Coal Update - Demand from Europe
According to Bloomberg, coal prices in Europe have declined 26% this year. In Europe, coal's demand experienced an upsurge of 3.3% last year, while natural gas sales fell by 2.1%, the steepest drop since 2009. Unlike U.S, in Europe the switch from natural gas to coal is going on.
In the U.S., primarily due to the shale gas boom, natural gas prices plummeted to record-low levels and the coal-to-gas switching trend continued as a consequence. Furthermore, the record-high coal inventory levels and the reduction in metallurgical coal prices, due to slowing demand in China and fewer production disruptions in Australia, have all contributed to the overall downturn in the coal market. As a result, coal's share in electricity generation dropped to 32% from 41% in the last year, while natural gas contribution increased from 23% to 32% during the same period.
According to the BP Statistical Review of World Energy 2012, global coal demand increased by 5.4% in 2011, which is the highest increase among fossil fuels. This suggests that despite a low demand from the U.S., coal's demand is improving in other regions. As a result, U.S. coal companies started to expand operations in alternate markets, particularly in Europe. Currently, they are spending at least $530 million so as to increase their coal-export capacity in order to meet high overseas demand.
A week ago, the positive outlook of the Chinese demand expressed by Peabody Energy (BTU) CEO Gregory Boyce, caused coal stocks to appreciate. This was in line with our recommendation of staying away from coal stocks and wait for metallurgical coal trends before taking long positions in the fuel's stocks. According to Boyce, "The global metallurgical coal use will increase by 25% in 2016 resulting in an additional 250 million tons of demand growth."
U.S. producers such as Arch Coal (ACI) are increasingly focusing on Europe as an export market. Other main producers, especially Alpha Natural Resources (ANR) and Peabody Energy Corp., are expected to benefit from rising coal demand in Europe. Let us analyze the major coal stocks now.
Arch Coal Inc.
We upgrade our recommendation from hold to buy for the stock because the company will probably benefit the most from the surge in European coal demand. Kim Link, a company spokeswoman, said that the company has "expanded its reach with a dedicated sales team in Europe because we see increasing energy demand". Plus, ACI's cheap valuations and the fact that it has become the second-largest coking coal producer after acquiring international Coal Group (ICG) make us favor the stock.
Alpha Natural Resources
Given the recent improvement trends in the coal market, we now recommend a long position in its stock. This is because after acquiring Massey Energy Co., it is the top met coal supplier. In addition, it is very cheaply valued with its EV/EBITDA ratio of 4.8x being the lowest relative to its peers. Furthermore, it is extensively cutting down production, as is evident from the recent foreclosure of its four Kentucky mines, which is expected to improve its margins in future.
Peabody Energy Corp.
We reiterate our recommendation of a long position in BTU due to its strong liquidity position (cash in hand of $952.4 million), an increase in its demand for ultra-sulfur coal, and most importantly, due to the diversification in its operations as a result of its Australian asset base.
CONSOL Energy (CNX)
CNX is not as much affected by this positive news as its peers, but the reopening of its previously closed mines along with the fact that it produces both coal and gas means it is safeguarded against the coal-to-gas switching trend. We reiterate our recommendation of a long position.