The World’s Best-Positioned Junior Coal Play?

I've said previously that India is going to be the biggest story no one's heard yet in thermal coal.

Last week came some of the first public recognition I've seen on the incredible changes taking place in the Indian coal supply-demand dynamic. Giving us a more solid view on the ground-shifts happening in the Asian coal market as a whole.

These changes lead to some very interesting conclusions. Chiefly, coal projects around the Indian Ocean are going to get a lot more valuable.

There's one country particularly I believe will make big gains because of the looming changes (and it's not Indonesia, Australia, South Africa, Mozambique or any of the other "big names" in the space). One tiny company seems to be perfectly positioned here, with a sizeable coal project. And trading at half of its cash value.

More on all that in a moment. First, let's look at the recent news on India's coming coal import boom.

One big event last week appears to have confirmed my thesis on India's hunger for coal. James O'Connell, Editor-in-Chief for coal at global data powerhouse Platts, told reporters in Mumbai that India's thermal coal imports are on the rise. Then came the surprise: O'Connell said he expects the nation to become the world's largest thermal coal importer during the next three to five years.

That's a big prediction-from people who watch enough numbers to know what they're talking about.

Here's the implication. China is currently the world's top coal importer. The Chinese brought in just under 235 million tonnes of coal in 2012. That included 147 million tonnes of thermal coal (as opposed to coking coal for steel-making).

India's imports were considerably less than that in 2012. Indian consumers imported 121 million tonnes of total coal. Out of that, 89 million tonnes were thermal coal.

Those numbers imply that Indian imports have to explode in order to grab the number one importer spot. Assuming Chinese imports stay flat (which is not a given-China's thermal coal imports grew 45% in 2012), India's imports would have to grow by 58 million tonnes over the next three to five years in order to rank on top.

That kind of growth will likely make supply very tight around the Asian market. It looks like demand from major consumers here-China, Japan, South Korea and Taiwan-should stay more or less steady. Maybe losing a few million tonnes of demand from Japanese buyers.

The big concern in regards to the coal price has been increasing Asian supply. Numbers from Indonesia so far in 2013 show that its exports may increase by 34 million tonnes this year.

Export numbers also appear to be growing at some Australian ports. At Dalrymple, Queensland, exports between January and May were up 10.1 million tonnes. Exports from ports like Gladstone also seem to be growing.

But continued growth in Australian exports is not certain. Australian mines are not low cost producers. At current prices, three-quarters of Australia's thermal coal operations are probably not making money. That should limit the amount of supply growth here.

The other wrinkle lately has been a move by China to limit Indonesian coal imports. Effective August 30, the Chinese government imposed a new 3% duty on low-calorie Indonesian coals--a move apparently aimed at reducing consumption of this lower-quality product. If Chinese consumption of Indonesian coal is impacted, the recent production increases from Indonesian producers may have less effect on the overall market.

On the whole, it looks like import growth in India should be more than enough to absorb all the increased supply from Asian-sphere producers. And then some.

If India does become the center of the coal-importing universe, there are some interesting knock-ons. Particularly for producers.

Currently, Australia and Indonesia are the top dogs in Asian coal mining. Largely because of positioning. The two nations are ideally located to ship to China, Japan and Korea.

But India is a little further away-especially for Australia. Traditionally, Indian importers have relied much more on African coal supplies. From South Africa, for example.   

For this reason, Indian coal producers seeking supply abroad have been quick movers into countries like Mozambique. Trying to set up mining operations to secure production that could be shipped back home.

But infrastructure challenges in that nation have turned it from a coal miner's dream into a nightmare. Punctuated by Rio Tinto's $3 billion write-down of its Mozambique coal projects earlier this year.

South Africa's coal export situation is also looking less certain. The government is ramming through a revision of the South African mining code-one that will see coal declared a "strategic mineral". There's speculation this may be a first step to commandeering coal for the domestic power sector. Which could reduce export supply significantly.

With these East African stalwarts facing issues, would-be Indian importers have fewer options for new supply. But this could open the door to new players in this increasingly-valuable space. One of those might be Madagascar.

Although not currently a significant producer, Madagascar's southwest Sakoa coal fields have been estimated to hold billions of tonnes in coal resources. Projects here have already attracted attention from Asian producers. In 2008, Thailand conglomerate Italian Thai Development bought Canadian-listed Pan African Mining for its Sakoa coal projects. And just last year, Thailand's state energy firm PTT paid $50 million for a 66.5% interest in Australian-based Red Island Minerals, also developing coal deposits in the area.  

I believe the proximity of Madagascar's projects to coal-hungry India is going to make them a lot more valuable over the coming few years.

There's one play here that's particularly intriguing. A tiny Australian junior called Lemur Resources (ASX:LMR).

Lemur owns a series of coal licenses in the Sakoa area. The company has so far identified a resource of 135 million tonnes of good-quality thermal coal.

That's not a huge deposit. But it's a decent start, with a lot of expansion potential. Infrastructure here will take some development-but based on the buyouts that have already materialized for coal projects in the area, it appears that Asian consumers are willing to tackle this challenge.

Here's where Lemur Resources gets really intriguing: the company's share price has fallen 50% over the past year, with the market capitalization today sitting at a paltry A$9.6 million. Yet, as of the beginning of August, the company held nearly $17 million in cash. Meaning investors can today buy the company for half of its cash value-and get the prospective coal projects for free.

There's one more twist to the Lemur story. In May, AIM-listed Bushveld Minerals (LON: BMN) launched a hostile takeover offer for Lemur. Offering three Bushveld shares for every five Lemur shares.

The battle is still raging, with Bushveld announcing at the end of August that it has only taken up 44.3% of Lemur's shares under the bid. This gives Bushveld voting control of the company, but not complete ownership.

But the bid itself appears to offer an interesting arbitrage. Bushveld today trades at 10.45 pence per share, equivalent to about A$0.18. That means you could buy five Lemur shares (costing A$0.05 per share, or A$0.25 total) and exchange them under the takeover offer for three Bushveld shares, worth A$0.54.

That represents over a 100% return, simply by phoning your broker. I know this sounds suspiciously too good to be true. But there could be some simple reasons for the disconnect.

Lemur is a small and relatively unknown company, so there may not be much buying to prop up the share price. Or, investors may have been frightened off by the complex takeover (Lemur and Bushveld share some common directors, which can be an uncomfortable situation). Or, potential buyers might be uncertain what Bushveld will do with Lemur corporately if and when it acquires the company.

None of those concerns however, significantly affect the value of the company. Absent some more-sinister reason for the under-valuation, this is one of the best ways to play the emerging Indian coal story. Lemur's coal project is one of the best-positioned in the world to benefit from surging Indian demand. The company is flush with cash, and selling cheap. That's a pretty good combination.