Coal Gets a Shot in the Arm

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

The International Energy Agency (IEA) recently gave coal, and the companies that mine the fuel, a much needed shot in the arm, as it predicted that … “ by 2017 coal will come close to surpassing oil as the world’s top energy source...” To get to that point, coal demand has to continue to increase, painting a much more positive picture of the industry than most investors have today.

What About The United States?
Demand in the United States is expected to remain weak because of low priced natural gas. This, the agency believes, is a structural change that will keep coal prices in the United States weak for years. However, increased demand from emerging markets, notably China and India, will more than make up for that slack.

The Rest Of The World Loves It
The IEA notes concerns about the environmental impact of increased coal use, but truth be told, many emerging markets, particularly China and India, pay much less attention to the environment than most developed nations. Thus, it doesn't seem likely that this issue will be a meaningful headwind to coal demand. A bigger wild card, however, is natural gas. Should the new drilling methods that have made this fuel so abundant in the United States find similar success throughout the world, low natural gas prices could become a world-wide phenomena. That would be a problem for coal.

Still, coal companies in the United States are suffering and, perhaps, rightly so. However, taking the IEA's long-term view into account could mean the current malaise is a buying opportunity. Coal is already exported, so it isn't hard to conceive of coal companies adjusting their businesses to export more fuel to markets with greater demand. Additionally, natural gas prices have already begun to rise to the point where coal is again becoming the cheaper alternative for utilities. So the supply/demand balance appears to be adjusting as you would expect. So there may be some upside, maybe even material upside, based on the sharp fall that coal miners have taken.

Peabody Energy (NYSE: BTU)
Peabody Energy is one of the most diversified companies in the industry and is a good choice for more risk-conscious investors because of its ability to participate in both domestic and foreign markets. Indeed, it has material operations in the United States and in Australia, which gives it direct access to the Asian market. For dividend focused investors, however, the stock's yield of around 1.3% is on the low side.

Alliance Resource Partners (NASDAQ: ARLP)
Alliance Resource Partners is the largest limited partnership (LP) focused on coal and has a relatively long and solid track record. Its operations are based primarily in the Illinois Basin, Central Appalachia, and Northern Appalachia. Its customers are primarily located in the United States, which means it has materially less diversification than Peabody. That said, the LP structure allows for certain tax benefits and materially higher distributions to flow through to unit holders. Impressively, distributions have been increased every quarter since mid-2008. This is the best positioned of the three LPs that focus on coal and, subsequently, it is afforded a premium valuation. For the more risk averse, however, this would be a good way to invest in coal while generating a fair amount of income.

Rhino Resource Partners (NYSE: RNO)
Rhino Resource Partners, which went public in late 2010, sits at the opposite side of the risk spectrum from Alliance. Although Rhino is relatively strong financially, the company has cut its distribution in the face of the current coal market and it has eliminated dividend payments to its sponsor, Wexford Capital. While Wexford's willingness to support Rhino's distribution to unit holders is admirable, it could also be an early indication that Rhino expects to have trouble maintaining its distribution to unit holders at its current level. Investors should keep close tabs on this issue.

Rhino operates in Central Appalachia, Northern Appalachia, the Illinois Basin, and the Western Bituminous region. Although it operates its own mines, it also has businesses that lease out coal mines, natural gas interests, and a newly formed unit that builds drill pads for the natural gas industry. The diversification efforts are a good sign, but there is still a material amount of uncertainty here. This is why the units yield well over 10%. For aggressive investors willing to take on added risk for a higher yield, this company is worth additional review.

Natural Resource Partners (NYSE: NRP)
Natural Resource Partners, with reserves in Appalachia, the Illinois Basin, and the Western United States, is something of an odd participant in the coal industry because it does not operate any of its own mines. Its only business is leasing mineral rites to others, which saves the company the hassle, and risk, of operating coal mines. It, too, has made an effort to diversify into other types of natural resources in recent years, including natural gas. Although the current environment is difficult, Natural Resource Partners hasn't cut its distribution. Partly because of its odd operating model, however, it also yields well over 10%, but it likely sits between Alliance and Rhino on the risk spectrum.

Coal has been an important fuel source for a long time, and that isn't likely to change in the near term. So long as there is demand somewhere in the world, domestic coal miners will likely find a way to tap into it. Although not for the risk averse, an investment in currently depressed coal shares could turn out to be a big winner over the long term.

Yours,

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ReubenGBrewer has a position in Natural Resource Partners. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Alliance Resource Partners, L.P.. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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