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Coal comfort

16 Mar 2012 By Christopher Swann

U.S. coal has crossed an ominous milestone, with its share of power generation falling below 40 percent for the first time since 1978, the Energy Information Administration reported last week. Cheap gas and tougher pollution rules should extend the trend. But investors can still make winning bets if they plan for the industry’s decline.

Long the cheapest source of electricity, the black rock is being pushed aside by natural gas. With U.S. gas trading at the lowest prices in a decade, it is now twice as costly to produce electricity from Appalachian coal as from gas, according to investment bank Brean Murray, Carret.

Gas prices would have to skyrocket before coal’s economic supremacy was restored. And tighter emissions rules have already contributed to the retirement of over 100 coal plants over the past year – around 13 percent of the total coal capacity in the United States – and more are set to follow. It’s a far cry from the nearly 60 percent market share coal commanded in the mid-1980s.

There’s a brighter outlook for coal worldwide. The U.S. Department of Energy expects demand to climb 50 percent by 2035. But only about 5 percent of America’s coal is typically exported. By the time port facilities are upgraded, China and Australia are likely to have ramped up production, satisfying much of the growth in global demand.

It is small wonder that miners like Patriot Coal and James River Coal have lost three-quarters of their market value over the past year. Still, for brave investors there may still be money to be made. The coterie of possible U.S. winners will have access to stronger foreign markets. Such names include Peabody Energy, with its global footprint, and Consol Energy, which owns its own port.

Peabody’s stock price has halved over the past year, and the company now trades at an enterprise value of just under six times estimated 2012 EBITDA, according to Barclays – well below the five-year average of eight times. Meanwhile Barclays reckons Consol’s market value is 30 percent less than the combined worth of its parts – a wider discount than is typical. Players like these stand to make the most of weaker rivals’ difficulties in a tough domestic market, too.


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