A Sterne Agee Industry Report dated March 25, 2014 and titled “Coal 360: Burn Up, Stockpiles Down” points out that the last few months of very cold winter weather across the U.S. has depleted the coal stockpiles of many utilities. Sterne Agee analysts Michael S. Dudas and Satyadeep Jain argue that this is likely to lead to higher coal prices in the near future as utilities begin to purchase more to refill their reserves.

The analysts summarize their call below: “Jan ’14 coal stockpiles have now dropped to lowest levels, on an absolute basis, since Sep ’06. Given continued below normal temperatures, we expect above average coal stockpile drawdowns in Feb ’14 and Mar ’14 as well. As utilities continue to work down inventories, we expect pricing to pick up on expectations of market tightness and increased contracting.”

Coal Prices

Electricity generation and coal consumption up

The Sterne Agee report highlights that net electricity generation in the U.S. increased 8.2% year over year (y/y) in January, and almost all of the increase can be attributed to the cold weather. Related to this, given that many utilities generate a good bit of their above-projected-demand electricity from coal, coal consumption increased 11.6% y/y in January to 83.7 million tons. Coal consumption in January was the highest monthly coal consumption since July 2012.

Coal prices increasing, stockpiles shrinking

Dudas and Jain also point out that coal stockpiles slipped 15.6 MT in January compared to a 5-year average January stockpile drawdown of just 5.6 MT. Bituminous coal stockpiles decreased by 10.8 MT in January, while sub-bituminous coal stockpiles dropped 5.2 MT.

The SA analysts provide further details below. “Jan ’14 coal stockpiles of 132.3 MT are at lowest levels, on an absolute basis, since Sep ’06. On days of burn basis, bituminous coal stockpiles have dropped from 87 days in Jan ’13 to 66 days in Jan ’14 while sub-bituminous coal stockpiles have dropped from 75 days in Jan ’13 to 50 days in Jan ’14.”

Days of Coal Burn Coal Prices

Recommended coal equities

Based on their analysis, Dudas and Jain believe coal prices and coal stocks are headed higher. They rate four companies in the sector as a Buy. “We continue to believe coal equities are reflecting a much more onerous pricing and volume environment than we anticipate during 2014-15. We suggest investors add to positions in Alpha Natural Resources, Inc. (NYSE:ANR) (Buy, PT $14), Arch Coal Inc (NYSE:ACI) (Buy, PT$7), CONSOL Energy Inc. (NYSE:CNX) (Buy, PT$60), and Peabody Energy Corporation (NYSE:BTU) (Buy, PT$30) at current levels.”