U.S. Future in Coal Burns Bright

The future of U.S. coal is burning bright and long-term options may be the best way to capitalize on the trend. Growing demand in China combined with higher comparable valuations abroad will create a catalyst for the U.S. coal industry, according to many experts. The environment may also spark an unprecedented number of domestic and cross-border mergers and acquisitions. Investors looking to take advantage of these trends with leverage and limited risk should consider purchasing LEAPS options.

China is expected to generate the majority of demand for coal over the next decade. The fast-growing developing market economy requires coal to supply 80 percent of its energy needs, which makes it the largest consumer of coal in the world. The country may also be the largest producer of coal, but it may still become a net importer within the next couple of years. The increased demand in China has helped jumpstart global coal prices, which have risen substantially over the past year.

Investors looking for a safe way to play these increases in coal prices may want to consider purchasing the Market Vector Coal ETF (KOL) for a diversified portfolio of companies. The most actively traded calls options are the September 50 calls followed by the October 48 calls. However, the January 35 puts have the largest open interest, indicating that at least some investors remain bearish on coal over the next year despite the bullish news. Notably, this ETF contains international companies as well.

Those investors looking for more direct exposure to U.S. coal plays may want to check out James River Coal Company (JRCC), which is one of the more volatile players in the industry operating out of Kentucky and Indiana. The firm is trading down after reporting wider-than-expected losses thanks to bad weather, higher costs, competition for skilled labor, and detrimental hedging contracts. To make matters worse, the pricing increases of 2008 weren’t yet realized because of the way futures work.

Luckily, these are problems that are either temporary or can be solved. Investors should expect strong pricing through the remainder of 2008 and even stronger pricing throughout 2009. Meanwhile, the pricing of 2009 to 2011 contracts came in at $125, which is higher than expected. Pressured profit margins from struggling coal prices and higher costs are also set to recover thanks to lower oil prices and continuously strengthening demand from China for worldwide coal supplies.

Investors looking for other potential U.S. oil plays should look at how long their contract obligations go out. Those selling more to the spot markets stand to benefit more quickly and directly from higher coal prices. Additionally, those dealing exclusively in the United States may hold greater potential because of the higher coal quality and lower valuation relative to others thanks to the lower value of the U.S. dollar. Long-term options can also help increase leverage and help diversify through multiple companies in the sector via a lower total cost per position.

Comments

[Norman Lepo...:]

Good article. I agree.

2008 Aug 11 09:10 AM

[john s. gordon:]

china is the kuwait of coal but many of the mines are unsafe due to corrupt or incompetent management as well as karst topography which leads to drowning the miners.
> jack

2008 Aug 11 09:38 AM

[HarryHope:]

When I chart KOL and USO over 5 years, they pretty much trade in sync. Historically lower oil means lower coal not the reverse as this article claims.

A slowing global economy is likely to cause reduced commodity demand and that means lower coal as well as oil.

2008 Aug 11 09:49 AM

[buyitcheap:]

JRCC has very poor management, any manager that can't make money on skyrocketing coal prices AND has margin contraction, needs to be bought. It ran from $3- $60 in 3 months(?) and should, at best,be watched as it falls back to 3. There's something very odd about the stock's price movement. That's enough for me to stay away.

2008 Aug 11 12:30 PM

[jimmy46:]

How much does it cost to send a ship full of coal from powder river basin to China?
And how much is that cargo worth?

2008 Aug 11 12:32 PM

[Brinkstruck:]

Headwaters HW www.headwaters.com

Coal Reclamation – In the United States today there
are more than 3 billion tons of coal resulting from
previous and ongoing mining and preparation plant
operations. This coal is stored in slurry ponds and gob
piles.

Headwaters acquires the high ash coal
resources, removes the ash, clay, silt, and many of the
contaminants that cause air emissions when burned,
and develops a high quality coal product – a product
that would otherwise remain in undeveloped mines,
waste ponds, or landfills that need to be reclaimed.
In addition to coal cleaning, Headwaters is also
involved in converting coal to liquids, and in March of
2007 began operations of its ethanol plant located in
North Dakota. Through its energy activities,
Headwaters has also made advancements in other
industrial applications of nanotechnologies, e.g.,
manufacturing hydrogen peroxide.

2008 Aug 11 01:28 PM

[john s. gordon:]

jimmy - seems unlikely that PRB coal in its as-mined state would be worth hauling to china, due to high moisture content & low calorific value. however processes have been demonstrated which upgrade the coal & remove most of the excess H2O as well as some of the sulfur (which is already pretty low). this might be worth exploring.
> jack

2008 Aug 11 06:01 PM

[john s. gordon:]

gob piles & coal prep waste are suitable fuel for a CFBC. this is preferable to leaving the stuff there, it likes to ignite spontaneously & pollute the environment, also hazardous to humans (no more buffalo creeks please).
> jack

2008 Aug 11 06:04 PM

[billp37:]

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"The adverse public health and environmental effects of these toxic chemicals are both serious and long lasting. Mercury pollution from power plants, for example, is deposited on soil and in water, where it transforms chemically into a highly toxic form (methylmercury) that accumulates in the tissues of fish.74 "

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2008 Aug 11 06:54 PM

[ChipSeal:]

Harry- "A slowing global economy is likely to cause reduced commodity demand and that means lower coal as well as oil. "

How much of that demand reduction comes from less electricity use? The rule of thumb estimate of coal use for a power plant in 4000 tons of coal a year for each kilowatt the plant is rated for. As coal plants are base load producers, they have a predictable demand on energy once they are built that continues year after year.

Since India and China struggling to meet electrical demands right now, and the supply has along way to go to satisfy demand, (For example, for every American who enjoys electrical power in their home, there is one Indian and two Chinese who do not.) how much demand destruction do you envision?

2008 Aug 12 05:02 PM

[Breadnight:]

Some of you are way off in thinking that US coal producers will be exporting to China. The increased demand in China will come from Australia and (decreasingly) Indonesia. I can only think of 1 US listed pure play coal producer that has assets in Australia -Peabody (BTU).

The increased demand from China, in my opinion, will not influence US coal supplies/inventories. The two markets are independent enough, I think to have much affect on each other.

When thinking about the China demand (which is/will be huge) you must ask yourself "what type of coal fired boilers are bing built in China today?" Each boiler is built to a specific coal type, quality, moisture, and sulphur content...

Once you find out what coal specs the Chinese boilers are being built for, you can figure out what coal regions will benefit.

BTW, I have made huge coin on JRCC puts, stay away from that one, and any other coal producer that is not making money currently.

Someone needs to help me with the Chinese coal fired power plants/boiler research... any takers??

2008 Aug 19 08:53 AM

[loretta brown:]

what happens when private homeown finds a high grade of coal on their property

Jun 05 03:18 PM