The coal business continues to suffer from depressed demand, which has created the highest inventory levels in years despite major production cutbacks from industry leaders. The equities have recovered nicely from lows reached in March 2009, as investors discount a recovery sometime later in 2009 and 2010.

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The Big Picture
The fundamental picture is not good for coal, despite an apparent stabilization in the economy as seen in the "green shoots" that are popping up. Coal inventories at generating plants are at a multi-year high, as the recession cuts into demand. Inventories are 16% above last year, and 40% above the five-year average.

Government statistics show that coal as a percentage of utility generation is at 44.1%, compared to 48.4% in the same period last year. Electric sector consumption of coal is now at 2002 levels.

Why The Decline?
There are probably two reasons for this decline. Demand is obviously down due to the economic contraction, and is being impacted by possible substitution of natural gas for coal to generate power where possible. Demand for natural gas generation was up 7% and 9% in February and March 2009, respectively.

Another issue impacting coal companies is evolving rules on carbon emissions that are becoming law in the U.S. This raises investor uncertainty, making some reluctant to commit.

The industry is trying to cope with the downturn, and several companies have announced production cuts so far in 2009 to help balance the market. Peabody Energy (NYSE:BTU) produced 256 million tons in 2008, and has production guidance of 235 million tons for 2009.

Arch Coal (NYSE:ACI) produced 138 million tons in 2008, and now is guiding to production in 2009 of 118 million tons. Two smaller producers, Massey Energy (NYSE:MEE) and CONSOL Energy (NYSE:CNX) have each instituted production cuts of approximately 5 million tons each. Total production cuts equal approximately 75 million tons for the entire industry, compared to total U.S. production of 1.2 billion tons.

On The Bright Side
There are a few positive signs out there for consumption. Currently, 16 GW of coal-fired generation are under construction. This capacity should come online sometime between now and 2012.

If an investor wants to make a bet on an economic recovery using the coal stocks, some analysts favor Peabody Energy due to its international exposure, particularly its mines in Australia. These mines feed the growing Pacific market, which is still solid in the long term.

Another choice to research further is CONSOL Energy, which besides its coal business owns a majority stake in CNX Gas Corp (NYSE:CXG). CNX Gas has drilling rights in Appalachia, including acreage in the Marcellus Shale, a major new source of natural gas.

The Bottom Line
Investors are optimistic about coal equities and have bid the stocks up as much as 100% off the bear market lows, despite a weak fundamental picture for its business. (Read more about alternatives to coal energy in our article, Clean or Green Technology Investing and Spotlight on the Solar Industry.)

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Tickers in this Article: BTU, ACI, CNX, MEE, CXG

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