Should Coal Investors Be Worried?

Should Coal Investors Be Worried?

Many people will tell you that the use of coal as fuel around the world is declining. That said, people will also tell you that rapidly growing 'tiger' economies within Asia will need to use cheap coal to power their economic growth.

Unfortunately, this does not make things clear for investors who have placed bets on coal. However, one thing we do know is that the price of Australian thermal coal recently hit a low not seen since the financial crisis of just under $83 per metric ton, down from a high of $142 per metric ton seen back in 2008. But the question is, should investors give up on coal?

Coal is still important
According to the world coal association, Coal provides around 30% of global primary energy needs, generates 41% of the world's electricity and is used in the production of 70% of the world's steel. However, it would seem that coal's use as a fuel is starting to slow, as the world's largest coal consumer, China, recently announced measures to tackle air pollution, which included slashing of coal consumption. On the other hand, Japan's coal consumption jumped 26% year on year based on figures released at the end of October, as the country, still recovering from its recent nuclear disaster, increased its dependence on the black mineral.

Still, it would appear that the falling price of coal has very little to do with supply and demand. In particular, based on numbers supplied by BP and the World Coal Association, global consumption of coal expanded 2.5% during 2012, and supply increased 2.9% -- not a huge supply/demand deficit or surplus. Consumption of coal outside OECD nations expanded 5.4%, the global average was dragged down by consumption of coal within the United States, which collapsed 12%.

Obviously this is not good news for Peabody Energy . Peabody Energy is the world's largest private-sector coal company with 16 coal mines within the United States and 10 in Australia. Fortunately, Peabody provides a full cost breakdown for its investors; unfortunately, these numbers do not make for good reading.

For the first nine months of this year, Peabody sold 124.4 tons of coal from its mining operations in the western United States, this production accounted for 67.2% of total company production. However, and this where the numbers shock, the company reported that it sold this coal for a figure of $17.80 per ton. Peabody also reported that its operating cost per ton for this production was $12.85 for the first nine months of this year. So, profits weren't totally illusive.

In comparison, the company's coal produced within Australia was sold for $111.84 per ton during the first nine months of this year, costing $79.32 per ton to produce.

Meanwhile, coal is expected to only amount to 16% of Cliffs Natural Resources' (NYSE: CLF)tonnage output during fiscal 2013. However, Cliffs is forecasting a revenue per ton figure of $100-$105 and a production cost per ton of $85 to $90 -- both figures are higher than those of Peabody. Moreover, Cliffs has its highly lucrative iron ore operations to carry the torch while coal margins decline. Indeed, it is cheaper for Cliffs to mine one ton of iron ore for $65-$70 per ton within the U.S. than it is for the company to mine coal. Currently, the price of iron ore is trading above $100 per ton, so margins are significantly more appealing.

One of the key takeaway points from both Peabody and Cliffs is the fact that their U.S.-based coal operations are not that profitable and margins are thin. Indeed, were it not for the international operations of Peabody and iron ore mining operations of Cliffs both companies would be struggling to turn a profit.

Expensive U.S. coal
Unfortunately, Arch Coal has no international diversification outside of the United States, or diversification, and the company is suffering. For example, during the fiscal third quarter the company reported a cash cost per ton of $16.51; if we add in other operating costs such as depletion and depreciation, the cash cost per ton rises to $19.37. This appears fine until we discover that the company's average sales price per ton for the period was only $19.54, leaving an operating margin of $0.17.

This is not good and it would appear that things are only going to get worse for Arch from here on out. As coal consumption within the U.S. continues to decline, the company is likely having to going to have to make some deep cost cuts during the next few years.

Foolish summary
So should coal investors jump ship? Well, looking at the numbers from Peabody and Cliffs, I would say not yet. The international diversification of both companies is allowing them to both produce and sell coal for less and profits are still coming in. What's more, Cliffs is benefiting from its exposure to the iron ore market, which is reporting strong demand as the Chinese construction market remains robust.

Unfortunately, Arch Coal's investors are unlikely to see the company post profits again anytime soon as the price of coal within the U.S. continues to decline and production costs remain high.

The big picture
The decline of coal as a method of energy generation is in-part down to the record oil and natural gas production, revolutionizing the United States' energy position. Finding the right plays while historic amounts of capital expenditures are flooding the industry will pad your investment nest egg. For this reason, the Motley Fool is offering a comprehensive look at three energy companies set to soar during this transformation in the energy industry. To find out which three companies are spreading their wings, check out the special free report, "3 Stocks for the American Energy Bonanza." Don't miss out on this timely opportunity; click here to access your report -- it's absolutely free.

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Fool contributor Rupert Hargreaves 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.

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