Prepare Now for the Met Coal Surge

The miners are preparing for it. The world's steelmakers are bracing for it. Are you positioned for it?

I am referring to the looming resurgence in prices for metallurgical coal, which by all accounts is a predictable outcome of the ongoing tectonic shift in the structure of the world's coal markets. As China, India, and other Pan-Asian economies continue to charge forward with fresh demand for steel, the world is facing a shortfall of the high-grade coal that is interchangeably referred to as met coal or coking coal.

Like iron ore, met coal prices are built around a benchmark price, set annually through negotiations between the world's leading producers and the steelmakers that need it. Prevailing spot prices hovering well above last year's benchmark signal a substantial increase in the making, and the outlook for overall demand approaching global production capacity has producers scrambling to adapt.

This is not my forecast, but rather the clear consensus view of all the major industry players that I track for Fooldom. Appalachian miners Massey Energy (NYSE: MEE  ) and Patriot Coal (NYSE: PCX  ) both released their year-end earnings reports this week, and both reiterated the clear signals transmitted throughout the latter part of 2009 by producers like Peabody Energy (NYSE: BTU  ) and insightful mining equipment manufacturers like Joy Global (Nasdaq: JOYG  ) .

Massey's massive move
Massey Energy revealed 2009 earnings of $104.4 million, easily surpassing a prior year that was dogged by legal snags, but the outlook for met coal is what dominated the discussion. Massey increased projected 2010 met coal output from the prior guidance range of 8-10 million tons to 10-12 million tons, reflecting the impact of a concerted effort to ramp up met coal production from six existing mines. Meanwhile, the company is fast-tracking the construction of the Rowland mine for start-up around mid-2011. With 56 million tons of met coal reserves, the Rowland complex could eventually add another 2 million tons to annual output. Massey CEO Don Blankenship had this to say about the Rowland project:

We are increasingly optimistic about the strength of the metallurgical coal markets around the world. We believe the current and forecasted shortage of metallurgical coal makes this the right time to proceed with the development of this high-quality coal reserve.

Coking confessions from a patriot
Patriot Coal turned in yet another loss for the fourth quarter after missing expected revenue by $20 million. Meanwhile, operating metrics like the 150% increase in 2009 EBITDA over 2008 levels tell the story of a company picking itself up from a frightful fall from pre-crisis heights. Here again, the coking coal market formed the nucleus of Patriot's upbeat outlook, as the company eyes a 20% increase in met coal sales to 6.5 million tons in 2010. Taking note of a met coal market that is "extremely active with an upward trend in pricing," Patriot's CEO lays out an explanation that mirrors this Fool's ongoing analysis:

Asian economies are recovering more rapidly, and are importing met coal at a robust pace. Idled steel mill capacity is being restarted around the globe. European and Brazilian markets are poised to expand further, while U.S. steel markets have stabilized.

Robust indeed: Massey indicates that China's production of crude steel increased 35% in the fourth quarter over prior-year levels. Peabody tallied total Chinese imports in 2009 at 34 million tons -- more than a tenfold increase over 2008 imports. Although the U.S. steel industry remains downright stinky, emerging-market demand has more than absorbed the slack.

The king of coke?
As I have noted before, Peabody Energy appears beautifully positioned to profit from the strengthening price environment for met coal. With about 5 million tons of unpriced Australian met coal production for 2010, and a further 9 million to 10 million tons for 2011, Peabody retains upside through unpriced production (potentially a key determinant of the sector's outperformers). Through an aggressive growth initiative, Peabody Energy is targeting a doubling of Australian coal capacity by 2014, including 12 million to 15 million tons of met coal. Furthermore, the miner owns a major stake in a new coal terminal in New South Wales, which itself is expanding to an export capacity of 60 million tons.

Location, location, location
Fools are reminded to consider geography when selecting their favorites in this race to quench Pan-Asian met coal demand, and in this respect Peabody's Australian operations are far better positioned than its Appalachian competitors.

Appalachian coking coal will still find recovering export demand within the Atlantic basin as traditional supply routes -- like that from Africa to Europe -- are diverted to Asia. If supplies grow thin enough, we might even see these coals shipped through the Panama Canal. Among Appalachian producers, I consider Alpha Natural Resources (NYSE: ANR  ) the most attractive. Despite the major shift into thermal coal production realized through last year's acquisition of Foundation Coal Holdings, Alpha retains some of the sweetest met coal assets in the region. Walter Energy (NYSE: WLT  ) , while representing the only pure play on met coal, appears rather fully valued to this bargain-seeking Fool.

In short, I strongly believe that access to Pacific shipping ports will play an important role in determining the coking coal outperformers over the years to come. This geographical consideration formed part of my rationale for selecting Peabody and resurgent miner Teck Resources (NYSE: TCK  ) for my list of five top coal picks for the next 20 years. I stand by those five picks.

Now that you know my preferred names to profit from met coal mania, please share your selection in our Motley Poll below. If you have something to add, or if your pick is not listed, please use the comment box below.

The "Coal" tag in the Motley Fool CAPS community lists 27 companies. Find out what other investors are saying about the stocks you're watching, or share your Foolish thoughts with us. CAPS is free and fun!

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly in the CAPS community under the user name TMFSinchiruna. He tweets. He owns shares of Peabody Energy. The Motley Fool scrubs its disclosure policy before releasing it into the atmosphere.


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