5 Ways to Hedge Your Coal Bets with Gas

Although solar and wind based power make the big headlines, the real shift taking place today is natural gas encroaching on coal's territory in the U.S. power grid. That's a long-term trend that isn't going to change, even though coal is a long way from extinction. Still, it makes sense to put yourself in a position to benefit from a coal rebound and a natural gas future.

Going all in
Perhaps the most obvious way to gain natural gas exposure is to buy a natural gas driller. On that score, Ultra Petroleum (NASDAQOTH: UPLMQ  ) is a solid option. The company owns land in Wyoming and Pennsylvania that it believes can support over 4,000 additional wells.

The real opportunity here, however, is cost structure. With drilling costs in the $3 per million cubic feet range, Ultra is among the lowest cost drillers in the industry. Although natural gas prices remain near historic lows, the company was able to turn in an impressive second quarter, with earnings of $0.76 a share, up from a loss of $7.76.

That comparison, however, is more than a little unfair. Because of the historically low price of natural gas, Ultra was forced to write down the value of its reserves by nearly $3 billion last year. With gas prices up from their 2012 lows, there's little reason to expect any more writedowns and any further price increases will only help the company's performance.

In fact, management sounded pretty upbeat when it discussed second quarter earnings: "Domestic production has stopped growing and is essentially flat since last July. Backlogs of uncompleted, unconnected wells are being worked off in every play, and production in most basins is declining..." Essentially, the supply glut that led to historically low gas prices looks like it's easing. That's good news for the whole industry.

Another interesting option is Chesapeake Energy (NYSE: CHK  ) , the second cheapest driller according to Ultra. The company appears to be doing a good job of shifting from a land acquisition strategy to drilling its own properties. That's a move that was precipitated by some very public bad press involving hedge fund manager Carl Icahn and the exodus of the company's co-founder.

Still loaded with debt, the company has been selling assets and refocusing around drilling. To that end, it has sold nearly $3.5 billion in assets so far this year and still has material operations in key energy plays from Texas to Pennsylvania. It reported second quarter earnings, adjusted for one-time items like asset sales, of $0.51 a share, up from just $0.06 last year.

Although the shares are up over 60% so far this year, the company is a well-positioned and low-cost driller that looks like it's successfully executing its corporate overhaul.

Mixing it up
Getting involved in a pure play gas company, however, doesn't result in any coal exposure. Instead of buying a pure play gas company and a coal player, CONSOL Energy (NYSE: CNX  ) is a way to get exposure to both at once because it owns coal mines and an oil and gas drilling business. As one might expect, the drilling side of the company has been expanding rapidly, but coal has been a drag.

Management has been looking at its alternatives, including everything from selling non-core assets to the rumor of a potential break up. For now, however, CONSOL provides exposure to both coal and gas, allowing you to benefit no matter which side of the business does well. And, depending on the outcome of its business review, CONSOL could turn into a special situation where corporate actions quickly boost shareholder value.

Rhino Resource Partners (NASDAQOTH: RHNO  ) is another coal miner moving into the gas space, however it isn't nearly as far along as CONSOL. In fact, when the partnership released second quarter results in early August it only had 15 wells—CONSOL, for comparison, expects to drill ten times that number of wells in 2013 alone.

However, working from such a small base means that every new well has an outsize impact on Rhino's results. For example, Rhino's gas revenues grew almost 300% between the first and second quarters. Coal is still the driving force at Rhino, but its natural gas efforts should increasingly add to the top and bottom lines.

Natural Resource Partners (NYSE: NRP  ) is another coal miner getting into natural gas, only with a bit of a twist. Unlike Rhino and CONSOL, which both own and operate the bulk of their properties, Natural Resource Partners leases all of its properties out to others, preferring to collect royalties.

It's also pretty diversified, owning natural resources from coal to frac sand, limestone, slate, and silica. Its most recent purchase was a share in a soda ash plant. Oil and gas drilling represents around 3% of the business. So, like Rhino, there's plenty of growth potential for its gas push. However, it won't likely have as big an impact on a company that already generates around 30% of revenues from non-coal royalty operations.

Playing both sides
If you already own coal companies, adding low cost drillers like Ultra and Chesapeake would be a good way to get natural gas exposure. However, CONSOL, Rhino, and Natural Resource Partners are a way to get coal and gas at once, with CONSOL providing the most gas exposure of the trio.

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