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Industry Outlook

The coal industry has been severely impacted by stringent regulatory measures to control emissions in electric power generation. But notwithstanding the many hurdles in coal’s way at present, this fuel source still holds an advantageous position thanks to its wide availability and lower cost compared to other fossil fuels and renewable sources of energy.

Per a report from the World Coal Association, we currently have 861 billion tons of proven coal reserves worldwide. This means that there is enough coal to last nearly 112 years at current rates of production. In comparison to this, proven oil and gas reserves are equivalent to around 46 and 54 years, respectively, at current production levels.

Proven reserves are considered economically recoverable at any given time, taking into account available mining technology and costsThe current availability of coal even outpaces the combined proven reserves of oil and gas. So the advantages of coal cannot be overlooked and it will definitely have bright long-term prospects for investors.

Yet regulatory measures like the Clean Power Plan will add to the mounting challenges of coal in the U.S. There has, however, been a temporary reprieve with the Supreme Court ruling in Feb 2016 to stay the implementation of the Clean Power Plan and blocking the efforts of the U.S. administration to lower global warming by regulating emissions from coal-fired power plants.

The crucial question is what’s keeping the coal industry afloat amid rising competition from other fuel sources and a hostile regulatory climate. Let’s dig a little deeper into the factors driving this industry going forward.

Coal Dominates U.S. Power Generation: Coal as a major source of generating fuel dominates the utility industry. Per the Energy Information Administration (EIA), coal was the generating fuel for nearly 34% of the electricity consumed in the U.S. in 2015. Moreover, electricity generation absorbs more than 90% of the total U.S. coal consumption. The reason is quite simple: coal is by far the least expensive and most abundant fossil fuel in the country.

Even though the EIA forecasts a 30% decline in coal usage for electricity generation in the U.S. this year, it also anticipates the fossil fuel’s usage to increase in 2017, thanks to rising natural gas prices and increase in electricity generation.

Long-Term Supply Agreements: Most of the coal companies in the business have existing long-term coal supply agreements with their customers. Coal producers are also prompt about renewing contracts on expiry as these provide earnings visibility into the future.

Not Just Electricity Generation: Electricity generation is just one use of coal in the U.S. Manufacturing plants and industries use coal to make chemicals, cement, paper, ceramics and metal products, to name a few. Methanol and ethylene, which can be made from coal gas, are used to make products such as plastics, medicines, fertilizers and tar.

Certain industries consume large amounts of coal. For example, concrete and paper companies burn coal, and the steel industry uses coke and coal by-products to make steel for bridges, buildings and automobiles.

Coal as Input for Steel Industry: Due to its heat-producing feature, hard coal (metallurgical or coking coal) forms a key ingredient in the production of steel. Nearly 70% of global steel production depends on coal. Since met coal is an essential ingredient for the production of steel, U.S. met coal producers could benefit from the increase in steel consumption.

Although the steel industry is expected to remain under pressure for some time, it is certainly expected to grow on the back of flourishing automotive and construction industries.A recent report by The World Steel Association predicts global steel demand to increase 0.2% to 1,501 Mt in 2016 and another 0.5% to 1,510 Mt in 2017. This must be a ray of hope for metallurgical coal producers.

In September, coal developer Ramaco Development and its partners announced that they are investing $90 million to develop two metallurgical coal mines in West Virginia and Virginia. This is surely good news given the present backdrop of numerous coal mine closures and bankruptcy filings by the big operators in the space.

Demand Upsurge in Asian Countries: The increase in coal demand in Asian economies like China and India has been a key price driver since the end of the recession in 2009. We expect this trend to continue in the future mainly due to rising energy needs in India, China and Southeast Asian countries.

The Asian countries also produce coal, but not enough to meet the growing demand in the region, resulting in a continuous need to import. The Southeast Asian country has a surging demand for electricity thanks to their improving economy. Numerous coal based power plants are presently under construction and more are being planned to be constructed over the next few years. This will create ample export opportunities for the U.S. thermal coal producers.

MLP and Diversification: Coal-based MLPs might be a mitigating element for the coal industry. SunCoke Energy Partners, L.P. (SXCP - Free Report) was formed by SunCoke Energy Inc. (SXC - Free Report) in 2013. CONSOL Energy (CNX - Free Report) followed the suit creating CNX Coal Resources LP (CNXC - Free Report) , which currently sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Both SunCoke Energy Partners and CNX Coal Resources LP are reporting in the green at a time when big players in the business like Peabody and Arch Coal have been forced to file for bankruptcy.

Coal companies are also resorting to diversification and are on the lookout for other sources of revenue besides coal. CONSOL Energy for the past couple of years has been expanding its natural gas portfolio and lowering its coal operation.

To Sum Up

Interestingly, among all other coal companies, Natural Resource Partners(NRP), with a Zacks Rank #2 (Buy), seems to be operating on a different level. This company has persistently stood out on the back of an unblemished earnings surprise record over the last four quarters. Its performance becomes particularly noteworthy as most of the big names continue their fight for survival.

The importance of coal in the fuel source chain is far from over. For the aggressively growing and energy-hungry Asian economies, coal seems to be the most popular source of power generation in spite of inroads being made by renewables.

Per an EIA report for the Jan 2015–Apr 2016 period, nearly 87 GW of coal-fired plants installed pollution control equipment to comply with the new emission standards, while many others are planning to do so. This makes it evident that coal will continue to be utilized in electricity generation for the foreseeable future despite the increasingly stringent emission control regulations.This surely makes it a good long-term investment for those interested in this space.

Large sections of the population in the developing nations of Asia and Africa have yet to access electricity. The lower cost of coal compared to other fuel sources and the stability coal-fired units provide to the grid’s performance make it a preferred choice in the emerging countries.

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