new coal float / coal story - it pays to be dirty.

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    The Rude Awakening

    Wall Street, New York

    Thursday, December 02, 2004


    *** It pays to be dirty...turn coal into diamonds!

    By Eric J. Fry

    Coal is dirty. Coal is messy. Coal is politically
    incorrect. But coal is also drop-dead an
    investment. The price of coal has tripled over the last two
    years, as has Bloomberg U.S. Coal Stock Index. But now that
    this perennial ugly duckling of the financial markets has
    become a runway model, should investors continue wooing

    Let's begin addressing this nettlesome question by
    examining the recent past. In the early 1990s, American
    utility companies started migrating away from coal usage
    toward natural gas and other "clean" energy sources. As a
    result, profitability migrated away from the coal
    companies. Throughout the 1990s, the coal industry
    inhabited a gloom as dreary as Oliver Twist's London. Those
    that managed to stave off bankruptcy, labored under
    mounting pension and health care liabilities. As recently
    as two years ago, many publicly traded coal companies were
    still producing losses.

    But then something changed; global demand started to swamp
    supply. The politically incorrect fuel source started to
    enjoy brisk demand from almost everywhere. But the demand
    was particularly acute from - you guessed it - China. Last
    year, the Asian juggernaut consumed nearly one third of the
    world's coal production - more than any other country. By
    comparison, the U.S. consumed only about 22% of global
    production. And China's demand continues to swell. Chinese
    coal imports surged a stunning 62% in the ten months ended
    October 31, according to the Tex Report, an industry

    This breakneck rate of coal consumption is unlikely to slow
    dramatically over the next few years. Here's why: China
    uses coal to power more than three quarters of its
    electricity production. Hence, as Chinese electricity
    demand goes, so goes demand for coal.

    "China's total energy demand surged 13.8% in 2003,"
    according to the Asia Times. "Increase in electricity
    demand in China last year accounted for 50 gigawatts of
    total global growth of 70GW (a gigawatt is 1,000 megawatts,
    a megawatt is a million watts)." Looking ahead, China will
    need to add about 30GW of generating capacity per year for
    the next 16 years in order to satisfy its growing energy
    demand. This rate of addition is roughly double the recent
    rate of capacity expansion. Coal will almost certainly
    power the majority of these planned capacity expansions.

    Coal investors are not blind to the delightful fundamental
    trends underpinning the bull market in this sooty energy
    source. As the nearby chart illustrates, industry bell-
    weather, Peabody Coal (NYSE: BTU) has handily outpaced the
    XNG Index of natural gas stocks over the last couple of

    And the frenzied buying of coal stocks continues...

    "Anything coal," a Canadian stockbroker informed your New
    York editor last week, when asked what his institutional
    customers were buying. "Anything coal, or coal anything.
    That's what my customers are asking for. They want to buy
    anything with the word 'coal' in it. It doesn't matter if
    it's small-cap or large cap, they'll buy it. Did you see
    Fording? That Canadian coal trust? That thing has tripled
    this year."

    Just maybe, we would surmise, coal stocks have become a bit
    too popular for their own good. Certainly, they carry
    loftier prices now than they did two years ago. But the
    question remains whether they might become even pricier
    over the next two years. For insight, we turned to the
    "experts" on Bay Street and Wall Street.

    "We expect North American coal markets to remain robust
    next year," predicts BMO Nesbitt Burns coal analyst Jay
    Turner, "and recommend Peabody Energy as the most
    attractive investment vehicle due to its diversification,
    industry leadership position and attractive exposure to
    international metallurgical coal markets."

    Legg Mason analyst, Paul Forward, shares Turner's optimism.
    "After two years of coal demand outstripping supply," says
    Forward, "we project a third consecutive supply deficit in
    2005 and sustained high coal prices for the next few
    quarters." Nevertheless, he cautions, "The remarkable rise
    in coal miner equity valuations over the past month causes
    us to be sensitive to valuation concerns."

    We will consider ourselves forewarned...certainly, the
    heady performance is cause for concern, especially for
    those investors who remember the recent dismal history of
    the coal-mining sector. Even so, the coal industry's long-
    term prospects suggest that this ugly-duckling-turned-swan
    might remain photogenic for several more years.

    "Over 100 new coal-fired plants are currently being
    planned," the Legg mason analyst observes, "after more than
    a decade of almost no new coal-fired power projects, and
    the last major wave of new coal plants (in the late 1960s
    and 1980s) helped drive the double-digit coal price growth
    rate over that period."

    Okay, so it seems, on balance, that we investors should
    regard coal stocks with a mixture of terror and optimism.

    "So what's the best way to play the next leg of the bull
    market in coal?" we asked Kevin Kerr, contributing editor
    of Outstanding Investments.

    "Why not buy some of the stocks that are RELATED to the
    coal business?" he replied. "I'd give you some specifics,
    but I'm actually writing up the ideas for the upcoming
    issue of Outstanding Investments, and I don't think my
    readers would be too happy if I gave you the ideas first.
    I'll give you a hint, though. One of the companies makes
    surface-mining trucks and different types of excavators for
    the coal industry.

    "We issued a pretty timely buy on CONSOL Energy a couple
    months back, and like most coal stocks, that one has
    soared. But in today's market it's probably a good idea to
    err on the side of caution. So I'd recommend indirect plays
    - also known as backdoor plays - in the coal sector."

    "Any examples?" your editor inquired.

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