Coal is one of the most plentiful and least expensive sources of energy on Earth. That's the good news. The bad news is that it's dirty compared to other fuel options like increasingly popular natural gas and renewables. Utilities, however, also consider price when making fuel choices, so the cleanest fuels don't always win the day.
This is why coal use was up about 5% in June, year over year, and natural gas use was down around 16%, according to The Energy Information Administration (EIA). As Cloud Peak Energy (NYSE: CLD ) noted in its second quarter earnings release, "...natural gas prices have remained at a level where most plants consuming PRB coal are economically able to dispatch coal."
To provide a comparison, the EIA notes that it cost utilities about $3.93 per million Btu (mmBtu) to burn Henry Hub natural gas in June. Coal giant Peabody Energy (NASDAQOTH: BTUUQ ) estimates that PRB coal is competitive with gas priced in the $2.50 to $2.75 per mmBtu range. ILB coal can compete with natural gas in the slightly higher $3.25 to $3.50 per mmBtu range. With natural gas in the $3.60 area, both PRB and ILB coal are competitive today.
Peabody Energy has notable exposure to both regions, but Australian operations account for nearly half of its revenues. So, Peabody is a great diversified coal miner, but it doesn't allow you to hone in on the two "sweet spots" in U.S. thermal coal. For that, you need to look at Cloud Peak or Alliance Resource Partners (NASDAQ: ARLP ) .
Focused on cheap coal
Cloud Peak is focused almost exclusively on the PRB area. That puts the company in prime position to benefit. That said, utilities have been burning their coal stockpiles instead of ordering new coal, so Cloud Peak is expecting coal volumes to be flat year over year in 2013. Add in lower coal prices, and this year is destined to be a difficult one even if demand picks up from here. Next year, though, should see much easier earnings comparisons as the coal market stabilizes.
An industry leader
The ILB, meanwhile, accounted for over 80% of the coal that Alliance Resource Partners mined in 2012, making it a focused investment on that region. Interestingly, however, while other coal miners have been cutting back production and shutting mines, Alliance has been increasing production. For example, in the first half the partnership sold about 19.5 million tons of coal compared to 16.5 million in the first six months of 2012.
That increase allowed the company to post record sales despite the year over year drop in coal prices. Management noted in the second quarter earnings release that, "The strong performance of our Illinois Basin operations through the first half of 2013 is expected to continue over the balance of the year." So, 2013 should be a record year for the company.
While other coal miners have struggled, Alliance has been a star performer. Although this limits capital appreciation potential, since the units have rebounded from their lows, you still might find the around 5.9% yield, regular distribution hikes, and at least modest capital appreciation potential appealing.
How about both?
Another name to consider is Arch Coal (NASDAQOTH: ACIIQ ) . Over 60% of Arch's reserves are located in the PRB, making it the number two player in the region. Another 13% of its reserves are in the ILB. That puts the miner is good position to benefit as utilities switch to replenishing their stockpiles.
And the early signs of a turnaround are taking shape at Arch. It sold nearly 25% more tons of coal in the second quarter of 2013 than it did in the second quarter of 2012. That said, an 8% price drop per ton is a big hurdle to overcome since operating mines is an expensive proposition. While 2013 should be a tough year, 2014 could see this PRB and ILB player's performance and stock price get back on track.
Watching for the turn
Additional evidence of a turn comes from rail company CSX (NASDAQ: CSX ) , whose operations touch the ILB region. It saw a 3% increase in domestic coal shipments in the second quarter. The company believes overall coal volumes will drop by a third this year, so a 3% uptick isn't much, but it does hint at the beginning of a turnaround for domestic miners, particularly those with operations in the PRB and ILB.
That will be good news for Cloud Peak, Arch, and Alliance. It also means that CSX could start to see notably improved domestic coal volumes next year. That would be a big boost to the company's results since coal accounts for nearly 15% of its shipping volume.
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