The Dim Short-Term Outlook for Coal in the U.S.

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Our country is slowly but surely becoming addicted to natural gas. Developments in shale gas drilling techniques have unlocked trillions of cubic feet of gas that a generation ago was thought to be unobtainable. As a power generation source, gas-powered plants are less expensive to build than either nuclear or coal of the same output, and have far less environmental impact upon being burned that coal. I have heard before that the debate about clean energy generation is not about wind and solar versus coal, but rather it is wind and solar versus natural gas.

Aiding the popularity of natural gas was its epic price decline in North America, from over $12 per mmBTU in mid-2008 to as low as $1.80 per mmBTU last spring. Since then, it has risen to about $3.30 per mmBTU. All prices refer to the Henry Hub price in Erath, Louisiana. At the same time that North American users marvel at their low prices, this has not been noticeable in Europe, Africa or Asia, where prices in 2012 averaged as high as $18 per mmBTU. However, this is not a sustainable situation, and at some point a world market will be created, though it still will likely be benchmarked to Henry Hub.

Inexorably, given cost issues and environmental impacts, natural gas has overtaken coal in this country as the favored source of electrical production. And since coal's role in this economy is to boil water for electricity, now is not a great time to be in the coal business, and tomorrow seems no better. Yet, I am mindful that I am speaking about an American perspective. There are countries that mine all the coal they can for exporting, and others whose energy needs rely on coal far more extensively than the U.S. economy does. Even Australia, whose climate change has been so well documented that the country's meteorological office has added colors to the temperature maps to indicate never before seen high temperatures, seemingly welcomes more coal mining.

Due to the imbalance between supply and demand, coal prices have stumbled badly in the past two years. But make no mistake; the decrease of coal demand is not about to abate in this country, and I believe there may never be another coal-fired plant constructed in the U.S. But slackening domestic demand is made up for by exports to Europe and Asia. Deutsche Bank issued a report that was generally bullish for coal prices headed into 2013. But as we will see, domestic coal production companies are generally over-leveraged, and are just shadows of what they were a few years ago.

I am not a fan of coal. I see the hundreds of billions of external costs ranging from health care to environmental damages that for some reason coal companies have never been compelled to pay. If these costs were priced into the cost of coal, well, there would be no such thing as coal fired power plants at all. It would be like pharmaceutical companies not being responsible for damages from their products!

Patriot Coal (NASDAQOTH: PCXCQ) is a fine example. Its stock was flying high at $90 per share as recently as mid-2008, and was in the $20's throughout the first half of 2011. Now the company is working through reorganizing in bankruptcy court and its stock is trading at less than a dime a share. Helping to ensure the flagging company stays down is the fact that Patriot's long term debt load increased from about $11 million in 2007 to about $450 million pre-bankruptcy. It has also handicapped its future by agreeing to halt profitable, if otherwise objectionable, mountaintop removal mining. I question Patriot's long term viability, and have no interest in it at this time.

Peabody Energy (NYSE: BTU) is trading at only about a third its mid-2011 price. At its late November 2012 Goldman Sachs Annual Metals, Mining and Steel Conference, Peabody painted a rosy future for global coal demand. More than other domestic coal producers, Peabody is a global entity not in its customers, but in its owned and managed mines as well. Led by growth in coal demand in India and China, Peabody sees global coal demand of nearly 9 billion metric tons by 2016, an advance of 13% from 2012's level. And Peabody is managing its balance sheet more effectively than most of its peers, with its 52% debt to equity level as the close of the third quarter of 2012 being no higher than the ratio in 2007. But the fact is, nobody sees a rosy earnings picture for Peabody. 2012 earnings are on track for $1.95 per share, scarcely more than half the $3.76 per share in 2011. And a further huge plunge is scheduled for 2013, with earnings of $0.76 per share projected. Why would anyone want to get involved in that sort of a situation?

If I had to pick a coal stock, I would choose CONSOL Energy (NYSE: CNX), a major provider of metallurgical coal, thermal coal, and dry gas, including natural gas and methane. With this diversity comes some earnings cushion, though in CONSOL's case both its major product lines, natural gas and coal, have had a rough go of it price wise. Although the company has had a poor 2012, with earnings estimated at about $0.90 per share versus $3.02 per share in 2011, at least most people see the company advancing in 2013, whereas analysts estimate earnings at $1.17 per share. The company has recently shifted more of its focus to gas plays, announcing a $122 million commitment to the Utica shale formation in early January 2013, and a substantial increase in its investment in the Marcellus shale formation in December 2012.

Another large coal supplier is Alpha Natural Resources (NYSE: ANR), an operator in both coal mining and coal related services. Its mining operations are nearly exclusively in the Appalachian area of the United States. Its stock price has fallen 53% in the last year, so the question is if the company's stock is set for a bounce. Noting at the Goldman Sachs conference that both Metallurgical and thermal coal use growth is most pronounced in Asia, the company had nearly 50% of its sales in 2012 from overseas. The company has experienced a substantial loss in 2012, much of which was caused by $2.5 billion in goodwill and asset impairment charges in the second quarter of 2012. But even on an operating basis, Alpha will lose about $1.30 per share this year. 2013 looks pretty darned bleak as well, with a loss forecast for $2.09 per share. I see no reason to invest in Alpha at this time.


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