1 Reason Why Met Coal Could See a Quick Rebound

1 Reason Why Met Coal Could See a Quick Rebound

Metallurgical coal has seen a nasty price drop because of industry oversupply. However, one interesting trait of such coal means that steel mills won't be loading up for later use. That's good news for Teck Resources , Peabody Energy , Alpha Natural Resources , and Arch Coal .

It's just a rock, right?
Metallurgical coal, which is used to make steel, isn't just a rock. Only the highest grades of coal can be used to make steel. It's one of the reasons why met coal commands such high prices. When met prices rocketed higher on Chinese demand, even high-cost mines were profitable.

So supply quickly outstripped demand. That's led to a drop in prices. Peabody saw its revenue per ton of coal from its Australian operations fall 23% in the third quarter, year over year. More than half of its Aussie coal is metallurgical. That compares to its U.S. business, which saw a price drop of just 5%. All of that coal is thermal.

Clearly, the pain on the met side is much more severe. With such a large price drop, however, you might expect steelmakers to load up on coal while the price is low. That's not likely because, as Teck recently pointed out, "Met coal sitting out, exposed to the air for awhile will degrade."

Good news and bad news
The good news is that "[G]enerally speaking most of our customers wouldn't be keeping more than 30 or 40 days worth of inventory," according to Teck. That means stockpiles aren't likely to skyrocket to the point where met miners have to wait not only for high-cost mines to shut but also for stockpiles to fall before prices recover.

For example, Cloud Peak Energy , which exclusively mines ultra-cheap Powder River Basin thermal coal, noted in its third-quarter presentation that coal-fired power generation was up 6% through the first nine months of the year while natural gas use was down 13%. It makes sense to think that sales of desirable PRB coal would have moved higher. But Cloud Peak saw sales drop 5%, year over year, in the quarter. Why?

Powder River Basin stockpiles fell nearly 23% year over year. So, despite the uptick in demand for coal, utilities have built up a hoard of the stuff that they must work off before they'll buy more.

Eagerly awaiting an upturn
Teck has seen low prices but has been successful selling its met coal in Asian markets. Generally, Peabody has been doing the same, since its met operations are located in nearby Australia. Alpha and Arch, on the other hand, have been suffering because of the low met prices and relatively weak demand from Europe. Right now, it's tough for the pair to compete in Asia and make money.

So while Teck and Peabody will be helped out by a met-price uptick, Arch and Alpha really need one if they want to see results improve. That's doubly true for Arch, which bought into the met arena at the peak of the market. This saddled the company with a heavy debt load at, perhaps, the worst possible time.

While that's a big negative for Arch, Alpha is hampered by a notable thermal presence in less desirable regions. For example, while Arch has a big position in the PRB, Alpha only gets about 10% of its revenues from that region. The rest comes from areas that are getting hit by coal-basin switching.

Neither Arch nor Alpha, however, is as geographically diversified or financially strong as Peabody. And Teck is more diversified by product, including a push into oil.

This too shall pass
At the end of the day, metallurgical coal isn't something you can let sit around. That will quicken the pace of the eventual price recovery for Teck, Peabody, Arch, and Alpha. Mines still must be shuttered to reduce supply, but at least demand is still strong and stockpiles, by necessity, low.

See our top stock pick for the new year
The market stormed out to huge gains across 2013, leaving investors on the sidelines burned. However, opportunistic investors can still find huge winners. The Motley Fool's chief investment officer has just hand-picked one such opportunity in our new report: "The Motley Fool's Top Stock for 2014." To find out which stock it is and read our in-depth report, simply click here. It's free!

The article 1 Reason Why Met Coal Could See a Quick Rebound originally appeared on Fool.com.

Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2013 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

Originally published