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Paulo Santos, Think Finance (372 clicks)
Long/short equity, arbitrage, event-driven, research analyst
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Coal has been left for dead for a while now. Both coal stocks and coal prices languished for all of 2013, mostly due to low natural gas prices as well as political headwinds. However, due to a rigorous winter at least part of this environment is changing fast.

Natural gas inventories below normal

The massively cold temperatures have led to significantly higher natural gas consumption for heating. With production being rather stable, this has led to massively lower natural gas inventories - indeed, inventories have even plunged below the lowest 5-year observations (Source: EIA)

This in turn had significant consequences for natural gas pricing.

Natural gas breaking out hard

With inventories below normal, for once natural gas was able to make a move stick and it broke hard on the upside today (Source: Stockcharts.com, today front month natural gas is trading above $4.90).

(click to enlarge)

This is where it becomes important to remember that there's an arbitrage between natural gas and coal for electricity production. With natural gas going up so hard, more coal-fired power producers will be dispatched ahead of natural gas-fired turbines. This means that this natural gas spike is going to translate into more demand for coal, which in turn is going to drive coal consumption and prices upward in short order.

Coal has not yet taken off but should in short order

While coal prices for the most part haven't moved yet, they will within days or weeks. And more importantly, the red-hot stock market is bound to speculate on this impact probably starting today. So coal stocks will move upwards at the same time, or even ahead, of coal prices (Source: CME).

Conclusion

Due to the arbitrage implicit in the way power generators are dispatched to produce power, the huge increase in natural gas prices is bound to make coal generators more competitive. This in turn will drive higher coal usage and, right after, higher coal prices.

For investors, this means that now is the time to try to put on coal longs, including Arch coal (ACI), Cloud Peak Energy (CLD) and Alpha Natural Resources (ANR). For sector-wide exposure the Market Vectors Coal ETF (KOL) can be considered.

Source: Time To Again Take A Flier On Coal