Tuesday, September 18, 2007

Another Look at Coal: Consol Energy (CNX) and Peabody Energy (BTU)

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I laid out the case for Consol Energy (CNX) and Peabody Energy (BTU) - along with Arch Coal (ACI) last Thursday. I see a new article on the via AP on the potential reasons for uptick in demand for US coal.
  • Strong international demand appears likely to help tighten the U.S. coal market by the middle of next year, according to market participants.
  • A key driver of this demand has been China's emergence as a net importer of coal in 2007. The country is firing up a new coal-burning plant each week, and this growing appetite has devoured coal from Australia, South Africa and other suppliers that would normally ship to European markets.
  • Some European consumers have therefore turned to U.S. suppliers to replace coal that is now too expensive to ship all the way from Asia.
  • "In July, China was a net exporter, but that's unlikely to last," said Jim Thompson, publisher of Coal & Energy Price Report. "Generally they'll be a net importer but sporadically they could be a net exporter."
  • That's the reverse of China's role in the global markets before 2007, when the country occasionally imported coal but was usually a net exporter.
  • The first beneficiaries of this trend will be companies that produce coal used for making steel. Prices for this type of coal have spiked to around $150 per metric ton for coal sold on the U.S. East Coast. Alpha Natural Resources Inc., based in Abingdon, Va., stands to benefit most from this trend, said Jeremy Sussman, a coal sector analyst at Natexis Bleichroeder. The company is the largest U.S. exporter of metallurgical coal, and it has plenty of production that isn't locked into contracts at lower prices.
  • Other U.S. coal producers won't benefit immediately. Most of the coal sold domestically is used to generate electricity, not make steel. But if metallurgical coal demand is strong, producers will divert their production for sale to steel companies instead of selling it to power companies.
  • Producers are even exporting more power plant coal this year than last. The industry is on pace to export as much as 58 million tons of both power plant and steelmaking coal in 2007, up from 49 million tons in 2006. That adds tightness to the market for power plant coal and should help cut large stockpiles that utilities have amassed since 2006.
  • "It's not affecting us yet," said Deborah Rouse, manager of coal and transportation at Southern Co., the giant power company that's one of the largest U.S. coal consumers. "It's not affecting the U.S. market yet because of the inventory hangover." "If the export demand continues, and domestic demand picks back up, then I think that just has upwards price pressure on the market," she added. "The domestic utility story isn't likely to be ripe for a few more months yet," said Thompson of Coal & Energy Price Report
  • Obstacles still remain, however, for producers, particularly those located in central Appalachia, a region spanning southern West Virginia, eastern Kentucky and southwestern Virginia. Much of the production in the region comes from smaller underground mines. These producers must cope with new worker safety laws that will significantly raise costs. Some will probably stop producing with prices too low to cover their costs.
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So this appears to be a long term way to play the China expansion with reasonably valued stocks; now that China is morphing from an exporter of coal to importer. Consol Energy (CNX) is a mix of metallurgical coal and power plant coal, whereas Peabody has most of its reserves in Wyoming, not Appalachia, so it's protected from some of the trends mentioned above - also Peabody has nice Australian exposure - meaning China exposure.

Both these stocks have pulled back from their initial thrust through resistance, so I am adding to both positions here in my 2nd round of buying in both names. Both are firmly above their 50 day moving averages since their recent spike, whereas Arch Coal (ACI) was unable to penetrate that level of resistance. Hence my buying of the former 2 names. Again, here is a situation where the stock prices were telling you something about the fundamentals. Since my coal analyst (ahem) left the research team, I was unaware of the new regulations in Appalachia.

Long Consol Energy, Peabody Energy in the fund; no personal positions.

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