Is This the Year for the Coal ETF? - ETF News And Commentary
02 January 2014 - 5:05AM
Zacks
Coal as a sector has been beaten down by lower natural gas prices,
muted electricity demand growth, reduced export demand and the need
to conform to the Environmental Protection Agency’s (EPA) Mercury
and Air Toxics Standards (MATS) regulations.
The regulations have recently forced many power producers to
announce plans for the termination of coal-fired plants. In fact,
coal prices saw a terrible yearly performance for 2013, falling for
the first time since 2000 (read: Are Coal ETFs Back on
Track?).
However, after suffering for a year, coal might breathe a sigh of
relief at least for the medium term thanks to relatively higher oil
and gas prices and relatively lower coal production in 2013.
Near-Term Bullish Price Outlook
U.S. Energy Information Administration (EIA) forecasts that average
delivered U.S. coal prices will be $2.39 per MMBtu in 2014, up from
$2.35 per MMBtu in 2013. A number of factors can be traced back to
this improvement:
Coal as a Substitute Fuel: Lower natural
gas inventories and higher household heating demand in winter sent
gas prices into a rally. Natural gas – almost exclusively and
highly used by commercial and residential customers – has thus seen
a considerable price rise in the recent period.
Amid these circumstances, a number of industrial and electric
generation consumers sometimes switch over to low-priced coal from
high-priced natural gas thus creating demand for coal.
Tight U.S. Supply in 2013: As per the
EIA, coal production was down 1.8% in the first 10 months of 2013
and was almost absorbed by consumption growth in 2013. This
will leave a short-term supply crunch in the space thus boosting
the price of coal. EIA now predicts coal production to grow 2.5% to
1,033 MMst in 2014 bolstered by a balanced inventory outlook and
growing consumption.
Notably, consumption surged 4.4% in 2013 thanks to increased share
from the electric power sector. Consumption will likely grow 2.2%
next year, as per the EIA (see all the Top Ranked ETFs here).
Global Recovery: As the majority of the
developed markets came out of recession and the U.S. economy too
remains on the growth path, output from industrial sectors are
poised to gear up. This will also trigger a certain level of global
coal demand especially when coal is a key input in the steel
industry. Investors should note that, nearly 70% of global steel
production depends on coal.
Growing Asian Demand: As per the PIRA
Energy Group – a leading energy marker researcher, Chinese
electricity demand expanded considerably in the recent times
leading to the strong demand for thermal generation. In spite of
being the world's largest producer of metallurgical coal, China
continues to import seaborne coal due to flat domestic
production.
Yet another global energy and mining research company – Wood
Mackenzie – forecasted that the seaborne metallurgical coal market
will likely grow 51% by 2035 from the levels of 2012. As much as
69% of this demand will come from Asia while the Atlantic market
will account for the rest.
Modest Sector Recommendation: To add to
this, Moody’s had upgraded its coal industry outlook to stable from
negative in August 2013, helping some to feel a little less bearish
on the space (read: Coal ETF in Focus as Moody's Upgrades Sector
Outlook). Higher demand for the thermal coal
segment through mid 2014 to early 2015 and supply
rationalization in metallurgical coal used for steelmaking were the
drivers of this upgrade.
The Zacks Industry Rank, which relies on the same estimate
revisions methodology that drives the Zacks Rank for stocks,
currently puts the Coal industry at 152 out of 259 industries in
our expanded industry classification. This puts the industry in the
middle one-third of all industries, corresponding to a neutral
outlook.
How to Play
There is only one ETF, namely
Market Vectors Coal
ETF (
KOL), which offers a pure play on
the U.S. coal industry. The ETF was down about 20% in 2013 but
performed quite well to close out the year.
KOL in Focus
Launched in January 2008, KOL tracks the Stowe Coal Index,
providing exposure to the companies related to the coal industry.
Even though this index has a global focus, nearly 45% of its
investments are directed toward U.S. companies, followed by China
with a 17% share.
KOL amassed an asset base of $168.3 million and charges 59 basis
points in fees annually. This fund holds 31 stocks and the top 10
companies holds 57.9% share of total net assets. Top three holdings
Consol Energy, China Shenhua and Joy Global make up for about 21%
of the fund (see more in the Zacks ETF Center).
The fund is currently trading a little higher than its 52-week low
which leaves room for rally as long as broad trends hold up well.
The Fund’s Relative Strength Index is 51.04 currently thus
indicating that KOL has way to go to enter the overbought
territory.
Bottom Line
While KOL currently holds a Zacks ETF Rank #4 (Sell), the valuation
has perhaps bottomed out and can call for a trend reversal. KOL has
greater share invested in mid-and-small caps thus having potential
to bounce back in a trending U.S. economy.
However, the risk quotient of the fund is high; be it in the form
of concentration risk or currency risk (as about 50% of assets
exposed to foreign currencies). Still, KOL could be due for a
bounce back this year.
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