Why this near-forgotten commodity will make a comeback
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Investment Director – The Fleet Street Letter
David Stevenson Jul 09, 2012
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The one bright spot arising from all the fears about a slowing global economy is that energy prices have fallen.
Oil is the most obvious example. The price has been all over the place recently, as investors can’t work out whether to be more concerned about Iran or about the eurozone.
But there’s another fuel that’s been on the slide – coal. And the reasons behind coal’s collapse seem to be much more fundamental than the factors driving the oil price.
So is coal set to become a fuel of the past? We very much doubt it. Coal’s fall from favour will be temporary.
Here’s why – and how to profit.
The collapse in coal prices
Why has coal fallen in price? There’s the weather for starters.
Here in Britain so far, we haven’t had much of a summer. But we didn’t have a particularly cold winter either. Nor did the US. And this milder-than-usual winter weather has been a big factor curbing America’s demand for electricity.
But it’s not just about the weather being warmer than expected. The US economy is still fragile, which means its power needs have been lower than usual in any case.
On top of that comes the plunge in natural gas prices. In the year to the end of April, US natural gas prices halved. That prompted American utility companies to switch to using natural gas to power their generators instead of coal, as I discussed two months ago.
So people have been using less energy, and what energy they do use can be generated more cheaply by a substitute fuel. Add it all up, and it’s little wonder that the coal price has suffered.
The somewhat arcane-sounding Central Appalachian thermal futures is the main US benchmark for gauging the cost of the country’s coal. On this measure, US coal prices are down 30% within the last 12 months.
That’s been great news for US coal users. But it’s been a nightmare for the producers and their shareholders. Indeed, several smaller American coal producers have recently been afflicted by rumours that bankruptcies could be about to hit the sector.
This wouldn’t matter so much if the outlook were about to improve. But according to the experts, it’s only going to get worse.
In May, Moody’s Investors Service lowered its outlook for the US coal industry to ‘negative’ from ‘stable’ on the back of weak prices and a drop in power demand. Moody’s expects the US cost of coal to drop by 5% next year. Meanwhile the US Energy Information Administration expects a 10.9% fall in coal consumption this year.
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Coal has a bright future ahead of it
None of this is good if you get the stuff out of the ground. So is coal as an energy source going into terminal decline?
“Not a chance”, says energy analyst Gregor Macdonald. “Indeed, everything currently unfolding for coal in the US is precisely what is not unfolding for coal globally.
“In the same way that falling US oil consumption has freed up global supply, US declining coal demand is freeing up production for export. Last year marked a 20-year high in US coal exports. Demand for coal in the developing world remains gargantuan. The global coal juggernaut rolls onward.”
Now, if you’ve been reading the latest headlines, you may question that. China is the world’s No.1 coal consumer. And its stockpiles of the commodity have climbed 50% over the last 12 months to their highest since 2008. Meanwhile domestic coal prices have fallen by 20%. That seems hardly promising.
And if Chinese economic growth keeps slowing, an immediate coal price recovery is just as unlikely here too. John Stepek looked at China last week, and he’s not too keen on what he sees.
On top of that, there are widespread climate change concerns. Coal is the dirtiest fossil fuel, emitting twice as much carbon as natural gas. European legislation to curb gas emissions will lead to a number of coal-fired power plants closing in the next few years.
So to repeat: should investors look elsewhere to make money?
I don’t think so. Good stock investing is about being ahead of the game. As my colleague James McKeigue noted two months ago, there are plenty of reasons to believe that coal could make a big comeback.
“Coal is cheaper per unit of energy produced than any other fuel apart from US shale gas. It’s also abundant, with enough left in the ground to supply current demand for over 120 years. Because it’s well spread out, importers are less worried about security of supply or having to deal with cartels such as OPEC.
“China’s demand for energy is so great that last year it overtook Japan to become the world’s biggest importer too. The country might be heading for an economic slowdown, or even a hard landing, but in the longer run its energy demand will continue to grow, even if slower.”
James pointed out that India’s coal use is also growing fast. With 300 million people still without a power connection, India desperately needs more electricity. It’s expected to triple the number of its coal-fired plants over the next decade. India has also cut import tariffs, making life easier for external coal exporters.
Indeed, “across Asia, from Bangladesh to the Philippines, the drive for more coal-fired power seems unstoppable,” says The Economist. No other energy source offers affordable electricity on a big enough scale. Even Europe may need to build more coal power plants and burn more of the stuff than it would like – just to keep the lights on.
And the time to buy shares in coal producers is when no one else wants to touch them with a bargepole. That’s certainly the case now – the Dow Jones US Coal index has dropped by two-thirds since April 2011.
It could still be a touch too early to get in – but you should be watching the sector. James recently spotlighted several ways of playing the long-term coal story in MoneyWeek magazine. You can read about them here: The return of old King Coal. His recommendations also include companies working on turning coal emissions into less harmful gas, meaning we could burn coal – without the unwanted side effects.
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