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Europe’s coal renaissance and how to play it

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The growth story for U.S. thermal coal producers is both simple and compelling.

It goes like this: Thermal coal's primary competition comes from natural gas, which is cheap in the United States and outrageously expensive in cash-strapped Europe. As a result, European utilities have been importing all the U.S. coal they can get, boosting revenues of the companies that produce the fuel.

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Granted, the notion that there might be money in coal will surprise many people. As investors in Teck Resources Ltd. are painfully aware, metallurgical ("met") coal – the type used for steel making – has a decidedly more downbeat outlook.

Prices for met coal, Teck's specialty, have fallen sharply on weaker Chinese demand. China is dealing with overcapacity in the steel industry and is also producing more met coal domestically.

But while met coal is hurting, the thermal coal industry is undergoing a renaissance. European natural gas prices are close to $12 (U.S.) per million British thermal units (Btu), almost triple the North American rate, and regional utilities are finding coal a much cheaper option. Scientific American reports that figures from the U.S. Energy Information Administration show that "Europe is now by far the biggest customer for U.S. coal, importing more than all other markets combined. U.S. exports to the U.K. jumped by about 70 per cent in 2012."

The United States is literally, as The Wall Street Journal notes, selling coal to Newcastle as British coal consumption for electricity climbed 50 per cent in 2012.

Data on U.S. coal exports to the continent in 2012 are not yet available, but we do know that 2011 saw a 92-per-cent increase and that total U.S. coal exports (to the entire world) hit a record 115 million tons (104 million tonnes) for the year.

Pennsylvania-based Consol Energy Inc. offers an interesting play on this theme. Bank of America analyst Devin Corr writes that "Consol Energy is our only 'buy'-rated stock in U.S. [coal shares], given our preference for less met exposure [and] its low-cost Northern Appalachian thermal operations."

Consol's internal estimates point to a 55-per-cent increase in coal consumption in the next two decades. In an effort to meet this demand, and expand non-U.S. revenues beyond the current 20 per cent of total sales, management has funded an $11-million upgrade of its Baltimore shipping terminal to increase the annual export capacity by 16 million tons.

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The company also has a growing natural gas production business, currently 15 per cent of sales. This provides a more stable, diversified revenue stream that protects investors from a sudden shift from coal to natural gas in any of their major markets. The natural gas reserves may prove an important buffer for the company's profits when new environmental restrictions on U.S. coal-power utilities take effect in 2016.

Mr. Corr is not the only analyst optimistic about Consol Energy. Of the 27 analysts who cover the stock, 21 have it rated a buy and the average price target is $41.76 – 27.4-per-cent more than current levels. As always, of course, investors should do their research before buying.

Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights , and follow Scott on Twitter at @SBarlow_ROB.

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About the Author
Market Strategist

Scott Barlow is The Globe's in-house market strategist. He is a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth (MPW). He was a highly ranked mutual fund analyst for 10 years and then, most recently, the head of a financial adviser support team at MPW. More

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