Playing the Natural Gas Downturn by Investing in Coal?
Joshua is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
As the price of natural gas has plummeted the demand for relatively expensive coal has decreased. The supply demand imbalance in these commodity markets will resolve itself but the process will not be instantaneous. Shutting down mines and reducing production in the natural gas market does not occur over night. There are a number of ways which one could use to take advantage of fluctuations in coal or natural gas prices and investors should not limit themselves to commodity ETFs like United States Natural Gas Fund, LP (NYSEMKT:UNG) and US 12 Month Natural Gas Fund LP (NYSEMKT: UNL).
Investing directly in ETFs has its' downsides as contango can remove a large percentage of the potential profits. As an ETF places more of their assets in front month futures the cost to switch from the front month future to the next delivery date future only increases. In order to make a commodity ETF track the current spot price a large percentage of assets must be placed in front month futures. Commodity ETFs like UNG and UNL. which invest directly in the futures markets may work great for those looking to hold positions for a couple weeks but over the long term serious tracking errors can occur during sudden price movements.
The coal industry and coal producers are heavily impacted by prices of natural gas. As stated at the energy information agency since the end of 2011 the price of coal in mmbtu has fallen roughly around 10% to 40%. The U.S. Energy information agency states that as of april 2012 supplies of coal are at an all time high even though producers have severely reduced production from a year ago. The majority of electricity produced in the United States is produced from coal. As the price of natural gas drops, power companies can reduce the load placed on their older coal powered power plants.
When the price of natural gas increases the demand for coal will also increase; raising coal prices and increasing the profitability of miners like Peabody Energy Corporation (NYSE: BTU), Arch Coal Inc (NYSE: ACI), and Alpha Natural Resources, Inc. (NYSE: ANR). As the long term contracts of higher cost producers based in the Appalachian region expire, the financial situation of these firms will only worsen. There is a great difference in the cost to produce coal in the Appalachian region and the west. Strong national producers are able to decrease production in higher cost areas and maintain profitability. Firms which are localized in one coal producing area do not have the luxury to shift production to keep in line with prices. The cost to open up a new coal mine is very large. The environmental effects of underground and surface mining mean that regulatory approval for such coal projects can be time consuming and uncertain. Coal mining is an industry with major economic moats.
It is possible that the coal boom and bust seen during 2008 could be repeated. Low inventories provoked cuts in productions which produced eventual shortages in supply. As the spot and futures price for coal spiked, coal producers gained large profits and their stock prices increased. Although the current spot price for some types of coal are not near the lows seen in the 2001 recession there is still room for a substantial increase in price. Long term investors who want to take advantage of the long term increase in the price of natural gas and thus coal should examine coal producers. By saving themselves from the cost of contango investors can gain exposure to this sector of the commodity market by investing in a coal producers.
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