The Low-Cost Way To Play Obama's "War On Coal"

Last week I got my boots muddy in the coal fields of West Virginia. Today I want to share an low-cost way to play Obama’s war on coal.

As we discussed last week, even though the coal industry is under fire, there’s sure to be some profitable niches. After all, the coal still burns like it always did and as long as the revitalized U.S. manufacturing sector and the emerging world keep demanding the dark, dusty fuel there’s surely a way to play it…

As you’ll recall from last week’s field report, there are several reasons that the coal sector is worth a look. Sentiment couldn’t be worse (there’s blood in the streets!), the sector involves more than one type of coal (metallurgic coal vs. thermal coal) and the technology to process coal isn’t the dirt-filled, knuckle-dragging industry that many claim.

Today’s opportunity comes to us in the metallurgical coal market.

As you’ll recall metallurgic or “met” coal is a hotter burning variety than your average thermal coal. That is, thermal coal (cheaply produced in areas like Illinois) is fine for spinning a turbine at a power plant but when it comes to processing and forging specialty metals you need a hotter burning, “met” coal.

Along with metal forging there’s also a whole market segment of “activated carbon.” This is a specialty coal sub-sector that needs a specific blend of coal (for making charcoal briquettes or carbon filters) and is willing to pay a premium for it.

The pricing tells the tale. As I type spot price for thermal coal is at the rock bottom price of $55/ton. The avg. price for met coal, however, is closer to $150/ton — activated carbon markets can command an even higher price.

To an outsider looking at the overall coal market, the carnage is evident. Many large coal outfits are feeling the squeeze of overall low coal prices via a pullback in both thermal and met prices. Big players like Alpha Natural Resources (ANR) and Walter Energy (WLT) are feeling the crunch — with share prices off 42% and 65%, respectively on the year. Indeed, even though these big coal players have a lot of met coal in the hopper their overall costs and lack of thermal pricing are eating away their bottom line.

In some instances I’m hearing that big coal is still producing tons of coal, at a loss. I’m still not sure on the reasoning for this — maybe it’s predatory, maybe it’s wishful thinking or maybe it’s just tough to stop big operations on a dime — whatever the case, losing cash on every ton you produce isn’t going to help your share price.

But that doesn’t mean niche players can’t find a seam in the met market and still turn a profit. It all depends where the coal goes and what price is commanded.

It’s all about regional pricing.

According to a June write-up on the met coal market from Platts, “regional price differences could have to do with steelmakers’ different evaluation of coals, and could reflect a willingness to pay more for coals which are more critical to their blends.”

So if a steelmaker or other met coal user likes your blend you can command a higher price.

From there, the math gets a lot simpler. That is, if you can you produce the coal and get it on a railcar for under $100, with prices above $150 you’re making plenty of money.

And for those keeping score at home, the price of met coal, as recently as 2011, was in the low $300s. So if there is any sort of rebound in the price of coal, low-cost, nimble producers could have a strong wind at their back.

That said, let’s get our boots back on the ground in West Virginia…

Find A Seam And Profit — A Little-Known Play On Coal…

Last week I blackened my boots at a West Virginia coal mine, operated by Xinergy (XRGYF) — the company also trades on the Toronto exchange under the ticker “XRG.”

From what I saw onsite, Xinergy is a perfect example of a niche coal operation that can still make a buck in today’s market. Although the market beat down the price of this tiny 47-cent company — off 40% on the year — there’s a lot of reason I like this play.

Indeed, opportunities like this are why we hunt for resource plays and get our boots on the ground in the first place! More specifically, everything thing that I saw on site leads me to believe that the company can still make a solid return, even with today’s beaten down price for coal.

I visited the company’s South Fork operation near Rupert, WV. The coal coming out of the hills there is part of the “Sewell” coal seam. As the locals will tell you, it’s the good stuff… it burns hot and commands a much higher price than thermal coal.

The South Fork operation is developing into a “crown jewel” asset, says President Bernie Mason. And after talking with the long-time coal man about the property I quickly began to see why…

Operations at the mine were just getting under way during my visit. But unlike some of the other startups I’ve been onsite with, this one was humming along with 30-40 workers on site.

Xinergy South Fork Coal Operations West Virginia

Several large excavators, trucks and front-end loaders were moving coal from the different mining pockets. In this case there were 2-3 active mining zones — in other words, coal was always being loaded into trucks and hauled to the processing pile with no delay.

What’s not seen in the pictures above is that Xinergy has its own rail spur and offloading facility. Conveniently located right down the hill (not by chance) from the processing facility is a conveyor-fed, rail car loading terminal. After the coal is mined and processed to spec it flows down a conveyor a football field long or so and onto the CSX system where it can be sent to the highest bidder.

It’s important to note the things unsaid, here. At a time when other mining operations are shutting down (or running at a loss) this start-up is heading full steam ahead to get processed coal ready for rail transport. Although they don’t have an official buyer just yet, you’d have to assume that moving hundreds of tons of coal, especially in today’s market, likely indicates a light at the end of the tunnel (or in this case a buyer!)

Which gets us to the economics of this play…

Is It Worth $20M or $200M?

Xinergy already has high-BTU, met coal coming out of the ground, it owns its own processing facility (where it can process coal to certain specifications) and it is about to break the champagne bottle on its newly updated rail loading facility. Check, check and check!

Startup operations are expected for 10,000-15,000 tons of coal per month but are set to ramp up to a short-term production goal of 50,000 tons per month.

In the long run the South Fork operation has capacity to run 1-1.5 million tons (Mt) per year (2Mt, I’m told would be a true logistical nightmare for coal hauling on the private roads.)

This is all great news for a company that’s trading at a miniscule market cap just over $20 million. Heck, that’s about the value of their new processing plant alone!

And get this…

Recently the nearby Greenbrier Smokeless mine and processing facility sold for a purported $200M. [Just to give you an idea the original offer for this property, back in the heydays of coal, was closer to $1B. Today with depressed prices the facility sold for around 1/5th of that.]

Depending on the metrics you use (bulk reserves or quality of reserves) Xinergy’s deposit and facility (just at South Fork alone) could hold just as much “buyout” value as the Greenbrier facility. For a company with a market cap in the $20M range you’ve got to like that writing on the wall.

Time will tell where Xinergy sells its coal. But there are plenty of buyers for met coal. One of which is a company by the name of Suncoke. The company works as a middle man between coal producers and specialty steel makers like ArcelorMittal, U.S. Steel and AK Steel. When steel producers need a reliable stream of met coal, depending on their facility, a lot of the time they turn to a company like Suncoke.

Another potential buyer is a guy by the name of Thrasher. Ernie Thrasher is the CEO of Xcoal, a leading worldwide supplier of U.S. origin met coal. If coal is heading overseas from West Virginia it’s likely going through Thrasher.

Regardless of the buyer, though, I can tell you that coal is piling up on site. And if the coal is hitting the conveyor belt at a cost of around $100, as I’m told, there’s plenty of money to be made on this one.

Remember, it’s the things unsaid that do the talking: this tiny company isn’t piling up coal for the hell of it.

To be clear a penny stock like this isn’t going to be the next Alpha or Walters Energy — and it won’t likely see the $10-mark any time soon (if ever.) But making 2, 5 or 10 times your money isn’t out of the question. And let’s just say the company proves to the market that it’s worth $200M like the recent mine sale in the area — that move would represent a 10-bagger.

Heck, as recently as 2011, the company traded above $6 a share — and that was before they had the operations up and running at their “crown jewel” South Fork complex.

Now that the diesel is burning in the excavators and coal is piling up, I think there’s an opportunity to play these beaten down shares. Indeed, it’s the low-cost way to play the war on coal.

Keep your boots muddy,

Matt Insley
Original article posted on Daily Resource Hunter