It's Quite Possible that Coal Will Recover in 2014

Soaring natural gas prices, increasing economic activity, and dwindling domestic supply are a trio of reasons for why coal may make a major comeback this year.

Mar 7, 2014 at 9:40AM

It's no secret that coal is under attack in the United States. Increasing public and regulatory scrutiny of the environmental impacts of coal, along with the abundance of available domestic natural gas, has dealt coal some serious body blows. Utilities, which have historically been major end users of coal, are switching their generation mix toward natural gas.

This resulted in a severe drop in profitability for coal companies across the sector, including Peabody Energy (NYSE:BTU) and Arch Coal (NYSE:ACI). With all this in mind, you're likely tempted into believing that coal is on the brink of extinction. However, the truth is that coal still has a large role to play in the United States, and isn't going anywhere anytime soon.

Rumors of coal's demise are exaggerated
It's absolutely true that major coal producers took it on the chin last year. Companies like Peabody Energy and Arch Coal saw their earnings fall sharply, as less demand resulted in collapsing margins and profits. For example, Peabody's earnings before interest, taxes, depreciation, and amortization (EBITDA) fell by almost half last year. Poor pricing was a major contributor behind Peabody's EBITDA getting slashed by $800 million in 2013.

However, it's a mistake to think that coal is on its way out. Major industrial users, including utilities, still very much count on coal. For all the talk about natural gas making coal obsolete, that largely didn't pan out in 2013. Utility giant Southern Company (NYSE:SO) produced 42% of its energy from gas last year, along with 38% from coal. This actually represented a boost in coal usage from the previous year. Southern Company generated 45% of its energy from gas and 36% from coal in 2012.

And, going forward, Southern Company is making coal an even bigger part of its future. It's in the process of building a huge coal-fired power plant called the Kemper facility in Georgia.

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The plant utilizes a new technology that burns coal at a much more efficient rate than previous gasification techniques. The end result is a much greater level of power production at a lower cost, with fewer adverse environmental impacts than existing coal burning methods.

Why 2014 won't be the end of coal
Utilities such as Southern Company continue to make use of coal. And, the coal industry more broadly may see some near-term recovery as well. That's because natural gas may soon become too costly for utilities. Coal did see reduced usage last year as a result of cheap natural gas. But, the economics of natural gas are changing as demand heats up. Natural gas prices have soared recently, which may compel utilities to switch back to coal in the near future.

According to Arch Coal internal estimates, coal consumption for power generation in the United States rose by 35 million tons last year. Meanwhile, coal production clocked in at 984 million tons, representing the first year since 1993 that supply fell below the 1-billion ton mark.

As a result, the outlook for coal producers themselves isn't terrible. This is why Arch Coal takes a cautiously optimistic view of the upcoming year. Arch Coal saw notable progress in thermal coal as 2013 drew to a close. Going forward, the company sees thermal coal markets gaining momentum.

Don't bet on the death of coal
Coal is by no means thriving. It's true that an abundant supply of cheap natural gas prompted utilities to switch from coal to natural gas last year. And, continued building of coal-fired power plants seems unlikely, with rising political scrutiny of coal.

At the same time, the reality is that coal is very much a part of U.S. power generation. Going forward, coal's standing may actually strengthen now that natural gas prices have soared. Restricted supply along with favorable weather trends, increasing economic activity, and rising natural gas prices mean coal could see some serious tailwinds in the year ahead. As a result, investors should be careful not to get overly bearish on coal in 2014.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool recommends Southern Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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