Should Coal Companies Diversify Into Gas?

The coal industry, especially in the United States, has taken it on the chin over the past year from a devastating combination of factors. Increasing regulatory scrutiny and depressed natural gas prices are the twin headwinds that have served as anchors on growth for many of the major domestic coal producers, including Alpha Natural Resources (NYSE: ANR  ) and Arch Coal (NYSE: ACI  ) .

Moreover, many utility customers are switching from coal to natural gas to provide end users with electricity, which has likely only further rattled the nerves of management teams throughout the coal space. At the same time, a recent major deal within the coal industry sheds light on one company taking significant action away from coal, and it could leave investors wondering whether other coal companies should do the same.

When actions speak louder than words
CONSOL Energy (NYSE: CNX  ) isn't sitting idly by while the domestic coal industry stagnates under the weight of harsh governmental oversight. It's placing its bets on natural gas, and its future now hinges on the success of its new diversified operations. CONSOL announced on Oct. 28 that it would sell five West Virginia coal mines to Murray Energy, the largest privately-held coal producer in the United States, for a grand total of $3.5 billion. Of this, $850 million would be in cash, with $184 million coming in the form of future payments, as well as $2.4 billion of liabilities being acquired by Murray Energy.

It's abundantly clear from this deal that CONSOL management takes a fairly dim view of domestic coal. Indeed, there's evidence to back up this assertion—namely, the fact that coal demand in the United States has dropped 16% in the past five years. And, consider the fact that the five mines CONSOL is selling accounted for roughly half its coal production by tonnage.

Along with the deal, CONSOL stated it would cut its dividend in half, and in all, the company is clearly raising as much cash as it can to expand its presence in natural gas and other gases. CONSOL has now adopted a clear strategy to be at the forefront of gas exploration and production. The company's long-term projections call for 30% gas production growth over the next several years.

Should other companies ditch coal?
There's no denying the awful performance of many major coal stocks in recent years. Alpha Natural's second-quarter results were ugly no matter how you slice it. Alpha Natural reported a second-quarter loss of $185 million, or $0.84 per share. Its margins and volumes collapsed: Alpha's coal margin fell by 59% during the quarter versus the same period one year ago. Not only did the company's average selling price collapse, but the amount of coal it sold dropped as well. Coal volumes sold fell a staggering 19%, and when combined, these factors resulted in a 28% drop in quarterly revenue. Alpha Natural is due to report its third-quarter results in just a few days, and the market isn't expecting these pressures to ease. 

Arch Coal, meanwhile, has written a similar script for investors. Their coal volumes have dropped each year since 2010, and the company booked a $681 million operating loss last year. To be fair, Arch has shown significant progress to begin 2013 as opposed to the same point last year. Investors should take note that the company's net loss through the first half of the year clocked in at $142 million, compared with a $434 million loss through the same period in 2012. That being said, I'm not sure how much enthusiasm should be reserved for a company still registering massive losses.

It's clear that the coal industry, particularly in the United States, is under extreme pressure. Investors are quickly losing patience, and as a result, it wouldn't entirely be a surprise to see further consolidation within the industry. CONSOL's moves away from coal to instead favor exploration and production of natural gas may be just the catalyst needed to propel further changes of direction among the nation's major coal companies.

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