Investing in Coal Requires Paying Attention to Details

It wasn’t that long ago that tapping into the red hot uptrend of coal stocks simply meant buying some of the Market Vectors Coal ETF (KOL) and being done with it. After a politically-charged economic recovery though – paired with a renewed (even if spotty) social interest in the environment – coal investors are being forced to pick and choose their targets. Why? Because not all coal stocks are the same.

The good news it, spotting coal’s hot spots and cold spots isn’t a shell game. Better still, it’s not as if there’s a lack of transparency in terms of what’s hot or not in the world of coal.

What’s Hot

Coal Usage in India and China: Stimulus supported growth is actually working on several international fronts, causing China and India to become major importers of thermal coal… needed by now-busier steel mills in those locales.

Who does this help? Companies like Walter Energy (WLT) and Peabody Energy (BTU), both of which enjoy strong market share within the Chinese market. Peabody is something of a double-barreled competitor, with Australian as well as U.S. operations. Australia meets about 2/3 of China’s coal needs; Peabody may need to double its Australian output based on current growth rates.

Metallurgical coal: Coal demand isn’t sky-rocketing for all coal equally. Metallurgical coal needed by smelts and factories – sometimes called coking coal – is where the demand is really growing. That’s marginally true for the U.S., but very true for Asian factories.

Who does this help? Companies like Rio Tinto (RTP) and BHP Billiton (BHP), two of the coking market’s dominant players.

What’s Cold

U.S. Electricity-Generating Coal: The recession crimped usage of coal for industrial purposes at the same time coal stockpiles surged to multi-year excess; coal production in the United States is running about 10% on a year-over-year basis, while inventories are about 20% higher than last year’s already–high levels. In other words, demand for coal in the United States isn’t apt to improve significantly anytime soon.

Who does it hurt? Coal companies like Arch Coal (ACI) and Alpha Natural Resources (ANR), which rely heavily on U.S. demand.

Thermal coal: Though the use of coking coal is up, the need for thermal coal – coal used to fire electric power plants – isn’t recovering nearly as well… particularly in the United States. Demand is still ramping up in China though.

Who does it hurt? Again, Arch Coal (ACI) relies a little too much on sales of thermal coal for investors’ comfort.

Yes, there are exceptions and plenty of overlap when it comes to companies affected by these trends. Now that the trends are identified though, identifying the better investments isn’t too big of a task.

(Originally written for Kapitall.com)