The Outlook for Coal Investors Continues to Deteriorate

At the end of last year, I wrote about the coal market and the supply/demand issues that the industry was currently trying to cope with. Unfortunately, it does not look as if investors who have money in the coal industry, in particular, shareholders of Cliffs Natural Resources (NYSE: CLF  ) , Arch Coal (NYSE: ACI  ) , and Peabody Energy (NYSE: BTU  ) , are likely to catch a break anytime soon.

In particular, according to comments from Moody's Investors Service, earnings within the United States' coal industry are expected to decline modestly throughout 2014 as a number of lucrative contracts expire and metallurgical coal prices remain low. What's more, sluggish global steel activity continues to weigh on demand and new mines are coming online within Australia, further adding to the supply/demand glut.

Multiple pressures
Furthermore, it would appear that these pressures are not just limited to the metallurgical coal market. The price of coking coal is also set to fall further according to the Australian Financial Review. The publication comments that although steel output has expanded within China over the past few months, dragging the price of iron ore higher, thanks to low restocking, the same cannot be said for coal as stockpiles of the resource within China have remained high.

Cutting expansive projects
Still, it would appear that there could be some relief for the industry around the corner. In particular, according to The Guardian newspaper, research from University of Oxford commissioned by HSBC's Climate Change Centre of Excellence found that a number of world-class mines in both output and size are at risk of becoming financially unviable due to declining coal prices. Putting the brakes on mining developments would certainly go some way to alleviate oversupply within the coal market. However, a number of measures in China aimed at getting its pollution problem under control are likely to further reduce demand for the mineral..

Investors need to pay attention
With these pressures overhanging the coal market, investors really need to keep an eye on both the price of coal and production costs of miners. Luckily, Peabody, Cliffs Natural Resources, and Arch Coal all provide detailed production cost breakdowns within their quarterly reports, allowing investors to make informed decisions.

Crunching numbers
Peabody, the world's largest private-sector coal company, sold 124.4 tons of coal from its mining operations during the first nine months of this year. However, the company reported that it sold the coal mined from its mines within the United States for a figure of $17.80 per ton, while Peabody's operating cost per ton for this production was $12.85 for the same period. These are operating costs and exclude other items such as taxation and interest costs, which are likely to push all-in production costs higher.

Cliffs is in a better position as coal is only expected to amount to 16% of the company's output during fiscal 2013.

Cliffs is forecasting a revenue per ton figure of $100-$105 and a production cost per ton of $85 to $90 -- both figures are higher than those of Peabody. What's more, Cliffs has its highly lucrative iron ore operations to carry the torch while coal margins decline. Indeed, it is cheaper for Cliffs to mine one ton of iron ore for $65-$70 per ton within the U.S. than it is for the company to mine coal. Currently, the price of iron ore is trading above $125 per ton, so margins are significantly more appealing.

Surprisingly, one of the key takeaway points from both Peabody and Cliffs is the fact that their U.S.-based coal operations are not that profitable and margins are thin. Actually, were it not for the international operations of Peabody and iron ore mining operations of Cliffs both companies would be struggling to turn a profit.

Expensive U.S. coal
Unfortunately, Arch Coal is really suffering from declining coal prices. For example, during the fiscal third quarter the company reported a cash cost per ton of $16.51; if we add in other operating costs such as depletion and depreciation, the cash cost per ton rises to $19.37. This appears fine until we discover that the company's average sales price per ton for the period was only $19.54, leaving an operating margin of $0.17.

As a result, including other costs but excluding exceptional items, Arch has made a loss of $35 million on average for the last three quarters.

Foolish summary
So all in all, the coal market's outlook is not pretty and things could be about to get worse. As the market changes, investors really need to keep an eye on their investments in the coal industry, and companies like Cliffs with diversification outside of the coal industry look to be in the best position to avoid the pain.

The big picture
The decline of coal as a method of energy generation is in part down to the record oil and natural gas production, revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, the Motley Fool is offering a comprehensive look at three energy companies set to soar during this transformation in the energy industry. To find out which three companies are spreading their wings, check out the special free report, "3 Stocks for the American Energy Bonanza." Don't miss out on this timely opportunity; click hereto access your report -- it's absolutely free.


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  • Report this Comment On January 15, 2014, at 3:24 PM, Peter405 wrote:

    Please do not lump ACI with Cliff.

    ACI is up nicely today, pays a dividend and is selling at almost40% of book value.

  • Report this Comment On January 16, 2014, at 9:45 AM, Peter405 wrote:

    Really? You must drive looking in the real view mirror ! I am long ACI . UNG is about to break its Golden Cross; if that happens the inflection point for utilities to switch back ( OB or NoB ) faster from Gas back to Coal for Thermal generation.

    ACI is best positioned in the US ( with ANR too dependent on Met Coal and China)

  • Report this Comment On January 16, 2014, at 11:23 AM, johnydowrong wrote:

    How is Cliff considered a coal mining company you do understand Coal only accounts for 11% of the companies production its primary production is iron ore used to make steel. So coal going down makes a very small impact to cliff who only uses it to create iron ore. Thanks Genius do some research in the future.

  • Report this Comment On January 17, 2014, at 7:57 AM, RupertHargreav wrote:

    johnydowrong: How about you read the whole article next time?

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