It is well known that 2012 has not been kind to coal stocks. The
30-stock Market Vectors Coal ETF (NYSE:
KOL
) paints the picture. Year-to-date, KOL has slid 22.4 percent as
waning emerging markets demand and depressed natural gas prices
have battered coal equities and prices of the commodity itself.
As a high beta, cyclical sector levered to things such as global
steel demand, the coal group usually outperforms to the upside when
investors view the global economy through rose-colored glasses.
Conversely, the sector's downside moves can be deep when investors
are skittish about the macroeconomic outlook.
The latter scenario has ruled the roost for coal stocks this
year, but a fair assessment must include the fact the group has
recently shown signs of life. Even before news of
China's $157 billion infrastructure stimulus
program
crossed the wires, coal stocks were moving higher.
KOL is up 3.3 percent in the past month and now traders expect
the deployment of Chinese infrastructure stimulus to deliver more
upside for coal equities. The question is with names such as Alpha
Natural Resources (NYSE:
ANR
) and Peabody Energy (NYSE:
BTU
) up 22.2 and 12.4 percent, respectively, in the past month, how
much upside is left?
Maybe a little, though a bear case can be made. For example,
Alpha Natural Resources said on Tuesday it "will reduce
approximately 1,200 positions from the current workforce of 13,100
employees." Eight mines in Virginia, West Virginia and Pennsylvania
will be idled. The company said by early 2013 it will reduce coal
production and shipments by 16 million tons.
"Approximately 40 percent of the reduction will come from
higher-cost thermal coal operations in the East that are unlikely
to be competitive for the foreseeable future,"
Alpha Natural said in a statement
.
One way of interpreting that last quote is that producing
thermal coal, the type of coal used by power plants, is not the
place to be when electric utilities can get their hands on cleaner,
cheaper natural gas. It is possible that it would take a dramatic
decline in production and subsequent spike in natural gas futures
prices to send electric utilities back to thermal coal from
gas.
The thermal coal situation is not much better overseas.
Benchmark Australian thermal traded for $87 per ton in June, down
from
$142 per ton in early 2011
. Goldman Sachs said 6 million tons of thermal coal production will
be lost in the fourth quarter due to mine closures, another
anecdote that illustrates the problems cheap natural gas is causing
for coal producers.
The most dour of assessments would be that much of the lost
thermal coal production is gone for good with the U.S. shale gas
boom being a primary culprit. For coal stocks, this means the bulk
of the recovery thesis lies with metallurgical coal demand.
Metallurgical coal is the coal grade used in the production of
steel. It is the coal variety China, India and other emerging
markets were once addicted to.
Alpha Natural Resources is the world's third-largest producer of
metallurgical coal. Peabody is major "met" coal producer as well
and so is Consol Energy (NYSE:
CNX
). There may opportunities with met coal, but those opportunities
do not come without significant hurdles. Met coal cost $225 per
metric ton in July, but plunged to $160 per metric ton earlier this
month,
Reuters reported
.
Slack steel demand prompted Consol to announce the idling of a
met coal mine earlier this month. Peabody is facing headwinds in
Australia in the form of the Queensland government's proposed
royalties on coal production.
Add to those dour headlines is the fact that coking coal prices
are falling. Recently, a contract was signed for the fourth quarter
that priced coking at $170 per metric ton, well below the
third-quarter price of $225 per ton and barely above the
spot price of $150 per ton
.
If metallurgical coal prices remain below $200 per metric for an
extended time frame, that scenario will almost certainly strain the
earnings power of companies such as Alpha Natural, Consol, Peabody
and Walter Energy. Below $200 per metric ton, these companies will
struggle to generate positive free cash flow needed to run their
businesses,
Bloomberg reported, citing an industry analyst
.
All of this sounds bad, but the European sovereign debt crisis,
China's record stockpiles of coal and Indonesia's plans to
significantly boost coal exports also cannot be ignored. Combined,
these factors affirm the notion that coal stocks may make for great
short-term trades, but the long-term investment outlook is murky at
best.
(c) 2012 Benzinga.com. Benzinga does not provide investment advice.
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