In November of 2010, Warren Buffett paid a visit to Arch Coal’s Powder River Basin operations in Wyoming. At the time the company was selling at a price of $28. Since that time the price has fallen to $12 with a price to earnings of 17 for 2011 and forward p/e of about 12 for 2012.

The energy landscape has changed dramatically since Buffet looked at Arch Coal in 2010. Not only have natural gas prices nearly fallen by half, but prices of solar panels have also grown much cheaper as cheap Chinese solar panels have flooded the market. Berkshire’s MidAmerican utility most recently invested in a solar farm in California. Even more remarkable is that even as the costs for these forms of electricity production have gone down, the price of coal as gone up.

Coal’s share of total US electricity generation has been steadily dipping as it recently fell below 40%. Most of the gains have accrued to natural gas and as the price of natural gas dipped further in 2011 that trend will only exacerbate problems for the coal industry.

Figures for Arch Coal:



But for companies like Arch Coal, exports are making up an increasingly greater share of revenues. India and China, with their insatiable demand for metallurgical coal that’s used in steel production, are driving up global demand for coal and along with it prices. China is both the largest producer and importer of coal. However, that coal is not coming from Arch Coal as the miner ships nearly half of its exports to Europe.

Many question marks surround Buffett’s trip to the Powder River Basin. Surely he must’ve had some interest in the company even though it probably was not the asking price. Arch Coal is one of the low-cost coal producers and was able to record a net profit in 2011 while Patriot Coal and Alpha Natural Resources both logged net losses. The Berkshire subsidiary Burlington Northern counts coal as one of its largest segments at 27% of total freight revenue so Buffett must feel good about coal’s long-term economics.

Despite coal’s poor reputation for the environment, it’s not going away anytime soon. Compared to most forms of electricity production it’s still the cheapest. Natural gas may very well be cheaper at today’s prices, but its unlikely natural gas prices will remain so low if drillers aren’t able to produce economically.

If coal companies can continue to ship out increasing amounts of coal to foreign markets then this could certainly balance out the loss in market share within the U.S. Earlier this year Buffett proclaimed Burlington Northern would be spending record amounts on capital expenditures. I wonder if these improvements are being made for the coal customers of which Arch Coal is one of them.

Josh Zachariah

The Strategy of Ben Graham – Warren Buffett’s Mentor

From 1923 to 1957 Warren Buffett’s mentor, Ben Graham, followed a strategy of investing in net-nets. He said: “It always seemed, and still seems ridiculously simple to say that if one can acquire a diversified group of common stocks at a price less than the...net current assets alone…the results should be quite satisfactory. They were so in our experience, for more than 30 years.”
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