June 28 Dave Steinberg often feels like one of the last remaining bulls in the tumbling U.S. coal market, and even he struggles to put a happy face on the industry.
Coal stocks "have been terrible," said Steinberg, a managing partner at Chicago-based DLS Capital Management, which oversees $350 million in assets and owns positions in coal producers such as Peabody Energy Corp, Arch Coal Inc and Alpha Natural Resources.
Each stock had fallen more than 40 percent for the year at Thursday's close, and was down at least 24 percent this month, to levels Steinberg calls "absurd." All told, Steinberg has lost "more than I would like to admit," he said.
"I've been in the business for 30 years and I don't think I've ever seen worse sentiment," he said, adding that he thinks each company is worth "at least double" its current trading price. He sees rising consumption and falling inventories stabilizing prices over the next year - a view that not many other investors share.
Despite their relative optimism, Steinberg and other coal bulls have a tough road ahead, with few believing they've seen the bottom for coal stocks even as some hit 10-year lows.
Most U.S. coal miners sell a mixture of thermal coal, used to generate electricity, and higher-margin metallurgical coal, used to make steel. Right now, both markets are under pressure.
With the shale gas revolution cutting the price of natural gas, U.S. power plants have been burning less coal. And the threat of regulation that could discourage coal generation - like the carbon rules promised by President Barack Obama on Tuesday - has cast a shadow over the U.S. thermal industry.
Nomura analyst Curt Woodworth believes the most recent slump in coal stocks has been largely driven by a slide in the global coking coal market, as steel production slows and the Australian coal supply recovers from some operational problems.
"I think we're getting close to the bottom - I'm not sure we're there yet," said Woodworth, who covers U.S. metal and mining companies. Shares have fallen, Woodworth said, but so have earnings, so the stocks are still "very expensive."
Investors that are bullish on the emerging economies see long-term potential in steel, and thus in metallurgical coal. But right now the slowdown in Chinese growth, paired with a glut of capacity, is weighing on the steel market.
Benchmark coking coal has dropped to $145 a tonne for the third quarter, its lowest since 2009, from $172 in the second quarter, according to Doyle Trading Consultants.
Any investors looking for relief in the thermal coal market suffered a blow on Monday, when the U.S. Supreme Court agreed to revisit a lower court ruling that invalidated the Cross-State Air Pollution Rule. The rule, which limits nitrogen oxide and sulfur dioxide emissions from coal-fired plants in 28 states, could cut coal demand.
Then on Tuesday, President Barack Obama said he had directed the Environmental Protection Agency to craft new carbon emission rules for thousands of power plants, the bulk of which burn coal.
Any rules are likely to be challenged in court and take years to implement, but even if the regulatory push fizzles, thermal coal miners may still face competition from cheap natural gas.
Given the competition and regulatory risk, KeyBanc Capital Markets analyst Mark Parr said he remains "cautious" on the coal industry, wary of both metallurgical and thermal sectors.
NERVES OF STEEL
But even with share prices tanking, some buyers do remain.
Brian Burrell, an energy analyst for the $28.7 billion Thornburg International Value fund, said it has been adding to its position in Canada's Teck Resources Ltd, whose revenue is split between metallurgical coal, copper and zinc.
The company's shares have fallen nearly 40 percent year-to- date, but he points to rising steel demand in emerging markets countries, Canada's political stability compared with competitors, and Teck's share buybacks as reasons for optimism.
Other investors are turning toward master limited partnerships, or MLPs, that produce and distribute coal. Structured much like real estate investment trusts, these companies pass through most of their revenues to investors. They are less sensitive to spot coal prices because they have long-term hedges and contracts that give them constant revenue streams.
Darren Schuringa, a managing partner at New York-based Yorkville Capital Management, has been shying away from coal equities given that the spot price is "too tough to forecast," he said. Instead, he has been buying Alliance Resource Partners LP and Natural Resource Partners LP. Both MLPs are up more than 10 percent for the year, offer yields of 6 percent plus, and are on track to increase their cash distribution this year, he said.