HardAssetsInvestor

Written by Julian Murdoch  |

October 22, 2009

Coal Stocks: Heating Up?

Details

As coal companies begin reporting their earnings, how can you tell the stars from the stinkers?

• Why thermal vs. metallurgical matters
• Why Peabody's earnings were better than expected
• How to pick a coal stock

Taken as a whole, coal industry stock prices have done pretty well for themselves since January, and as Brad Zigler discussed in Oct. 19's "Time to Clean Up With Dirty Coal?", playing the Market Vectors Coal ETF (NYSE Arca: KOL) is a good way to trade the entire sector.

But sometimes investors want a more targeted approach, choosing one or more companies to invest in. That's the allure of stock-picking: Even in the best-performing sector, there will always be that one shining star - and that one stinker to avoid.

But as we enter earnings season, it can be tough to tell which is which, given that coal mining companies are expected to report lower year-over-year third-quarter earnings.

Ultimately, it may come down to the coal itself: Analysts have noted that how well and how quickly companies have recovered in Q3 will strongly depend on what type of coal they produce. Companies selling metallurgical coal, used for making steel, should see higher prices than those who produce thermal coal, used in generating electricity.

A Cruel Summer For U.S. Coal

Of course, in the United States, coal is mainly used for electricity generation; in fact, almost 50 percent of all electricity in the U.S. comes from burning coal. But since the recession has severely slashed industrial electricity needs, as a result, U.S. coal demand is down - way down.

Just look at these production figures from the latest EIA report:

That black line on the bottom is 2009, and as you can see, it has hovered below 2007 and 2008's production levels for most of the year. That's mostly due to intentional efforts by the industry; by shuttering mines and instituting planned production slowdowns, companies hoped to keep demand and supply in balance.

But the U.S. experienced a cooler summer this year, which led to less demand for electricity to power air conditioners. Complicating matters, low natural gas prices also helped tamp down coal demand, as electrical companies opted for the cheaper fuel.

So not only has less coal been produced this year, says the EIA, but stockpiles are at their highest levels since 1999. Compared with the previous three years, coal stockpiles are now 20 percent fatter: