Betting Against Coal: A Green Lottery Ticket

Includes: BTUUQ, CNX, KOL
by: Tom Konrad, CFA

In the battle to reduce greenhouse gas emissions, coal is enemy number one. The global disarray in Copenhagen can only be good for coal mining companies, and they duly rallied when the climate talks ended with little to show for it.

Yet carbon emissions are not the only black mark on the coal industry's record, and investor relief may be premature.

None of this is to say that coal mining stocks have to fall anytime soon. Rather, I'm pointing out that there are large and significant risks that coal investors ignore at their peril. The polarization of climate debate is such that many conservatives seem unable to see these risks because of their preconceived notions. Climate deniers may crow in anticipation about their impending victory in the climate change debate, but this is a debate they cannot win because the facts simply do not support their case, no matter how many careless emails they are able to dredge up.

Investors usually have to operate in a realm of uncertainty. We don't know what next year's earnings of any company will be, we only hope that our estimate is better than the rest of the crowd. The climate debate, on the other hand, is a rare opportunity where we know the outcome with near certainty, and yet there is a large contingent of climate deniers willing to put their money down on the other side of the bet.

Today, with recent polls showing fewer Americans supporting action on climate change than last year, it's easy to become discouraged about the chances of real action to confront climate change. As an investor, it is dark moments like these when courageous investors put their money down and are rewarded when the pendulum swings back, as it always does.

Why Betting Against Coal Is A Green Lottery Ticket

I'm not one of those courageous investors. I prefer to take small risks that still have the potential for large rewards. Since I don't know if the pendulum of public opinion on climate change will begin to swing back today or ten years from now, I'm not ready to start shorting coal companies. However, I am ready to make a few small bets that change might be sudden and soon. I've bought a couple cheap, long-dated puts on coal companies.

The Market Vectors Coal ETF (NYSE:KOL) has exchange traded options, but only with expiration dates going out six months. In contrast, many of the large coal mining companies have exchange traded options that go out two years. This situation is similar to the one I ran into when shorting the Mexico ETF and shorting airline stocks. In particular, I chose to buy January 2012 $30 puts on Consol Energy (NYSE:CNX) and January 2011 $25 puts on Peabody Energy (BTU.) I chose these two because, as with airlines, they are the top two holdings of KOL. Furthermore, both of these came near the bottom of Newsweek's Green Rankings, and BTU scores badly on quantitative valuation measures.

To be sure, these are long-shot gambles. Coal will be with us for decades to come, and coal companies have an annoying habit of getting politicians to do their bidding. On the other hand, these bets could pay off even if there is no real action on climate change, because of another stock market collapse (both of my puts would have been in the money at March 2009 lows,) or from some company-specific problem.

Where else are you going to buy a lottery ticket that is so environmentally sensitive?