In the energy sector, perhaps nothing is as hated as coal.
The commodity’s had a heck of time gaining many fans over the last few years thanks to a myriad of factors conspiring against it. The hydraulic fracturing revolution sweeping America’s shale geology continues to unearth record amounts of natural gas and drive prices for the fuel towards record lows.
At the same time, the Obama administration and the EPA have issued new rules designed to limit carbon-dioxide emissions from new power plants. These have resulted in company bankruptcies, slashed dividends and falling share prices.
All in all, it seemed like King Coal may have been reduced to lowly Duke or the commodity world’s court jester.
Well … until coal mining giant Peabody (NYSE:BTU) reported earnings and critical guidance, that is. The canary in the coal mine might not be dead after all.
The nitty gritty of Peabody’s earnings report was a loss for the company. BTU reported a 5-cent-per-share loss and a 14% decrease in revenue for the last three months.
That shouldn’t come as a shock to anyone following the coal sector over the last year or so, though. Like many other coal companies, Peabody struggled amid stubbornly soft demand as utilities turned to cheaper natural gas to generate electricity. That slack demand drove down coal prices and hurt margins at a variety of producers.
But the interesting thing about the earnings report was just how upbeat Peabody is about the remaining chunk of the year.
First things first, that 5-cent loss actually was better than analyst expectations. The reason — aside from cost controls at the firm — was the shift back towards coal from natural gas at utilities. As many E&P firms have curtailed production of natural gas due to record low prices, inventories have finally begun to shrink. With the summer quickly approaching, natural gas prices have begun to creep up. Prices for the fuel have surpassed $4 per million Btus and are rapidly approaching $4.50.
As natural gas prices continue their way up, there are now more incentives for utility companies to switch back to coal for their generation needs. That shift seems to be happening sooner than many analysts predicted. During the first quarter, Peabody noted that overall natural gas electricity generation was down about 11%. However, that trend continued to ramp up in March. For the third month of the year, natural gas generation plunged 16% year-over-year, while coal power generation popped up 15%.
Peabody chairman and CEO Gregory Boyce expects that “during 2013, coal will recapture the vast majority of its 2012 demand that was lost to natural gas.” Plus, increased electricity generation is slated to grow coal usage by 60 to 80 million tons over 2012 levels.
Meanwhile, in its metallurgical coal segment, Peabody showed that China’s coal imports increased by 30% through March, and expects full-year imports to rise more than 10%. Likewise, major market India reported similar import gains.
However, it’s not just Peabody that is reporting bullish news from the coal sector. Rival Arch Coal (NYSE:ACI) — while also showing an earnings loss — reported a slight recovery in coal demand from utilities and forecast more gains for the rest of the year. Arch projects that U.S. coal consumption for power generation will increase by 50 million tons this year.
Given rising natural gas prices, it seems like coal may be finally returning to the spotlight as utilities’ prime choice for electricity generation. Additionally, the threat of dwindling Chinese imports due to its own growing domestic coal mining sector seems to be “more bark than bite” at the current moment.
That’s good news for U.S. coal producers. Eventually, any bump in demand from these two factors will cause coal prices to rise.
Plus, it wouldn’t take much of price increase to make Peabody, Arch or Alpha Natural Resources (NYSE:ANR) pop, considering their recent cost-cutting measures and canceled expansion plans.
With that in mind, it could finally be time for investors to get in on the coal sector.. Coal firms currently sit at multi-year lows and Arch alone is down about 80% since 2010.
Peabody represents the global leader with production in key regions like the Powder River Basin and Australia. That makes it both the export and domestic specialist for all varieties of coal and still the top “investment” in the space. Meanwhile, Arch is the leading thermal coal provider in the U.S. and Alpha is the top choice for a rebound in metallurgical coal demand. ANR is the third largest miner in the world of coking coal.
No matter which you choose, the trend is clear — King Coal is regaining his crown.
As of this writing, Aaron Levitt did not own a position in any of the aforementioned securities.