Thursday, April 12, 2007

Coal: There Is Green In It..

America has a growing demand for electricity and is currently the largest consumer of electricity in the world. In our homes, our businesses, and industries, Americans spend more than $210 billion on electricity each year. In fact, electricity and food are the two largest commodities bought and sold in America.

Electricity demand has continued to increase since the 1970s. While we are more efficient in our use of energy, demand has grown largely due to the introduction of new technologies — such as the Internet — which consumes about 8 percent of U.S. energy. Between 1970 and 1999, electricity use grew by more than 130 percent, and will continue to climb: According to the U.S. Energy Information Administration (EIA), America's energy demand is anticipated to grow over 45 percent in the next 20 years. What is the main fuel for all this electricity? Coal, it fuels about 40 percent of the world's electricity and over half of America's electricity (this amount continues to climb annually), which is more than all other sources combined.

Other than electricity, what are some additional uses of coal?
  • Coal liquefaction offers promise for nations that are rich in coal, yet scarce in oil. There are four plants in the United States and South Africa currently using coal as feedstock to create liquid fuels. A plant using more than 6 million tons of coal annually could produce more than 3.6 million barrels of diesel and Naptha annually, making diesel liquefaction competitive at $35 to $40 per barrel oil prices. China has earmarked $15 billion for coal-to-diesel-fuel conversion plants and has targeted replacing 10 percent of its oil imports with coal-liquified oil by 2013.
  • Partial oxidation - gasification - combines feedstock, oxygen and steam to produce a synthesis gas that is cleaned of impurities. Syngas can be used as a fuel to generate electricity and steam or as a chemical building block for the petrochemical and refining industries. The gasification process converts feedstock such as coal, crude oil, petroleum-based materials or gases into marketable fuels and products.
  • Syngas from gasification historically has been used as a feedstock for the production of chemicals, accounting for nearly one-half of syngas use worldwide in the late 1980s. World gasification capacity grew by 50 percent during the 1990s, with more than 40 plants coming on line.
  • Today, there are approximately 155 commercial gasification plants in development, construction or operation around the world in 28 countries in North and South America, Europe, Asia, Africa and Australia. When operational, these facilities will provide the energy equivalent of more than 770,000 barrels of oil per day.
How to invest and make money on coal?

Just as investing in alternative fuels begins and end with Archer -Daniels Midland (ADM), commercial roofing and insulation with Owens Corning (OC) and paint and coatings with Sherwin Williams (SHW), investing in coal begins and ends with Peabody Energy (BTU) . Since their initial public offering on May 22, 2001, at $28 per share, or $7 per share on a split-adjusted basis following the March 2005 and February 2006 two-for-one stock split, shares hit a high of $75 in May of 2006. Since then, shares have fallen steadily (40%) to their current level of $45 despite growing earnings last year 60% . The world's largest public coal company, their products fuel approximately 10 percent of America's and 3 percent of the world's electricity.

So, how much coal does Peabody have? If you converted their coal into each one of the following energy sources, Peabody's reserves would provide :
  • Enough electricity to provide all the US electricity demands for 5 years
  • More that 10 times the total US natural gas uses
  • Diesel fuel: enough to fuel the US truck fleet for 42 years
  • Hydrogen: enough to replace all oil in US transportation for 6+ years
BTU has not traded in a PE range this low since early 2003 when it's stock traded for a split adjusted $9 a share. Since that period they have grown earnings from 25 cents a share to $1.92 last year (680%) and dividends have grown from 11 to 24 cents a share (118%). Since 2001, shipments of coal have grown from 194 million tons to 240 million tons in 2006 and in 2006, their worldwide coal sales were 38% greater than their closest competitor and in the US, Peabody's shipments were 22% of all US coal shipments and 80% greater than the closest competitor. They clearly dominate the coal market both nationally and internationally.

The Future:

So, now that we know where we are, we need to figure out where coal and BTU is going. Let's take a look at both worldwide demand and demand here at home in the US. The EIA estimates that 115 gigawatts of coal fueled electricity will come on line worldwide in the next 3 years and by 2030, an additional 156 gigawatts will come online in the US. These uses by themselves will require an additional 500 million tons of coal annually. This does not include additional coal demand for the other uses previously mentioned.

Currently BTU has a 1 billion ton backlog of orders with contract ranging from 1 to 19 years with the average being 5 years. All long term contract have "price re-opener" provisions in them which protects BTU from a profit squeeze should input costs rise unexpectedly.

BTU is currently is in the process of building 3,100 megawatts of electrical generation capabilities in two locations at BTU owned mining sites. This will enable BTU to become a "minimal cost" electrical producer at these locations as they would be using their own coal to produce the electricity they would then resell.

Debt grew by $1.7 billion in 2006 as this money was used to purchase Excel Coal in Australia and repay its debt. The acquisition makes BTU that largest coal producer in that country also and provides BTU a lower cost basis to export coal to Asia and China whose demand for it is surging. The Australian mines primarily produce "metallurgical coal" . This high BTU coal is primarily used for the production of steel and is highly sought after by China. Selling for about $100 a ton (vs approx. $26 a ton for all other coal), BTU estimates it will sell an additional 3 to 6 million tons of this in 2007 vs 2006 providing about $500 million in additional revenue with no added cost.

For 2007 BTU is predicting 265 to 285 million tons of coal shipments for a 10.4% to 18.7% increase over 2006.

From 1990 to 1999 the price of coal declined from $1.38 per million BTU's to $ .91 per million BTU's. Since 1999, that trend has reversed and prices have risen to $1.15 in 2005 and the EIA estimates this price will continue to rise to $1.84 by 2030.

Geopolitical Considerations
The news this week made reference to, but did a lousy job of covering the "summit" of natural gas producers. These nations are attempting to band together and create an OPEC like cartel for the sale of natural gas. The US is not one of these nations and the formation of an organization like this would only be done for one reason, to raise the price of natural gas. This event, should it come to fruition, would be monumental to the coal industry. It would create a huge demand for reliable, low cost fuel for the production of electricity and more plants and other industries would move from natural gas to coal as their main fuel source. I anticipate these nations will form this alliance and Peabody and its shareholders will be the main unintended beneficiary of it.

So, all this now has us considering buying shares of a company that is the world leader in its industry, with increasing demand and pricing power for its products selling at historically low levels....

ValuePlay anyone?

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