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Are there signs of hope for coal companies?

30 Aug 2013

Coal use for the generation of electricity was up almost 5% year over year in June according to the Energy Information Administration (EIA). Natural gas use was down 16%. The rise in natural gas prices over the past year continues to support a shift back to coal. Although that hasn't led to a changed view of the beleaguered coal industry, it eventually will boost the fortunes of companies with access to cheap coal.

The problem is that, despite increased coal use, coal purchases haven't started to rebound yet because utilities are burning coal they have on hand. In fact, the EIA reports that coal stockpiles were over 13% lower year over year in June. That trend, then, is just delaying the inevitable.

Changing Gears
There is, of course, a major shift in the energy industry toward the construction of natural gas powered plants and alternative energy, like solar and wind. For example, American Electric Power more than doubled its use of natural gas between 2010 and 2012, increasing it to 17% of its overall fuel use. Coal saw its use drop drop a similar amount over that span. However, through the first six months of this year the utility's natural gas use has fallen a massive 37% but coal use has increased about 4%.

So, on a large scale, coal's customers are using more coal, but they aren't actually ordering more coal yet. The lacklustre sales environment in the first half pretty much ensures that 2013 will be a bad year for most coal miners even if sales pick up in the second half. That's particularly true since most miners have contracted out the vast majority of their 2013 sales already.

Powder puff
For example, Cloud Peak Energy, which operates out of the Powder River Basin, sold 86.2 million tons of coal domestically in 2012, but only expects to sell between 83 million tons and 87 million tons this year. Flat to lower tons sold coupled with lower coal prices has left the company's earnings well off year ago levels. The second quarter saw earnings drop to $0.08 a share from $0.55 last year. There's not much hope for the rest of 2013, but 2014 should look much better as utilities start to replenish their stockpiles and increased demand provides support for coal prices.

On that front, Cloud Peak sounded almost optimistic in its second quarter earnings release: "There has been a significant increase in utility contracting during the quarter with many customers looking to rebuild their forward contracted positions after letting them decline significantly last year." In fact, the company notes that Powder River Basin inventories had declined to around 78 million tons by mid year, down from 98 million tons in the middle of 2012.

Management went on to highlight that "natural gas prices have remained at a level where most plants consuming PRB coal are economically able to dispatch coal." In other words, its cheaper for Cloud Peak's customers to burn coal. That's because the Powder River Basin produces some of the cheapest coal around.

Coal giant Peabody Energy estimates that coal from this region is competitive with natural gas priced in the $2.50 to $2.75 per million Btu (mmBtu) range. According to the EIA, Henry Hub natural gas came in at nearly $4 per mmBtu in June. Cheap prices is why Powder River coal has been a favorite of utilities and foreign countries in recent years. That's great for Cloud Peak, but it's solely focused on this coal basin, which increases business-specific risk.

A little variety
Peabody Energy is a more diversified player. The company is focused on coal, but mines it from various areas within The United States and abroad. The company's western US operations, which includes the Powder River Basin, accounted for 37% of its 2012 revenues. So, the region is important to the company's top and bottom line, but isn't a make or break focus.

That said, in its second quarter earnings release, Peabody noted that "Customer inventories of Powder River Basin coal are approximately 25 percent below prior-year levels..." And "Longer term, Peabody expects U.S. coal consumption of Powder River Basin and Illinois Basin coal to continue to increase, led by higher coal plant utilization and basin switching." Illinois Basin coal is the second cheapest option and another area in which Peabody has notable operations.

Peabody's Australian operations, meanwhile, accounted for about half of the company's sales, with Australian metallurgical coal coming in at 27% of total sale. Although met coal is suffering from slack demand and weak prices, too, Peabody's global focus, diversified resource base, and varied end markets helps to reduce the company's overall risk profile.

Like the other coal miners, 2013 is going to be a bad year for Peabody. However, long-term trends appear to be turning, which should support 2014 results. With easy earnings comparisons versus 2013, next year should be filled with positives for this diversified coal miner.

On the mend
Although coal will always suffer from its dirty image, that doesn't mean the coal mining industry won't rebound, eventually. In fact, while the sector hasn't turned yet, the fundamental trends that have held coal back of late are starting to turn. Miners with cheap coal, like Cloud Peak, should be among the first to benefit. However, a more diversified player like Peabody will benefit from cheap US coal and provides upside from it global footprint and met coal operations.

Source: The Motley Fool