Did you know that there is more potential fuel in U.S. coal than Saudi Arabian oil? The coal industry does, and it is throwing all of its political weight behind making Coal-to-Liquid technology (CTL) the belle of this year's energy bill, which arrived on the floor of the Senate this week.
From Washington to Beijing, governments are debating whether to include CTL in their national energy strategies. Its supporters trumpet energy security and the prospect of petrodollars flowing to the Midwest instead of the Middle East. But that independence comes at a cost, environmentalists warn -- CTL's "lifecycle" of greenhouse gas emissions is twice that of oil diesel.
These trade-offs between economics, security and the environment will play out in the political arena and present the shrewd pundit with an array of investment opportunities.
Old Technology, New Opportunity
The energy in worldwide coal reserves dwarfs that of oil -- and it lies in the right places. The U.S. is the Saudi Arabia of coal, with 26% of proven world reserves (enough to power the country for over 200 years at current consumption rates), and the energy-hungry economies of Asia lie close to huge deposits in the former Soviet Union (23% of world reserves) and China (12% of world reserves).
However, CTL plants are expensive and production costs run higher than historical oil prices. A typical CTL plant costs $3 billion to $5 billion and can produce 50,000 to 150,000 barrels a day from coal feedstock. Its product is price competitive with oil-based diesel between $40 to $50 per-barrel, according to a recent U.S. Department of Energy report. This compares to an $18.43 per-barrel (in 2006 dollars) median price for crude since World War II.
Consequently, oil price volatility has inhibited investment in CTL. For a venture to be attractive, the producer would have to be confident that the price of oil would remain above the CTL-equivalent price point for many years -- a decidedly optimistic bet given that average annual crude prices have not exceeded $40 per-barrel for more than six consecutive years since World War II.
It should come as little surprise, therefore, that the only countries to develop CTL at an industrial scale -- Germany during World War II and South Africa under apartheid -- were those excluded from oil markets by embargo.
But times have changed.
With rising Asian energy demand, political instability in producer nations and tight upstream capacity, oil futures are trading over $66 per-barrel through at least December 2015. Around the globe, coal-region politicians, industry lobbyists and energy nationalists are arguing that CTL's time has come.
Energy Independence vs. Environment
CTL-advocates march under the banner of energy independence. By converting a portion of their vast coal reserves into diesel, countries like the U.S. and China could reduce their dependence on volatile oil markets and hostile producers while developing a domestic production cushion in the event of a major oil market disruption. Unlike most other alternative fuels, CTL is:
1) Proven technology on an industrial scale that
2) Draws upon a well-developed and resilient feedstock supply chain, and
3) Produces a product that can be distributed through existing petro-infrastructure and burned in conventional engines.
What is more, its champions contend, greater energy independence breeds economic strength. Petrodollars would stay at home, injecting needed money into domestic rural communities instead of OPEC coffers.
CTL's problem is global warming. The production and use of CTL diesel releases nearly twice the carbon dioxide of oil diesel. CTL's champions argue that carbon sequestration technology will enable producers to capture carbon dioxide during the production process and bury it underground. However, that technology is untested on an industrial scale and even if it worked as promised, net greenhouse gas emissions would still be no better than oil diesel.
As an investor weighing the trade-offs between security, economics and environmental concerns that determine CTL prospects, it makes sense to examine CTL's promise from three political angles: near-term domestic, near-term international and long-term global.
A showdown over CTL is shaping-up in Congress that will determine its near-term prospects in the U.S.
The Democratic leadership is working urgently on a new energy bill that would provide a variety of incentives to promote renewable fuels but none to promote CTL. In opposition, a coalition of Republicans and coal-state Democrats, backed by unprecedented coal industry lobbying, is proposing a rash of CTL incentives, including a 51-cent-per-gallon tax credit for CTL fuel, loan guarantees for six to 10 CTL plants likely to cost at least $3 billion each and leave for the Air Force to sign a 25-year supply deal for CTL jet fuel.
While Democratic sentiment runs against CTL, political timing and geography favor it. Heading into the 2008 elections, Democrats see their chance to recapture the Oval Office and grow their one-seat Senate majority turning on the votes of coal-producing "Blue Dog Democrat" states like West Virginia, Montana, Illinois, Ohio and Pennsylvania.
CTL's fate will likely be determined by the Senate as House leadership appears unwilling to risk battleground districts in coal-producing states to block incentives. Senate debate pits coal state Democrats like presidential aspirant
Barack Obama and Senate Finance Chairman Max Baucus (D., Mont.) against the party rank-and-file.
The outcome is unclear but time seems to be on CTL's side. The combination of increased summer gasoline prices, growing frustration with Iraq and heightened tensions over Iran's nuclear program by the time the House and Senate energy bills reach conference proceedings in July should only increase the odds of some CTL incentives passing this session.
If incentives are enacted, both downstream CTL producers and upstream coal suppliers stand to gain.
Domestic CTL producers have fared poorly this year with all major producers' stocks down 10% to 30%. If Congress opens its purse, however,
is probably the best CTL pure-play in the market. The company just announced a cooperative effort with
to convert an existing Illinois Rentech fertilizer factory into a 400,000 barrels-per-year CTL plant and has plans for additional plants that loan guarantees and subsidies would accelerate.
Also look to
. Syntroleum is an innovative small-cap company that has never turned a profit, but enjoys the greatest exposure to the military among CTL producers and is well-positioned to take advantage of Congressional authorization for the Air Force to sign 25-year CTL jet fuel agreements.
While passage of CTL incentives and construction of the new plants envisioned would only marginally increase domestic coal demand in the near term, the affect on Wall Street's perspective could be greater.
Peabody CEO Gregory Boyce told an industry conference two years ago that if its coal reserves were converted into CTL fuels, their value would increase ten-fold. While that scenario is only illustrative, the combination of pro-CTL policy action in Congress and continuing uncertainty in oil markets could well lead Wall Street to revalue more dearly the coal reserves of producers like Peabody,
( FCL) and
China and India's relentless growth in energy consumption, anxiety about energy security and proximity to substantial coal reserves give CTL a rosy near-term future abroad.
China's 2006 imports of approximately 163 million tons of oil are expected to rise to 200 million tons by 2010. In response, the country has begun to move aggressively into CTL with about $25 billion worth of CTL investments in the pipeline. Beyond predicted economic savings, CTL provides China strategically valuable domestic capacity in the event of an import disruption, as could occur if it came to blows with the U.S. over the Taiwan Straits.
is the vehicle to capitalize on this opportunity. Sasol developed next-generation CTL technology and industrial-scale production experience during the apartheid embargo. It is moving forcefully into China where it is building two CTL plants in Ningxia and Shaanxi to the tune of over $10 billion. Moreover, its Gas-to-Liquid (GTL) business, with production plants in Nigeria and Qatar, provides a complement to its CTL portfolio.
To handicap CTL's long term prospects, follow U.S. leadership on climate change. If the U.S. successfully throws its weight behind worldwide mandatory emissions caps, CTL's future will probably resemble its past -- a last-resort for the politically isolated. If it does not, CTL's future looks bright.
Rising oil demand, flat production capacity and growing concern over political instability in producer states means high oil prices. Add to this the economic and security advantages of domestic energy and the value proposition should prove irresistible to China, India and other developing nations with significant coal reserves.
In the face of these considerations, only mandatory greenhouse gas emissions caps will change the investment equation, either through outright prohibition or the added expense of purchasing carbon credits. However, these developing countries will not impose caps on their own because the benefits of CTL are immediate and local while its environmental costs are diffuse and long term.
Indeed, just before this month's G-8 Summit, both China and India stated that addressing global warming cannot come at the expense of economic development and declared their opposition to mandatory caps on greenhouse emissions.
Only the U.S. has the political leverage to try to curb the greenhouse gas emissions of the three biggest potential CTL producers -- China, India and itself. Although it may seem like another age, only 10 years ago the U.S. led world negotiations on the Kyoto Climate Change Protocol that provided the first mandatory greenhouse emissions caps. If the U.S. seized leadership of the issue again and applied its political, economic and diplomatic capital in concert with Europe and allied developing nations, it stands a real chance of striking a new global greenhouse emissions agreement that would include China and India.
So keep your eye on Washington. If we elect a president and Congress in 2008 that aggressively pursue greenhouse emissions caps, then CTL's prospects may dim. If we do not, get out your sunscreen and go long on CTL.
To see Keith Lieberthal discuss this issue, check out the following videos:
Liquid Coal's Promise and Pitfalls
U.S. Pols Pose a Hurdle
Liquid Coal's Future Is Brightest Overseas
Greens Will Decide Liquid Coal's Fate
At the time of publication, Lieberthal had no positions in any of the stocks mentioned in this column, although positions may change at any time.
Keith Lieberthal is general counsel of Clinical Advisors, LLC, and is a term member of the Council on Foreign Relations. Lieberthal appreciates your feedback;
to send him an email.