An Allocation to Coal

Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Ever since the recent Presidential debate in which Mitt Romney announced, “I like coal,” most of the big coal producers have seen healthy advances in their stocks. This strength can only be bolstered by the recent Pew survey that puts Romney four points ahead in the race for the most influential job on earth. Despite this jump, however, there continue to be important developments in both the coal and natural gas industries that are important to consider before making an allocation to companies like Arch Coal (NYSE: ACI) and Alpha Natural Resources (NYSE: ANR). While Presidential support is a critical element in the future of coal, the reality of shifting market forces need to be carefully weighed.

Good Press

The day after the debate, coal stocks were up sharply across the board. Arch Coal gained nearly 8%, while Alpha Natural Resources was up 6.8%. While the spike was substantially contained in a single day, the gains have remained in place ever since. The dynamics of the coal market are fairly complex, but a vote for “clean coal” makes a great sound bite. Coal is an abundant U.S. resource, making it a nod to energy independence, while the addition of the word clean is an attempt to soften the attack on the $90 billion President Obama directed toward green industries. This is politics at its best.

The Coal Market

Coal prices have been under pressure for a considerable period as a result of the abundance of natural gas, which serves as a suitable substitute for various uses, most notably the production of electricity. As thermal coal is used in the generation of electric power, the fact that power plants can run on coal or natural gas power means that low natural gas prices have meant low coal prices. When natural gas prices are significantly depressed, as they have been as a result of large fracking operations, thermal coal prices must drop to remain competitive.

The abundance of natural gas in the U.S. has not had a significant impact on coal consumption globally. Coal still drives roughly 80% of energy production in China – where pollution controls are much looser – and nearly half of energy production in Japan. Given the near-term constraints on exporting natural gas from both a structural and regulatory standpoint, it is more likely that the U.S. will become an exporter of coal in the near-term.

Developments in Natural Gas

In response to demand in Asia, Exxon-Mobil (NYSE: XOM), ConocoPhillips (NYSE: COP), TransCanada (NYSE: TRP) and others have agreed to proceed with a pipeline project across Canada with the goal of exporting liquefied natural gas (LNG) to Asia. The project is expected to cost at least $65 billion and take five years or more to complete once it begins. Additionally, Exxon has entered into a partnership with Qatar Petroleum International to construct LNG exporting stations in Texas that will allow transmission of LNG to the Middle East. This later project has received U.S. Department of Energy approval, but will take five years to complete as well.

What these developments signify for the global energy market is a shift in power and the reality that export-import figures may finally be in flux. The culmination of these events is clearly well into the future, but expectations can be as powerful in driving prices as current events. While five years is a long horizon, even for the long end of the energy market, investors will do well to begin seeing the bigger picture as it relates to the interaction between coal, natural gas and oil.

Trading Coal

While the near-term picture for coal may be improving slightly given the uptick in both coal and natural gas prices, I continue to see mid to high levels of volatility ahead for the energy markets. As such while an allocation to coal is a reasonable part of a balanced portfolio, finding solid values in the industry is especially critical. In the immediate-term, coal stocks will likely be influenced by the campaign, but anyone with an allocation to coal must carefully watch natural gas prices and the state of the global energy market.

Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of ExxonMobil. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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