Coal-Fired Portfolio Still A Good Bet

By Aaron Levitt | May 04, 2011 AAA

The future promise of green and renewable energy is certainly great. Finding these cleaner and carbon neutral sources of fuel could be one of the better longer term investment themes. In the short to medium term, fossil fuels will continue to show their dominance. While natural gas is finding new prominence in various nations' energy plans, the worldwide demand for coal is going strong. In addition, recent developments across the sector have created some opportunities for investors to add exposure to this fuel source. (For background reading, see Coal Stocks With Clean Energy Potential.)
TUTORIAL: Exchange-Traded Funds

Coal's Still Growing
Despite advances in renewable energy technologies, coal is still the major fuel for worldwide electricity generation. Nearly 40% of the planet's electricity is produced using coal and it is the dominant fuel source in India, the United States, Australia and Europe. Coal accounted for more than 71% of China's energy in 2008. Analysts estimate that China's coal demand will reach 1.92 billion tons in 2011, up approximately 10% versus 2010's demand. Overall, the Department of Energy estimates that international trade in coal will grow to account for 47% of the fuel market by 2035 and still represent a dominant 28% of market share.

More recently, the Japanese tsunami and questions about the role of nuclear energy is giving coal a boost. The disaster took out nearly 9.7 GW worth of nuclear power capacity as well as 9 GW of thermal capacity. As a result, coal is being seen as a readily available power source and many coal-based power producers are over-extended. Thermal coal prices have been steadily rising throughout producing regions as weather and other issues have negatively impacted supply. By the end of March, coal prices were nearly 33% higher than a year ago.

Coking or metallurgical coal is also seeing a boost in prices and demand as the emerging world continues its infrastructure binge. Coal is used to produce 70% of the world's steel and is essential to the production of cement. The U.S. Energy Information Administration (EIA) estimates that Australia's total exports of metallurgical coal to Asia, including Japan and India, will increase 64% by 2035. Rebuilding efforts in Japan will also continue to put pressures on coal supplies and prices. Prices for coking coal have risen 47% to a record $330 a metric ton.

Finally, coal could see a long-term boost as a result of various "green" initiatives. The U.S. and China have committed to so-called "clean coal" technologies such as carbon capture strategies and new scrubber filters. These plans could make coal competitive with other "green" energy sources and boost overall demand. (For more insight on green energy, see Clean Or Green Technology Investing.)

A Coal-Fired Portfolio
Arch Coal's (NYSE:ACI) recent $3.4 billion bid for International Coal (NYSE:ICO) highlights the supply/demand imbalance and need for coal. Investors looking to add the sector can do so with the Market Vectors Coal ETF (NYSE:KOL). The fund follows 38 different firms associated with the fuel source including many of the "pick and shovel" plays such as Joy Global, (Nasdaq:JOYG). Alternatively, the PowerShares Global Coal (Nasdaq:PKOL) is another broad play on the theme. Funds such as the SPDR S&P Metals & Mining (NYSE:XME) also make adding the sector easy.

The more interesting coal plays could be some of the smaller miners. Both James River Coal (Nasdaq:JRCC) and Patriot Coal (NYSE:PCX) have a mix of valuations and assets that could make them takeover targets as the industry consolidates. Even if a takeover never materializes, the pair will benefit from strong global coal demand.

Norfolk Southern (NYSE:NSC) railroad derives about 30% of its revenue from coal, and will therefore also be a beneficiary of global coal demand. As coal miners continue to produce more coal for export, Norfolk will be the one transporting them across the country to various ports for shipping overseas. Shares of Norfolk yield 2.1%.

Finally, for investors looking for more income from their coal plays, both MLPs Penn Virginia Resource (NYSE:PVR) and Alliance Resource (Nasdaq:ARLP) yield more than 4%.

The Bottom Line
As energy demand increases and new infrastructure projects continue to be created, demand for coal is set to rise. Investors with long enough time lines should allocate some capital not only to renewable energy and natural gas, but to coal as well. (For related reading, also take a look at Forget Green Stocks, "Green" Will Do.)

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