Buying a Lump of Coal for the Holidays

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

We are all familiar with the warning given to children that if they do not behave they may find a lump of coal is all they receive for the holidays. Unfortunately for Peabody Energy (NYSE: BTU), Arch Coal (NYSE: ACI) and Alpha Natural Resources (NYSE: ANR), there are not enough naughty children in the world to counteract the likely impact of this week’s election results. As with any great story, there needs to be a winner and a loser. In this case, coal’s loss is likely to prove to be natural gas’s win. Still, as global energy demand can be a fickle master, shifting trends make a diversified play like ExxonMobile (NYSE: XOM) the best bet moving forward.

Coal’s Plunge

In the aftermath of Tuesday’s election results, each of the above three stocks came under serious pressure during Wednesday’s session. Peabody was off over 9.5%, Alpha Natural Resources dropped over 12% and Arch Coal led declines by falling roughly 12.5%. Looking at the chart below, you can see that each of these stocks had surged heading into the election, largely on hopes that a victory for Governor Mitt Romney would grant the industry some needed relief. As this hope failed to materialize with the closing of the polls, investors looked for the exits.

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BTU data by YCharts

Under the Obama administration, the regulations faced by the coal industry have intensified. The standards for the use of thermal coal – used to run power plants that generate electricity – have been heightened such that the construction of new coal-burning plants is untenable. While existing plants continue to operate, in the cases of older plants, the cost of upgrading the facility sufficiently to meet current standards is often prohibitively expensive. During a period where global demand for coal has remained strong, U.S. demand has weakened considerably.

The Natural Gas Effect

Adding to the pressure that increased regulation has put on the coal industry is the pricing pressure created by sustained low natural gas prices. Natural gas serves as an acceptable substitute for thermal coal for electricity generation, meaning that when gas prices are low, coal prices remain under pressure. U.S. fracking operations have created a bit of a supply glut in natural gas that has led to the low prices for both commodities.

Natural gas enjoys a better reputation as a clean energy than does coal, leading some experts to surmise that the Obama victory may lead to increased pressure on the energy industry as a whole to focus on gas. This could include expanded use in power facilities, but also a push for the introduction of natural gas powered vehicles. Particularly given the current abundance of natural gas, consumers may ultimately benefit from such a shift.

The Diversified Play

While the bulk of the energy industry openly backed Governor Romney, there are many Obama policies that may benefit companies like ExxonMobil. As discussed in a recent Bloomberg article, the push towards a greater role for natural gas is helpful to Exxon, which is the second largest natural gas producer in the world. Greater focus on natural gas and expanded uses should drive demand, while a Republican controlled House of Representative can take steps to block further restrictions on U.S. fracking operations. These joint factors set Exxon up to be properly positioned heading into the future.

The Trade

While the major coal companies have not given up all of their gains, they face serious risks from additional regulation. An allocation to coal may still pay off, but the risk profile has deteriorated significantly. Under the current circumstances, an allocation to Exxon has greater potential and far less risk. As such, Exxon is a buy on the Obama victory.

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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