As bad as it as been for many of the energy companies, its been even worse for the coal stocks on the way back down. Most of the major coal stocks are down over 50% from their highs since around the beginning of June. Much of this fall can be attributed to the violent swings in the price of the commodity itself, the rest of it deals with the premium at which the stocks trade due to their predicted earnings growth over the next 5-10 years. There has been massive liquidation from all asset classes that involve risk, and the coal stocks have been in many cases unfairly labeled as extremely risky equities. While I will be the first to admit to their volatility, I do not think the stocks are inherently riskier than your average natural gas exploration and production company. The swings in the price of the underlying commodity are larger, but I see this as a short-term trend rather than a fundamental difference between coal and the other energy commodities.

Is The Original Story Still In Place?

Yes, I do believe so. A quick fact check on the fundamentals of the coal market should leave no doubt that coal is not down for the count. A few key things to keep in mind:

• Currently 28% of all coal fired power plants in China are shut down because of massive coal shortages from the Australian floods earlier in the year
• From 2001-2007 coal had the largest compounded annual growth rate when compared to all other forms of energy (besides solar and wind which are still inconsequential in the grand scheme of things)
• Coal is expected to be the fasting growing energy source in use through the end of this decade and potentially through the following decade
• Coal is used to generate over 40% of the United States electricity and over 28% of the world’s electricity

Even if you are one of the investors that believes the world will push towards cleaner energy, it is important to understand that transferring away from coal cannot occur quickly. These power plants and the other uses for coal cannot use other forms of energy as perfect substitutes. Because this infrastructure has not yet been built, it would take year to put into place. This new infrastructure build up will only occur if the world does not go into an economic slowdown. At this current pace, it seems like this build up may be delayed by a few years. By the time build up could be finished, it is likely that carbon capture technology will be in place. This technology will allow coal to be almost or equally as clean as other forms of energy consumption.

What is the Risk?

To me the only substantial risk of owning a coal stock would be environmental based risk. Many governments and their citizens are not open to how “dirty” it is to both mine and consume coal. Many regulations have been passed on air quality and the number of coal fired electric power plants built in the United States has been less than what the market is demanding due to environmental standards. The good news is it is not always a losing battle when it comes to the regulators. Peabody Energy Corp. (BTU: 31.52, 0.00 (0.00%)) recently won a large court case in Kentucky that will allow them to continue construction and operation of a new coal facilities. It is also important to remember that carbon capture technology is progressing very quickly and the sooner this technology is available the less environmentalists will be able to complain. When you have companies as large, prestigious, and accomplished as Schlumberger Ltd. (SLB: 65.49, 0.00 (0.00%)) and General Electric (GE: 20.30, 0.00 (0.00%)) focusing large amounts of energy and capital on this development I would highly suspect that this technology will be completed and effective within the next few years.

Conclusion

Many of the names in the sub-sector are attractive at these levels, I have compiled a list of some of the names I feel are more compelling.

• Arch Coal Inc. (ACI: 24.35, 0.00 (0.00%))
• Alpha Natural Resources Inc. (ANR: 35.76, 0.00 (0.00%))
• Peabody Energy Corp. (BTU: 31.52, 0.00 (0.00%))
• Cleveland Cliffs, Inc. (CLF: 31.42, 0.00 (0.00%))
• CONSOL Energy Inc. (CNX: 33.21, 0.00 (0.00%))
• James River Coal Co. (JRCC: 17.05, 0.00 (0.00%))
• Massey Energy Co. (MEE: 23.78, 0.00 (0.00%))

I don’t foresee a substantial bounce back in the coal stocks in the short term, but I think these are extremely attractive long term entry points. I would not trade these stocks for short term gains unless you are willing to lose all the capital you put into a trade. The risk is extremely high, but so is the potential reward.

Disclosure: The author’s family is long SLB and GE and the mutual fund the author manages is long SLB.