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Why coal producers like Arch Coal will benefit in the near term

Kshitija Bhandaru

Why coal producers like Arch Coal will benefit in the near term (Part 2 of 3)

(Continued from Part 1)

Coal and natural gas current consumption levels

Coal still plays an important role in the U.S. in power generation. As per an EIA report, U.S. coal consumption in 2013 was 925 million short tons (MMst), which is expected to go up 4% in 2014. Also as per the EIA, the country’s current coal reserves will last for 168 years at the present production rate.

Natural gas, on the other hand, has continued to benefit from the shale gas revolution. Shale gas is natural gas trapped within dense sedimentary rock formations or shale formations, therefore proving to be an inexpensive and abundant new source of fuel for the world’s largest energy consumer. The booming shale gas production in the U.S. has played a key role in boosting domestic natural gas reserves. As a result, once faced with a looming deficit, natural gas is now available in abundance. In fact, natural gas inventories in underground storage hit an all-time high of 3.929 trillion cubic feet (tcf) in 2012 and currently stand at 0.82 tcf, indicating repeated withdrawals.

The EIA expects total natural gas consumption will average 72.1 Bcf per day (Bcf/d) in 2014, an increase of 0.7 Bcf/d from 2013.

Energy shifts

According to the EIA, the demand for natural gas will increase gradually in the coming years as it continues to replace coal to generate electricity in the U.S. The primary cause of concern related to coal is global warming caused by the emission of greenhouse gases (or GHGs). Burning coal emits 205.7 pounds of carbon dioxide per million British thermal units compared to 117 pounds per million Btu for natural gas. Given mounting environmental pressure, there’s definitely a move away from coal as a power source. Per a report from Industrial Info Resources, active coal mining projects in the U.S. have declined by 39% from 2011 levels. Also, there were $12.3 billion worth of active coal projects in 2011, which declined to $7.5 billion in 2013.

However, lower natural gas inventories and higher household heating demand in an unrelenting winter sent gas prices into a rally. Prices were around $3.5 per mmBtu for much of 2013, but they’ve spiked to around $6 now. The sudden increase in natural gas prices could have a positive impact on U.S. coal demand for the year as utilities shift to coal to generate electricity.

Coal-to-gas or gas-to-coal?

Natural gas, almost exclusively and highly used by commercial and residential customers, has seen a considerable price rise in the recent period. Colder-than-normal weather has prompted utilities to burn more of the less expensive coal. Coal is far cheaper than other sources of fuel. Further, the EIA predicts average coal prices in the utility industry to decrease to $2.36 per million British thermal units (MMBtu) in 2014 from $2.38 per MMBtu in 2012. Amid these circumstances, a number of industrial and electric generation consumers sometimes switch over to low-priced coal from high-priced natural gas, creating demand for coal.

Within three years, coal’s share of power production could climb to 40.3% from about 39% last year, while gas’ share will probably drop to 27% from 27.5%, the EIA said. However, coal production is expected to decline by 1.4% year-over-year, to 1,013.1 MMst in 2015.

Also, coal as a sector has been beaten down by muted electricity demand growth, reduced export demand, and the need to conform to environmental regulations. This has raised concerns for many power producers, which have started to move away from coal to natural gas–fired power plants.

Given that natural gas prices are significantly higher than they were in the past two years, and higher relative to coal prices. Coal will likely regain some market share in the power generation sector in the near term. Coal-producing companies include Peabody Energy Corp. (BTU) and Arch Coal Inc. (ACI)—both of which are a part of the S&P Metals & Mining Select Industry Index (XME). Natural gas demand, on the other hand, will increase when prices decrease or natural gas storage facilities increase their inventory levels, creating a demand-and-supply balance (and driving down prices). Domestic natural gas producers include Chesapeake Energy (CHK), Southwestern Energy (SWN), and Range Resources (RRC). Investors can also gain exposure to natural gas through the U.S. Natural Gas Fund (UNG)

Continue to the next part of this series to find out about the one major factor that affects coal-to-gas switching.

Continue to Part 3

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