Investing in the Coal Rally
A Snapshot of the Opportunity Set
Coal Backdrop
Coal companies do not all have the same risk and return profiles. Some, like Twitter darling Peabody Energy (BTU), I put in the category of trading like an option on it’s own. The daily standard deviation of BTU is like riding a bull, you have to have conviction in the fundamental backdrop and hold on for dear life or else get bucked off at the lows for a loss.
With risk comes reward and there’s obviously a reason BTU is trading like an option - they were having a liquidity crisis not too long ago and the bankruptcy rattle was getting louder and louder. Like someone no longer able to swallow or cough effectively enough to clear their throat, BTU shareholders had the collective despair of a terminally ill patient.
With the resurgence of natural gas prices however, the rodeo was rescheduled and today’s persistent energy price appreciation has given new life to BTU shareholders, and the collective group known as #CoalTwitter.
Thermal Coal
Shown below is the Jan. ‘22 Henry Hub Natural Gas Futures contract:
With the failure of fracking business model in 2020, and associated gas from the Permian basin being crushed, natural gas prices are finally shifting structurally higher.
Natural gas prices are finally shifting structurally higher.
The above line is important so let’s break it down. I say “finally” because we’ve known for some time that fracking doesn’t make money. It was all the way back in 2015 that David Einhorn recognized that fracking companies are a joke. It took WTI going negative and with it energy companies crashing for the easy money to finally get shut off.
I also say “structurally” because I believe we are exiting a world with sub-$3 natural gas prices and entering a world of energy scarcity with greater than $4 natural gas prices being the norm.
Metallurgical Coal
Shown below is Aug. ‘21 US Midwest Domestic Hot-Rolled Coil Steel futures contract:
With the post Covid pent up demand for products containing steel (appliances, autos, etc.) finished steel prices have reached new all time highs. Likewise, the raw materials for steel production are also rallying. Iron ore has hit all time highs and metallurgical coal (with it’s move being somewhat delayed due to the Chinese ban on Aussie coal imports) is now approaching rarely seen highs as well.
Maximize Returns
So how do we maximize returns in an environment of rapidly changing structural issues? The simplest answer is to play the catalyst directly. Why invest in a coal company if the catalyst is rising natural gas prices, for example; why not just go long natural gas itself or invest in natural gas producers for that matter? The answer is that because the coal companies have been so massively beaten down, they could easily spring back. I tweeted the other day the following:
Of course it’s hard to make apples to apples comparisons for each company compared to itself 3-5 years ago. Especially a company like $BTU where so much has changed during that time (which is why I left it off the list). But you get the point; IF capital markets realize that coal is not dead and capital flows back into these “value” names, then there is a massive risk/reward opportunity to take advantage of.
The Playing Field
List of publicly traded coal companies listed on US exchanges worth considering:
AMR - Alpha Met Resources (mostly Appalachian met coal)
ARCH - Arch Resources (mostly App. met coal but includes PRB thermal)
ARLP - Alliance Resource Partners (Illinois Basin thermal coal)
BTU - Peabody Energy (PRB & ILB thermal US & Australia, some met)
CEIX - CONSOL Energy (Northern App. thermal)
HCC - Warrior Met Coal (Southern App. met)
HNRG - Hallador Energy (Sunrise Coal; ILB thermal)
METC - Ramaco Resources (mostly met)
SOUHY - South32 Ltd (Australian met)
TECK - Teck Resources (Mix of Canadian met, thermal, copper, etc.)
Cheat sheet on how to think of them:
AMR - benefits from higher US East Coast met indexes, somewhat from higher Australian FOB QLD prices and from higher US domestic met price contracts.
ARCH - Arch Resources - benefits from higher USEC prices, higher US domestic met contracts, and higher PRB thermal prices.
ARLP - benefits from higher US domestic thermal prices and somewhat from higher export thermal markets via Gulf Coast ports.
BTU - benefits primarily from higher PRB prices and volumes.
CEIX - benefits from higher Atlantic seaborne export thermal markets and US domestic thermal prices.
HCC - benefits from higher Australian FOB QLD met indexes.
HNRG - will get it’s lunch eaten by ARLP & other ILB producers.
METC - benefits form higher met US domestic and USEC met prices.
SOUHY - benefits from higher Australian FOB met indexes.
TECK - trades with copper producers of late, not a coal pure play.
Direct ways to play Natural Gas prices (without trading futures):
UNG - front month(s) natgas futures contract tracking ETF
UNL - 12 month natgas futures contract tracking ETF
BOIL - leveraged ProShares natgas ETF
Option Liquidity:
Things to Consider
I really think you have to consider whether small caps are doing well relative to large caps, whether value indexes are doing well relative to growth indexes, and whether equities in general are trending up or down. For example, if small caps are doing well relative to large caps OR if value indexes are doing well relative to growth, then I think you have to be invested in coal equities. Conversely however, if large caps are outperforming OR equities are trending down (which is rare these days), then it may be better to look towards natural gas plays on the commodity instead of equities generally.
There are always special situations that require you to hold despite whatever the overall trends may be signaling. For example, I wrote an article on Warrior Met (HCC), describing what I believe is a special situation which once resolved could be a catalyst for rapid price rally in the stock. In these situations you have to sit and hold, perhaps with some predetermined stop loss or calendar stop out in order to better define your risk.
Summary
There is definitely a coal rally happening in equity and commodity markets. Coal can be confusing to the uninitiated due to it being two different products (thermal & met) and involved in (at least) two different raw material supply chains (electricity & steel production). I hope I have provided a quick overview of what is happening in each to cause such a spike in coal prices as well as how to think about the ramifications in coal equities.
If you have any questions on investing in coal, or the opportunity set I described please let me know. If you think I left anything important out, please let me know that as well.
Hmmm... I recently loaded on some BTU during the pullback. I am wondering if you have a target price to exit the position? Do you use coal price as the indicator? When coal supply starts to ramp up by a lot, and prices cool off, then we sell BTU and other coal equities?
In your cheat sheet comment about Hallador, could you provide a little more information. I own shares. Thank you for the excellent analysis.