Seeking Alpha
, Think Finance (1,429 clicks)
Long/short equity, arbitrage, event-driven, research analyst
Profile| Send Message|
( followers)  

For many months already, coal (NYSEARCA:KOL) stocks have been consistently plunging. Most recently, the main reason why this plunge got steeper was due to coal to natural gas (NYSEARCA:UNG) switching happening in the power generation sector, where 93% of U.S.'s coal is used. This temporary switch happened because natural gas became the cheaper fuel in terms of cost per energy equivalent, also taking into account the higher efficiency of modern combined cycle natural gas turbines. For further explanation of the long and short thesis on coal, you can read my article "The Long And Short Theses In Coal."

Today, again, we see coal plunging anew. One might think that it's the same reason at work. But it isn't. I believe today's plunge has a much more specific reason. Basically, yesterday after the market closed, Patriot Coal (PCX) issued an update on its outlook. In this update, PCX slightly increased the price it hopes to realize for its coal during the remainder of 2012, but lowered the volume it hopes to ship by a full 1 million tones, to 3.9 million tones. This large cut in guidance naturally led to another severe punishment of PCX.

Perhaps more telling is the reason why Patriot Coal lowered its shipment estimates. PCX tells us, in its update, that this reduction was due to a potential default by one of its customers. It also tells us that the price this customer was contracted for was $25-$30 higher per ton than the present spot rates for the same coal. Now, PCX is saying this makes it seem that the customer reneged on the contract, but didn't really default financially. If the customer had really defaulted financially, that would be a large red flag indicating that we'd soon be seeing steelmakers default. That doesn't yet seem to be the case.

Also important here, the coal that PCX sells is met coal, which is coal used in the steel making process. Most of the coal shipped in the U.S. is thermal coal, coal used to make electricity. So we cannot generalize heavily from this PCX warning into every other coal miner. Sure enough, thermal coal is going through well-debated difficulties as well, but at least in that particular market we now have hope of a better 2013, because right now there are good reasons to expect natural gas to go up both during 2012 and 2013.


Today's plunge in the coal sector, motivated by PCX's problems, is perhaps a good opportunity to establish or reinforce coal positions with a view to taking advantage of natural gas's ongoing rally. Two interesting stocks in the sector might be Cloud Peak Energy (NYSE:CLD), which is a pure PRB producer, and Arch Coal (NYSE:ACI) which also carries a significant exposure to PRB (76.6% of coal tonnage, in Q1 2012). Exposure to PRB coal is desirable because PRB coal is less subject to natural gas dispatch switching, given that it's cheaper than Appalachian coal in terms of energy content, and also significantly cheaper to mine.

Disclosure: I am long ACI.

Source: What's Moving Coal Today?