For centuries, the world has relied on coal as the main source of electricity. Despite the growing competition presented by other non-renewable energy – oil and gas, for instance – and renewable energy – solar and wind, for example – sources, coal is still indispensable when it comes to power generation. In addition to power generation, coal is also being used in several industrial processes – notably the steel and cement industries.
One question that people often ask is: why is coal so important to the world economy? There are a couple of reasons for that. First, coal reserves are notably large and extensively dispersed around the world, as compared with other energy sources like oil and gas. Another thing is that coal is relatively easy and safe to transport. These two factors combined make a compelling case for the use of coal in the energy industry. Like any other commodity, there are certain factors that affect the price of coal. We’ll look into the most important ones here.
The easiest way of understanding these factors is by dividing them into two categories – demand side factors and supply side factors. However, you should note that there are some other really important factors that can’t be adequately placed under any of the two categories. We’ll touch on them too.
Demand side factors
Just as it’s been pointed out, coal is the largest source of power. This means that the demand for coal for energy is quite the strongest factor that moves the price of coal. It is important to note that the reliance of the price of coal on the demand for energy is subject to a number of other factors. So when looking into the topic of the effect of power demands on the price of coal, you need to look in different directions. Here are some.
The direction to look is the emerging economies – China and India for instance. Let’s consider China for example. Since 2010, China has been the world’s largest consumer and producer of energy since 2010; its energy consumption has been increasing year-over-year. Why is this happening in China? The one-word answer is industrialization. More industries are springing up. And naturally, as more industries spring up, the demand for energy grows, as it is needed to power these industries. As such, since coal is the number one source of power, the growth of China’s economy – and other emerging markets – would drive the price of coal in response to the law of demand and supply.
Another big factor that affects the price of coal due to its demand for electricity is what I like to call the substitute effect. It talks about how the accessibility of substitute fuels – oil and gas, solar and so on – affects the price of coal. For instance, if gas or oil becomes expensive, the demand for coal would rise, which, in the end, moves price. While it’s yet to be proven, there have been arguments that the price of coal rises whenever the price of oil or gas rises. That is not always true. The only condition under which this is true is when the hike in the price of oil alters the fundamentals – mainly demand – of coal.
So, in other words, the accessibility of substitute fuels – most of which are usually more expensive than coal – have the potential to affect the fundamentals of coal, which in turn affects the price of the commodity.
Weather is another factor that is capable of affecting the price of coal. In this aspect, an increase in the volatility of the temperature often leads to a change in the demand coal. This effect is especially apparent during the winters. For instance, with the extremely cold winter that was witnessed in 2014, the demand for heat went up along with the demand for electricity. And as long as coal remains the world’s number one source of power and heat, such weather condition is bound to move the price of coal.
Another demand side factor is the commodity currency factor. Just so you know, a commodity currency is the currency of a country whose economy depends on the export of certain commodities. The Australian dollar, or the AUD, is a good example. If, for instance, the value of the AUD rises, usually, an increase will also follow for holders of non-commodity currencies.
Supply side factors
At the moment, the supply side factors aren’t bearing too much weight on the price of coal futures. However, that could change in future. First, you should note that, despite coal being a non-renewable resource, supply is not a problem for the now since global reserves are still very large. However, if, in future, more investment is made toward coal production, the industry might experience congestion – too much supply in simple terms. Too much supply, in the end, is bound to overweigh the demand for coal, which in turn brings down the price of the commodity.
Other supply side factors involve the production process such as the supply of equipment, transportation, replacement parts, fuel, and so on. If the supply of any of these is not up to the required quantity/standard, the production process might be slowed, which might also slow down supply – a prerequisite for a price increase.
That these are called ‘other factors’ doesn’t mean they are not important. In fact, some of them could alter the demand and supply side factors.
Governmental regulations on coal trade seem to be the biggest of all. As stated above, it has the ability to alter the demand and supply spectrum. As you probably already know, the use of use affects the environment adversely, and the world is on the lookout for alternatives to coal. At some stage, governments might start pushing laws – such as increased tax – that discourage the trade of coal. So it’s always important to keep tabs on what governments are doing to encourage or discourage the use of coal.
In conclusion, you should note that there is no one factor that can controls the price of the commodity alone. In most cases, a combination of the above factors is what determines how coal is priced. So when you’re looking to understand the price situation of coal at anytime, you might want to look in different directions before coming to a conclusion.