Coal Is Dead; Long Live Natural Gas

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 |  Includes: ACI, ANRZQ, BP, BTUUQ, CHK, JRCCQ, WLT, XOM
by: Gutone

Major coal manufacturers in the United States, including Arch Coal Inc (NYSE:ACI), Alpha Natural Resources, Inc. (ANR), Peabody Energy Corporation (BTU), and James River Coal Company (JRCC), made the same mistake the predecessors of today's oil giants, such as BP p.l.c. (NYSE:BP) and Exxon Mobil Corporation (NYSE:XOM), made in the 1980s. They built up too much capacity when commodity price was high, raising their own fixed cost structure and increasing their debt burdens along the way.

When reality turned out to be different from expectations, coal price collapsed with natural gas flooding the electricity generating market. Since natural gas is more efficient, cleaner, and now inexpensive, the coal industry as a whole faces major trouble. Power generation from natural gas has matched coal for the first time. This major trend appears unstoppable. And the worst may be yet to come. All coal miners will have to downsize, and more will go bust.

Within the United States, coal consumption has dropped sharply during recent years as natural gas gradually becomes cheap and abundant, replacing thermal coal in power plants. The following chart shows this trend vividly.

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In the meantime, U.S. coal stocks have been rising as supply constantly outruns demand, which almost inevitably leads to lower prices. Given coal miners' razor-thin profit margin in general, a small coal price movement often translates into huge stock price swings.

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And finally, as coal production piles up, the export of coal has been rising sharply (in the following chart). The sharp rise in exports is a consequence of price collapse—it becomes so cheap that it's a better deal for other continents to ship coal across the ocean, still cheaper than digging in their own backyards. Coal mining is a dirty business, polluting self while serving cheap coal to other countries perhaps wouldn't serve the industry well politically.

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Given such overwhelming trends, one has to be very suspicious of the sustainability of this industry for years to come. One possible policy change that might help coal mining is that the environmentalists and the EPA manage to stop hydraulic fracturing of natural gas, which will curb natural gas supply and make dirtier coal a viable option again—a bit ironic, isn't it?

The one that might do better than the others is Walter Energy, Inc. (NYSE:WLT), which has a focus on metallurgical coal for the steel industry, and is not so much dependent on thermal coal (for burning).

So what about natural gas? Would major natural gas businesses such as Chesapeake Energy Corporation (NYSE:CHK) become the new king? Not necessarily. With abundant reserve and a relatively cheap way of exploration, competition will be fierce. Big players like Exxon Mobile still have an edge in financial resources. At the end of the day, companies like Chesapeake are not necessarily winners even if natural gas becomes mainstream.

Overall, investors shall not count on a turnaround of the coal industry like what happened during the last roller coaster cycle of coal prices.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.