This Could Be the Best Thing to Happen to Coal Companies in Years

Rumors that China will start to impose import bans on certain coal types could bring relief to the much beleaguered coal industry.

May 6, 2014 at 1:30PM

Basically any recent news related to American coal has been roughly equivalent to getting round-house kicked in the face by Chuck Norris. The slow decline in metallurgical coal prices, the increasing scrutiny on coal-fired power plant emissions, and clean coal looking more costly than burning $100 bills for power has made major coal producers Peabody Energy (NYSE:BTU), Arch Coal (NYSE:ACI), and Alpha Natural Resources (NYSE:ANR) assume a financial fetal position and keep spending to an absolute bare minimum to weather the storm. 

Coal Operations

Source: Peabody Energy Investor Relations.

There is a recent development that could have a profound impact on the coal market, but this time, it's actually good for a change. Let's take a look at what it is and how it could potentially impact these new players. 

The changing coal climate in China
China isn't completely oblivious of the impact its coal reliance has on the country, but it is awfully difficult for the country to completely pivot away from coal without taking some huge economic hits. One way to help change that, though, is to change the type of coal it uses. Coal is classified based on both its moisture content and its calorific value -- basically how much energy you can get from a fixed weight, measured in Calories per kg. Coals with lower calorific values are considered low-quality coals and generally produce high levels of ash as well as other pollutants, such as sulfur.

According to a recent article from Platts, the Chinese parliament is working on rules that wold ban the import of low-quality coal that has a calorific value of less than 3,900 Calories per kg and a sulfur content greater than 2%. This would mean the country would need to find a new source of coal to replace the 57 million tons of coal it consumed in 2013 that did not meet these standards. Just about all of the coal that did not meet this threshold was imported from Indonesia, and it represents about 34% of all coal imported to China.

China is trying to wean its way off of coal through increased production of domestic natural gas as well as major investments in nuclear power facilities, but it would be next to impossible to replace 60 million tons of coal consumption in a matter of months. So, it is highly likely China will need to rely more heavily on other sources of coal.

Chinese consumption could cover America's weakening coal market
Domestic coal has been on a steady decline for quite some time. Between 2007 and 2013, total U.S. coal consumption has declined by nearly 18%. With the rise of cheap domestic natural gas and the increased efficiency of alternative energy, it will be extremely challenging for coal to gain any of this ground back. It also doesn't help that between 2012 and 2013, total coal exports declined by 6.4%. Both of these two issues have led to near unprofitable level prices for coal. During this past quarter, all three of the companies mentioned above saw coal prices just barely outpace cash costs, and both Arch and Peabody had negative operating margins on coal from their most prolific mines in the Powder River Basin.

If China were to move away from low-quality coals, U.S.-based coals could stand to benefit immensely. U.S. coal meets the requirements for improved coal quality, and with over 200 million tons of coal capacity not used in the United States, it is capable of handling a major uptick in demand.

Of all the coal producing regions, companies with large operations in the Powder River Basin would likely be the candidates to benefit the most from increased Chinese coal demand. Not only does it have a low sulfur content that would be attractive to Chinese customers, but it is also closest to West Coast ports and would likely be the cheapest to export. This would obviously play well to Peabody, Arch, and Cloud Peak Resources (NYSE:CLD) since they are the three largest producers of coal in this part of the country. The one hitch to this plan is that there has been strong resistance to constructing coal export facilities on the West Coast, which would be required to move Powder River Basin coal -- or any other coal for that matter -- to China. 

Indirectly, though, increased demand could help boost prices for thermal coal in the U.S., which would be a positive for just about every company in the U.S. coal business. 

What a Fool believes
Unfortunately, these coal companies can't bank on this development yet because this Chinese regulation has not been put in place, and even if it does, it will take some time for the physical infrastructure to export the additional coal to actually get built. Also, U.S. coal producers will be compete with other coal producing nations such as Australia to fill that Indonesian-sized hole in China's coal demand.

Still, any good news for coal companies will be well received by these companies. With most companies tied to fixed pricing contracts for almost all of their production for 2014 and a large part of 2015, it will likely still be some time before Peabody, Arch, or Alpha dig their way out of their financial woes, but if coal can start making its way onto Chinese-bound ships, it could be the shot in the arm the industry needs. 

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Tyler Crowe has no position in any stocks mentioned.  You can follow him at Fool.com under the handle TMFDirtyBird, on Google+, or on Twitter @TylerCroweFool.

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