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Homequarterly investment guideThe biggest energy dog bet of all, or value trap?

The biggest energy dog bet of all, or value trap?

Some contrarians have been singing the praises of an out-of-favor energy investment. Nope, not oil and gas.

Love it or hate it, coal is still pretty hard to ignore for investors who look across the market's breadth, even amid the current sector bloodbath. Simply put, it's big, still used to generate an estimated 40 percent of electricity needs in the United States and tethered to what's expected to be the biggest growth story of all in the world for decades to come: China.

Jim Urquhart | Reuters

So is coal the ultimate energy value play, or is it a value trap that opportunistic stock pickers should stay far away from because it's never coming back?

The coal sector's investment outlook is a paradox.

What's not to like? Plenty.

Coal stocks have been clobbered, and there remain few signs of life in the sector. The Dow Jones Coal Index has plunged 36.5 percent in the past year, and in the past five years (brace yourself) it is down almost 75 percent—87 percent since before the last recession began in 2007.

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Of coal companies that have publicly traded debt, Moody's Investors Service and Standard & Poor's rates all their bonds as junk. "If you look at the long term, it's not getting any better," said Standard & Poor's analyst Aneesh Prabhu. "It's a secular decline."

Almost none of the companies are currently growing sales—a recipe for stock inertia, at best—and at a time when they're beset by utilities' switch to natural gas, prompted by hydraulic fracking, a transition that skeptics still don't think the sector can manage. Natural gas prices collapsed beginning in 2008 as new supplies hit the market, changing probably forever the competitive landscape for fuels used in the electricity business.

In both the U.S. and Europe, regulatory changes now in the pipeline are expected to make new coal-powered electricity plants economically unfeasible, and even accelerate the mothballing of existing coal plants.

We have the absolute destruction of the coal industry. If you think it's coming back, you don't understand the business … because it's not going to come back.Bob MurrayCEO of privately held Murray Energy

What's to like?

It's been a political football in Washington, D.C., for years, but now has Republicans, emboldened by midterm elections, planning a push to roll back President Barack Obama's proposed limits on electricity plant carbon emissions. That kind of Capitol game can often create short-term trading windows.

In the U.S., electricity plants account for about 85 percent of coal demand, with higher-priced coal destined for steelmaking plants making up most of the rest, said Moody's analyst Anna Zubets-Anderson.

Moody's thinks new EPA rules could cut U.S. coal demand 20 percent by 2020, cutting into the 39 percent share of the market for electricity fuel it held last year, with up to a quarter of coal-fired electric plants closing. Standard & Poor's thinks coal will produce only 27 percent of America's electricity by 2025.

It's not as if the industry hasn't noticed. Bob Murray, CEO of Murray Energy, the largest underground coal mining company in the U.S. and an outspoken critic of regulation in general and the Obama administration in particular, raised eyebrows with a September energy conference speech in which he cited U.S. Chamber of Commerce data that coal might supply only 14 percent of U.S. electricity fuel by 2030.

"We have the absolute destruction of the coal industry," said Murray, whose company is privately held. "If you think it's coming back, you don't understand the business … because it's not going to come back." Murray predicted that prices would not recover until 2016, if then, and several coal companies would be bankrupt soon. He declined to elaborate on his September comments.

Is it a war on coal jobs?
The coal industry's argument has always been that it is good for the country because it generates lots of jobs and creates cheaper electricity, an argument Murray repeated when suing the EPA over the proposed carbon standards this summer.

Coal mining is down to just 75,900 U.S. jobs, from 175,000 in 1985 and about 80,000 during 2009, when President Barack Obama took office, according to the Bureau of Labor Statistics. But at current rates, the U.S. economy would replace those jobs in a week if they all disappeared tomorrow. In Kentucky, where Sen. GOP Leader Mitch McConnell used the administration's "war on coal" as a rallying point in this year's election, the 11,000 coal-mining jobs equal the number created by the state's economy in October and represent less than 0.6 percent of Kentucky jobs.

New regulations have less to do with coal's job losses so far than the explosion of natural gas does, Zubets-Anderson said. One piece of evidence: Overall, mining and extraction employment has risen by about 5,000 jobs in West Virginia, the nation's second-largest coal producer behind Wyoming, to 33,200 since 2009 as hiring by oil and gas drillers has offset cuts by coal miners. Wyoming has only 6,400 coal mining workers, down 500 since 2008.

The regulations will effectively squeeze out any rebound in U.S. utilities' demand for coal, Prabhu said. Most U.S. coal plants are at least 35 years old, and the capital investment needed to upgrade them to comply with the Obama administration's proposed carbon limits would require running many of those until they are 65 years old or more, well past the average useful life of about five decades, Standard & Poor's Prabhu said.

Investors should not be fooled into thinking it is just regulation that has crimped coal demand and all it would take is a pushback against the EPA and Obama administration to change the equation. Utilities are especially wary of coal with natural gas trading at less than $4 per million BTUs, and in the range of $5 or lower over the past five years, except for a brief spike above that last winter.

"A lot of utilities have lost their appetite for coal,'' Prabhu said. "If you don't think gas is going to $6, you won't make the investment. It's throwing good money after bad."

Even as Republicans begin efforts to roll back some carbon measures, none of the coal companies are banking on a major rebound in U.S. coal usage for electricity. They are looking elsewhere.

Pivoting for profits

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