Coal Generates Global Strength

As investors continually look toward commodity-based investments to solidify their portfolios in these sagging market times, Zacks senior coal industry analyst Neil Malkin was on hand recently to give us his updated outlook on coal.

While some commodity-oriented stocks are growing more conservative in their profit-margin outlook, you are staying bullish on coal companies. What is the advantage coal stocks have, looking ahead?

Coal companies should see more favorable margins than some of the E&P [exploration and production] players in the energy sector. While crude prices have been extremely volatile of late, the downward movement in prices since mid-July has spread to coal prices. Additionally, investors have worried about shrinking margins as futures market prices for coal from certain basins have pulled back somewhat inline with crude’s pullback.

However, these futures markets are cash markets and don’t correlate with the prices for actual deliverable coal prices that are currently being contracted. As global supply and demand fundamentals have not changed, coal producers should maintain their outlook and their margins should not be adversely affected. I think that the main advantage coal companies have relative to other energy sector participants is that the global story supporting strong coal prices has not deteriorated.

Additionally, coal companies don’t feel the effects of higher prices immediately as prices from legacy contracts weigh down the average realized prices. As these older contracts roll off, average realized prices will jump higher, thus increasing margins to a greater extent. These contracts have begun to roll off for a lot of producers and this will allow them to not only have increasing margins but maintain a higher average pricing base going forward.

The U.S. is still a net exporter of coal. Does the possibility of a global economic slowdown concern you?

Well that possibility is always there, but the actions of domestic coal producers suggest otherwise. Several companies have been looking into and starting to contract with European and Asian buyers for contract terms with longer-than-usual durations. I think that if you look at the low stockpile levels in the Pacific Rim, it is clear that foreign demand for U.S. coal won’t be slowing down. Many industry participants forecast a global coal supply deficit of 30 million tons in 2008, which suggests that demand is increasing faster than supply. This basically goes against the whole global slowdown idea.

Of the coal companies you cover, which would you consider the strongest, and why?

If I had to pick one company I would choose Peabody Energy (BTU). This company has the largest presence in essentially every basin it operates in domestically. It also has a substantial operating arm in Australia which is a very valuable piece of its business as its proximity to Pacific markets yield premium prices for the coal “down under.” It has an impressive track record for safety and operational performance which help it consistently meet its production estimates.

It has the ability to increase production with projects in the western U.S. and ramping up production and port capacity in Australia. Lastly, with the significant amount of cash flow BTU will generate this year and next, it should be able to pay down its $3 billion worth of long-term debt.

For investors looking to increase their exposure to coal, what advice would you give them that they might not already be aware of?

Look at companies involved with coal gasification technologies. This process basically takes low grade coal and coal waste that would otherwise have no value and turns into synthetic gas which can be used commercially or used as feedstock to create gasoline and other transportation fuels.

Although in the U.S. the progress has been slow due to insufficient backing from the government and more stringent environmental standards, China has been the focus of these companies as the government has been dedicated to creating additional sources of transportation fuel to mitigate its oil dependence.

These programs could be incredibly lucrative as the input cost is much cheaper on a million per Btu [British thermal unit] basis relative to gas or oil. As coal is most plentiful in the U.S. and China these countries will most likely be targeted for coal gasification projects.

Neil Malkin is a senior analyst covering the coal industry for Zacks Equity Research.

Comments

[schminkie:]

gasification and liquifaction are a ways off profitabilitywise.

2008 Sep 04 10:22 AM

[billp37:]

Pollution caused by coal combustion wastes appear to have caused concern in New Mexico where three coal combustion electric coal-fired generating plants operate: four corners, san juan, escalante (for arizona electricity).

www.theoildrum.com/nod...

More on New Mexico coal production

www.prosefights.org/co...

2008 Sep 04 10:23 AM