While There's Action in Oil Stocks, There's Real Energy in Coal Shares

By Martin Hutchinson
Contributing Editor

Oil prices above $100 per barrel have made the headlines recently, and investment advisors have competed with each other in recommending oil investments.

But here's some inside insight from the shrewdest investing pros: The true energy play is an energy source whose price has risen more than oil in the last year, and which is located primarily in politically stable, friendly countries - most notably the U.S. market itself.

I'm talking, of course, about that miracle fuel of the 19th Century - coal, the forgotten fossil fuel.

As picturesque as it sounds, I'm not suggesting that if oil runs out by 2050, we'll be chugging to work in coal wagons - frantically shoveling the black rocks into the firebox trying to build up some steam for the passing lane on the freeway.

Nor can we expect to glide to work in solar-powered yachts, their photoelectric sails gleaming in the morning sunshine [For one thing, London, Los Angeles and other cities around the world would be periodically paralyzed by the smog-induced shrouds that regularly cover these fair cities].

No, if oil runs out we'll undoubtedly putter to work in a wheeled vehicle that contains a bunch of batteries and something called a "fuel cell" - but the power stations that recharge those batteries will be fueled primarily by coal.

Coal prices have zoomed northward during the past year. The current spot price is around $135 per metric ton, more than double the level of a year ago. For longer-term contracts, Rio Tinto PLC (RTP) is currently seeking a contract price of $135 per metric ton from Japanese power companies for its deliveries in 2008, up 143% from the contract price of $55.65 that was in place for most of 2007.

Indeed, negotiations are under way on new coal contracts that could cause coal prices to double in price this year. The contracts go into effect April 1.

Meanwhile, coal production is running way ahead of forecasts. In 2005, the World Coal Institute reported production of 4,970 million metric tons, up 78% over 25 years. At that point, its 2030 forecast of 7,000 million metric tons seemed reasonable - 44% above 2005's level, suggesting a modest worldwide relaxation in environmental concerns. However, 2006 saw an 8.8% production increase and 2007 was another excellent year. At current growth rates, the WCI's 2030 production target would be achieved by 2010.

The main reason for coal's growth is that 80% of China's power needs and 65% of India's come from coal-fired stations. Other alternatives are not big enough to supply their rapidly growing economies. Nuclear power offers its own safety dangers, and nuclear power stations take an extremely long time to construct, while solar power is hopelessly short of the scale needed.

Plans for the world's largest solar power plant were unveiled Tuesday. It will be built in Victoria, Australia, will cost a mere $270 million, and when fully operational will supply 354 megawatts of power - equal to 0.1% of Australia's needs, which are modest compared to those of India and China.

Since both India and China are expected to quadruple their power consumption by 2030, most of that increase must come from coal-fired stations. With modern clean coal technology, the new plants' environmental impact can be lessened, but no reasonable carbon pricing will significantly slow the rapid rise of coal usage.

That's good news for coal. While oil supplies depend on the whims of governments not necessarily friendly to the United States, coal is abundantly available in countries with a healthy respect for private property, with the United States, China, India and Australia being the top four producers.

Coal stocks have done very well during the past year. Consider the 12-month returns of the following companies, which are U.S.-listed and which specialize primarily in coal:

  • Peabody Energy Corp. (BTU): 51%.
  • Consolidated Energy Inc. (CNX): 126%.
  • Arch Coal Inc. (ACI) 72%.
  • Massey Energy (MEE) 74%.

Among the international players, China's Yanzhou Coal Mining Co. (YZC) has returned 65% in dollar terms, while Australian-listed Centennial Coal Co. Ltd. has returned 176%.

You can also invest in coal through general mining companies such as Australia's BHP Billiton Ltd. (BHP).

What's the best buy? Well, the bad news is that all these stocks have been bid way up. On the basis of trailing earnings, most are trading at a pricey 40 or 50 times earnings [Centennial actually is trading at 440 times earnings]. However, the big jump in coal prices means that earnings are rising rapidly, too, meaning that their "forward" Price/Earnings ratios - those based on earnings for the current year - are in a much-more-reasonable range of 16 to 17.

Of the companies listed, I'd go for two:

  • St. Louis-based Peabody is the world's largest producer of pure coal, with reserves of 9,000 million metric tons [which have a sale value of $1.3 trillion at today's inflated prices]. At 16 times 2008 earnings, it's not overly expensive; indeed, given its reserves, its market capitalization of $14 billion makes it look like a bargain.
  • China-based Yanzhou is alluring, in part, because the company is headquartered where the market is. This stock is a little more reasonably priced - at 40 times trailing earnings and 14 times prospective earnings - and has a market capitalization of $9 billion.

The bottom line: Who needs oil companies, with all their political risk and the accompanying market volatility?

The real "black gold" is coal.

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