Coal Gets Red Hot Again

By Aaron Levitt | November 02, 2011 AAA

At this point, it's no secret that global energy use is rising very rapidly. As emerging markets continue to grow, build-out their vital infrastructure and create the consumers of tomorrow, the world will continue to see energy demand skyrocket. To that end, both investors and governments have been exploring solutions, such as efficiency measures and renewable energy generation as a way to satiate that exploding demand. Funds like the PowerShares WilderHill Clean Energy (ARCA:PBW) have become popular ways to play these themes. However, despite the promise of these measures, one old fossil fuel is still reigning supreme.

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King Coal Still In Charge
For all its promise, renewable resources are still playing second fiddle to coal. Recent earnings estimates, from a variety of coal firms, have shown that global demand is stronger than many analysts have anticipated. Despite the recessionary rallying cries, coal demand is showing quite the contrary. Short-term demand continues to rise, as coal inventories are being diminished. Monthly inventories levels have fallen for five straight months, and are now 13% lower than 2010 levels. Production cuts and strong exports have helped fuel the recent drops in stockpiles. Analysts at UBS (NYSE:UBS) estimate that serious supply and demand imbalances, in the coal market, could be coming to a head, which will ultimately keep prices high. (Find out all about supply and demand and how it related to your daily purchases. For more, see Introduction To Supply And Demand.)

Those supply and demand imbalances are even more apparent when you look at coal's long-term picture. Developed nations markets will add an additional 50 quadrillion Btu to their current demand levels over the next two decades. The U.S. Energy Information Administration (EIA), predicts that coal demand by non-Organization for Economic Cooperation and Development (OECD) Asian countries will rise to nearly 220 quadrillion Btu, in annual demand by 2035. China will more than double its coal fired power generation capacity in that timeframe, and India's coal generation will rise 72%. Emerging market nations, looking for cheap fuel sources to drive their breakneck growth, will continue to rely on coal for a major part of their energy pies. Overall, the EIA predicts that coal will remain the dominate fuel source for electricity generation, growing to about 11,000 terawatt hours from its current level of about 8,000. Besting even the growth in natural gas and renewable sources.

In addition, investors in the coal sector may have something else to smile about: merger activity. As recessionary fears have taken hold, many of the stocks within the sector have fallen harder than the broad market. This has caused a variety of stronger firms to make bids for other companies. Recent bids, such as Peabody Energy (NYSE:BTU) and ArcelorMittal's (NYSE:MT) $5 billion offer for Australia's Macarthur Coal, have become common place. Industry experts expect buyouts like this to continue, as stocks within the sector are cheap relative to the long-term supply and demand equation.

Adding Anthracite to a Portfolio
With coals long-term status as king still intact, investors may want consider the sector for a portfolio. Both the PowerShares Global Coal (Nasdaq:PKOL) and Market Vectors Coal ETF (ARCA:KOL) allow investors to bet on a wide swath of coal firms such as Arch Coal (NYSE:ACI), and could be used as proxies for the industry. However, some of the biggest bets could be in the individual miners themselves.

Analysts at UBS suggest that the current environment of coal growth in Asia will benefit firms with direct port access. Both Consol Energy (NYSE:CNX) and Alpha Natural Resources (NYSE:ANR) stand to benefit from current market conditions. Alpha Natural is a supplier and exporter of both metallurgical and thermal coal, and recently saw its profit double. Consol is also making moves into the natural gas industry, and should benefit from addition growth there.

The more interesting coal plays could be some of the smaller to mid-sized miners. The trio of James River Coal (Nasdaq:JRCC), Cloud Peak Energy (NYSE:CLD) 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, these firms will benefit from strong global coal demand. (For related reading on takeovers, see Corporate Takeover Defense: A Shareholder's Perspective.)

The Bottom Line
Despite the estimations of a softening economy, coal demand shows otherwise. For investors, the recent rout in coal equities offers a chance to participate in the long-term growth in coal energy. The previous firms and funds make ideal ways to add that exposure.

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At the time of writing, Aaron Levitt did not own shares in any of the companies mentioned in this article.

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