There’s an old Wall Street adage that goes “markets can remain irrational longer than you can remain solvent.” That saying seems to have been written especially for coal stocks.
Coal, as you know, has been under siege from the combination of higher environmental regulation and cheaper alternatives.
Rising natural gas production and the EPA have punished coal stocks for the better part of three years. And just when coal seems like an insane value, big-time bargain and is on the cusp of a return … it gets even worse for the miners, and coal stocks continue to be a bloodbath.
For investors, sometimes you just need to walk away and never look back.
Coal Stocks Slide
The terrible tale for coal stocks begins back in 2010 and 2011. Fracking had just started to unearth a plethora of natural gas. Surpluses of the fuel surged and prices dropped. And at one point, natural gas broke $1 per MMBtu.
Well, that cheap price was enough to cause utilities to think twice about how they generate electricity.
And if that wasn’t enough, changes to environmental rules pushed coal stocks right over the edge. Under a sweeping new set of regulations, the EPA and Obama Administration set forth to fight pollution and climate change.
The new rules basically forbid the building of new coal plants, and old existing plants would require more scrubbers and air filters to stay operational. Given the immense costs of keep old coal plants alive — and the newfound cheapness of natural gas — utilities didn’t spend much time trying to justify their coal plants.
Neither of these two factors have been good news for coal stocks.
Demand has plummeted, which has caused prices for coal to tank. In the pre-fracking days, a ton of metallurgical coal — think steelmaking — cost a whopping $330. During the first quarter of 2015, that same ton could be bought for $117. Today it’s about $95. Thermal coal — the kind used in electricity generation — has fallen by a similar staggering sum.
Profits for coal stocks have anything but positive. Bankruptcy potential has increased — and in some cases has struck companies twice. As of the end of last month, the Market Vectors Coal ETF (KOL) has lost a staggering 13% annually since its launch in 2008.
But don’t be fooled by the potential value in the coal sector — things keep getting worse for the industry.
Avoid the Value Trap
For one thing, demand keeps on falling. China is often the largest consumer of almost any commodity and coal was no exception. But it seems that china’s appetite for coal has been satisfied.
According to Reuters, China’s General Administration of Customs’ data shows that total coal imports — thermal & metallurgical — for the first five months of the year hit 83.26 million tons — a 38% drop year-over-year. Lower economic growth and renewable energy adoption caused the decrease.
Meanwhile, here in the United States, coal consumption continues to drop as well. The Energy Information Administration (EIA) predicts a 7% decrease in coal usage for electric power this year as utilities continue to shut down old plants and switch to natural gas.
As for those shut-downs, the EIA estimates that 90 gigawatts (GW) worth of coal-fired power plants will be retired by the year 2040. The story is similar in Europe.
Of course, that falling demand has continued to erode prices for both kinds of coal. Mines that were profitable as late this spring may be forced to close or seriously reduce capex spending.
The quote of the hour comes from analysts at BB&T, who said that prices are “putting U.S. miners in a position where they can’t avoid losing money” and that prices are bad enough to effectively preclude any financial improvement.
And as if falling demand and prices weren’t enough, coal stocks are being forced to deal with extra issues as well.
For example, the Wyoming Department of Environmental Quality has begun reviewing many of the miners’ financial data to determine if they still qualify for a self-bonding program. That program “allows coal producers to cheaply insure their clean-up costs in case of bankruptcy,” according to one of the department’s economists. If they don’t qualify, miners may be forced to buy corporate surety bonds or hold enough cash/T-bills to cover potential reclamation liabilities.
Just Take a Pass on Coal Stocks
The big three coal stocks — Arch Coal (ACI), Alpha Natural Resources (ANR) and Peabody Energy (BTU) — are trading basically for pennies. Industry stalwart BTU is down about 85% over the past 12 months alone. Shares of Walter Energy (WLT) trade for little more than a quarter, and Powder River Basin specialist Cloud Peak Energy (CLD) has lost nearly half its value in just a year.
That fall and perceived cheapness of the coal stocks may have grabbed the attention of your inner value investor. It happened to me last March, when both ACI & ANR broke a buck and still had a few years to work on their debt loads. I assumed that things couldn’t get much worse for the coal industry and that if it got better, that both ACI & ANR could be worth the gamble.
Nope. It got worse and it’s still getting worse.
The short-term demand is gone. The long term demand is going away. Prices for coal are dropping. Debts for many of the coal miners still remain high. Nothing about this situation screams value, and it’s time to stop pretending that eventually this movie will have a happy ending. Not as long as the world has an abundant supply of natural gas.
The best advice is to run — not walk — as far away from the coal sector as possible.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
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