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Should You Invest in Coal or Natural Gas?

Vinay Singh

Vinay Singh

5 followers

Electric utilities care about price more than fuel source, so natural gas and coal use will continue to seesaw back and forth for years. You can protect yourself by buying companies with exposure to both commodities like CONSOL Energy (CNX), Natural Resource Partners (NRP), and PVR (PVR).

The Future Is Variable

In a recent presentation, Alliance Natural Resources (ARLP) projected that global coal demand will increase over the next 20-plus years on demand growth in Asia. The next slide, however, presented a more sobering view of U.S. demand, which it expects to remain stable.

One reason is that new government regulations are leading to plant closures. However, low natural gas prices are the other big issue since utilities generally switch to the lowest cost fuel option to keep costs down. This is why coal plant usage rates are off about 25% from their levels of just five years ago.

Alliance expects coal to stabilize at just under 40% of electricity production over the next decade or so. Of course that will fluctuate from year to year based on the price of each commodity. Alliance is a great coal miner, posting record production and sales last year, with plans to do the same again in 2013. And it regularly increases its dividend, recently on a quarterly basis. That's impressive given the tough coal market. However, Alliance only does coal.

There are several coal companies, however, that have chosen a different path to the future. They have embraced natural gas.

Balanced Profits

CONSOL Energy is a major coal producer and has notable natural gas operations. While coal accounted for 80% of the company's top line in 2012, natural gas is an increasingly important part of the company's business. That exposure has been a major benefit through a difficult coal market.

CONSOL was profitable in 2012, unlike many coal focused peers. In fact, it managed to increase its dividend slightly last year, which is a clear demonstration of the benefits of its dual focus. Even after that dividend hike, however, the recent yield is only around 1.4%. So this isn't a good option for income investors.

Those looking for a safer way to invest in coal's potential rebound, however, should like the prospects here. And, if that doesn't pan out, the company should benefit from continued natural gas demand. Note that the shares haven't sold off like others in the coal industry, so CONSOL is more of a growth play than a turnaround play.

A Higher Yield Option

Natural Resource Partners has a similar model to CONSOL in that it owns coal assets and, increasingly, other assets like natural gas and various other mineral assets. However, it doesn't actually mine or drill for anything, it leases out its properties so others can do the dirty work. That removes much of the regulatory and operational risk from the equation and simplifies the partnership's business model.

In 2012, roughly a third of the company's business came from assets not related to coal royalties. While oil and natural gas drilling only made up about 3% of the total, the company has made this segment a priority. Acquisitions and development should fuel rapid growth here.

Natural Resource Partners was able to increase its dividend last year, though it has kept the payout static for six quarters now. That said, using the low-risk, high-margin lease model on both the coal and oil & gas sides of the business puts the company in a good position over the long term. A yield of nearly 10% should be ample reason to stick around while it grows its gas exposure.

Royalties and Pipes

PVR, formerly Penn Virginia Resources, also has a large coal portfolio. Like Natural Resource Partners, it leases its coal lands out to others and is essentially a toll taker. In 2012, coal represented about 45% of the company's earnings before interest, taxes, depreciation, and amortization (EBITDA). It expects that to fall to about 20% in 2013.

The rest comes from the company's midstream assets. Low coal prices and demand are part of the reason for the reduction in coal's impact, but so too is PVR's aggressive shift into midstream. Much like the coal royalty business, midstream is a toll taker business. PVR owns the infrastructure that gets natural gas and oil from where it's drilled to where it can be used--a relatively low risk affair.

Coal's fall hurt results in 2012, but the midstream segment limited the damage. In fact, the partnership actually increased its distribution in 2012. For income investors looking for a safe way to play both coal and natural gas, this toll taker with its around 8% dividend yield is a good option.

Insurance

Coal is unloved today despite positive long-term dynamics. That said, natural gas is increasingly important. The two fuels will be fighting for domestic electric market share for years. Investors looking to win no matter which natural resource is on top should consider CONSOL, Natural Resource Partners, and PVR.


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