When a particular market or stocks in a particular industry have been under pressure for a while traders and investors tend to search for some good news. Maybe it is the natural human disposition towards optimism or the inherent love of a contrarian trade, but the worse it gets the more likely a relatively strong rally on anything remotely positive becomes. This can produce great results for those that bought on a "how low can it go?" basis, but for the rest of us it can be a dangerous time. The negatives that caused the drop get forgotten as the narrative changes and it is easy to get swept up in the new optimism and buy in, even long after any value that there may have been has disappeared. That is where we are right now with coal stocks, but investors should resist any such temptation.
Immediately following the election most coal stocks jumped significantly. That was an understandable reaction. After all the President elect described global warning as a hoax perpetrated by China and promised to revitalize the American coal industry if he were elected. Then, as that initial rally quickly faded it was given another boost Mr. Trump nominating Scott Pruitt, a prominent climate change skeptic and legal opponent of the EPA in his role as the Attorney General of Oklahoma, to head up that agency. There could be no clearer message than that the future President Trump intends to foster an environment that is extremely friendly to coal companies.
The problem, of course, is…
When a particular market or stocks in a particular industry have been under pressure for a while traders and investors tend to search for some good news. Maybe it is the natural human disposition towards optimism or the inherent love of a contrarian trade, but the worse it gets the more likely a relatively strong rally on anything remotely positive becomes. This can produce great results for those that bought on a "how low can it go?" basis, but for the rest of us it can be a dangerous time. The negatives that caused the drop get forgotten as the narrative changes and it is easy to get swept up in the new optimism and buy in, even long after any value that there may have been has disappeared. That is where we are right now with coal stocks, but investors should resist any such temptation.
Immediately following the election most coal stocks jumped significantly. That was an understandable reaction. After all the President elect described global warning as a hoax perpetrated by China and promised to revitalize the American coal industry if he were elected. Then, as that initial rally quickly faded it was given another boost Mr. Trump nominating Scott Pruitt, a prominent climate change skeptic and legal opponent of the EPA in his role as the Attorney General of Oklahoma, to head up that agency. There could be no clearer message than that the future President Trump intends to foster an environment that is extremely friendly to coal companies.
The problem, of course, is that for that to actually benefit the coal companies substantially you have to believe that most of their problems are the result of EPA regulations and the so called "War on Coal". There is no doubt that encouraging domestic electricity production by almost any other means than coal and enforcing regulations designed to prevent another Upper Big Branch type disaster have not helped U.S. coal companies, but there are plenty of other reasons why the American coal industry is struggling. Let's start with the chart below that shows China's coal production since 1980.
China has been the world's largest importer of coal for a long time and still is, but it is also now the top producer in the world. That no doubt has had some influence on the next chart, showing U.S. coal prices since 2008, but there are other factors at play in that case too.
As this chart shows, when the global recession of 2008/9 started to be felt in the coal industry the drop came from an extremely frothy looking high. As anyone with a grasp of basic economics will understand, elevated prices like that encourage increased production, so, just as demand and therefore prices were collapsing, new capacity was coming on line. It is essentially the same thing that has caused such tumult in the oil market, but without the demand backstop that comes from gasoline. That made a real recovery virtually impossible and ensured a rash of bankruptcies among coal companies who used leverage to exploit those $120+ prices.
Both of those conditions, low prices and massively increased production will remain no matter what Mr. Trump says he will do for the coal industry and who he appoints to the EPA. That isn't it though. There is one more factor weighing on coal in the global market. Climate change denial may exist in the U.S. but it is laughed at in most of the world. From a global perspective the march towards cleaner fuel sources continues and even if it stops in the U.S., converting power plants back to coal makes no economic sense for utilities. Demand is set to continue to fall.
The market seems to believe right now that rescuing the coal industry is a promise on which a politician, if admittedly a different breed of one, will deliver, despite the economic conditions. The future of the coal stocks will therefore likely come down to a battle between the wishes of a politician and the economic realities of increasing supply and decreasing demand. If that is the case then I know which side I am picking.
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