Don’t Let the EPA Spook You Out of Coal Stocks

by James Brumley | June 3, 2014 9:35 am

Don’t Let the EPA Spook You Out of Coal Stocks

On the surface, the news that the Environmental Protection Agency is cracking down on carbon dioxide emissions seems like the beginning of the end for coal stocks like Peabody Energy (BTU[1]), Walter Energy (WLT[2]) and Arch Coal (ACI[3]).

coal Dont Let the EPA Spook You Out of Coal Stocks[4]If the EPA is serious, then coal is the prize-winning goose to put on the chopping block.

However, before anyone assumes the worst for WLT, ACI or BTU stock — or any other coal stocks — there’s a much bigger flipside to the story.

Don’t Dig a Grave for Coal Stocks Yet

Just as a quick recap, the EPA officially proposed on Monday that the nation take the necessary actions to reduce carbon emissions by 30% (from 2005′s levels) by the year 2030[5]. The proposal itself doesn’t explicitly and solely target coal, though considering coal produces about 40% of the United States’ electricity[6] and burning it is twice as dirty as natural gas, investors quickly connected the dots.

The end result: ACI stock dropped 3.1%, in addition to the 22% pullback Arch Coal shares saw over the course of May. WLT stock fell 5.3% on Monday following its 32% selloff last month.

Investors knew the proposal was on the way weeks ago.

The $64,000 question is, are investors of coal stocks right to be worried here, or is this weakness a buying opportunity?

As it turns out, there are three reasons the latter might be the more plausible choice.

1. The EPA proposal still is subject to change

It should be made clear to anyone who currently owns BTU, ACI, WLT or other coal stocks that the proposal so far is just that — a proposal. Public hearings will be held in late July to get feedback from both sides of the table.

As expected, the pro-coal camp is already fine-tuning its arguments. The planned pushback so far consists of threats of lawsuits to be filed against the EPA by states that heavily rely on coal power for energy and/or revenue. The arguments might hold some water, too.

2. The EPA has more bark than bite

The new standard of greenhouse gas limitations might be established by the Environmental Protection Agency, but it’s leaving it up to individual states to come up with a plan to reduce the carbon output of power plants in those respective domains.

Problem: There’s no clear recourse for states that don’t abide by the new rules.

The EPA has preemptively notified states that if they don’t come up with their own game plan, the agency will impose its own plan on the states. What the EPA has not done, however — and has little authority to effectively do — is clarify how it could actually enforce such a plan, particularly when the political or social support for the plan is as wobbly as it is for the clean power proposal unveiled Monday.

3. We were on the path to a 30% reduction in carbon output, anyway

With all of that being said, one of the key details that investors of coal stocks have overlooked in the matter is how we’re already halfway to a 30% reduction in the greenhouse gases we were creating in 2005.

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As Forbes’ Christopher Helman explained following Monday’s news, the advent of electricity sources like solar, wind, natural gas and cleaner-burning coal power plants in the meantime has already reduced 2005′s carbon output by 15%[7]. Ergo, we’ve only got 15% left to carve out, and we’ve got 15 years to figure out how to get there. That’s plenty of time not just to optimize alternative sources of electricity, but 15 years to figure out how to use less electricity in the first place.

Thing is, we’ve already got the tools to put make that happen in a very significant way. LED light bulbs use 80% less electricity than conventional light bulbs.[8] That’s a big deal, considering that lighting accounts for 40% of electricity usage in a typical home. Mathematically, switching to LED bulbs alone would mean a typical home could use 32% less energy than it presently uses, achieving the EPA’s goal.

And if that doesn’t do the trick, zero-carbon-emission solar energy is close to reaching cost-parity with most grids, and the financing of solar panels now makes them affordable for any consumer. Solar only supplies about 0.2% of the nation’s current energy demand[9], so the sky’s the limit for the positive impact more solar power could make to offset coal’s downside.

Point being, the states might be able to reach the mandated goals simply by accelerating initiatives that are already underway.

Bottom Line for Coal Stocks

None of this is to say coal stocks like Walter Energy and Arch Coal (Peabody primarily serves the Pacific market and isn’t overly vulnerable to EPA rules) won’t feel the effect of tougher greenhouse gas emission standards. They will. These companies make more money by selling more coal, and if we’re burning less of it, it means less revenue for these miners. Under the EPA’s proposed plan, however, the coal industry survives. That’s more than many of its critics were expecting in 2009 when fracking became common and solar power became feasible.

And interestingly, while one arm of the government seems to be doing all it can to crimp coal, another arm of the same government — the Energy Information Administration — still predicts that annual coal production will grow between now and 2040[10] (albeit at a modest 0.3% per year). It’s not great, but it’s better than the alternative.

The reason for the tepid optimism is rich, too … growing demand for natural gas should, ironically, push gas prices to levels that make coal attractive again, regardless of the carbon emission costs. The EIA seems to be the first and only organization to recognize that natural gas prices will ramp up with the coming swell of demand the EPA is ultimately working to create, creating more pain in the pocketbook than most consumers are going to overlook.

The bottom line is, while they might never be red-hot again like they were in 2008, coal stocks are still oversold from their 2011-13 implosion, and still have more upside than downside here now that the EPA has found a way to fit coal into the long-term plan. The fact that coal prices are still on the rise since last August’s low[11] confirms demand is still recovering.

The highly vocalized posturing and threats from all the interested parties in the meantime is just good business.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Endnotes:
  1. BTU: http://studio-5.financialcontent.com/investplace/quote?Symbol=BTU
  2. WLT: http://studio-5.financialcontent.com/investplace/quote?Symbol=WLT
  3. ACI: http://studio-5.financialcontent.com/investplace/quote?Symbol=ACI
  4. [Image]: http://investorplace.com/wp-content/uploads/2011/03/coal.gif
  5. reduce carbon emissions by 30% (from 2005′s levels) by the year 2030: http://yosemite.epa.gov/opa/admpress.nsf/bd4379a92ceceeac8525735900400c27/5bb6d20668b9a18485257ceb00490c98!OpenDocument
  6. coal produces about 40% of the United States’ electricity: http://www.eia.gov/electricity/monthly/epm_table_grapher.cfm?t=epmt_1_1
  7. has already reduced 2005′s carbon output by 15%: http://www.forbes.com/sites/christopherhelman/2014/06/02/obama-epa-issues-coal-killing-rules-to-cut-carbon-emissions-30-percent/
  8. LED light bulbs use 80% less electricity than conventional light bulbs.: http://www.kilowattours.org/mediakit/Energy-Facts-and-Stats-from-Kilowatt-Ours.pdf
  9. Solar only supplies about 0.2% of the nation’s current energy demand: http://cnsnews.com/news/article/terence-p-jeffrey/solar-provides-02-electric-supply-002-obama
  10. annual coal production will grow between now and 2040: http://www.eia.gov/forecasts/aeo/MT_coal.cfm?src=Coal-b1
  11. coal prices are still on the rise since last August’s low: http://www.infomine.com/investment/metal-prices/coal/all/

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