The short thesis as defended by me isn't really a call to short, as much as a call to a defensive posture. The rationale is that the situation is serious enough that it might at some point generate a panic where much lower valuations will be attained by the stocks in the sector. This has repeated itself many times in the market even under less serious circumstances, so it cannot be ruled out today.
Panic/distressed valuations are usually much lower than the valuations the coal companies still trade for today. It's easy to see EV/EBITDAs in the 6.5 area still, and these are "normal" valuations, not distressed. Distressed valuations can imply drops of more than 50% for most coal stocks. Given the chance that these valuations might happen during 2012, I am cautioning people to not get in front of this possible train. At least not yet.
Not long after publishing this article, on April 24, I published "Natural Gas In 2012: Electric Generation Switch Implications," an article where I turned positive on natural gas (UNG) for 2012, but kept the door open for a possible panic in coal in the next two months:
The implications for coal stocks such as Peabody Energy, Alpha Natural Resources, CONSOL Energy, Arch Coal and James River Coal depend on how much natural gas moves. The rise in natural gas prices might not be enough to impact coal substitution or prices significantly (anything less than a 40% pop doesn't change the equation much). Still, if a coal panic doesn't happen in the next two months, the sector should be broadly safer from there on.
As I said, the panic on coal has arrived. And the trend up in natural gas is also obvious at this point. With natural gas' futures front month at $2.68/mmBTU, such represents a rally of over 40% since natural gas bottomed on April 20. All the data coming out of EIA confirms the thesis that this rally should continue unless we get a mild summer. The data are also supportive of a continued rally into 2013.
As natural gas prices rise, the pressure toward lower coal prices is removed. As natural gas prices exceed $3/mmBTU, either we get higher coal prices, or we get some switching back from natural gas to coal in power generation, leading to higher volumes and later, higher prices.
Any way we cut it, there's reason to believe that the coal market, like the natural gas market, has bottomed. This, in turn, means that for long term investors, this is the time to get into coal.
The coal panic I was afraid might happen has already happened. The natural gas market as turned positive. The coal market has in all likelihood also bottomed. This time is the time to buy coal stocks for the long term. Some care should be taken to avoid the financially challenged companies, however, as the bottoming process might be long enough that some won't survive.