The One Investment Obama Hates, But I Love

Includes: BTUUQ, KOL
by: Lou Basenese

Forget about being universally shunned. Coal is downright hated. As I told WSD Insider subscribers back in May, sentiment is so bad, in fact, that corporate executives are turning into obituary writers. At The Wall Street Journal’s ECO:nomics Conference in March, NRG Energy’s (NYSE:NRG) CEO, David Crane, said, “Natural gas is in the process of wiping out the coal industry.” Talk about a dire prediction.
At the same time, President Obama is unofficially declaring a war on coal via his advisors. Last month, Daniel P. Schrag, Director of the Harvard University Center for the Environment – and part of the science panel that helped advise the White House on climate change – told The New York Times, “Politically, the White House is hesitant to say they’re having a war on coal. On the other hand, a war on coal is exactly what’s needed.” No wonder investors are “beginning to write off much of the industry,” as Zacks’ analyst, Eric Dutram, recently observed. To this contrarian, though, all the negativity smacks of an opportunity. And the most recent earnings report from industry bellwether, Peabody Energy (BTU), suggests that I could be on to something.
Sparking a Comeback
Last week, Peabody made analysts look foolish beyond belief. The company reported second-quarter profits of $0.33 per share, while expectations called for a loss of $0.05 per share. We can credit aggressive cost-cutting efforts for part of the surprise, which is an indication that the industry is still facing headwinds. But the rest of the credit goes to (shocker) improving fundamentals.
Year-over-year, Peabody actually sold 3.6 more tons of coal. As Peabody Energy Chairman and CEO, Gregory H. Boyce, said, “U.S. coal generation is up significantly year to date [11%] and natural gas generation has declined sharply.” Come again? I thought coal’s days were numbered and that natural gas was in the process of “wiping out the coal industry.” Maybe Boyce misspoke. Nope! Elsewhere in the report, he says, “Both U.S. and global coal demand continue to grow.” Ultimately, this underscores a key misconception about coal. And it’s time to set the record straight.
Newsflash: Coal Still Makes the World Go Round
Even the White House is in on the ruse that coal has no future for electricity generation in the United States. Total hogwash. Sure, in recent years, utilities aggressively transitioned to using natural gas. But the move was purely economical. Not to mention, the magnitude of the change was perfectly consistent with history.
According to a recent U.S. Energy Information Administration (EIA) study on the “elasticity of substitution,” price is the primary factor in determining the mix of fuels that will generate electricity over time.
As you can see in the chart, during the late 1960s, coal use dropped as petroleum use increased. The cause? “Low and stable oil prices” and “concerns about emissions,” says the EIA. Fast forward to the late 1970s, and we see coal rebound to almost 80% of power generation. The cause? Again, price. Two oil price shocks during the period made oil the unattractive option. At the same time, coal prices dropped, thanks to a large capacity buildout.
You get the point. Although coal has been the predominant fuel used in power generation for over 60 years, demand is cyclical. And the latest downturn for coal merely reflected market forces at work.
But these forces are now turning back in coal’s favor… With natural gas prices up sharply over the last year, Boyce notes that “coal has regained significant market share from natural gas.”
What We Don’t Use, We’ll Export
Let’s ignore reality for a moment and assume that coal use is, indeed, in terminal decline in the United States. It still wouldn’t matter, because coal demand is on the rise everywhere else. Since the beginning of the 21st century, it actually represents the fastest-growing global energy source. And over the next five years, global demand is expected to increase by at least one billion metric tons.
No surprise, the emerging markets of China and India account for the majority of the past and future growth. From 2000 to 2011, the two countries accounted for 95% of coal demand growth, according to the International Energy Agency (IEA). And over the next 20 years, the Asian Development Bank says it’s a forgone conclusion that Asia’s use of fossil fuels is only going to keep rising. Make no mistake, coal is the fossil fuel of choice in rapidly expanding Asian economies. Why? Because it’s cheap, abundant, easily transported (since it doesn’t require a vast pipeline infrastructure) and less combustible. Heck, even Europe, which has some of the most ambitious emissions-control efforts in the world, can’t curb demand for coal. And that’s simply because natural gas isn’t an option. While it’s cheap in the United States, it can cost almost five times as much overseas.
So even if we have no use for coal in the United States anymore, there would be more than enough global demand to pick up the slack. That means we’d export our coal, which we’re starting to do more often, anyway. (Last year, U.S. coal exports hit a new record, reaching 120 million tons. That’s double the amount in 2009.)
Bottom line: Any talk about the death of coal is completely overblown. Even if it’s coming from the highest office in the land. Based on the latest fundamentals, the hard-hit industry actually appears to be bouncing off the bottom. So I recommend adding some exposure to your portfolio before yet another contrarian opportunity passes you by.