All across Europe, power companies are being forced to
mothball natural-gas power plants. In just the past few weeks,
renewable-energy companies such as Germany's E.ON and Norway's
Statkraft have done so as well, as a key dynamic taking place in
the United States starts to have a global effect.
That dynamic: abundant production of natural gas. As U.S.
power producers have shifted their multi-fuel plants from
coal-burning to gas-burning (known as coal-to-gas, or C2G),
demand and pricing for coal have collapsed.
Coal is now so cheap that European electricity producers now
realize it's far cheaper to switch back to imported coal rather
than continue burning pricier gas.Call it the gas-to-coal
In fact, the C2G trend, a key theme in the United States over
the past few years, has run its course. And a switch back to coal
has been the new response from some U.S. power producers as well.
There is a multi-month lag time regarding power-plant usage, but
UBS'sanalysts noted in a May 1 report that "Coal once again
appears to have continued to regainmarket share in February as it
outpaced electric generation while natural gas underperformed
electric generation for the third straight month."
This marks a very strongopen to theyear after coal lost
roughly 94 million tons of demand compared with 2011. UBS's
analysts added, "Lower production, falling stockpiles, increasing
exports, and fuel switching reversals are all finally pointing in
a positive direction for coal, especially thermal coal."
That's also a view shared by analysts at Morgan Stanley, who
recently wrote, "We think coal burnwill surprise to theupside in
2013, resulting in a faster-than-expectedinventory drawdown.
Thermal coal prices couldrally , benefitingshares of
Specifically, these analysts expect natural-gas prices to
average around $4.38 per thousand cubic feet, which, as I noted a
few weeks ago, should be quite beneficial for a wide range of gas
producers. Yet these analysts think gas prices in that range
should also help stimulate demand for coal, predicting that U.S.
power-plant consumption of coal will rise this year by 70 million
tons, compared with 2012, and another 45 million tons in
The U.S. export picture is also looking better. Coal exports
had fallen sharply in the past few years but have risen roughly
5% this year. The European power plantissue is a likelyfactor in
"We find the sudden strength in export volumes surprising as
export prices have not materially improved since the summer
decline," UBS's analysts said. "We believe there may be more hope
for the exportmarket despite tepid pricing."
As a quick primer, thermal coal has lower energy density, is
low-cost, and favored by power producers. Metallurgical coal
(commonly known as met coal) packs alot more heat and is
primarily used in the production of coke, which is an important
part of the integrated steel-mill process. In effect, these
analysts don't yet see a spike in met coal demand, though that
trend is certainly worth monitoring when steel production begins
to rebound. For now, this is all about the power-plant
Here's a quick look at a pair of appealing thermal coal
Five years ago, shares of this coal producer were trading
above $100, though the decimation in coal pricing and
demand has pushed shares of
CONSOL Energy (
down below $35.
Operating conditions grew bleak in 2012 assales fell 11%,
to $5.4 billion, and operating profits fell a sharper 37%,
to $497 million. And coal pricing got off to such a rough
start in 2012 that CONSOL will likely post further
full-year drops in sales and profits. But year-over-year
comparisons should turn positive this summer as
third-quarter sales and profits are expected to rebound at
a double-digit pace compared with a year ago.
Morgan Stanley, which carries a $44price target ,
considers CONSOL its top pick, due to the company's low
production costs. As an addedkicker , CONSOL owns a variety
of shale-gas acreage and is benefiting from the rebound in
thatcommodity as well.
Most importantly, management appears to be committed to
maximizing shareholder value by selling underperforming
assets, which should help the company free upcash tosupport
a boost in thedividend . CONSOL's dividend had been stuck
at 40 cents a share from 2008 through 2011. It now stands
at 50 cents a share -- and could approach 60 cents a share
once thoseasset sales are complete.
Analysts at UBS rate this thermal coal producer a "buy" as
industry conditions finally stabilize. They argue that
Arch Coal's (
considerable collection of coal-mining assets isundervalued
by many investors and that shares have roughly 80% upside
to their $9 price target.
Thanks in large part to the rebound in pricing and
demand that is now underway, analysts expect Arch Coal to
also post much better results into the second half of this
year and into 2014.Revenues are expected to rebound more
than 15% next year (to around $4.25 billion) and though
high levels ofdepreciation will trigger net losses,
operating profits should also grow in excess of 15%,
according to analysts.
Risks to Consider:
Morgan Stanley's analysts clearlynote the upside limit to the
coal trade. "By late 2014, thermal markets should break down
again as new environmental rules destroy demand and supply grows
in low-cost basins."
Action to Take -->
That risk factor implies that this is a timely trade and not a
long-terminvestment , which means you should be prepared to book
profits in comingquarters if the coal trade works out as planned.
Still, industry values are quite appealing at the moment.