – with present technology this does not appear to be a very profitable activity. (And it may be unprofitable with gas too, because according to information provided me by Mr Oliver L. Campbell, the price of gas in the UK recently touched 15 dollars per million Btu, which he calculates as equivalent to an oil price of 90 dollars per barrel. Someone else who is aware of this problem is the former head of the (U.S.) Federal reserve system, Alan Greenspan, as well as a former energy secretary.)
In South and Central America, only Colombia and Venezuela are major coal countries, and at the present time only Colombia is making a large contribution to the world market. Most of the mining in those two countries is of the opencast variety, which suggests a high productivity, but this is not the case as yet. Much, however, is expected of these two countries.
In Europe (outside the Former Soviet Union) Germany is the largest coal producer if lignite is counted, and it should be taken into consideration because it supplies the largest input for German power plants. Germany is similar to the UK in that it is a country where the ‘quality’ of coal produced may be increasing due to the closing of inferior deposits. I have also heard the remaining coal mines in the UK called the most productive in Europe, although everyone may not agree. Quantitatively, Poland comes after Germany, but according to Zach Allen the Polish coal mining sector has experienced severe labor relations problems, and these have resulted in extremely expensive coal. Of course, if economic growth in Asia continues at its present pace, and oil and gas prices remain close to their present levels, then the financial prospects for all the large coal producers in every part of the world should be considerably improved.
As with oil and gas, Russia ranks close to the top of the coal production league. Although its productivity (in output/man-year) is well below international averages, the intention is to produce and use domestically as much coal as possible, so that the highly profitable exports of oil and gas can be maintained or increased. The World Bank has taken a strong interest in that country, providing it with financial and technical assistance for so-called restructuring/privatising purposes. I hope that the Russians are grateful for any financial help they receive, however since I happen to find it strange that a country on Russia’s technical level requires technical aid from an extravagant refuge for high-flown mediocrity, I prefer to conclude that the basic intention of the World Bank in this matter is to justify its budget in the eyes of its most persistent critic, which happens to be the U.S. government.
Two highly productive and large coal producers and exporters are Australia (which specializes in coking coal) and South Africa. Of late though, the progress of exporters like China and Indonesia might raise problems for the enlargement of their market shares. Surprisingly, the U.S. is no longer the expansive force in the world export sector that it was during various periods of the last century. It is occasionally claimed that the reason for this situation is that high wages and salaries have decreased the international competitiveness of U.S. coal, and it might also have something to do with the power plant sector of that country consuming a very large (and perhaps increasing) fraction of the domestic coal output. Along with China, the U.S. occupies the top positions in global consumption (as well as production).
Much more could probably be added to the above discussion, however I think that everyone reading this paper appreciates that for good or evil, coal is extremely important in both the present and future energy pictures. Globally, trade in steam coal is expected to increase at a fairly high rate between now and 2030, and because the price of coal is seen as stabilizing in comparison to oil and gas, increasing amounts of coal-fired generating capacity will likely be the rule in much of the world. Japan was briefly mentioned above as a major coal importer, especially of coking coal, however steam coal generally has a poor image in Japan, and unless things have changed greatly in the last few years, I believe that the implicit desire of the Japanese energy establishment is to minimize the use of steam coal, while drastically increasing nuclear based generating capacity – if (or when) that is politically possible.
Unfortunately, it seems to me that it is highly unlikely that the huge amount of coal that is being used, and will be used, can be ‘processed/treated’ in such a way as to substantially and efficiently reduce the amount of carbon dioxide (CO2) that it produces. As you undoubtedly know, CO2 is a key element in global warming, which happens to be good rather than bad, because without it the earth would be uninhabitable; but on the other hand there is the possibility that too much of it is currently being produced, and perhaps this excess supply is due to anthropomorphic (i.e. man-made) sources rather than the various quirks of nature. The opinion of this teacher of economics and finance is that regardless of the actual situation, an assumption should be made that the overwhelming majority of the elite of climate scientists who say that there are dangerously excessive CO2 emissions know what they are talking about.
Furthermore, the excess production of CO2 should be negotiated down by heads of states, and not jet-setters from the environmental bureaucracies. To me the failure of the Kyoto exercise is precisely the inability of its participants to detect this option, and to recommend its immediate adoption. Of course, one reason they failed to do so is because half-baked talk-shops of the Kyoto variety are the life-blood of many foot-loose busybodies whose speciality is pseudo-intellectual environmentalism, and the waffle at these congresses counts for much more to many of them than attempting to evaluate a topic whose details they are unable to understand. As for emissions trading, which is a highly advertised offshoot of Kyoto, this is hardly more than a scam, and as an advisor to President Putin remarked, it’s about making money rather than curbing emissions.
Something else that is about making money is the attempt to ‘commoditize’ the trading of coal. In the words of Robert Murray, president and CEO of Murray Energy – perhaps the largest independent, publicly owned coal producer in the U.S. – trying to make a true commodity out of coal is like “trying to fit a square peg in a round hole” (Petroleum Economist, October 2002). He continued by calling coal trading “an unnecessary fad” and “a doomed concept”. The economic issue here involves putting an intermediary between buyers and sellers in the form of an formal ‘exchange’ of one sort or another, however for the time being the idea is that ‘over-the-counter (OTC)’ establishments are to fulfil this function. Here I should make it clear that there is a very great difference between an OTC market and a genuine exchange – roughly the difference between the Fulton Fish Market and the New York Stock Exchange.
To me the kind of language employed by Mr Murray is perfect for describing electricity deregulation and the attempt to commoditize electricity, although that bogus escapade is rapidly losing popularity. The new-old argument being used in the case of coal is that both buyers and sellers would be better off if they accepted the beauty of OTC trading and short-term contracts because – as we teach our beginning students – genuine competition always provides better outcomes to all involved. This is undoubtedly true for many items, but I have grave doubts as to whether it applies to a market like coal, where tremendous amounts are involved under very special circumstances.
In an ideal situation the OTC market would have many of the features of an auction market (like the stock exchanges), with full price transparency, and where the possibility exists for transactors to buy or sell almost any amount of the commodity at any time. It could then be argued that prices would correspond closely to the theoretically correct prices that would prevail in a textbook market. Moving beyond elementary theory, this would mean that the large inventories of coal held by e.g. sellers could be reduced because these ladies and gentlemen would always be in position to provide coal from their own mines or from the trading market-place, and presumably any saving they achieved would be shared to some extent by consumers. Some consumers (i.e. distributors) also maintain large stockpiles, but these could also be reduced because they too could use the open market.
Here the reader should be aware that this kind of argument was employed in California when the electric deregulation fiasco was being sold to the television audience and their representatives in the California legislature. By putting an exchange or pseudo auction market for large scale trading between buyers and sellers, the theory was that it would be unnecessary for sellers to maintain a large reserve capacity, which in turn should eventually work to the benefit of everybody. The outcome of this less than brilliant gambit was the ruining of the state budget, an electricity price explosion in San Diego, and the then governor using the quaint expression “out of state criminals” to describe wholesalers (i.e. generators) who took the opportunity offered by deregulation to charge outrageous prices for filling the gap between local supply and demand.
Moreover, in a ‘super-ideal’ situation some serious hedging (i.e. insuring against price risk) could take place, because the OTC contracts being used – or a spin-off of these contracts – could function in a manner similar to genuine futures (or perhaps even futures options) contracts, which would allow buyers and sellers to ‘lock in’ present prices and thus avoid being faced with ruin in the event of having to fulfill any unfavourable commitments that they might have entered into. Naturally, all of this was ‘hype’, but as with the electricity markets in California and Scandinavia, it was treated with complete seriousness by some very intelligent and highly educated academics and businesspersons.
That brings us to a comment on the difference between real markets and ideal markets. In ideal markets there are large numbers of transactors on both the buy and sell side, completely transparent prices, and a great deal of liquidity – which means that it is always possible to buy or sell any quantity without drastically altering these transparent prices. Furthermore, the prices that are formed are theoretically correct prices, which are sometimes called ‘scarcity’ prices, in that they accurately reflect the intentions and capabilities of buyers and sellers. In addition, in the light of the bad news from e.g. California, neither these prices nor the conditions under which they are formed encourage or facilitate ‘gaming the market’ by ambitious transactors.
Reality is very different from this. Although the physical coal market has many competitive aspects, various changes have taken place during the past few years, and in particular some large consolidations (i.e. mergers) have undoubtedly reduced the degree of competition. Most important for this discussion, liquidity (and probably transparency) in the OTC market are too low to make it attractive for hedging large volumes. As with electricity, the best hedging item for buyers and sellers are long term contracts. In addition, and this is crucial, Mr Murray berates the (OTC) intermediaries for their lack of knowledge of the industry. The same is even more true of the electricity market, where the gap between ‘quants’ and traders in the exchanges, and the men and women involved with in the physical market is enormous.
Part 2 of this paper will be published tomorrow on EnergyPulse.