Even If Coal Has Bottomed, Will It Ever Recover?

With MATS set to take effect in 2015, many companies are retiring coal-fired plants at an increasing rate.

May 12, 2014 at 4:01PM

Over the last few weeks, I've heard pundits and bloggers alike pontificate about the coal sector reaching a bottom. Indeed, the massive sell-off makes current valuations look attractive, but we invest based on future prospects, not what's happening now. So let's take a look at why coal will continue to have a very rough time over the coming years and if you should invest in this sector.

With the Mercury and Air Toxics Standards (MATS) set to take effect in April 2015, many companies are retiring coal-fired plants at an increasing rate. Currently 300,000 MW are generated from coal in the U.S. The EIA's revised estimate, released in February 2014, is now projecting retirements that represent approximately 20% of total capacity or 60,000 MW. This is up from 40,000 MW. This will permanently change the face of energy in the U.S.

In addition to the numerous retirements, new coal-fired power plant construction is practically nonexistent. 2013 saw the addition of only two new coal fired power plants to the U.S. energy grid, and both were delayed projects that were originally scheduled to be completed during 2011 and 2012.

A majority of coal produced in the U.S. goes toward electricity generation, making this a key sector to most coal producers.

Coal Quarterly

Coal producers are often tracked through the Market Vectors Coal ETF (NYSEMKT:KOL), which has seen increasing pressure lately. Let's face it, domestic producers of coal are losing one-fifth of their U.S. customer base. With that decreasing demand comes lower prices. Those low prices are resulting in significant losses for many coal producers.

This will take its toll on smaller domestic producers like Arch Coal (NYSE:ACI), which has been struggling with profitability lately. Arch's metallurgical coal platform is expanding, but a vast majority of Arch's coal goes to producers of electric power in 37 of the 48 continental U.S. states. Arch Coal recently reported a $0.60 loss for the first quarter and management appears to be lacking any original ideas on how to turn this trend around.

John W. Eaves, Arch's President and CEO, stated, "at Arch, we are taking proactive steps to manage our controllable costs and capital spending, reduce our cash outflows and preserve our liquidity. Moreover, we are reducing our expected metallurgical coal sales volume by approximately 1 million tons for 2014."

Kind of sounds a bit like business hibernation with the hope that things will someday improve. Analysts are looking for Arch Coal's declining EPS trend to continue in fiscal 2014, down 68% to a loss of $1.82, so that improvement isn't showing up anytime soon.

Established producers like Peabody Energy (NYSE:BTU) that benefit from diverse global operations aren't immune, either. Of the 251.7 million tons of coal the company produced in 2013, approximately 95% was thermal coal.

Peabody posted an adjusted loss of  $0.19 per share in the first quarter of 2014. Cost-cutting measures and higher sales volume following an unusually cold winter provided a buffer against lower realized pricing per ton. Australia saw a 17% decline in revenue per ton, while the U.S. experienced a 7% decline respectively.

The saving grace for Peabody will be significant holdings in the sub-bituminous low sulfur coal deposits in Wyoming and Montana (which is environmentally preferable) and access to the Asian markets. Peabody Energy Chairman and CEO Gregory H. Boyce acknowledged "Peabody's position in the low-cost U.S. basins and high-growth Asian markets allows us to navigate current market pressures and benefit from long-term demand trends."

While the company's long-term game plan is sound, until these "current market pressures" abate, it would be prudent to watch from the sidelines before jumping into the coal game.

The payoff
The future of coal doesn't look too good. Power plants are the main consumers of coal, but they are seeing significant retirements. Worse, there are not enough new coal-fired plants coming online to make up the difference. There currently doesn't appear to be a macroeconomic catalyst on the horizon that will provide support for the coal industry. Instead, it looks as though environmental policy, burgeoning natural gas production, and tepid international demand are all conspiring to further this commodity's decline. It would be wise to avoid calling a bottom in a sector with so many looming factors.

So how should investors play American energy?
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James Catlin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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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