Global Coal Rally Nearing End

NEW YORK (TheStreet) -- An increase in coal production in China is expected to put an end to the commodity's impressive five-month global rally.

Although Market Vectors Coal ETF(KOL Quote) has been able to take advantage of the recent run-up, the expected supply boost may bring down prices, and KOL will likely take a hit.

Recent tragedies in Shanxi, China's largest coal mining province, caused the government to halt a large number of small mines in order to reassess their safety. These smaller mines, which account for close to a quarter of China's coal production, were told that they had to merge with larger producers in the nation. Those that were deemed unsafe by the government were shut down.

Currently China uses coal to produce as much as 80% of its electricity. Therefore, with a quarter of the nation's domestic coal supply halted, China was forced to import a record 48 million metric tons of coal in the first six months of 2009.

However, on Monday news broke that with many new safety upgrades complete, a number of these smaller mines would be reopened in an attempt to bolster China's economic growth.

The reopening of these mines is expected to boost output in Shanxi 60% in the second half of the year. Analysts believe that the increase in domestic coal production will drive down the price of imported coal from Europe as much as 7%. Seaborne coal producers are also expected to feel the pressure.

I spoke with Glenn Smith, the director of ETF sales at Van Eck, yesterday about the implications of the expected supply boost and subsequent price drop on KOL. He informed me that, while the fund is likely to be negatively affected by the drop in coal prices around the world, coal is not a bad industry.