American coal companies have been enjoying some good times of late, as demand has outpaced production and led to exceptionally high prices. As I've discussed before, companies ranging from mine equipment manufacturer Joy Global
Usually when I talk about coal, I'm talking about thermal coal. Thermal (or steam) coal is the coal used by utilities to generate electricity. When you look at the likes of Arch Coal, Peabody, and Penn Virginia, you're mostly talking about thermal coal.
There is, however, another kind of coal called metallurgical coal. Metallurgical (or met) coal is used primarily in the production of steel. It's not as common as thermal coal, and it sells for a considerably higher price. As a majority owner of the world's second-largest metallurgical coal producer, Fording Canadian Coal Trust
Results for the second quarter reflect the incredibly strong market for metallurgical coal. Revenue climbed 51% for the period on the combination of slightly higher coal production and significantly higher coal prices. As a result, cash available for distribution tripled to $151 million (Canadian currency). Of that, Fording declared a $2.80 (Canadian currency) distribution to unit holders. By my math, that works out to $2.30 (U.S. currency) per unit for American unitholders -- more than double the first quarter's payout.
No doubt these are boom times for the metallurgical coal market. Contract prices are currently in the neighborhood of $125 per ton -- more than double the long-term average price of about $50 per ton. Look no further than the steel market for the reason; steel production has increased significantly in the past two years. Even though mini-mill producers such as Nucor
While Fording's distributions are likely to increase even more in the second half of the year, this won't last forever. The forward curve on met coal shows prices peaking this year and tapering off over the next couple of years. Even though steel production should remain robust, new sources of met coal are expected to come online. That means eventual lower distributions from Fording.
Investors need to be aware of at least two additional factors. First, distributions are subject to a 15% withholding tax from Canada. Second, the company is attempting a reorganization that would change its tax structure. Instead of paying taxes at the corporate level, taxes would be paid at the unit-holder level prior to distributions.
It's hard to do a trust like Fording justice in a brief column. Although the company has some risk elements, including a heavy reliance upon Canadian Pacific
Buying Fording is basically buying a stake in the met coal market and, by extension, the steel market. I have no qualms about the company itself, but I'm just not so keen on the met coal market. With low inventories and firm pricing, thermal coal seems like the place to be right now. That said, a patient income-oriented investor could likely do quite well throwing in with Fording, Penn Virginia, or one of the regular coal-mining corporations.
For more cool coal thoughts:
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
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