Coal is the new gold

It's likely to make greenies shudder but the prospects for Pike River Coal just keep getting better.

The company is still drilling its 2300m tunnel with about 250m to go before it hits the coal seam and starts producing the black stuff, expected in July.

The price of coal, particularly the premium hard coking coal Pike River will produce, just keeps rising.

Pike River has pre-sold 70% of its first three years' expected production and 55% of expected production for the life of the mine, most of it to its two cornerstone Indian shareholders, Saurashtra with 10.2% and Gujarat with 9.4%. The price will vary every year, benchmarked off the price set between the major Queensland producers and their Japanese customers.

The company is expecting to produce only 200,000 tonnes in the year ending June 2009, but forecasts an increase to about a million tonnes a year thereafter.

When Pike River floated in mid-2007, it was forecasting a price of $US101 ($126.53) a tonne. By the time it issued its rights issue prospectus in January, it was expecting something above $US130 a tonne for the year beginning April 1.

Now, managing director Gordon Ward says the price is likely to be close to $US300 a tonne.

That's based on BHP Billiton's acknowledgement earlier this month that market rumours were on the mark. Rather than spell out actual prices, the big Australian said it expects pricing to increase by between 206 and 240%.

BHP said it had reached settlements initially with customers outside Japan and "more recently with key Japanese customers".

BHP's followed a similar announcement from South Korean steel maker Posco. Another coal giant Xstrata is reported to be holding out for more than $US300 a tonne.

The Goonyella, Queensland, price used in the company's prospectuses was $US96 a tonne last year.

A number of one-off factors, including flooding of Queensland mines in February, electricity problems in South Africa and snowstorms in China, have contributed to short-term supply problems which have bumped up the price temporarily. But there are also underlying fundamental demand factors driving prices higher: voracious demand coming from China and India.

Analyst Jason Familton at First NZ Capital says the Asian coal team at sister broking firm Credit Suisse are predicting China will need an additional 100 million tonnes of lesser- quality thermal coal by 2010 if its current power demand continues at current levels. They also expect India will need another 35 million tonnes if its power generation growth picks up 4%. Familton says the underlying drivers are similar for coking coal.

Familton is now expecting Pike River's coal price will average about $US95 a tonne long-term, up from his previous $US80 assumption. That's near the middle of current market expectations ranging between $US80 and $US120 a tonne. And it's way higher than historical prices: industry newsletter the McCloskey Coal Report shows Goonyella coal sold for just $45.30 a tonne in 2003.

Ward isn't so sure about those long-term predictions. "It's going to take a few years for prices to drop to that level."

He points to what's been happening in the oil market, saying it took a long time for people to realise that a step- change upwards in pricing was occurring, rather than any short-term blip.

Analysts' predictions "may turn out to be a little on the conservative side", Ward says. He's heard Canadian coal producers are struggling to make any money at prices below $US100 a tonne which is likely to put a floor under the price. "We may see longer-term coal prices stay higher for longer but who knows how much."

Not surprisingly, Pike River shares have been among the best performers on the stock market recently. They traded as high as $1.35 last week, well above the $1 float price and the 90 cents rights price. Since it listed, the benchmark Top 50 Index has shed about 15%. The shares are still well below analysts' valuations which, if Ward is correct, my prove to be overly conservative.

Familton has a $1.39 valuation but a 12-month target of $1.55 and rates the stock "outperform". Guy Hallwright at Forsyth Barr has a $1.45 valuation and an "accumulate" recommendation. Perhaps not so surprising since his firm is Pike River's sponsoring broker and underwrote the rights issue (it was over-subscribed), John Kidd at McDouall Stuart is the most optimistic with a $1.75 price target.

* Jenny Ruth is a freelance financial journalist and a columnist for the Independent Financial Review.

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