China's ravenous apatite for steel drove demand for metallurgical coal over the last decade. A Chinese slowdown, similarly, has led to oversupply and a swift drop in met prices. If Walter Energy (NASDAQOTH:WLTGQ) is right, however, a met coal upturn could be under way.
Demand isn't gone
BHP Billiton (NYSE:BHP), which mines coal and iron ore, notes that steel production in China had been growing at an impressive annualized rate of 15%. That demand led to the opening of less profitable mines. Unfortunately, BHP Billiton sees China's steel growth moving closer to the 3% it expects over the next decade or two.
That's a big change that's left supply and demand out of balance. But it doesn't mean that demand is gone. It just spells less robust demand for iron ore and metallurgical coal. So BHP Billiton continues to see a solid base for steel, from which it generates more than half its business.
Reading the tea leaves
However, that's a big picture view. Right now the met coal market is in the dumps. That's one of the reasons why Walter Energy has put up red ink over the last four quarters. In fact, that trend probably won't change in the current third quarter, either. However, looking out to the fourth quarter, Walter Energy is seeing some signs of improvement, with prices for met coal up about 5% over third quarter levels and spot prices up nearly 20%.
Unfortunately, that's not going to be enough to salvage 2013 at Walter Energy. However, it points to a potential upturn that could make 2014 a better year for the struggling met miner. And, if demand starts to pick up appreciably, Walter Energy will be ready, with the ability to expand capacity by 35% when the time is right.
That time isn't now
That said, the met coal market hasn't turned yet, as Alpha Natural Resources (NASDAQOTH:ANRZQ) pointed out in its second quarter earning release: "During the second quarter of 2013, the global seaborne market for metallurgical coal deteriorated further..." That, coupled with a weak U.S. thermal coal market, has resulted in seven quarters of red ink at Alpha Natural Resources, the world's third largest supplier of met coal.
However, the company highlights important shifts taking place, too. "In the current market environment, a significant proportion of global production is uneconomic, and, consequently, production cutbacks have been widespread..." Thus, supply and demand are working into balance. While that's not helping Alpha Natural Resources, Walter Energy, or BHP Billiton today, it should support results in 2014 and beyond.
Everybody is shifting gears
BHP Billiton isn't the only diversified miner that will benefit from increased steel demand. Rio Tino (NYSE:RIO) is also a big player in the iron ore and met coal markets, competing head to head with BHP Billiton in well-situated Australia and around the world. In fact, the company's iron ore and energy segments (which includes its met coal operations) account for about half of Rio Tinto's sales.
That said, Rio Tinto offers a great example of the industry transitions taking place. Like all of the others here, Rio Tinto has been focusing on cutting costs and increasing efficiency. It shaved nearly a billion dollars from its expenses in the first half alone. And, like BHP Billiton, the company is still profitable despite the tough mining market.
It's not bad to be early
Although a recovery in the met coal market isn't taking place right now, companies are starting to see positive signs on the horizon. And most are streamlining operations so they'll be ready when the upturn comes. If you're contrarian and are willing to be early at the risk of being wrong, but would like diversification, BHP Billiton and Rio Tinto are the best options. Alpha Natural Resources, with met and thermal coal businesses, would be next up. Walter Energy, meanwhile, is pretty much a pure-play met miner.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.