Prospect of Coal, Compared to Other Commodities

Some time ago a friend complained, ‘Dear Sir, I wonder why the shares of Elnusa (ELSA) keep falling? While on the other hand, I heard that the price of oil rose high’ (FYI, ELSA is a oil drilling service company). Well, if I received question like that, then my answer is usually normative, ‘Related to why the stock goes down, I do not know, but the fundamentals of ELSA are not so good in the first place, so the stock is not worth to buy. Also, the rise in oil prices may have no effect to the company’s financial performance, because even when the oil prices were high in 2011, still ELSA suffered losses in that year.’

But indeed, there is one simple formula related to commodity stocks: If the price of a commodity rises, the stocks of the related companies will usually rise as well. The easiest example is the stocks of coal mining companies, which have risen a lot since mid 2016 after the price of coal itself rose from US$ 54 to US$ 87 – 90 per ton today.

But if we look once again, the above formula is not applicable to all types of commodities. For example, ELSA, although oil prices have risen from US$ 27 to US$ 50 per barel today, but the oil-related-stocks simply did not moving anywhere, or even dropped. The decrease in ELSA’ share price is actually better than the shares of Ratu Prabu Energi (ARTI), another oil company, which fell from Rp200s to die at Rp50 per share. Then, when the price of crude palm oil (CPO) arose from Malaysian Ringgit (RM) 2,000 to RM3,000 per ton, but the shares of one of the largest oil palm plantation companies in IDX, Astra Agro Lestari (AALI), kept stable at price range of Rp14,000 – 15,000 per share, which is actually its lowest prices in the last five years.

Then what makes coal stocks different? Well, actually the answer is quite simple: Since early 2000s, when the prices of oil, coal, and CPO began to rise, it were coal miners who posted the largest net income in their financial statements, followed by oil palm plantation companies, while the owners of domestic oil companies didn’t even became rich like those in the middle east (probably because Indonesian oil is already controlled by big guys like Chevron, Exxon Mobil, etc.). Beyond these three commodities, Indonesia also have gold, silver, copper, tin, lead, iron ore, nickel, and bauxite. But again, the financial performance of mining companies are also inconsistent, even though the price of gold had once reached US$ 2,000 per oz.

So when coal prices started to rise since last year, most investors in the market knew well that it will have a positive impact on the financial performance of coal companies, thus the stocks rise. But when oil prices rise, that doesn’t mean that oil companies, at least the listed companies (PT Chevron Pacific Indonesia, a subsidiary of Chevron Corp. in Indonesia, and also any other international oil companies in Indonesia, they do not listed on the Indonesia stock exchange), will make big profits.

And that's because, when compared to other commodity businesses, coal business is the most simple. You see, if you already hold a mining license for a certain land in Kalimantan or Sumatra, then just can just clear the land, dig the soil, take the coal under the soil layer, deliver it to the port, sell it, profit! All of the process only require time of no more than few months. And if you are not willing to do that, you can just ask mining service companies, who own the heavy equipments, to do the work (so you can sit back and relax). Sometimes for a certain land, you do not even need to dig the soil (or only need to dig for 50 – 100 feet down), because the coal is already visible on the ground. This coal business is so simple and easy, even a friend once said that it feels like taking free money from the ground. Of course, when the prices of coal were low, we can not call coal as ‘free money’, because the cost of digging could be more expensive than the price of coal itself. But as the price of coal has now risen once again, then it’s time to dig the treasure!

(click image to enlarge). A picture of Bengalon Coal Mine owned by PT Kaltim Prima Coal, a subsidiary of PT Bumi Resources, Tbk (BUMI). Do you see the black surface? That's coal, all of them!

But that’s for coal. Then what about palm oil plantation? Well, if you plant a palm tree, then the tree can only produce CPO about three years later. The problem is, what if the CPO price drops just when the tree is ready to be harvested? I mean, if we have a coal mine and the price of coal is currently low, then we could simply stop the mining work until the price rises, or we can reduce the volume of production, and we don’t have to worry because the coal will remains in the ground. But when a palm tree is ready for harvest, you would have to take the harvest and sell it right then, even though the price is low.

What about oil and gas? Unlike coal, oil can only be obtained by drilling deep into earth, about 15,000 – 30,000 feet or even more, so the cost is very expensive. If the mine site is offshore, the cost is even more expensive, and most of local oil companies in Indonesia just didn’t have enough capital to fund the work (so that the largest oil fields in Indonesia is owned and controlled by larger international oil companies). Oil and gas business has long been known as a ‘business of luck’, because a company could have spent tens of millions of dollars on exploration in one location which is estimated to contain oil reserves, but after drilling here and there for years, they found nothing. But if they’re lucky, they could find a very large oil reserves, and that's what happens to oil companies operating in the Middle East (the two largest oil fields in the world, namely Ghawar and Safaniya oil fields, both located in Saudi Arabia). But unfortunately the same thing does not happen in Indonesia.

Then what about the companies that produce gold and other minerals? Well, it’s the same with oil: The cost of exploration to produce gold is very expensive, not including for refinery or purification for the minerals unearthed. Unlike coal that only needs a little cleaning, crushing, and drying after unearthed, you will not find gold bars in the ground, instead it is still mixed with soil, rocks, and other minerals, and you have to dig very deep into earth to take the gold. Thus, when a company finds a mine site with (estimated) gold reserve, the mining process from early study, exploration, until the pure gold was finally delivered to jewelry companies and others, it takes a very long time, at least a few years.

For other minerals such as copper, tin, and nickel, we have the same stories. In fact, for companies that produces nickel ore, then based on government regulations, the ore should be processed first in the smelter to become a downstream product, say nickel pig iron or ferronickel, then it can be exported. Thus the company must invest large capital to build a smelter, and once again, not all the companies have such big money. But the same regulations do not apply to coal companies, where although they can build their own power plants (so what they sell is electricity, not coal), but it is okay if you want to directly export the coal. All you have to do is to pay royalties to the government.

Therefore, if you read many articles in this blog since the last year, I only wrote about the coal sector, because I myself only interested in this sector and did not/have not been interested to go into other commodities. Including when commodity prices hit their lowest point in mid-2015, then I only saw opportunities in coal stocks, but not in another commodity stocks (you can read the article here).

And indeed, just a year and a half later, as commodity stocks began to rise, only the coal stocks which scored the highest gains. But since their current prices are not yet as high as in 2011, then maybe the opportunities are still there. Well, let's see how it goes in the future.

Original article was written and published (in Indonesian language) in February 27, 2017. Any inquiries, contact the author (Teguh Hidayat) by email teguh.idx@gmail.com.