There’s Still Money in Coal
Now the situation couldn’t be more different. I’ve highlighted the ongoing tightening of supply and demand in the
Although the coal mining firms aren’t as inexpensive and depressed as they were back then, the fundamentals continue to improve; I see the potential for a further spike higher in coal and coal-related stocks in the coming weeks.
Far too many investors and pundits made the mistake of misinterpreting the fourth quarter earnings releases from the major coal mining firms. Several of the big US-based coal producers either missed or barely met expectations for fourth quarter earnings; the stocks tended to sell off sharply in the immediate aftermath of these reports.
Some investors were puzzled by the seemingly weak results in the face of sky-rocketing coal prices. The reality was that these results were widely expected and nothing new. Check out the chart of Big Sandy Barge coal prices over the past few years.
Clearly, spot coal prices—the price of a ton of coal for immediate delivery—are trading at new highs.
Smaller miners simply couldn’t shoulder these costs, especially with coal prices so depressed earlier in the year. Many smaller operations shut down entirely, while larger, better-capitalized players scaled back production from their highest cost mines.
At the same time, demand for
The situation became so dire earlier this year that the Chinese government actually banned exports of coal from
The end result of all these forces is that coal supplies are tight in
For the first time in more than a decade, European utilities are contracting with US producers for coal supplies. US exports of coal are rising rapidly. And Europeans are paying top dollar to ensure coal supplies under long-term contracts. Already, according to mining giant Consol Energy, there are two- to five-year contracts being signed. And there are also ongoing discussions for 10-year deals.
With exports rising and production pressured by new regulations, inventories of coal in the
The obvious question is why the
The fact is that most coal companies sell only a small part of their production under spot deals; coal miners instead contract with utilities for longer-term supply at fixed or relatively fixed prices. The reason earnings lagged is that fourth quarter earnings were based primarily on contracts signed about a year ago at much lower coal prices.
Over time, those older contracts will roll over to new deals signed at much higher prices. The realization of this fact is likely why most of the mining stocks quickly recovered from their post-earnings malaise.
But this contract cycle isn’t really the key point to emerge from the recent earnings season; this is well known to any coal analyst. What’s far more interesting are some of the bullish comments to emerge from fourth quarter conference calls. Consider the example of Union Pacific, the largest railroad in the
The railroad noted weakness in transport volumes for a variety of consumer items as well as a few commodities such as lumber. Lumber demand has some leverage to the weakening housing market.
The market where Union Pacific sees the most strength for 2008: moving coal, particularly out of the Powder River Basin (PRB) of the western US. During the conference call, coal transport demand seemed to be one of only a handful of business lines where Union-Pacific has high visibility in terms of demand and pricing for 2008. In fact, the railroad continues to work on improving efficiency on its coal routes. This suggests that demand for moving coal continues to outstrip rail capacity.
Union Pacific went on to note another few important trends. First, management highlighted that the demand for moving coal is tied to export demand. Coal from the PRB hasn’t traditionally been exported because it has a lower heat content. (A given amount of coal contains less potential energy.) PRB coal does, however, have the advantage because it’s cheap to mine and is typically ultra-low in terms of sulfur content.
It’s likely that coal from the eastern US is being burned locally or sent off as exports to
That said, Union Pacific did offer a tantalizing hint that PRB coal may find a direct export market. Management alluded to the fact that some producers want to move coal out of the PRB to the West Coast, likely for export to a coal-starved
Another interesting coal-related conference call to listen to was Consol Energy. This company noted that, although coal prices are rising, they’re not yet at levels that would encourage producers to actually open new mines. Management noted that although there are plenty of potential unexploited reserves in the
This suggests two points. First, coal prices can move a good deal higher from where they are today. And, more important, there will be no rush of new coal supply from new
And Consol’s management appears to be acting accordingly. The company still has more than half of its planned 2009 production unsold. Management went on to say that the company is in no hurry to contract that coal. That clearly suggests the firm believes the coal price bull market hasn’t played out yet.