U.S. Coal and the Demand of the Global Supercycle

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American coal producers are scrambling to increase their production volumes. Although stockpiles at domestic utilities remain elevated above historic norms, forecasts for 2011 GDP have been revised downward, and cheap natural gas continues to offer an attractive substitute.

One might normally expect those sorts of factors to constrain bullish sentiment among domestic coal miners -- but quite to the contrary, they convey excitement about their outlooks for earnings growth and sustained strength for coal prices. Arch Coal (NYSE: ACI  ) this week discussed its vision for "a multi-year upswing in the coal market," while reporting ample net earnings of $59.4 million for the first quarter.

So where is the demand behind this strength in the coal market originating? We can see the phenomenon is not unique to any one region of the country, since Arch Coal revealed sequential sales-price increases for the first quarter across all three of the major coal basins in which the miner operates. Neither can we ascribe such strength to the encouraging upswing in U.S. industrial activity that bellwethers Nucor (NYSE: NUE  ) and Steel Dynamics (Nasdaq: STLD  ) revealed within their first-quarter results. As it happens, U.S. railroads to date have hauled only 2.9% more coal by volume in 2011 than they did for the anemic corresponding period of 2010.

The reason why we struggle to pinpoint the source of growing coal demand among the traditional domestic culprits is that the real source of demand growth is neither domestic nor traditional. Exports are now the key driver of strength in U.S. coal markets, which links the outlook for domestic miners to the very same "global supercycle" that international operator Peabody Energy (NYSE: BTU  ) has touted for some time.

While headlines have focused upon efforts by BHP Billiton (NYSE: BHP  ) and other Australian coal miners to grow export capacity in response to demand from China and India, U.S. coals are quietly expanding their reach. Peabody Energy has proposed construction of a new coal terminal in Washington State that could inject up to 48 million tons per year into the Pacific trade (of which Peabody envisions contributing 24 million tons from its mines in the Powder River Basin).

For Appalachian metallurgical coals, even the long voyage to Asia has proven economical for miners like CONSOL Energy (NYSE: CNX  ) , and Patriot Coal (NYSE: PCX  ) intends to increase met coal output to 11 million tons by 2013 in response to export demand. Since global thermal coal supplies remain constrained as well, Patriot will export more than 3 million tons of thermal coal through 2012 (primarily to Europe).

The Foolish bottom line
The bottom line: That is precisely where Fools will find the bullish impact of the global supercycle manifest among the domestic miners of coal through persistently elevated coal prices. Coal prices rose sufficiently during the first quarter to easily offset rising cash costs for Arch Coal, and still yield a very healthy 35% sequential margin expansion. For the company's operations in the Western Bituminous Region, operating margin surged a remarkable 60% sequentially to $6.36 per ton. On the top line, that same pricing strength turned a year-over-year drop in total coal produced into a welcome 23% increase in revenue. Arch credited coal exports as the key ingredient to its successful quarter, recording a 40% increase in export volumes to 1.6 million tons.

For the U.S. coal industry at large, total coal exports during the first quarter reached 26 million tons -- an increase of 47% over the prior-year mark. Arch expects full-year exports of 105 million tons, which is more than twice the export volume from 2006. Although on a volume basis this remains a relatively modest slice of the 1.12 billion tons of coal produced each year in the U.S., the predominance of high-margin metallurgical coals within that mix makes it a very powerful force within the broader market.

When I offered my 5 Top Coal Picks for the Next 20 Years back in 2009, it was precisely the incipient nature of this powerful global supercycle that led me to hone in on those miners that displayed outstanding potential to capitalize upon Pan-Asian coal demand in particular. I stand behind those very same high-quality picks today, and encourage all Fools to consider some investment exposure to this powerful secular bull market for coal.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Peabody Energy and Teck Resources. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool scrubs its disclosure policy before releasing it into the environment.

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