Will Coal Stay Hot?

Given how coal prices have shot up this year, you could have done worse than a lump of coal this Christmas. Shareholders of coal mining companies Peabody (NYSE: BTU  ) , Massey Energy (NYSE: MEE  ) , Arch Coal (NYSE: ACI  ) , and CONSOL Energy (NYSE: CNX  ) have been celebrating the 2007 increases. But will these coals remain stoked in 2008, or are they about to go cold?

The fire this time
The U.S. Department of Energy estimates that 1,000-plus coal-fired power plants will be built over the next five years, most of them in India and China. In fact, despite having the third-largest coal deposits after the U.S. and Russia, China recently became a net importer. India is already a big importer despite ranking fourth in the world in coal reserves, in part because its reserves are mostly of lower quality.

The prices of oil and natural gas are high and seem likely to stay that way, making coal an attractive alternative over the long term. Based on information-provider Platts' data from 2006, the average total production cost of electricity based on coal is $2.19 per million kilowatt/hours, versus $7.97 for natural gas and about $14.69 for oil. Few prognosticators are predicting lower prices for oil and gas, which tend to move together, so some utilities are making the necessary investments to switch to coal.

Gray skies are gonna clear up
One of coal's drawbacks has been its environmental impact. In the U.S., half of all electricity is generated from coal. Many utilities burn the cleaner variety found in the Powder River Basin in Wyoming, but more are now installing scrubbers that allow them to burn the mid- and high-sulphur versions found in the Appalachian region.  

This will benefit coal producers like CONSOL Energy, whose operations are concentrated there. CONSOL told analysts in November that over the next five years, the number of scrubber-equipped plants in the eastern U.S. will rise 149%.

More than half of power plants in Europe are already equipped with scrubbers, according to CONSOL, and this has contributed to rising U.S. coal exports. CONSOL expects its European exports of steam coal used in power generation to jump 25% in 2008.                                              

No nukes is good nukes
The one fuel source that is cheaper than coal on a kilowatt/hour basis is nuclear, which accounts for about 20% of U.S. electricity generation. For nuclear to maintain that share, though, almost 40 nuke plants would have to be built over the next 20 or so years.

Despite a few recent nuclear plant applications here in the U.S., I believe the long payback periods on nuclear plants and the still-present political obstacles will keep this option from pushing coal from the table anytime soon.

The cost advantages and abundance of coal make it especially attractive here in the U.S. Even assuming higher rates of use in the future, the National Coal Council believes we have an estimated 100-year supply. So, barring a technological breakthrough in alternative energy or a significant drop in prices for natural gas, coal is likely to be the fuel of choice for electric utilities for a long time to come.

Before you stoke the coals ...
Still, you might want to wait for the next hiccup in the market before getting into the coal business. Except for Massey, the other top coal miners are trading at hefty premiums to the market as a whole.

While coal producers might already be priced for success, bargain hunters might instead want to take a look at mining equipment players, including Bucyrus (Nasdaq: BUCY  ) and Joy Global (NYSE: JOYG  ) . Both companies make massive electric shovels and draglines used in open-pit coal operations, as well as the longwall systems used in underground mining. Bucyrus, for one, sees significant growth in the market for these products. Fools would do well to keep these companies and their coal-producing brethren on their radars in 2008.

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