Sell-Off In Coal Stocks An Overreaction

Includes: KOL
by: StockRiters

U.S. stocks were hammered in Wednesday's trading session amid rising worries over the looming threat of the dreaded "fiscal cliff." A day after the U.S. presidential election that saw President Obama getting re-elected, focus turned to the terror of the oncoming "fiscal cliff."

All eyes are now on lawmakers in Washington DC. If the Congress fails to reach an agreement on trimming America's burgeoning fiscal deficit before the year-end deadline, automatic spending cuts and tax increases worth $600 billion will be implemented. This could drag the U.S. economy into a recession.

While all industry groups in the S&P 500 plunged on concerns over the fiscal cliff, coal stocks were among the hardest hit, albeit for a different reason.

Among the major coal producers, shares of Peabody Energy Corp. (NYSE:BTU) dropped 9.64%, while those of Alpha Natural Resources Inc. (ANR) dropped 12.16%. James River Coal Company (JRCC) shares were the biggest losers, falling 30%. Arch Coal Inc. (ACI) shares tumbled 12.47%, while CONSOL Energy Inc. (NYSE:CNX) dropped 6.11%.

So what sparked the sell-off in coal stocks?

The sell-off in coal stocks was directly sparked by the re-election of incumbent Barack Obama as president on Tuesday. Investors are speculating that the re-election of President Obama would mean tighter regulations for coal producers.

In fact, coal stocks had been rallying prior to the election on hopes of a win for Mitt Romney, who had made coal a major part of his plan for energy independence. President Obama has also spoken enthusiastically about energy independence; however, he doesn't see coal playing a major part. Obama is a proponent of alternative fuels even though he has seen a few setbacks, including the Solyndra bankruptcy. However, the fresh mandate may give him the confidence to push with his plans for developing alternative fuels.

So does this mean difficult four years for the coal industry?

Indeed, President Obama is no friend of the coal industry. However, the problems for the coal industry stem not so much from tighter regulations as they do from change in market dynamics. The biggest challenge for the coal industry is cheap natural gas prices.

Recently, natural gas has for the first time become a serious competitor to coal as the biggest fuel for domestic power generation. As a result, coal demand has fallen sharply in the U.S. The performance of coal stocks this year reflects the changing dynamics for the coal industry. Coal stocks were helped for a while by hopes of a Romney win; however, with that hope gone, the sentiment has once again turned bearish on the coal industry.

However, the rally in coal stocks in the last month or so before Wednesday's sell-off was not entirely due to hopes of a Romney win. Another major factor was a sharp rise in natural gas prices as seen by the chart below.

(Click to enlarge)


In addition, coal producers are also implementing measures to adapt to the changing environment. Back in September, Peabody Energy announced that it ceased production at its Air Quality Mine in Indiana and will permanently close the mine based on soft market conditions that make operations uneconomic.

Alpha Natural Resources announced a strategic repositioning plan back in September under which the company is looking to reshape its mine operations, establishing core sets of durable, cost-competitive assets with sharp focus on metallurgical coal business.

The measures announced by coal producers will help in improving the supply-demand balance.

So, another four years of President Obama may mean a strict regulatory environment for coal producers. However, the coal industry's prospects do not solely really depend on who is in the White House. What will have an impact on coal producers are natural gas prices. Peabody, at the time of the release of its third-quarter results, had said that U.S. coal demand rose sharply in the third quarter given higher natural gas prices and a 22% rise in cooling degree days over the long-term average. According to the company, this lead to an increase in the coal's market share of U.S. electricity from the low 30% range in the second quarter to 39% in September.

Also, shale drilling, which has led to record low natural gas prices, is not exactly an environment friendly activity. So, the industry, like coal, may see some stricter regulations. This could curb supply and push prices higher, making coal prices competitive.

Finally, while U.S. coal demand has fallen, coal producers have been looking overseas. The Energy Information Administration expects coal exports to hit a record this year. And, remember the global economy is weak, with China and India, two major consumers for coal, seeing a sharp slowdown. U.S. coal exports are therefore likely to accelerate once the global economic situation improves.

Sell-Off an Overreaction

While the outlook for the coal industry is not bullish, Wednesday's sell-off may have been a bit of an overreaction. As I said earlier, the future of the coal industry depends not so much on who sits in the White House, but on natural gas prices. If natural gas prices rise, coal demand in the U.S. will bounce back. In addition, coal producers have been streamlining operations and shutting down mines. In the end, the coal industry may emerge more efficient and stronger from the changing market dynamics.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.