Biggest aftershock reserved for energy

[] — STOCK markets will go up and down, but one of the longer lasting features of Japan’s earthquake and subsequent tsunami is their effect on the world’s energy market.

According to Deutsche Securities, energy will be most affected of the four broad commodity markets since Japan imports 85% of its energy use. The bank believes about half of the power loss from Japan’s shattered nuclear stations in could be offset with coal, resulting in an additional 3 million tonnes of thermal coal demand in 2012. The market may then be in deficit in 2011.

Industrial capacity in Japan – the world’s third-largest economy at 8.2% of global gross domestic product (GDP) – will also fall off and may provide a compensatory affect. The fact remains, however, that imports of fossil fuels into Japan will be above normal levels, at least in the next quarter.

Astonishingly, the plume of gas above the Fukushima plant, and faintly ridiculous efforts to douse a radioactive meltdown risk with sea water, have led other industrial nations to review the safety of aged nuclear facilities in their countries.

On March 16, China announced it had suspended the approval of several nuclear plants, while German Chancellor Angela Merkel said seven nuclear reactors equal to 6.2 gigawatts and commissioned before 1980 would have to close, at least temporarily.

This is obviously bad news for uranium oxide producers, the mineral patted into yellow cake and shipped off to nuclear plants where it is further refined. Surely the response of world leaders is, at best, a political one and at worst, sentimental over-reaction?

Well, you can’t be too sure when it comes to the nuclear power industry.

It is uniquely vulnerable to the caprice of popular consciousness which affects the permitting and development of new plants. You can see old chestnuts about risky nuclear energy being voiced in the media already. Take The Daily Beast, an online publication which is running a story on a nuclear meltdown survivor, one of the engineers at Three Mile Island.

The likelihood is that some coal – and iron ore for that matter – will be diverted into the spot market…

It’s worth noting that in the wake of the Three Mile Island and Chernobyl disasters in 1979 and 1986 respectively, the uranium market went into hibernation for close on 20 years. Quoted in the Financial Post on March 14, stockbroker BMO Markets highlighted a similar market risk: “The market’s expectations for nuclear power expansion may be reduced in the near term while the world considers its options.’

In my view, other factors were at play to suppress uranium prices in the 1980s.

There are now fewer inventories from nuclear weaponry, while the forecast double-digit growth China’s GDP means the country is developing the capacity of Eskom every year for the foreseeable future. This will surely require, in some part, a nuclear energy response.

As for short-term uranium market risks, these are limited. About 80% of the world’s uranium is negotiated in long-term contracts. Even though Japan accounts for 12% of uranium demand, uranium price switches are mostly speculative floss.

The prospects for coking and thermal coal through this crisis are a question of perspective. Interestingly, a Goldman Sachs report dated March 16 focuses almost exclusively on the short-term risk factors.

Japanese ports within a 275-mile radius of the earthquake handled 46 million tonnes (mt) of coal (thermal and coking coal), as well as 50 mt of iron ore in 2010. The assumption is that at least part of these volumes are at risk in the short term while salvage efforts continue in the region.

In the short term, the suspension of operations at Sumitomo Metal Industries Kashima plant is most significant. The likelihood is that some coal – and iron ore for that matter – will be diverted into the spot market, which will place short-term pressure on the coking coal price. Most affected are the Australian coking coal producers, which export about a quarter of total output to Japan.

In the longer term – amid a potential rethink of how nuclear energy is installed, while aged plants are maintained safely – it’s now possible to view the Japanese and European coal markets as growth areas again.

Enter Exxaro Resources. The company is being tipped as the go-to coal stock on the JSE as the exposure offered by BHP Billiton, Anglo American and Xstrata, all significant exporters of thermal coal from South Africa, are somewhat diluted by their mineral diversity.

Thermal coal comprises 33% of Exxaro’s net asset value, and 67% of group reported pre-tax profits. Moreover, Exxaro has decent exposure to the spot market for thermal coal. Of total coal derived revenue, including that supplied on contract to Eskom, 57% is from the spot coal market, even though this is only equal to a fifth of total volume produced.

Optimum Coal Holdings is additional exposure for South African investors, but you have to get hold of the share first owing to a lack of liquidity.