The Utility Industry Could Be in for a Double Whammy

CONSOL Energy's new CEO likes the prospects of both its businesses -- that could be bad news for utilities.

May 13, 2014 at 9:44AM

CONSOL Energy (NYSE:CNX) recently introduced new CEO Nicholas DeIuliis. He was, of course, asked about his view for CONSOL's future during the first-quarter conference call. With limited supplies of coal and natural gas, it's no surprise DeIuliis sees good things ahead, and that's bad for utilities.

The big change
CONSOL turned in a solid first quarter, earning $0.50 a share compared to essentially break-even results in the prior-year period. That's a great start for a company that completed the transformational sale of half its coal business in December. That $3.5 billion, five-mine deal changed CONSOL from a coal miner expanding into natural gas into a gas driller with some solid coal assets.

That's very different from a company trying to get out of coal. CONSOL sold its most expensive and least efficient coal mines; it kept "the good ones." In fact, the company just started operating a new mine, which allowed it to increase coal production by nearly 10% year over year at the mines it retained.

Ten

Source: Evelyn Simak, via Wikimedia Commons.

Natural gas, meanwhile, saw a production increase of 23%. Better yet, CONSOL's "Gas price realizations increased, year over year, to $5.37 per Mcf from $4.21 per Mcf." And that's an important trend, because it's a key part of CEO DeIuliis' positive outlook for the future.

What's the future look like?
Low natural gas prices were pushing utilities to use gas over coal in 2012. However, gas prices have been rising, and the trend has reversed. Only utilities burned coal from their inventories instead of buying it from miners.

But after a cold winter, there are some problems brewing. CONSOL CFO David Khani explained during the call, "Right now, we have these very low inventories in the gas markets and the coal markets... And we don't see any quick fix to rebuilding the coal or gas inventories."

Ironically, Khani notes that, "The gas markets are looking to coal generation to bail them out. And the coal markets, frankly, need gas generation to help bail it out to get its inventories built back up again." In other words, suppliers win. No wonder CEO DeIuliis, who runs a company that supplies both coal and natural gas, described CONSOL as, "best in class" and owning assets that have, "vitally strategic positioning relative to the growing markets and demand centers."

Gas

Source: George Shuklin, via Wikimedia Commons.

The proof of the problem
And that is why the future could hold bad news for utilities. A good example is Southern Company (NYSE:SO). Although the company is in the process of building new power plants (coal and nuclear), it has been shifting toward natural gas in recent years. In fact, during the company's fourth-quarter conference call, CEO Thomas Fanning described Southern as, "the second or third largest gas consumer in the United States."

In the first quarter, 45% of Southern's generation was coal based, 35% was gas. That was almost a complete reversal from a year earlier. The reason? Southern used its diversified generation footprint to switch to the most cost-effective fuel. But, if CONSOL's outlook is even close to correct, Southern's choice over the next year or two may be between the cheaper of two increasingly expensive fuels.

That, too, is the exact opposite of what's been happening since natural gas and coal have both been trading at depressed levels in recent years. Southern is hardly alone in this problem. Look for fuel costs to be an increasingly important, and perhaps negative, factor for utilities.

The way to play it
If you're looking for a way to play the problems that utilities like Southern Company appear set to confront, CONSOL Energy is a great choice. It's leaner and meaner on the coal side and continuing to expand its gas footprint. That's going to allow it to benefit as key utility customers look to get their businesses back to normal on the fuel supply side -- no matter the cost.

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Reuben Brewer 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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