Coal May Surpass Oil as Better Bet on Demand for Cheaper Fuel

July 31 (Bloomberg) -- Coal, the hard, black byproduct of fossilized plants used as fuel since China's Western Han dynasty 2000 years ago, may overtake oil as the best performing energy investment.
That, at least, is the emerging consensus from a diversity of speculators, investors and giant corporations including Wilbur Ross, the billionaire bankruptcy specialist, BHP Billiton Plc, the world's largest mining company, and Merrill Lynch & Co., the third-largest U.S. securities firm.
Because ``coal is the cheapest, most abundant energy source,'' from North America to China, ``the surge in oil has encouraged people to plan new coal-fueled power plants and to start using conversion technologies such as coal-to-diesel,'' said Richard Price, an investment banker at Westminster Securities in St. Louis.
Coal is poised to top its recent highs because of record oil and natural-gas prices, said Francisco Blanch, chief commodity analyst at Merrill Lynch & Co. in London. In Europe, coal was $62.55 a ton last week and reached a 10-month high of $66.83 in March, broker ICAP said. Prices paid by U.S. utilities will climb 5 percent in the next year and double by 2021, said Price, a former vice president at Peabody Energy Corp., the largest U.S. coal producer.
Converting coal into liquid fuel or natural gas becomes economical when oil remains above $40 a barrel, said Stephen Leer, chief executive officer of Arch Coal Inc., the second- largest U.S. producer.
Oil more than doubled since January 2004, reaching a record $78.40 a barrel on July 14 and averaging $68 in New York this year. It hasn't traded below $40 since June 2004 and will fall 19 percent next year to $60, according to the median forecast of 19 analysts surveyed by Bloomberg.
Coal Turnaround
Ross, the 68-year-old chairman of International Coal Group Inc., is convinced the search for a cheaper alternative to oil and natural gas will enable coal to outperform oil. ``We certainly bet on that,'' Ross said in a telephone interview from Paris.
``The argument against it is not an economic one,'' he said. ``It's about the environment and emissions.'' Ross, who was worth about $1 billion last year, according to Forbes magazine, made much of his fortune transforming troubled companies into money makers. He founded Ashland, Kentucky-based International Coal in 2004 after acquiring mines from bankrupt producers.
Coal in the U.S. is forecast by analysts to recover from a drop this year caused mainly by a mild winter. Prices in Wyoming's Powder River Basin, the largest U.S. producing region, have fallen from a record $21.50 a ton at the end of last year to $11.50, according to data compiled by Bloomberg, while the eastern coal benchmark has declined 15 percent to $49 a ton.
Acquiring Reserves
For the U.S. and China, the world's biggest energy users, coal offers the chance of reducing their reliance on Middle East oil that has tripled in cost since 2002. The U.S. has enough coal to last almost two centuries and today imports two-thirds of the oil it uses.
Coal producers are acquiring reserves after the U.S. government estimated demand will increase by 3 percent a year, almost twice the rate for oil. St. Louis-based Peabody Energy on July 5 offered A$1.83 billion ($1.4 billion) for Excel Coal Ltd., Australia's third-biggest coal producer.
``A lot of the future energy requirements globally will have to be satisfied by coal,'' said Michael Schroder, head of resources at Old Mutual Asset Management in Cape Town, which manages the equivalent of $55 billion, including shares in mining companies BHP Billiton and Anglo American Plc. ``Coal seems to be on the agenda of lots of countries.''
Coal-to-Liquids
Using more coal is part of President George W. Bush's initiative to make the U.S. less dependent on imports. U.S. Defense Secretary Donald Rumsfeld in May authorized the Air Force, which burned 3.2 billion gallons of jet fuel last year, all refined from crude oil, to begin testing 100,000 gallons of a similar fuel derived from natural gas and coal.
Peabody Energy says it needs government-backed loans to build coal-to-liquids plants near its deposits in Montana and Illinois. The plants may cost as much as $4 billion apiece, said Arch Coal's Leer.
South Africa's Sasol Ltd., which developed coal-to-liquids technology to reduce the nation's reliance on oil, has won the endorsement of the airline industry for a jet fuel mix half derived from coal, and has sought approval for a 100 percent coal-based variety. The technology has helped turn Sasol into Africa's most profitable company and biggest by market value.
Energy Independence
Illinois, Indiana, Montana, Alabama, Colorado, Wyoming and Pennsylvania provided incentives and tax breaks to encourage construction of almost two dozen coal plants to use more local reserves. The plants use technology that reduces pollution.
``The U.S. seems set on working toward energy independence and coal is by far the most economical option,'' said John Piccard, a senior analyst at Jersey City, New Jersey-based Lord Abbett & Co., which holds a 2.3 percent stake in coal producer Massey Energy Co. ``Once the infrastructure for conversion gets built, coal will become an alternative to oil.''
China, which has tripled oil imports in the last five years, has enough coal for a hundred years. Royal Dutch Shell Group Plc, Europe's second-largest oil company, and Sasol are investing in plants in China with domestic coal companies.
Power plants also may boost their use of coal. The U.S. will build plants that increase coal's share of fuel used to generate electricity to 57 percent from 50 percent today, the U.S. Energy Department said.
Undervalued Coal
Investors value coal reserves at a fraction of oil deposits. Peabody Energy's reserves are worth 7 cents per million British thermal units, a measure of energy content, based on the company's market capitalization. At today's share price, Exxon Mobil Corp.'s oil deposits are worth $3.16 a million British thermal units. That gap may narrow, raising the value of coal relative to oil, as more plants are built that allow coal to compete with oil, Piccard said.
Peabody Energy shares have risen 12 percent this year, while Exxon Mobil has gained 19 percent. Consol Energy Inc. shares have risen 17 percent. Arch Coal Inc. has fallen 13 percent, while Ross's International Coal has lost 32 percent.
``Too much of a discount is being paid for coal equities at the moment given their inherent energy value and long-term ability to provide growing returns,'' said Kevin Bambrough, who helps manage C$3.8 billion at Sprott Asset Management Inc. in Toronto. Coal producers over the next decade are more likely to generate ``superior returns over oil companies,'' he said.
Pirate Capital, Carl Icahn
Pirate Capital LLC, a Connecticut hedge fund headed by former Goldman Sachs Group Inc. investment banker Tom Hudson, this month said it bought an $89 million stake in James River Coal Co., which has mines in Kentucky and Indiana. Pirate Capital is betting the shares will rebound from their 44 percent decline in 2006. Hudson didn't respond to calls seeking comment.
Billionaire financier Carl Icahn, 70, acquired a 2.7 percent stake in Pittsburgh-based Consol during the first quarter. Icahn couldn't be reached for comment.
Global coal prices are likely to rise during the next year as consumers switch to coal from oil, Merrill's Blanch said in a July 17 interview.
``Coal demand continues to set records in the U.S. and globally,'' Greg Boyce, Peabody's chief executive offer, said July 21 after the company posted a 61 percent gain in second- quarter profit. ``The long-term estimate of global coal use continues to strengthen.''
The recent slump in coal has depressed shares of producers. The Bloomberg U.S. Coal Index of eight companies has fallen 34 percent since rising to a record of 810.55 on May 11.
``That kind of a meltdown creates a lot of buying opportunities,'' said James Rollyson, a coal analyst at Raymond James Financial Inc. in Houston. ``It's a short-term weakness because coal is the fuel of choice going forward.'' To contact the reporters on this story:
Christopher Martin in New York at
cmartin11@bloomberg.net;
Matthew Craze in London at mcraze@bloomberg.net