KING COAL'S COMEBACK

UNCLAS SECTION 01 OF 03 CALGARY 000736

SIPDIS

STATE FOR WHA/CAN, EB/ESC/ISC, EB/PPD

USDOE FOR IA (DEVITO, PUMPHREY, DEUTSCH)

MOSCOW FOR TOM HUFFAKER

E.O. 12958: N/A
TAGS: ENRG EPET ETRD PGOV SENV CA
SUBJECT: KING COAL'S COMEBACK

REF: CALGARY 0622

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SUMMARY
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1. In a surprise to many energy economists, King Coal is
returning to the throne. As recently as two years ago, many
experts were predicting a rapid demise for a fuel long
associated with black lungs and melting ice caps, but the
outlook is once again promising for an industry older than the
Industrial Revolution itself. Coal is the world's largest and
one of its fastest growing energy sources, with its 38% share of
global electricity generation likely to grow over the next two
decades. While developed nations have largely shunned increasing
coal use in favor of cleaner energy sources, the developing
world has more than made up for the West's stagnant demand.
Fueled in part by rising consumption in China and India, this
unexpected increase has been the driving factor in the booming
coal contract market, where several pricing records were broken
earlier this year.


2. As one of the world's larger coal-exporting regions, and a
center of research for new coal technologies, Alberta stands to
gain much from the new market realities. Alberta's nine thermal
coal mines produce up to 30 million tons a year (followed
closely by British Columbia producing primarily metallurgical
coal) representing nearly half of Canada's yearly output of 67
million tons (the industry employs about 4500 persons).
Additionally, the province's coal industry has plenty of room to
expand, with Alberta's 33.6 gigaton coal reserve comprising 60%
of Canada's reserve, the tenth largest in the world. While
unresolved environmental and economic issues may hamper the
development of the province's coal industry, the opportunity for
wealthy companies newly flush with resource dollars is
substantial. End Summary.

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THE OTHER BLACK GOLD
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3. With 60% of Canada's total coal reserves and enough
in-province to last for nearly a thousand years at current
extraction rates, Alberta has the potential to capture a large
portion of the world export market. Thermal coal from Alberta
mines contains less sulfur and burns cleaner than that of other
provinces, making it an attractive fuel source in a
Kyoto-constrained nation. Alberta currently produces about 30
million tons of thermal coal each year, or 43% of Canada's
total. The majority of production (about 80%) eventually makes
its way to coal-fired power generators within the province, with
the remainder shipped overseas, primarily to Japan and South
Korea. Alberta is also one of the few provinces currently
expanding coal power facilities, with 32% of all new electricity
capacity from 1999-2007 coming from a fuel that is, almost
literally, still cheap as dirt.


4. Although the recent international recognition of Alberta's
oil reserves has overshadowed a growing manufacturing capacity,
an expanding telecommunications sector, and virtually everything
else of interest in the booming province, increased demand for
coal ensures the commodity's future as an integral part of the
local economy. Provincial royalties from Alberta's nine mines
amount to around C$10 million per year. While this figure pales
in comparison to the C$14 billion the provincial government was
paid in 2004 by the oil and gas companies, Alberta is hoping
that high coal prices will result in more mines "paying out,"
allowing the province to benefit from taxes on profit. One
oft-quoted statistic estimates that Alberta's coal reserve has
twice the energy potential as all other non-renewable energy
resources in the province, including crude oil, bitumen, and
natural gas. At current rates of consumption, this
oft-overlooked energy bonanza will last another 800 years.

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A LUMP OF COAL IN ALBERTA'S STOCKING
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5. According to Jim Popowich, President of Alberta-based coal
giant Fording Canadian Coal Trust, "Unprecedented demand from
China has driven the price of coking (metallurgical) coal to
historic highs. Annual increases from China in their steel
productions have dwarfed anything that we've seen in the past
couple of decades". The Energy Information Administration (EIA)
predicts world consumption of coal will increase by at least 40%
by 2025. While metallurgical coal will fuel much of this
increase, Alberta exporters are placing their bets on the
thermal coal used for electricity generation. Many of the
nations where demand for thermal coal is most rapidly increasing
are in the developing world, where Kyoto restrictions do not
apply and strong environmental lobbies have yet to form. (Note:
Thermal coal is lower quality coal used to process heat, steam
and electricity generation. Metallurgical coal is higher
quality used primarily for making steel in integrated steel
mills using the basic oxygen furnace.)


6. This isn't the first time rising interest in coal has created
a mini-boom in the industry: Popwich adds that: "History has
shown how sometimes we can be our own worst enemies, and that we
go out and do a significant supply increase only to have the
market fall on us." The Alberta coal industry has been more
cautious during the recent upsurge in coal prices, with most of
the increase in production coming from upgrades and the
reopening of old mines. Long term prospects for growth are more
promising; dozens of small companies have entered the market,
several of them with plans for new mine expansions. Allen
Wright, Executive Director of the Calgary-based Canadian Coal
Association of Canada (CAC) told us that in Canada, "Five years
ago, half the companies in existence today hadn't started
producing. Business is booming". Wright previously told CG
that, "there is more stored energy in Canadian coal than the
country's oil, natural gas and oilsands combined", pointing out
that coal makes up "more than 92% of North America's hydrocarbon
reserves". Insisting that coal gets a "bum rap", Wright
outlined a future driven by new clean coal technologies, seeking
ways to improve coal-burning technologies and reduce emissions.
He also pointed out that Western Canadian coal is considered
"cleaner" because of its low sulphur content.


7. The value of coal is notoriously difficult to predict; in the
absence of global standards like those for oil, natural gas, or
gold, the price of coal is determined on a contract basis, with
most companies and power facilities preferring to strengthen
ties with existing suppliers than to develop new relationships.
The average negotiated price in 2004 was US$64 per ton.
Following a record US$125 per ton of coking coal secured by
Alberta Grande Cache Coal Corporation in a contract earlier this
year, the price has stabilized between US$110 per ton and US$120
per ton. These prices recently prompted Australian think tank
Access Economics to declare metallurgical coal the "most
overvalued" mineral of 2005. Prices negotiated for thermal coal
have been close behind, though generally lower because of the
commodity's lower purity. A decrease in price is expected next
year, but a return to the market of 2004 is unlikely.

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TRUST US, WE'RE NOT A MONOPOLY
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8. The upswing in the coal market couldn't have come at a better
time for Alberta. A comprehensive restructuring of the coal
industry occurred in 2003, when five Canadian companies and
mutual funds came together to create Calgary-based Fording
Canadian Coal Trust, the second largest metallurgical coal
producer in the world. Under Jim Gardner, first president of the
Trust, Fording instituted many efficiency and belt-tightening
measures, including the downsizing of hundreds of workers in
British Columbia. The strategy would pay off in 2004, when
Fording first turned a profit. The trust is still in the process
of transformation and expansion, with employee rolls up 50% in
preparation for mine upgrades next year. The majority of
operations for Fording are in SE British Columbia, with five
metallurgical mines in Elk Valley, and one nearby in Alberta.

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WITH GREAT PROFITS COME GREAT CHALLENGES
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9. However, the future of Fording and other coal producers based
in Alberta is uncertain. While the industry is currently sitting
on large cash reserves resulting from the high prices, rising
transportation costs threaten to eat away at profit margins.
Shipping costs for Fording were up by a third in 2004, with
soaring fuel prices promising further damage to the company's
bottom line. Another factor in rising expenses has been Canadian
National Railway's tenuous relationship with labor; tensions
between the railroad giant and unions erupted into a month-long
strike in March of last year, causing expensive delays in coal
shipments. Icy relations with the provincial and federal
governments have also hampered further development for Fording,
which will soon be forced to pay a higher royalty rate as its
profits expand beyond the limits of its original tax shelter.
Even more damaging to the Trust is legislation passed last year
which causes organizations like Fording to lose their mutual
fund status if they are more than 49% foreign-owned. Currently,
Fording is 56% Canadian-owned, but with Asian investors eager to
pour money into their mines, the trust is actively screening new
shareholders to ensure compliance.


10. Apart from Fording, numerous smaller coal mining companies
have expanded operations in Alberta over the past five years.
The largest, Luscar Energy Partnership, purchased Fording's
thermal coal assets in 2003 and continues to be the most
important domestic source of coal for Alberta power facilities.
While coal is an international and "north-south" market, meaning
Canada-US trade is larger than interprovincial, Luscar does play
a significant role in providing eastern Canada with coal.

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CLEAN COAL: OXYMORON OR NEXT BIG THING?
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11. Although Alberta may be in the middle of a quiet rediscovery
of coal's benefits, many still view the energy source as a
necessary evil, at best. In a nation already embarrassed by the
prospect of being beaten by the United States in lowering
greenhouse gas emissions, any support of coal technologies is
sure to raise eyebrows. However, if the Canadian Clean Power
Coalition (CCPC) has its way, much of coal's negative effect on
climate change and air quality could be eliminated. The
coalition, which receives substantial support from the province,
Ottawa, and the coal industry, sponsors a research initiative
aimed at building a commercially viable power facility fueled by
coal and emitting zero greenhouse gases by 2012. With the first
phase now completed, CCPC hopes to retrofit an existing
coal-fired plant by 2007 to demonstrate new technologies
developed in Alberta. Much of the research has been focused on
coal gasification and the process of amine-scrubbing, through
which carbon dioxide is separated from other waste gases
produced by burning coal. A carbon sequestration project,
located near Weyburn, Saskatchewan (reftel) is developing
techniques for pumping carbon dioxide into the oilsands, hoping
to replace natural gas as the primary method for bringing heavy
crude oil to the surface. The fortuitous timing of the two
projects may enable Alberta to free up valuable natural gas,
increase crude oil yields, decrease carbon emissions, and
increase the value of the province's extensive coal reserves
over the next decade.


12. Many conservationists argue that if this sounds too good to
be true, it's because it is. The cost of carbon sequestration is
still prohibitively expensive, and the possibility for leakage
remains a concern. The diversion of funds to both projects has
angered renewable energy researchers, who say Canada should
focus more on developing proven technologies like solar or wind
power rather than rehabilitating one of the world's worst
contributors to global warming.

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COMMENT
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13. While the United States imports minimal amounts of Alberta's
coal, the indirect impact of growth in the industry will be
substantial. The development of clean coal technologies, as
President Bush has recognized with the Clean Coal Power
Initiative, will likely play a significant role in solving some
of the worst environmental hazards facing the world, including
climate change. The December 7th announcement from American
clean coal proponent FutureGen concerning plans for the
construction of a zero-emissions coal plant by 2012 emphasizes
the importance of developing these technologies. The efforts of
the CCPC and the Weyburn Project in Canada have proven the
technical feasibility of clean coal; FutureGen is proving its
economic. If the province's research into clean coal and
development of its abundant resource wealth is successful, the
resulting increase in natural gas and oil supplies, and decrease
in emissions, will contribute to a more unified, cleaner, and
less energy-dependent North America.


14. This cable was drafted by our fall intern, David Dill.
AHMED