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Tickers in this Article: BTU, BNI
We are inundated with discussion about the price of oil daily, but those higher crude prices have more to foretell than just higher pump prices this summer. As we see the price of oil head toward the highs of last year (last week's close was pushing $70 per barrel, compared to 2006's high of roughly $78) we should all be thinking about who stands to benefit from this trend.

While estimates on the exact number of "years left" vary, nobody denies that we are at - or very near - peak production in oil, meaning that prices could be under severe upward pressure from here on out. That's not even taking into account the massive geopolitical uncertainties in the heart of the oil-producing world. All of this plays right into the hands of investors who are willing to take a stake in coal. (If you've got stomach for other sin stocks, check out A Prelude To Sinful Investing.)

Global Demand Chart Going Vertical
For any Rip Van Winkles out there, India and China are in the midst of an unprecedented infrastructure buildup, and just as thunder follows lightning, more growth means more electricity consumption.

Unlike in the United States, there are few (if any) restrictions on greenhouse gases in the Asian nations, so the cheapest source of electricity will win out. And the cheapest source of power has been, and remains, thermal coal, a commodity in which the United States has the largest known reserves in the world - a full 26% of the total, known supply.

The spot price of thermal coal has swung all over the place in recent years, most recently taking a dip in 2006 as too much inventory got built up in the electric generators that burn coal.

Spot prices for most types of coal have been clicking up during 2007, a trend likely to continue with recent Congressional backing for coal-to-liquids (CTL) subsidies in the United States, a process which creates a petroleum-like substance from raw thermal coal.

Mr. Peabody Doesn't Need the "Wayback Machine"
Peabody Energy Corp (NYSE: BTU) is the largest stand-alone coal producer in the world, and currently is the source of about 10% of all electricity used in the United States today. As of December 31, 2006, the company had more than 10.2 billion tons of proven reserves, enough supply to last for nearly 50 years at current demand levels.

Peabody made recent acquisitions of reserves and facilities in Australia, further opening the door to the lucrative Asian markets by moving right into their neighbor's backyard.

In 2001, about 1% of Peabody's revenues came from overseas. In 2006, that percentage had jumped to over 13%, and that was before China became a net importer of coal, which will probably happen during 2007 for the first time. Expect this trend to continue, as coal supplies a full 80% of China's electric power.

The Missouri-based company recently announced it would be spinning off its patriot Coal division to shareholders sometime later this year, which should really free-up Peabody's stock to push for higher multiples down the road, as well as unload some of the hefty $3 billion in long-term debt on the balance sheet. The Patriot group controls mining interests in the Eastern United States, where most of Peabody's unionized (i.e., more expensive) labor resides.

The leaner Peabody that will be left will have its most valuable assets in Australia and in Wyoming's famed Powder River Basin - most likely the richest source of "compliance coal" in the world, so-called for its low sulfur content which meets the new emission standards in place for 28 U.S. states. The assets of the Powder River Basin are one of the stated reasons why Warren Buffet has taken a recent position in three major railroad operators, most notably a $3.25 Billion stake in Burlington Northern Santa Fe (NYSE: BNI), whose railways serve that area of the country.

Going Green Takes Time

While some investors may balk at owning a coal producer in today's ever-increasing "green world", the truly safe energy alternatives, while exciting in theory, are a long way from being viable, cost-effective and scalable options. We should be thankful that our capitalist economy fosters advances in solar power, hydro, geothermal and wind energy - but we've got some time to go on these. Nuclear is a low-cost option over many years, but it's just too unlikely that any notable increase will happen in America. The simple fact is that nobody wants a nuclear plant in their backyard, and regulatory hurdles are massive.

So, while CTL plants will take some extra nurturing-time in the beginning, the payoff could be huge for the coal producers - and there's none bigger than BTU.

Parting Thoughts
I truly believe that when it comes to all things China, we are watching the second or third inning of a nine-inning ballgame. China is firing-up an average of two 500 megawatt coal-fired plants per week - growth the planet hasn't seen since the Industrial Revolution.

Members of Congress seem to be in favor of at least trying to make coal liquification a reality. Most importantly, liquification is coming with support from both political parties. While time will be the true test of CTL success, billions in federal funding and a world increasingly "going green" in its thinking should certainly spur some extra innovation. As the old saying goes, "necessity is the mother of invention."

As such, I believe that Peabody's stock should have a nice floor in the mid $40s (BTU stock currently trades for about $49). It has a stable yet growing demand, and a relatively small amount of production locked in at current prices (about 30% through 2009). I like Peabody's exposure to the future, where higher coal prices almost certainly await. Investors could be well rewarded for sticking around for the seventh-inning stretch on coal.

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