Should You Buy Into the Coal Supercycle?
Kyle is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Peabody Energy (NYSE: BTU) Chairman and CEO Gregory H. Boyce has been pitching the so-called “coal supercycle” for a few years now. The pitch is that coal will become the world's largest energy source any day now due to rising demand in China and India, and the cost of coal is just a fraction of global oil and liquefied natural gas. It's all related to Chinese steel and Indian electrical production, goes the pitch, which is bound to come back online sooner rather than later.
Boyce does have some interesting data to back up his claims, which he eloquently laid out in a presentation earlier this year at the Howard Weil 2012 Energy Conference. Allow me to summarize the more compelling points:
Exhibit A: China and India are leading the global buildout of coal-fueled generation.
Exhibit B: Chinese coal consumption consistently exceeds targets. During the 10th five-year plan, 1.1 billion tonnes of coal use was targeted for the last year while 2.3 billion tonnes were actually consumed. During the 11th five-year plan, 2.5 billion tonnes of coal use was targeted for the last year and 3.5 billion tonnes were consumed. If you assume 8.5 percent economic growth, China's 2015 coal consumption could reach 5.0 billion tonnes.
Exhibit C: India is expected to add 40 GW of coal-fueled generation in the next two years, requiring 140 million tonnes of added coal, much of which could come from imports. And India has a trillion dollars planned in infrastructure needs in its five-year plan, requiring steel and power to put into place.
Exhibit D: The seaborne coal market exceeding 1 billion tonnes for the first time in history.
(Source:Coal Commodity Mine)
Wow, this sounds like the deal of a lifetime, doesn't it?
As with so many sales pitches, however, there are a few data points that haven't been so much “massaged” as omitted. Boyce has given us the Bullish case for coal. But before allowing ourselves to get knocked off our feet by all of these impressive sounding numbers, let's flip the coin over and examine what the Bears have to say.
Exhibit A: Prospects for coal are especially sensitive to government energy policies – notably in China, which today accounts for almost half of global demand. With oil, the reverse is usually true: the market dictates government energy policy. Oil is ringed with a moat that simply doesn't exist for coal due to environmental regulations.
Exhibit B: More efficient power plants and carbon capture and storage (CCS) technology could boost prospects for coal, but the latter still faces significant regulatory, policy and technical barriers that make its deployment uncertain.
Exhibit C: Natural Gas (UNG) and Shale Oil are flooding the Energy market. In this sense, the demand for coal ultimately depends on the mmBBTU price cost of natural gas (LNG). In April 2012, for the first time on record, natural gas generation matched coal-fired generation. Natgas generation is also getting more efficient: Average capacity factors for the Nation's fleet of natural gas combined-cycle power plants have increased steadily since 2005. And converting to natural gas is often cheaper than can often cost less than installing the emissions control systems required to keep an antiquated coal plant running. If LNG prices were to resume free fall, Chinese and Indian coal consumption won't be enough to save investors.
Exhibit D: Coal mining inflation has been running rampant. James River Coal Company (NASDAQ: JRCC) hasn't returned a positive net income in 8 years. Potential customers are flush with coal and are tightening their purse strings until they get a clearer picture from Washington as to what kind of regulatory environment they'll have for the next several years.
Exhibit E: Domestically produced coal is also subject to the monopoly of the environmentally friendly railroads over shipping rates. These same railroads have a federal exemption from anti-trust laws.
That's a bit more of a balanced picture than the one Peabody's CEO originally painted for investors, don't you think? For the record, Peabody is the crème de la crème when it comes to private sector coal.
Investors who prefer a more dividend oriented play should consider Alliance Resource Partners (NASDAQ: ARLP). Alliance is structured as Master limited partnership (MLP), which means that it owns coal assets just like other private sector companies. Because MLPs are classified as partnerships, they avoid corporate income tax at both state and federal levels, which in turn allows them to focus more on dividends. Alliance is also the only major U.S. producer that will see an increase in production YoY in 2013.
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