Revisiting Investment Opportunities In Coal Mining

by: Bennington Investment Ideas


Most coal mining companies have posted abysmal returns over the past three years.

Industry outlook is threatened by potential carbon taxes and other environmental legislation.

Forward looking opportunities seem scarce.

In April of 2011, I wrote an article on coal miners and tried to identify some investment options. My suggested short positions did quite well, a few of my longs were also okay, but several longs would have resulted in losses. The following table summarizes the simple total returns from all companies reviewed:

Ticker Name April 21, 2011 Close Intermediate Dividends June 20, 2014 Close Simple Total Return
WLB Westmoreland Coal Company 17.05 0.00 36.66 115.0%
SPY S&P 500 Trust ETF 133.78 10.24 195.94 54.1%
AHGP Alliance Holdings GP, L.P. 50.60 9.24 62.69 42.2%
ICO International Coal Group, Inc. 10.87 Assumed no intermediate dividend Cash Acquisition of $14.60 by Arch Announced in May 2011 34.3%
VAW Vanguard Materials ETF 88.31 5.05 111.64 32.1%
ARLP Alliance Resource Partners, L.P. 38.24 3.48 45.13 27.1%
PVR Penn Virginia Resource Partners LP 27.91 Merged in Regency Energy Partners (NYSE:RGP) 12.9%
IYM iShares Dow Jones US Basic Materials Sector Index Fund 82.71 4.29 87.78 11.3%
CLD Cloud Peak Energy Inc 19.94 0.00 19.55 -2.0%
CNX CONSOL Energy Inc. 51.26 1.45 47.25 -5.0%
RNO Rhino Resource Partners LP 25.16 5.47 13.73 -23.7%
NRP Natural Resource Partners LP 34.12 6.73 15.65 -34.4%
XME SPDR S&P Metals & Mining ETF 74.04 1.81 41.78 -41.1%
BTU Peabody Energy Corporation 66.02 1.11 16.95 -72.7%
MEE Massey Energy Company 66.81 Assumed no intermediate dividend Acquired by ANR at 69.33 with $10 cash and 1.025 shares of ANR -83.5%
OXF Oxford Resource Partners, LP 26.15 2.83 1.00 -85.4%
ACI Arch Coal, Inc. 34.64 0.66 3.66 -87.5%
ANR Alpha Natural Resources, inc. 57.08 0.00 3.75 -93.4%
LLEN L&L Energy, Inc. 7.28 0.00 0.37 -94.9%
WLT Walter Energy, Inc. 136.38 1.17 5.5 -95.1%
JRCC James River Coal Company 22.77 Assumed no intermediate dividend 0.25 -98.9%
PCX Patriot Coal Corporation 26.09 Assumed no intermediate dividend 0.00 -100.0%

Source: Yahoo!Finance, company websites, author calculations and analysis.

It is quite clear that several of these companies have delivered horrible performances. Both Patriot Coal Corp. (OTCQB:PCXCQ) and James River Coal Company (OTCPK:JRCCQ) have filed for Chapter 11 bankruptcy. Six other companies have delivered total returns of less than 80% declines. With the exception of Westmoreland Coal Company, every company has underperformed the S&P 500 as measured by the SPDR S&P 500 Trust ETF (NYSEARCA:SPY). Most of the companies have also underperformed basic materials ETFs including Vanguard Materials ETF (NYSEARCA:VAW) and iShares Dow Jones US Basic Materials Sector Index Fund (NYSEARCA:IYM). The exceptions have been companies that got acquired (for cash or by broader energy companies) and two smaller scale partnerships. Massey Energy Company was acquired by Alpha Natural Resources, inc. which did not help its situation.

The following table summarizes the results of recommendations which lost 11% of the total value. Without question that is a bad result, but it is at least substantially better than the result of going long all these companies, which would have resulted in a loss of about 50%.

Recommended Ticker Recommendation Result Gain on $1000 investment Percent gain
CLD Long Neutral (20) -2%
ACI Long Bad (875) -88%
BTU Long Bad (727) -73%
JRCC Long Bad (989) -99%
MEE Short Good 792 79%
PCX Short Good 1,000 100%
AHGP Dividend longs Good 422 42%
ARLP Dividend longs Good 271 27%
OXF Dividend longs Bad (854) -85%
Total (979) -11%

Source: Yahoo!Finance, author calculation. Gain on $1000 assumes $1000 was committed to the position April 21, 2011 and measures the gain or loss to June 20, 2014.

Coal outlook continues to be strained

The outlook for coal is not good in the electric power industry, as it continues to fall out of favor due to less expensive natural gas and increasing use of renewables. The following table shows the recent historical production of electricity by source for utilities.

Source: EIA, author calculations *Renewables includes solar, wind, wood and wood derived products, conventional hydroelectric, geothermal, and other biomass.

With the ever present challenge of climate legislation and various other environment initiatives, I would expect this trend to continue for the near future. Furthermore, with recent announcements that China is pushing hard to get solar to be at cost parity with coal, coal's place in electric production is further challenged and only secured by the presence of existing coal plants. Over time, that position will erode as plants are retired.

Coal is also used in steel manufacturing, commonly referred to as metallurgical coal. Lignite and Sub-bituminous coal are typically only used in power generation due to their lower heat content. However, they typically also have higher levels of impurities. Next is bituminous coal which is also often used in power generation, but can also have some other industrial applications. The highest quality coal is anthracite. It has the highest heat content and the lowest level of impurities. It can be used in both power and metallurgical applications, as well as some chemical applications, as a reducing agent and for local heat generation. However, its high price typically makes power generation a less economic application. Still, US steel production in 2013 was approximately 87 million tonnes, which is down from the 90-100 million tonnes posted annually through the late 1990s and until 2008. The upside is that global steel production is generally driven by emerging markets.

Can technology save coal?

Given these facts and the recent trends in the industry, the outlook for coal is pretty bleak. However, if Internal Gasification Combined Cycle (IGCC) technology can be made cost effective in combination with Carbon Capture and Sequestration technologies, coal could once again increase its share in the electric power sector. IGCC is a process in which a synthetic gas is produced from the coal. The advantage in IGCC is that the emissions are produced in a highly concentrated stream during the gasification process, instead of in a diffuse stream out of the smoke stack in a traditional coal power plant.

Looking forward

The first thing to note is that not all companies performed poorly. Alliance Holdings GP, L.P. and Alliance Resource Partners, L.P. posted decent returns. Cloud Peak Energy Inc which mines sub-bituminous thermal coal in Wyoming and Montana was essentially breakeven over the time period. WLB has gone from a $223 million market capitalization to $552 million. Furthermore, they too are a lignite and sub-bituminous thermal coal miner with mines in Texas, Wyoming, Montana, and North Dakota. Clearly it was possible to make money in the industry without even being diversified. These companies could be revisited as potential investment opportunities. Will WLB's acquisition of Sherritt International Corp. pay dividends or will it be more akin to ANR's acquisition of Massey Energy? While the electric industry is slowly shifting away from coal, it still represents over 40% of the produced power - someone is supplying that coal.

Disclosure: The author is long SPY. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.