Investing in Coal

Aug 6th, 2007 | By Jim Nelson | Category: Commodities

A few weeks ago, we wrote to you about the Clean Energy Act of 2007 that the Senate passed in late June. If you remember, this was an act requiring 36 billion gallons of renewable fuel production in this country annually by the year 2022. It also mandated a 35 miles per gallon minimum on new cars by 2020. We told you we’ll have to just wait and see what Nancy Pelosi and the House does about it. Well, that wait is over…

In a 241-172 vote on Saturday night, another energy bill was passed in the House with slightly different requirements. In the new bill, there is a provision requiring electric utilities to generate 15% of their electricity from renewable energy sources. Currently, only 2.6% of our energy comes from renewable sources. This new requirement could spell some big changes elsewhere.

Currently, coal accounts for about half of all electricity production in this country. This bill would significantly hurt the already damaged coal industry, or so one would think…

The coal industry has been in bad shape for the past few years because of higher diesel prices and new safety rules. Industry experts are now expecting a massive consolidation will hopefully change things.

Compared to other mining industries, coal is the only one in the U.S. that hasn’t undergone a consolidation. In today’s Wall Street Journal, Kris Maher tells us why; “[The] three major drivers of acquisitions in other commodities – resource scarcity, high cash flows that companies are eager to reinvest, and favorable valuations of companies based on strong pricing models of commodities – are lacking in U.S. coal.” This is about to change…

Coal is not scarce. Of any resource, we have the most coal. The U.S. still has the world’s most coal reserves. But other countries don’t have that luxury. So countries like China and India, which are burning through coal like it’s a three-pack-a-day-smoker’s morning cigarette, are in great need of foreign coal. They just can’t produce enough to meet their own demand.

Unfortunately, the United States hasn’t benefited much from this. In the first quarter of this year, only 3.9% of the coal produced was exported. Most of the coal companies in the U.S. are small regional producers, not exporters. But with more demand from abroad, the big international coal companies like BHP Billiton and Rio Tinto, who have the capability to ship their coal around the world, could easily swoop in and gobble up a few U.S. companies.

The second point made by Maher was the low cash flows of these coal companies compared to other mining companies. That make sense in the U.S., but companies like BHP and Rio have enough cash on hand to buy a few of the smaller U.S. ones, without batting an eye.

Just look at Wilber Ross and his International Coal Group (NYSE: ICO). Ross, billionaire/textile, steel, and auto components tycoon, bought out two distressed American coal companies Horizon and Anchor because he realized the potential here. It is quite foreseeable that other big investors and companies could jump in on the reserve potentials of these types of junior mining companies.

Lastly, the WSJ article mentions valuations of coal companies based on strong pricing models of commodities. These models are thrown out the window, or at least they should be, when you bring in the complexities of international demand and clean coal technologies. No one is capable of determining how big this clean coal trend will become. It is still in the initial stages of a potential industry-changing breakthrough.

Whichever bill comes out on top (if any), either the House’s or the Senate’s, the coal market will be affected, but not as much as people are guessing it will. Even if the U.S. goes 15% green, it’s only 15%. Plus, it won’t affect exports one bit. Look for these international mining companies to come down from their perch and devour these tiny U.S. coal companies to exploit their reserves.

Sincerely,
Jim Nelson
August 6, 2007

P.S.: The best way to invest in possible acquisitions like these is to buy shares in the smaller buyout candidates before they get bought. But, this is not always easy. You don’t know for sure which ones are the buyout candidates and which ones are going to miss the boat. It’s tough to navigate the world of acquisitions. Luckily, you don’t have to. My fellow Penny Sleuth editor, Greg Guenthner, is an expert at this, and in his newsletter, Penny Stock Fortunes, he tells his readers which companies are the most likely to be bought out and which ones don’t need to be.

Jim Nelson

Jim Nelson is the managing editor of Penny Sleuth. He has been playing the stock market since he was 14, always with a preference toward smaller companies. He has honed his stock picking skills at Agora Financial since 2004, effectively combining a growth and value approach. Like Greg Guenthner, Jim also contributes to Penny Stock Fortunes on top of bringing you the Penny Sleuth every weekday.

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