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While coal stocks like Alpha Natural Resources (NASDAQOTH: ANRZQ ) , Peabody Energy (NYSE: BTU ) , and Arch Coal (NASDAQOTH: ACIIQ ) are each up nearly 12% in the past three months, all three are sitting on significant year-to-date declines; ANR is down nearly 58% this year. Against a backdrop of economic uncertainty and the fiscal cliff, you would expect all commodity prices to be soaring, but this has not been the case. The global macroeconomic pressures on coal have been more significant than those in many other areas, leaving this highly volatile market with heavy losses. Still, the fiscal cliff is likely to have an impact on all U.S. operations and understanding this impact can give us an edge looking ahead to 2013.
The fiscal cliff
The "fiscal cliff" is the name given to various scheduled tax increases and spending reductions that are scheduled to be initiated in 2013; while they can be avoided if an agreement can be reached in Congress, negotiations thus far have been futile. The Congressional Budget Office predicts that in the absence of a resolution, it will cause a deep recession and cost Americans as many as 2 million jobs. The most critical areas likely to be influenced are the pending debt ceiling, the cancelling of various tax relief measures, and the onset of sequestration cuts.
In early January, various tax relief measures will end. Included in the list of those affected are the so-called Bush tax cuts, the payroll tax holiday, and extended unemployment benefits. Sequestration refers to pre-arranged spending cuts that were agreed to as a self-imposed threat by Congress if it couldn't find bipartisan support for some needed budget reductions; to everyone's great surprise, no agreement was reached and the cuts are poised to take effect.
Overriding all of this is the looming debt ceiling that is about to be hit in the next few days. In a recent letter to Congress, Treasury Secretary Geithner wrote: "I am writing to inform you that the statutory debt limit will be reached on December 31, 2012, and to notify you that the Treasury Department will shortly begin taking certain extraordinary measures authorized by law to temporarily postpone the date that the United States would otherwise default on its legal obligations."
Other factors driving coal
One of the single largest factors that has influenced the price of coal recently has been the cost of natural gas. The two commodities are substitute goods, specifically when burned for the production of electricity. Gas prices have remained very low as a result of the explosion of readily available shale gas, which has led to the closing of many coal-burning power plants in the United States. This has driven industry insiders to consider the potential impact of export for both commodities, as both command higher prices in non-U.S. markets than domestically. In a recent article, fellow Fool Arjun Sreekumar examines the impact of increased U.S. export on the economic welfare of multiple economies.
Citing a comprehensive study by NERA Economic Consulting, Sreekumar concludes "that gas exports could increase the price of U.S. natural gas by between $0.22 and $1.11 per thousand cubic feet, depending on variables like the intensity of demand from U.S. manufacturers and the number of export terminals that are constructed." Under this scenario, not only do the coal companies I've mentioned benefit, but so do natural gas producers such as Chesapeake Energy (NYSE: CHK ) and Devon Energy (NYSE: DVN ) . The general impact will be to let prices find a global equilibrium, bringing U.S. prices more in line with those abroad. This would benefit U.S. energy concerns but be offset by placing additional pressure on U.S. operations that are heavily energy dependent, including the manufacturing sector.
So what about the fiscal cliff?
While so many pressures impacting coal prices are related to international supply and demand, the impact of going over the fiscal cliff should not be overlooked. The position of the U.S. economy has a deep impact on all world markets, so stability at home drives stability abroad. If the Congress finds another "kick the can down the road" solution, there is the real possibility that U.S. credit will be hurt and that our perception among our trading partners will weaken. These factors play out not only in the fixed income market, but in the currency market as well.
A weak dollar, a potential impact if the fiscal cliff isn't resolved, will have a bearish impact on the price of U.S. exports, but a bullish impact on the overall price of commodities. At this point, it remains unclear which driver will be more significant, as export options remain extremely limited in both coal and natural gas. Overall, the most likely impact is short-term weakness followed by medium-term strengthening in both markets, particularly if U.S. energy policies adjust to meeting changing global realities. As such, I would probably take a wait-and-see approach on coal but be prepared to buy on weakness.
The coal industry in the United States has been in a state of flux since the arrival of a cheaper alternative for energy production: natural gas. Exports are becoming a much bigger part of the domestic coal landscape, and Peabody Energy has deals in place to get its cheaper coal from the Powder River and Illinois basins to India, China and the EU. For investors looking to capitalize on a rebound in the U.S. coal market, The Motley Fool has authored a special new premium report detailing exactly why Peabody Energy is perhaps most worthy of your consideration. Don't miss out on this invaluable resource -- simply click here now to claim your copy today.