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Coal and coal stocks have been the object of much commentary. Patriot Coal Corporation's (PCX) recent bankruptcy has illustrated the industry's depressed state. Upon digging into the business, the investor will notice that misunderstandings seem abound.

There are two different aspects to the coal industry. Metallurgical coal is used in the steel-making business. Met coal currently still commands good pricing, giving strong returns for the producers, typically large mining conglomerates such as BHP Billiton Limited (NYSE:BHP) and Teck Resources Limited (NYSE:TCK). Our focus is on depressed thermal coal, which is used for generating electricity.

Gregor Macdonald's recent outstanding coal report shows the long-term opportunity for coal. India seems to have a chronic shortage. China currently has heavy inventory, but inhales coal at a breathtaking pace. But coal has a short-term problem.

In short, thermal coal has been crush by natural gas (The United States Natural Gas ETF, LP: UNG) oversupply. Natural gas prices have been sinking for several years, searching for pricing to incent power generators to switch from coal to natural gas. The natural gas oversupply was first driven by E&P producers drilling to lock up their newly leased land from their land grab. More recently, strong natural gas production has been associated with oil and wet gas drilling.

This spring and summer have seen unprecedented fuel switching because of $2 handle natural gas pricing. And it is the pricing, which drives the economics. A rise in natural gas prices will cause the switching to reverse, a reversal of which the coal industry needs to survive.

The natural gas oversupply can be seen in two ways: storage and production. The storage overhang is off the charts, yet is being worked off. Coal investors need to carefully watch the overproduction for clues.

I will suggest the natural gas rig count will be the most important factor for a possible coal industry rebound. Unknown is the exact point at which production will fall meaningfully, but the point has likely been passed only recently. The dry gas Haynesville rig count, for example, has collapsed 76% to 29 in the last 12 months. After a time lag, this will lead to a fall in natural gas production.

Upon a significant fall in natural gas production, a coal revival could occur sooner than expected. The industry has deferred capital spending plans and closed mines. Last week saw U.S. coal production down 9.9% from year earlier levels.

In future essays, I will consider some of the industry participants. James River Coal Company (JRCC) is probably to be avoided, for without an immediate industry turnaround, bankruptcy is to be expected. Peabody Energy Corporation (NYSE:BTU) is the group blue chip. Peabody looks to be a more safe way to invest in coal along with income securities like low-cost producer Alliance Resources Partners, L.P. (NASDAQ:ARLP) and royalty Natural Resource Partners LP (NYSE:NRP). With more risk, perhaps Arch Coal Inc (NYSE:ACI) and Alpha Natural Resources, Inc. (NYSE:ANR) offer the possibility of the most reward.

As I continue to evaluate the industry, be sure to keep eyes on the rig count. It fell by 20 to 522 last week. The historical natural gas oversupply destroyed coal mining economics, and is the key to the industry rebounding.

Disclosure: I am long ACI.

Source: Coal Introduction: Watch The NG Rig Count