Why Investors Should Be Encouraged By the Outlook for Coal

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The past few years have seen a severe deterioration of the coal industry, as it nearly drowned under the weight of several overhanging factors. First, more restrictive environmental protection standards have made it very difficult to build new coal-fired plants in the United States. In addition, booming natural gas production has served to undercut coal.

As demand for natural gas rises in the United States, the price of natural gas is starting to increase in tandem. This may finally ease the pain for coal producers, whose end-users are now incentivized to once again return to coal. That's why, at least in the short term, coal is likely to see a rebound.

Evidence that coal's decline is leveling off
Fortunately for coal companies, there's already evidence suggesting a slight recovery in coal. In fact, the U.S. Energy Information Administration expects coal production to increase by 3.6% in 2014, following a 9% production decline from 2011 to 2013, and cites higher natural gas prices as the primary reason.

While shipment volumes to industrial end-users remain in decline, the nation's railroads are beginning to see some signs of stabilization in the coal market. For example, even though its coal volumes remain challenged, Union Pacific (NYSE: UNP  ) grew its coal freight revenues by 2% in both the most recent quarter as well as through the first nine months of the year. The fact that railroads like Union Pacific are seeing coal revenues increase signals at least some measurable improvement.

Will utilities return to coal?
As previously stated, it's extremely difficult for utilities to build new coal-firing plants, due to increasing regulatory scrutiny. However, some utilities, including Southern Company (NYSE: SO  ) , are devoting billions to research new coal-processing technologies that may result in a promising future for coal after all.

Southern Company considers its Kemper facility to be the future of coal. It employs a revolutionary technology that utilizes lignite coal, which converts to gas at a much lower cost than traditional gasification techniques. It's a much more environmentally friendly process as well, and the facility is expected to become operational by the end of the year.

A spectacular coal MLP to capitalize on the recovery
Alliance Resource Partners (NASDAQ: ARLP  ) stands atop the list of coal companies in the United States, thanks to its extremely advantageous cost structure. It produces primarily Illinois Basin and Northern Appalachian coal, which are low-cost sources that compete very well with natural gas on pricing.

This is what has allowed Alliance Resource Partners to keep increasing coal production, and profits, even during the difficult environment afflicting the entire industry. This is illustrated by the fact that the company has realized 12 consecutive years of record results in terms of tons produced and sold.

Alliance Resource Partners is the first and largest master limited partnership that engages in the production and marketing of coal. As an MLP, it's required to transfer the bulk of its cash flow through to investors as a distribution. Amazingly, Alliance Resource has raised its distribution for 22 quarters in a row, and yields 6% at its recent unit price.

If natural gas prices keep rallying, coal should be a winner
As it's often been reported, the United States is sitting on an ocean of natural gas supply that is now commercially viable thanks to new, advanced drilling techniques. Depressed prices in recent years have only accelerated natural gas' momentum. Of course, once demand catches up, the price of natural gas is likely to catch up. This should actually work in coal's favor, and is already happening as natural gas prices have risen steadily in recent months.

If natural prices keep going up, utilities will once again consider returning to coal. And, since utilities like Southern Company are developing cleaner-burning coal technologies, the future for coal may be bright after all.

Position yourself for higher natural gas prices
Record oil and natural gas production is 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 here to access your report -- it's absolutely free. 


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Bob Ciura

Bob Ciura, MBA, has written for The Motley Fool since 2012. I focus on energy, consumer goods, and technology. I look for growth at a reasonable price, with a particular fondness for market-beating dividend yields.

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