Coal stocks' super strength isn't built to last

The energy market will eventually find a way of quelling the cost of natural gas while it continues to add renewables to its mix.

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

It's been a banner year for coal prices and, subsequently, coal mining stocks. Alliance Resource Partners (NASDAQ: ARLP) is up 92% since the end of 2021, while Peabody Energy (NYSE: BTU) is higher to the tune of 167%. Consol Energy (NYSE: CEIX) shares have rallied an incredible 214% year to date. The sky-high cost of natural gas is forcing electric utility companies to shop around for cheaper fuel sources, and coal is it. The International Energy Agency estimates this year's global consumption of coal is on pace to roughly match a previously set record.

These stocks' incredible strength, however, is likely only a temporary phenomenon. Investors lucky enough to be in any of these hot stocks may want to think about getting out of them sooner than later, as the underpinnings of this bullishness isn't apt to last.

Coal is strictly a temporary, stopgap solution

That's an admittedly tough thing to do. The prevailing advice (as well as instinct) suggests sticking with your winners as long as they're making forward progress. Tickers like Peabody and Consol Energy are still doing so.

But, this is one of those scenarios where the smart-money move is proactive rather than reactive. Coal's price correction is coming, and once it starts to peel back, coal mining stocks could roll over in a big way with little to no warning.

Fitch Ratings spells out the bad news. While last month's revision of its long-term coal price outlook nudged them all higher than its previous outlook, Fitch's forward-looking prices are still below their current levels. This is as true for the coking coal used to make steel as it is for thermal coal needed to generate electricity. Take a look.

Thermal coal prices are projected to fall from 2022's frothy levels.

 

Data source: Fitch Ratings. Chart by author.

And Fitch isn't the only organization anticipating an abrupt end to coal mania. Only a month ago, the Institute for Energy Economics and Financial Analysis posted a similarly grim outlook for Australia's thermal coal mining industry, which supplies Japan, China, South Korea, and Taiwan, all of which rank among the world's most prolific users of the coal, and all of which rely heavily on Australia's production. Despite brisk demand right now, the institute's coal analysts Simon Nicholas and Andrew Gorringe argue, "In the longer term, the shift of Asian nations toward more reliance on renewable energy and domestic coal will see volumes of Australian thermal coal exports fall significantly." Nicholas and Gorringe add, "This process is outside of the control of Australian state and federal governments."

The dynamic could prove particularly problematic for Peabody, as much of its mining is done in Australia.

It's a proxy for the entire coal industry though. Wood Mackenzie analyst Adam Woods also commented last month on the current coal price surge (in light of the inevitable mainstreaming of renewable energy sources): "We believe that this will be a relatively short-term event, and we do not see companies making major investments to increase [coal] infrastructure or long-term [coal] production."

To this end, note that while still historically high, thermal coal prices have fallen substantially from July's and September's peaks in just the last few days.

Thermal coal prices are already starting to peel back from recent highs.

 

Data source: Business Insider. Chart by author.

So, connect the dots. This year's 90% run-up in thermal coal prices -- and nearly 300% advance since the beginning of 2021 -- doesn't look like it's built to last.

Not necessarily now, but soon... very soon

None of this is to suggest coal stocks like Consol Energy and Alliance Resource Partners must be sold immediately or that there's no further potential upside remaining for these tickers. Indeed, there are some clear long-term benefits to this short-term price surge.

Peabody, for instance, has used its recent windfall to reduce its debt load by more than $200 million (about 20%) over the course of the past year. That should help boost profit margins even once coal prices are reigned in. Alliance Resource Partners recently secured commitments to sell nearly 25 million tons of coal through 2025 at prices that reflect coal's current lofty value rather than its tepid prices from just three years back. The company is also expanding operations at its Gibson South and Hamilton mines. That's greater scale which may never have been possible without the industry's current boon or its healthy sales agreements.

In the meantime, although the world is addressing the tight supplies of natural gas that are renewing demand for coal, there's no assurance any of these efforts will make a meaningful impact in the foreseeable figure. Coal is readily available right now.

This shift in demand and miners' increased capacity to invest in themselves is an exception to the norm rather than the norm though, and exceptions aren't the stuff of great stock picks. They are (by definition) temporary situations. Investors should be seeking out companies that can consistently capitalize on the norm, which will eventually be restored.

And that's where things can get tricky.

Stocks caught up in unusual situations like this one can behave erratically and unpredictably. It's possible the aforementioned thermal coal stocks as well as their peers could pre-emptively tumble before coal prices themselves do -- with or without seeing similar price action from natural gas -- as investors make sure they're not left holding the proverbial bag once coal mania cools.

Between the sheer risk of this unknown and the fact that so many other quality stocks can be scooped up at a discount here, now would be an ideal time to cash in your coal stocks' gains and go shopping for some new bargains from a different industry.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

James Brumley has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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