Would You Add Coal to Your Portfolio? - Industry Outlook

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There is no denial that the stricter regulatory measures to control pollution will have an adverse impact on the unrestricted use of steam coal for power production. Having said that, coal still holds an advantageous position due to its wide availability and lower cost compared to other fossil fuels and renewable sources of energy. Importantly, the Congress resulting from the recent mid-term elections is expected to be a lot more sympathetic to the industry than it had been previously.

Per a report from World Coal Association, we currently have 860 billion tons of proven coal reserves worldwide. This means that there is enough coal to last nearly 118 years at current rates of production. In comparison to this, proven oil and gas reserves are equivalent to around 46 and 59 years, respectively, at current production levels. Proven reserves are considered economically recoverable at any given time, taking into account available mining technology and costs.

So, as per the above data, the current availability of coal outpaces the combined oil and gas proven reserves.

Per a U.S. Energy Information Administration (EIA) report, coal production in the first nine months of 2014 was 742 million short tons (MMst), down 0.4% from the year-ago period. However, EIA projects fourth-quarter U.S. production to improve and overall 2014 production to go up 1.4% in 2014 to 998 MMst. Production is further expected to increase 0.4% year over year to 1,002 MMst in 2015.

What keeps the coal industry rolling amid rising competition from other fuel sources and a stringent regulatory climate? We have tried to address these factors below.

Coal Dominates U.S. Power Generation: Coal as a major source of generating fuel dominates the utility industry. Coal is used to generate near about 40% of the electricity consumed in the U.S. Electricity generation absorbs about 93% of total U.S. coal consumption. The reason is simple: coal is by far the least expensive and most abundant fossil fuel in the country. The worst of the regulatory overhang is likely behind us as well, particularly following the mid-term elections.

Not Just Electric Generation: Electricity generation is just one use of coal in the U.S. Manufacturing plants and industries use coal to make chemicals, cement, paper, ceramics and metal products, to name a few. Methanol and ethylene, which can be made from coal gas, are used to make products such as plastics, medicines, fertilizers and tar.

Certain industries consume large amounts of coal. For example, concrete and paper companies burn coal, and the steel industry uses coke and coal by-products to make steel for bridges, buildings and automobiles.

Recently, Westmoreland Coal Company (WLB) signed a long-term coal supply agreement with diversified chemical company FMC Corporation (FMC). The new deal terminates two old contracts and extends the fresh one through 2026.

Coal as an Input for Steel Industry: Due to its heat-producing feature, hard coal (metallurgical or coking coal) forms a key ingredient in the production of steel. Nearly 70% of global steel production depends on coal.

There is some good news from the World Steel Association as it predicts global steel usage to increase 2% year over year to 1,562 metric ton (Mt) in 2014 and by another 2% in 2015 to reach 1,594 Mt.

Since met coal is an essential ingredient for the production of steel, U.S. met coal producers like Walter Energy (WLT) and Alpha Natural Resources Inc. (ANR) could benefit from this revival.

Demand Upsurge in Asian Countries: The increase in coal demand in Asian economies like China and India has been a key price driver since the end of the U.S. recession in 2009. We expect this trend to continue in the future mainly due to the growing energy needs in India, China and South Korea.

Of the Asian countries, economic growth in China and India will be the fastest. These two countries do produce coal, but their domestic coal production has yet to match the growing demand, resulting in the continuous need to import. These two countries rely heavily on coal for electricity generation.

Japan is also importing large volumes of coal following the deactivation of its nuclear power plants. Given the rising demand from the fast-growing Asian economies, companies find it attractive to export coal to these regions. Peabody Energy (BTU) in a bid to access the Asian coal markets had acquired Macarthur Coal of Australia in 2011. Australia is a developed country with huge resources and is strategically located closer to the Asian nations. Peabody is also extending its operations to Thailand, the world's largest supplier of sea-borne thermal coal and located nearer to the Asian demand centers.

To Sum Up

Hence black diamond hasn't seen its last days yet and is continuing to lend support to the industry. For the aggressively growing and energy hungry Asian economies, coal seems to be the popular source of power generation though renewables are increasingly making inroads.

As per a report from International Energy Agency, total global coal fired generation units at the end of 2012 was 1,627 GW. Gross installation of coal fired units worldwide is expected to increase by 1,112 GW at the end of 2035. A major portion of these additions will be in India and China. So there will be no waning in coal demand for the next couple of decades in spite of increasing greening.  

Check out our latest Coal Industry Outlook here for more details from an earnings perspective, and how the trend is looking for this sector from now onwards.


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WALTER ENERGY (WLT): Free Stock Analysis Report

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