Time to buy coal stocks?

An American mining giant thinks Australia’s coal industry is looking increasingly competitive. This Fool doesn’t agree.

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Major coal companies, including privately owned US giant, Peabody Energy, say that the falling Australian dollar and operating costs are making coal look more and more enticing.

Greg Boyce, chairman and chief executive of Peabody says, “we’re starting to see Australia come back into the competitive range that it always held in terms of the global seaborne market”.

However, some of our local coal producers aren’t so bullish. For its most recent quarter, Whitehaven Coal (ASX: WHC) realised an overall thermal price of $US 81.39 per tonne.

Currently, Peabody HQ is proud of its Australian division’s ability to cut costs. “Our Australia team continues to advance our cost containment initiatives, reducing cost by 6% from 2012 levels to $US 73 per tonne”.

Putting Peabody’s and Whitehaven’s cost of production and sales price together leaves extremely thin margins for Australian coal producers. However, the industry believes the prices have been adversely affected by a weakness in market demand and the high exchange rate. As a result Whitehaven cut it loss making project Sunnyside and put it into care and maintenance.

However, current market conditions are not only affecting our smaller coal miners. BHP (ASX: BHP) and Rio Tinto (ASX: RIO) have had to cut hundreds of jobs in their coal businesses in the past year. In the past month alone, Peabody has cut 620 jobs from its Queensland and New South Wales coal mines but says the total Australian workforce could be cut by 20% without affecting its production targets. The company believes the lower costs associated with job cuts and other reductions will allow the productivity numbers to continue to improve.

The drought in coal prices could be likened to iron ore a few years from now, when margins are tightest and cost cutting is even more rampant. Yancoal Australia (ASX: YAL) highlighted significant issues for the short term in the industry. “The weakening of the Australian Dollar has helped producers but has not entirely offset the decline in prices” and added “all metallurgical coal types are currently trading below recently settled contract prices for the July to September period, indicating that the metallurgical coal market is well supplied with coal”.

A similar situation exists in the thermal coal market and indicates that many producers have ramped up production in a bid to keep costs per tonne low. Demand for thermal coal remains strong however it is being overwhelmed by the increased supply.

An upside

Both Yancoal and Peabody believe that for both thermal and metallurgical coal to return to a healthy price, it will require production cuts from some producers. Although there are a few cuts occurring across the industry (like Whitehaven’s Sunnyside) it’s not enough to break out the champagne. Although in the short term the outlook remains very weak, the longer term may be a different story but it’s a big maybe.

A lesson for iron ore

In the past week, iron ore exporters have ramped up production in the face of lower prices, reduced demand and over supply. Rio, BHP, Fortescue (ASX: FMG) and Atlas Iron (ASX: AGO) have all increased their output substantially in a bid to maintain the bottom line through what seems a much more competitive industry ahead.

Foolish takeaway

With the risks associated in Australian mining, you’ve got to ask yourself if it’s worth it. Warning bells are ringing loud and clear for iron ore miners and the coal industry’s woes might last for some time yet. This Fool is still yet to see any company within the coal space that ticks all the boxes of good investment.

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Motley Fool contributor Owen Raszkiewicz has no financial interest in any of the mentioned companies.

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