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Queensland’s coal industry has never had it better. Yet one of the ironies of the recent rise in contract thermal and metallurgical coal prices is that coal producers may not be able to take advantage of them this year.

If you missed the news, thermal coal prices for 2008 more than doubled from $50 to $130. Meanwhile, the 2008 contract price for coking coal used by steel makers tripled, going from $80 to $300.

Unlike more widely traded commodities such as oil and copper, the prices for coal (both thermal and metallurgical) and iron ore are set in annual negotiations between major producers and consumers. The major producers are the large mining companies. Those include BHP Billiton, Rio Tinto, Xstrata (in coal), and Value (in iron ore).

The major consumers for thermal coal, used to heat boilers for steam-generated turbines and electric power, are Japanese Korean and electric companies. The relationship between these companies and Aussie firms go back all the way to the 1960s, when Japan and Korea began their post-war industrial growth spurts. For steel, the major consumers of Australian metallurgical coal and iron ore are Japanese, Korean, and, of course, Chinese steel makers. China is the world’s largest steel-producer (and consumer).

The price rises should be good news for Aussie producers. The trouble, at least in the coal business, is that bad weather and infrastructure bottlenecks are making it harder for Aussie firms to increase production volumes this year. You can’t sell what you can’t get to market.

So while export earnings for Aussie resource producers will be up this year because of the rising coal price, actual production volumes will not increase. As evidence, consider the first quarter production figures from Rio Tinto earlier this month. Rio’s coal operations are in the Bowen Basin of Queensland. That area was subject to heavy flooding in the first quarter. Coal production fell by 27%.

So who will benefit from the rising contract prices? The short answer is that coal mining service companies probably will. For the coal producers to expand production, they will to invest in mine expansion and infrastructure. In Queensland, where many of the mines are underground, that means work for the specialist firms that help build underground mines. Stocks to watch in the sector include:

1. Walter Diversified Services (ASX:WDS). According to the company, “Walter Diversified Services Limited (WDS) is principally engaged in the provision of specialist services to the underground coal mining industry, and to the infrastructure oil, gas and water pipeline construction and maintenance sectors in Australia.”
2. Whitehaven Coal Limited (ASX:WHC). Whitehaven actually operates several open-cut coal mines in New South Wales. But the company, which is really a group of companies, also mines and sells metallurgical and high grade thermal coals
3. Cockatoo Coal (ASX:COK) Cockatoo isn’t producing any coal yet. But it’s involved in four projects in Queensland, the Wonbindi project, the Dingo Coal Project, Guluguba and Mintovale. Cockatoo’s are in Queensland’s Surat coal basin, with slightly lower quality than the Bowen Basin coal. But as they are unmined, when production commences the company will be able to take full advantage of higher contract prices.

Another development to watch for? Coal-to-liquids (CTL) production of diesel fuel becomes economic with high crude oil prices, especially in areas where “stranded coal seams” are not large enough to mine economically as conventional coal. Those stranded seams now have to new routes to energy viability.

We covered one Aussie company engaged in the CTL business late last year in the Australian Small Cap Investigator. We suspect that there may more like it soon, if current events are any indicator.

Al Robinson
for The Daily Reckoning Australia

–Thanks to the rise in rates, credit card interest rates are 20% higher than this time last year. And it means, with current balances, Aussies are paying about $500 million in interest on stuff they already bought. Is it too late to buy into the Visa IPO?

–By the way, today’s Daily Reckoning turned into a rather in-depth look at the fundamental trends in the Aussie economy. If you want the share market news and some trading analysis, we recommend you amble on over to Money Morning. Today’s DR has a big task: to determine Australia’s role in global economy history. If that’s not your style, go straight to the weekend and pass our passionate discussion of the terms of trade.

–But before passion, something more mundane. What is so annoying about the credit card headline?

–Well, it suggests that credit card debt has actually declined. It hasn’t. It’s just growing less fast. This is like those ridiculous announcements that periodically emanate from the bowels of the U.S. Government about the size of the Federal deficit.

–In the months that the deficit grows less fast than the month before, you see headlines like, “Deficit shrinks.” Of course it’s deliberate deception (a lie, if you like). If a tumor grows less fast it doesn’t mean it’s less dangerous. It’s still cancer (nearly all debt is malignant). And growing less fast isn’t really a qualitative improvement.

–The goods news for Glenn Stevens is that high interest repayments on credit cards will eat into domestic consumption. The bad news is that the higher rates actually led to lower repayments according to the latest RBA figures. Repayments in February fell by 7.9% from $18.21 billion to $16.71 billion. That was for the month, by the way.

–You may have felt cheated that we did not spend more time, as we promised, digesting the hard truths published in the Reserve Bank’s Financial Stability Review last month. But one chart did come to mind in light of yesterday’s credit card news. It’s the climb in household interest repayments as a percentage of disposable income.

–Not surprisingly, it’s on the rise. Granted, the combined number includes many older homeowners who are willing to carry higher debt loads later in life. But the simple truth is that paying interest on debt is not a good way to accumulate wealth. Never has been. Never will be. Simply not possible to get rich by spending the bank’s money.

–Let’s put it this way: unless wages rise (something that would probably cause the Reserve Bank to put up rates again), Australians on the margin of the boom will have to use their credit cards to finance essential consumption, and they will pay dearly to do so. Either that, or they will have to reduce consumption. “If we do not discipline ourselves,” the old saying goes, “life will do it for us.”

–But there are congratulations in order. So congratulations Australia! You’re getting a $30 billion raise.

–Reserve Bank economists now reckon that the recent coking and thermal coal deals inked between Aussie sellers and overseas buyers will haul in another $30 billion to the economy this year. That is not the kind of news the RBA wants to hear while it’s busy putting out inflationary bush fires in the economy. But facts are facts.

–Thirty billions dollars in coal and iron ore earnings, where will it go? To producers? To investors? To mining service companies like Walter Diversified Services (ASX:WDS)?

–While you think on that, let’s talk about “terms of trade” for a moment. “Terms of trade” is one of those terms of the trade that gets throw around by economists all the time. But what does it mean?

–The simple definition is this: it’s the ratio between export prices to import prices. If you get more for what you sell and pay less for what you buy, your terms of trade improve. And guess what people? Thanks to this particular moment in history, Australia gets a lot more for what it sells and pays a lot less for what it buys (except for crude oil).

–The chart below is taken from a 2005 Reserve Bank research paper called “Long-Term Patterns in Australia’s Terms of Trade,” by Christian Gillitzer and Jonathan Kearns. If you’d like to read the whole thing, you can find it here.