The Deep Value Play In Coal Exports

By Aaron Levitt | May 16, 2012 AAA

The hydraulic fracking boom isn't just having its way with natural gas producers across in the United States. As firms like Range Resources (NYSE:RRC) continue to tap America's various shale formations at a rapid pace, the price of natural gas has been driven down to record lows. These rock-bottom prices amid the glut of natural gas have prompted a variety of utilities to switch their generation capacity from more expensive coal. Add this to unfavorable new legislation from the Environmental Protection Agency (EPA) as well as the recent economic slowdowns in key consuming nations like China, and it's easy to see why shares of the various coal producers have fallen over the last few months. However, despite the negatives, the coal sector could be one of the best values in the commodity complex.

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Don't Give up on Old King Coal
According to new data from the U.S. Energy Information Administration, coal currently makes up around 36% of the electricity generation capacity in the U.S. That's down from 44.6% a year ago. The glut and over-abundance of shale gas production is certainly having its way with demand, and coal prices within the U.S. Spot Central Appalachian thermal coal prices have plunged to just $60 per ton, while metallurgical prices have fallen to about $205 per ton, down from $330 last spring. While the shale revolution and the new EPA restrictions may have been the "straw that broke coal's back" in the U.S., globally is a different story.

Despite the recent slowdowns in key consumer nations like India, international demand for the fuel remains robust. Commodity powerhouse Glencore (OTCBB:GLNCY) recently reported that its thermal coal operations saw an increase in demand of 8% as global coal usage remains elevated. At the same time, a host of new coal-fueled generation capacity is coming online within the next year. Nearly 90 gigawatts worth of new power plants will begin producing electricity in 2012. These new plants will represent more than 300 million tons of additional thermal coal demand. Additionally, Japan has been upping its reliance on the fuel in the wake of the Fukushima disaster and its nuclear slowdown.

Furthermore, as the emerging world continues to urbanize and build-out its infrastructure, the demand for metallurgical coal continues to skyrocket. Coal producer, Peabody (NYSE:BTU) anticipates that global metallurgical coal demand will grow about 50 million tons annually over the next five years. That demand will not only be driven by rising steel production in China, but a host other Southeast-Asian nations. Overall, the coal miner expects global coal demand to rise 10% throughout 2012.

SEE: A Primer On Coal

Big Value
However, while the long-term picture for coal remains bullish, many of the producers have seen their shares dwindle in the face of low natural gas prices. This gives investors an opportunity to add the sector to a commodity portfolio at big discount to their potential. The Market Vectors Coal ETF (ARCA:KOL) is still the easiest way to gain direct broad access to the sector. The fund tracks 33 global coal firms including Peabody as well as Walter Energy (NYSE:WLT) and James River Coal (Nasdaq:JRCC). The fund charges 0.59% in expenses and sits about $20 below its 52-week high.

Perhaps the best coal play lies within Wyoming's Powder River Basin. Featuring vast reserves of low sulfur mineral, the region will be a hot bed of exporting activity and could be the key to coal's future success. Peabody is currently in talks to build an exporting terminal in Washington state, while railroad Union Pacific (NYSE:UNP) already has plenty of infrastructure built in the area. These two firms will likely be some of the major beneficiaries of the shift towards exporting more coal. Likewise, both Cloud Peak Energy (NYSE:CLD) and Arch Coal (NYSE:ACI) have significant acreage in the region as well.

SEE: Using ETFs To Build A Cost-Effective Portfolio

The Bottom Line
The shale gas boom has certainly taken the wind out of coal's sails in the short term. However, that's providing a buying opportunity for the longer term. Overall, the fundamentals are pointing to greater coal demand over the next decades. For investors, the previous picks along with smaller plays like Patriot Coal (NYSE:PCX), make ideal selections to play coals value.

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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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