Although how much coal a miner like Peabody Energy (NYSE:BTU) pulls out of the ground each year is the big headline, its future success is actually more dependent on how much coal it has left in the ground. That coal, known as proved and probable reserves, represents the company's future earnings power. You should get to know it well.
That's a big... number
In 2012, Peabody pulled around 250 million tons of coal out of the ground. That's a huge amount of coal, considering that competitor Arch Coal (NASDAQOTH:ACIIQ), another industry giant, mined "only" about 135 million tons.
Looking at proven and probable reserves, however, makes the size of these two industry players even more disparate. At the start of the year, Peabody had 9.3 billion (with a b) tons of coal that it had yet to pull from the ground. Arch started the year with about 2.1 billion tons. This provides a sense of Peabody's scale.
What is proved and probable?
Although there are explicit regulations around the terms proved and probable, suffice it to say that this is the amount of coal that a miner believes can be profitably mined. The number changes. For example, buying or selling coal lands and mines would clearly impact the number. However, the price of coal is also a factor: "Only coal reserves expected to be mined economically are included in our reserve estimates," explains Peabody.
So the reserve number is always a work in progress. What isn't up for debate, however, is how much coal gets mined. With 9.3 billion in reserve coal at the start of 2013 and using first half production as an average run rate, Peabody has around 35 years of coal left to mine, often called reserve life.
Dividing Arch's coal in the ground by what it's been mining shows that the company has less than half that at 15 years. Metallurgical coal focused Walter Energy (NASDAQOTH:WLTGQ), meanwhile, has reserves of 400 million tons and, based on its recent mining rate, has around 30 years of reserves.
Proven and probable reserves aren't usually headline grabbing numbers and they don't really need to be. However, they are worth looking for at least once a year. Over short periods, a falling reserve number isn't the end of the world, but longer term it has significant implications. For example, if Arch did nothing but mine its current coal it would go out of business in 15 years or so, well before Peabody or Walter.
Looking at the oil sector can give a different perspective on how important this is. French energy giant Total (NYSE:TOT), for example, only found enough new oil to cover 75% of what it sold between 2007 and 2009. Looked at in another way, its reserves fell by 25% of its annual production in those years. It was pleased to point out, however, that the average replacement rate was 136% between 2010 and 2012. The company is trumpeting a turnaround in its exploration efforts because it improves its corporate outlook.
Easier to find
Coal is a lot easier to find than oil, which is why reserves are so important in the oil industry but make fewer headlines in the coal space. Still, the current coal market malaise has left miners hitting the pause button on expansion projects and even selling assets in some cases.
Going back a couple of years to when times were flush, however, shows that mistakes were made. Walter bought Western Coal for $3.3 billion in early 2011, increasing its reserves from just under 200 million tons to around 385 million tons. A year or so later, the company wrote off a third of the acquisition. It overpaid for that coal and shareholders suffered for it.
When lean times turn flush again, you'll want to make sure that companies aren't overpaying for an acquisition to boost reserves that have languished during the downturn. Of the trio above, Arch is probably most at risk of pushing the envelope on this front. But you should take the time to check the reserves for all of your coal companies so you know where they stand, too.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Total SA. (ADR). 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.