Party On, King Coal

Over the past year, the prices of coal company stocks have surged. Industry leader Peabody Energy (NYSE: BTU  ) has nearly doubled, while Arch Coal (NYSE: ACI  ) , Consol Energy (NYSE: CNX  ) , and Alliance Resource Partners (Nasdaq: ARLP  ) have enjoyed nearly as spectacular a run. There have been two successful IPOs -- International Coal and Foundation Coal (NYSE: FCL  ) . Related concerns such as mining equipment manufacturer Joy Global (Nasdaq: JOYG  ) and Headwaters (Nasdaq: HDWR  ) , a company that turns coal-mining waste into burnable fuel, have also done well.

Coal companies became diamonds in the rough in 2004 because of increasing demand from electric utilities, compounded by forecasts of an impending shortage of natural gas that's expected to put coal in even greater demand. But after a year of such heady stock gains, surely the party's over for old King Coal. Right?

Wrong. Indeed, for some, the party looks to be just getting started.

Street's next catchphrase
Ever heard the phrase "minable coal"? Wall Street loves catchphrases, and I suspect that by year's end, that phrase will be bandied about on Wall Street as shorthand for why coal companies continued to rise in 2005, some by as much as another 50% to 100%.

Minable coal refers to the amount of coal in the ground that is technologically and economically recoverable. While conventional wisdom says that North America still has a 150- to 250-year supply of coal -- making it the so-called Saudi Arabia of coal -- experts say the amount of minable coal is actually a lot less -- perhaps only 50 to 60 years' worth.

America's minable coal reserves are limited in part by the fact that, especially in Appalachia, the remaining coal seams are getting thinner and deeper, making extraction increasingly difficult. Specifically, these thinner, deeper seams can't easily use the giant extraction machines, called longwalls, that have been responsible for rising productivity in underground mines.

Beyond reach
A second major limiting factor is environmental regulations, especially restrictions on disturbing the land, which have effectively put some reserves off-limits. Although the federal government and some state governments are expected this year to impose even harsher regulations on the burning of coal, utilities remain committed to coal for the long term. Given the number of new coal-fired power plants that are expected to be built, America will be consuming coal at a faster and faster rate over the next two decades, and that will further shorten the amount of time our minable coal reserves will last. (Recent forecasts suggest we'll be using about 2.5 to 3 billion tons of coal per year within 15 to 20 years, compared with only about 1.1 billion tons currently.)

To meet this rapidly rising demand in the face of limited minable reserves, prices will have to keep going up -- perhaps to as much as $70 to $80 a ton in Appalachia this year alone, compared with about $50 a ton now. Another positive for coal companies is that some of their minable coal reserves may be grossly undervalued, because they've been on company books for decades. Yet another positive is how electric utilities buy coal. Simply put, utilities have a tendency to leave themselves with too little coal on hand, exposing them to sudden price increases.

Biggest beneficiaries
Not all coal companies will benefit equally this year from the minable-coal story, according to Glenn W. Wattley, an independent financial analyst and coal industry expert. Wattley, whom I used to book to appear on CNBC, says that three companies in particular are poised to rise -- Peabody, Consol, and Arch -- because each has a solid reserve base, plus good contracts and mining capabilities.

Wattley says Consol and Peabody should especially benefit from the mining of more so-called dirty coal, which will occur because utilities are investing heavily in equipment that will enable their power plants to burn dirty coal without polluting the atmosphere. He further adds that Consol looks good also because of its capability for extracting methane gas from coal. Coal-bed methane gas is increasingly being seen as a supplement to America's natural gas reserves.

Asian assistance
As for Joy Global, it stands to benefit because, given the inability of longwalls to reach the thinner, deeper seams, coal companies will likely have to buy more of Joy's other mining equipment to do the same job. Meanwhile, Headwaters should continue to benefit from its technology for recovering and reusing coal waste, which clearly has greater value in a minable coal world.

Peabody, however, could be the best-positioned of all for 2005, in part because of rising demand from Asian steel manufacturers. Nippon Steel's recent announcement that it will buy coking coal for more than $120 a ton from BHP Billiton should help Peabody, which has significant production serving the same Asian market.

Fool contributorBill Paul, a former Wall Street Journal and CNBC energy reporter, does not own shares in any of the companies mentioned in this commentary. The Motley Fool isinvestors writing for investors.


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