Don't Fear New Coal Rules


President Obama has announced new efforts to combat climate change, many of which will be directed at limiting the use of coal. That's a headwind for the coal industry, but new rules won't be as detrimental as many think.

A Useful Point

For example, the U.S. coal fired fleet is running at about 55% of capacity, according to coal miner Peabody Energy (NYSE: BTU). The company is expecting around 60 gigawatts of coal generation to be shuttered by 2017, reducing coal demand by 70 million tonnes. The plants being retired are the oldest, least efficient, and dirtiest. Any demand loss from a plant being closed could easily be made up by higher usage at a plant that remains open.

Peabody estimates that every one percentage point change in utilization is equal to 15 tonnes of coal. Utilization would need to increase less than 5% to offset the 70 million tonnes lost to expected utility closures. Going from a 55% utilization rate to a 60% rate isn't a very big change.

Note, too, that as natural gas prices have moved higher, gas use has fallen and coal use has increased. Through the first four months of the year, Peabody estimates that gas use fell by 14% while coal use increased by 11%. Unless gas prices collapse again, coal is increasingly competitive as a fuel source, which supports utilization rates.

Cheap Coal

One of the best options for income investors is Alliance Resource Partners (NASDAQ: ARLP). The company's mines are predominantly located in Northern Appalachia and the Illinois Basin. Coal mined from these two areas tends to be very low cost, competing with gas priced as low as $3.

That's part of the reason why Alliance was able to increase production in each of the last four years, with plans for another increase in 2013. Revenues have been similarly strong, with production increases offsetting lower coal prices. So, even though the coal industry is going through a particularly difficult period, Alliance is putting up record results.

Income investors looking for a coal play will appreciate the company's around 6.4% dividend yield and long history of dividend increases.

Global Exposure

Peabody is another good option, though it hasn't been performing as well as Allied. Indeed, the company's top-line has grown steadily over the past few years but softened notably on a year-over-year and sequential basis in the first quarter. As a point of reference, Alliance's top-line was essentially flat sequentially, but still up on a year-over-year basis in the first quarter.

What Peabody offers investors, however, is diversification. Alliance's business is almost exclusively focused on serving utility customers in the United States. Nearly half of Peabody's business comes from its operations in Australia. It also has more exposure to coal used for steel production. Its Australian operations give it direct access to Asia, from which most of the growth in future demand for all types of coal is likely to emanate.

In fact, despite the recent economic slowdown in China, Peabody expects over 60 gigawatts of coal generation to come online in Asia in 2013 alone. Increased steel production is expected to up the demand for met coal, too. While prices for all types of coal are weak right now, Peabody is well positioned to benefit from increased demand. When prices pick up, results will quickly follow.

A Hedged Bet

Another option is for investors to focus on a company that is hedging its bets. Rhino Resource Partners (NYSE: RNO) is a good option. The company has been moving aggressively into natural gas drilling, setting itself up to benefit from increased use of that fuel. However, Rhino is still investing in new coal projects, too, so it isn't abandoning coal and will benefit from a coal rebound.

The biggest issue at Rhino, however, was a small distribution cut that was accompanied by the limited partnership's general partner cutting out its distributions. That would be a major sign of weakness if Rhino weren't continuing to invest in its future. And, a leverage level that's about half that of Peabody's suggests that Rhino isn't facing liquidity issues.

With a yield of around 13.8%, this is clearly an aggressive play. That said, it is paying investors very well to wait for a turnaround in coal while at the same time positioning itself to benefit from natural gas demand.

Fighting Fear

The news about coal is uniformly bad right now, at least according to the headlines. Digging a little deeper shows that there are some silver linings on the clouds. For aggressive investors, Peabody, Alliance, and Rhino are all interesting ways to play the potential for a coal rebound.



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