Why Coal Deserves Your Attention Right Now

By Aaron Levitt | July 29, 2014 AAA
Why Coal Deserves Your Attention Right Now

Fossil fuels have had a banner year so far. Both prices for oil and natural gas have surged on the backs of higher demand and a dose of geopolitical tension. Likewise, oil and gas stocks – as represented by the Energy Select Sector SPDR ETF (XLE) – have also produced some hefty returns this year.

The same can't be said for old king coal, however.

A host of issues from lower demand to emissions regulation have sent prices for both the underlying commodity and the companies that extract it down into the basement. Several miners have already filed for bankruptcy protection. However, coal’s full-on demise maybe overstated. For contrarians seeking value, the sector could be one of the best buys in today’s market. (For related reading, see: Winners and Losers in the Coal-to-Gas Switcheroo.)

A Host of Issues and Some Promise

For coal, the last few years have been fraught with difficulties. Here in the United States, natural gas has been its undoing. As we’ve fracked our away into shale, prices for natural gas have fallen to lows not seen in decades. Those ultra-low prices, along with the fact that we keep unearthing more natural gas than we can use, has made it the prime choice for utilities for electricity generation. Making the decision easier has been recent legislation hoping to curb carbon emissions. The EPA has basically made the cost of using and building new coal plants uneconomical.

The story across developed Europe is the same, with Germany, France and the United Kingdom opting to use piped natural gas as their primary generation source. As such, the Dow Jones U.S. Coal Index has fallen from a high of 500 reached in 2011 all the way down to its current reading of around 127. And some coal miners, such as James River Coal Co. (JRCC), have recently filed for bankruptcy.

Yet, there are some glimmers of hope for the beleaguered coal sector.

Currently, coal is burned for almost half of all the electricity in the United States. In some states it makes up about 80% of the generation mix. Given that size, analysts estimate that it will take nearly a decade for all the infrastructure to be built to replace coal with natural gas. As such, the EPA might be forced to scale back its ambitions. At the same time, coal use is currently rising. As natural gas prices have once again begun to rise, coal consumption in the U.S. has increased by 8.5% from a year ago. (For related reading, see: The Coal Industry Languishes, But All Is Not Lost.)

Meanwhile, demand is surging from emerging economies that have less stringent environmental regulations. Overall, the Department of Energy estimates that international trade in coal will grow to account for 47% of the fuel market by 2035.

Making A Play For Coal

With a rise in coal consumption, the broad coal index is up this year, though its still a long way off from the sector's all-time highs. That means there’s still a chance to participate in a coal rebound. With the closure of the PowerShares Global Coal ETF (PKOL) a few years ago, the only broad way is through the Market Vectors Coal ETF (KOL). Luckily, it’s a good option for most investors.

The fund tracks 36 different global coal producers, such as SunCoke Energy Inc. (SXC) and Arch Coal Inc. (ACI). Just under 60% of its holdings are outside the United States. That includes a hefty dose of firms located in key emerging markets like China and Indonesia. While that hasn’t necessarily protected the fund against losses, it should help longer-term, as that is were the demand is. Expenses for the fund run a cheap 0.59%. At that price, KOL could be the best broad-play to bet on a coal rebound.

In terms of the big name producers, Peabody Energy Corp. (BTU) remains the top draw for investors. BTU features assets across the world and has its hands in both coking and metallurgical coal. More importantly, many of those mines are surface or near-surface mines meaning they cost less to operate. That’s helped BTU, along with a steady stream of coal exports, to deal with its debt load, increase profits and increase its dividend over the last few years. That’s something that rivals like Alpha Natural Resources Inc. (ANR) can't say.

Speaking of debt loads, many coal miners made huge acquisitions at just the wrong time and many have been suffering under the weight of those buyouts. But not Hallador Energy Co. (HNRG) or Westmoreland Coal Co. (WLB). Neither stock was caught up in merger mania. As such, their debt loads are much more manageable than other coal producers, and the firms should be able to weather any downside in the coal sector with relative ease.

The Bottom Line

The coal sector has spent much of the last few years suffering at the hands of cheap natural gas and environmental regulation. However, investors shouldn’t count coal out. The sector could be primed for a turnaround sooner than later. That means the time to add coal stocks could be now.

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