Coal: A Global Arbitrage Opportunity

10/08/2013 9:00 am EST

Focus: STOCKS

An array of energy's sub-industries are making a fortune from America's natural gas boom. But perhaps the most unlikely beneficiary of the shale revolution is the coal industry, suggests Peter Krauth in Money Morning.

After all, King Coal has been dethroned in recent years by the swelling supply and bargain prices of clean-burning natural gas. And overall, ever-increasing environmental regulation is discouraging coal-powered electricity.

But the dynamic is suddenly changing. This is a pricing game—a global one. You see, while North Americans currently enjoy natural gas at close to $3.40 per million cubic feet (Mcf), Europeans are paying three times as much, between $10 and $11 per Mcf.

Asians are bearing more than four times the cost, at $15.60 per Mcf. That's why Japan and South Korea are ramping up their LNG imports.

And this massive arbitrage opportunity—low North American prices versus high European and Asian prices—is supporting natural gas here in North America. But it's making cheap coal attractive everywhere.

Massive shale gas production has caused North American utilities to switch from coal, while slowing Chinese demand simultaneously weighed on the fuel source.

And that has coal prices looking a lot more attractive to Europeans, despite their goal to reduce carbon emissions to 80% of 1990 levels within seven years.

With natural gas prices on a steady, albeit slow, upward climb, coal has become more attractive to American utilities, as well.

America, Europe, Japan, and South Korea are supporting natural gas prices, reviving coal demand in the process. But India could seriously tip the scales. At the end of June, 17 of India's power plants had less than seven days' worth of fuel, according to the Central Electricity Authority.

That's why India—already the third-largest consumer of coal—is ramping up imports, which jumped a stunning 48% in June, from 10.5 million tonnes last year, to 15.53 million tonnes this year, of which, 12.73 million tonnes was steam coal—one of the largest amounts on record.

If we were to project last quarter's Indian imports through to year's end, the nation of more than 1 billion would be on track to import almost 145 million tonnes of coal. And that would represent an increase of more than 60% over 2012.

The best way to gain exposure to the potential coal bull is through the Market Vectors-Coal ETF (KOL). This fund invests in companies that generate at least 50% of their revenues from coal production, mining, mining equipment, transportation, or storage.

Shares trade for about $19 right now. But now that they've jumped the 50-day moving average, $22 looks like the next upside target. And further momentum could take KOL to the $26 level—a 37% gain move.

It could happen quickly, too. Remember, there's often sizeable opportunity when a sector simply improves from awful to not so bad. And that looks like what's happening in the coal sector right now.

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