The coal sector has gone through a depression this year and many bottom callers have been steamrolled along the way. Understanding the stranglehold natural gas (UNG) held on the sector has been key. Associated gas production has been underestimated as the rig count has been watched.
To this point I have suggested waiting on coal. Several recent events have indicated the coal bottom has passed:
- Central bankers and policy makers are simultaneously increasing stimulus.
- The rig count has declined markedly, including the Haynesville down to a stunning 21 rigs.
- Coal producer mine closures have continued.
This morning Alpha Natural (ANR) announced a large restructuring. Chairman and CEO Kevin Crutchfield noted the 'structurally shifting power market' and 'fundamental changes' in the business resulting in a 'smaller domestic market'. The industry realizing and acting upon the reality is the foundation of a recovery.
Any coal rebound will be lead by the U.S. thermal market. If natural gas production declines meaningfully, the cycle could be stronger-for-longer. Both coal and natural gas producers have weak balances and need higher cash flows before investing to increase production.
The cyclical duration could be lengthened if Chinese economic growth re-accelerates. While currently experiencing a slowdown, the return of a strong China would result in increased U.S. thermal exports while coking coal bounce back as well.
Strong PBR producer Cloud Peak (CLD) is my favorite play. Alliance Resource (ARLP) is a conservative income security. Peabody Energy (BTU) would be the industry leader were it not for its Australian headwinds.
Weak industry participants like Arch Coal (ACI) and James River(JRCC) will survive if the industry rebounds. With high cost operations and debt laden balance sheets, however, only the low cost producers can thrive in a return to a $4 natural gas environment. Speculators looking for the highest alpha could consider call options on the strong companies over equity in the weak companies.
The collapsed rig count and coal industry supply rationalizations are real. Join me as I monitor the coal market.