Coal's 2009 Problems To Linger In 2010

By James Brumley | December 31, 2009 AAA

The year 2009 for coal stocks did not near the disaster of 2008. But if 2009 is any indication, coal stocks may not make for the greatest investments in 2010, either. On the flip side, 2009 showed us the issues, for better or worse, of why we need to understand coal stocks.

From There to Here
If you thought skyrocketing oil prices were good for oil stocks, you should have been watching the equivalent dynamic between coal and coal stocks. Between August 2007 and June 2008, the Dow Jones Coal Index - which includes the likes of Arch Coal (NYSE:ACI) and Massey Energy (NYSE:MEE) - rallied nearly 200%, as the average price of Central and Northern Appalachian coal also increased.

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As is usually the case, the best cure for high prices is... high prices. After peaking in October, coal prices as well as coal stocks sank back to 2007's pre-rally prices. The recession is partly to blame, but the part you can't blame on the recession remains a lingering problem. (Find out how to invest in this slippery sector in Peak Oil: What To Do When The Wells Run Dry.)

Mismatched Results
Despite the broad economic recovery, coal prices are still stuck in neutral. The current Central and Northern Appalachian coal prices are only a hair higher than they were in May - from roughly $42 to $46, a 10% drift. Meanwhile, coal stocks are an average of 33% higher, a party that was started by Goldman in May when the research firm put Massey Energy on its "conviction buy" list as part of a coal upgrade. The move fueled other sweeping recommendations of coal stocks, and the Market Vectors Coal ETF (NYSE:KOL), in particular.

And why not? Alpha Natural Resources (NYSE:ANR), James River (Nasdaq:JRCC) and Massey Energy all reported higher selling prices during Q1 2009 than in Q1 2008. In fact, James River turned a 78 cent per share loss into an 81 cent per share gain on those higher coal prices. Meanwhile, Peabody Energy (NYSE:BTU) generated an 8% YOY increase in revenue and a 200% increase in YOY earnings. So what's not to like?

As it turns out, the pricing scheme is "what's not to like". Early 2009's strong results stemmed from opportunistic price contracts forged in 2008 when spot prices went through the roof.

As those contracts expire and are replaced by 2009's lousy prices (for 2010), coal companies are going to lock in some disadvantageous deals. Considering they've rallied while coal prices have not is strike one against coal stocks in 2010. However, the bears may not have to wait that long for vindication. (Learn how understanding the business cycle and your own investment style can help you cope with an economic decline in Recession: What Does It Mean To Investors?)

Still Not Enough Help
Despite the nice bullish bumps in early 2009, the year still isn't going to be one of recovery for coal prices or its stocks. Although pretty much everything else seems to be doing better on a YOY basis, coal stocks are not. Massey Energy, Peabody, Alpha Natural Resources, Arch Coal and most other coal miners are poised to turn in much weaker results this year, despite the economic rebound. This is a price issue. Until prices go higher, coal stocks (and earnings) will be burdened. And, therein lies the crux of the aforementioned lingering problem. The economy could be catapulted, but coal supplies still would be excessive, while coal demand would remain tepid in comparison.

As we head to the end of 2009, stored coal supplies are the highest they've been since 1999. These supplies far surpass any levels we've seen in the last three years, despite a significant 9.4% cut in production in 2009, according to Argus. Some industry participants feel the supply needs to be whittled down by 100 million tons to bring the storage levels closer to 140 million tons on hand. But that could take until the end of 2010 to accomplish effectively. Furthermore, if pricing remains depressed and the supply/demand balance continues to stagnate, even the end of 2010 seems like a stretch.

Coal Lesson Learned
The excess coal supply is an overhang from overzealous production in 2007 and 2008 - a painful lesson, as excess coal production will dog these stocks beyond 2009 and well into 2010. The coal excess is one that most aluminum and oil companies could never fathom, although they'd never let their industries set up that kind of excess in the first place.

Needless to say, the problems of 2009 bode poorly for coal stocks in 2010, particularly for producers reliant on U.S. customers. China and India, where coal usage is now blistering, both pose coal opportunities and may indeed be the only meaningful future for the coal industry in the near-term. Either way, 2009 will go down as botched.

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