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Peabody Energy (NYSE: BTU) Stock

The One Stock You Can't Pass On

By Ian Cooper
Thursday, July 21st, 2011

About a year ago, I wrote an article about peak coal. And I took some heat for it…

“I’ve had it,” wrote Mark S. “Peak oil, peak natural gas, peak water, peak uranium. What about peak fear mongering, Ian? These peaks don’t exist. We have plenty of oil. It’s not going anywhere. You’re just trying to sell letters.”

You’re wrong, Mark... and you forgot peak coal.

"What you're missing," I explained in my response to Mark, "is that Peak Oil does not mean the world is running out of oil; Peak Oil refers to flow rates. It refers to the fact that the 'easy-to-get-to' oil is gone, and now we must go after the hard-to-reach, more expensive crude...

Even the U.S. Energy Information Administration and the CERA Global Oil Group — no friends of Peak Oil theory — agree that we've reached this point. And the UK and Germany, as well as the U.S. military, are preparing for it."

After apologizing for giving me a hard time (his words), Mark asked what he should buy.

But I didn’t have the heart to tell an 82-year-old man that he missed the monstrous run in shares of Brigham (BEXP) on some "crap" theory...

bexp chart 072011

I did tell him our massive coal supply is shrinking.

It was once thought there remained 250 years of coal reserves. We were told there was no need to worry about supply during our lifetimes, and that coal prices would remain cheap...

That's no longer the case. Like oil, the easy-to-reach coal is dwindling by the day. And like oil, as global supplies fall, demand will spike.

So Mark bought Peabody Energy (NYSE: BTU), watching it spike from $40 to more than $70 within a year.

BTU chart

Now, I don’t bring this story up to gloat, or to toss cold water on a loyal reader. I share it because Mark — who is now a lifetime subscriber — emailed me once again to get my next hot coal pick.

It seems Peabody did quite well for the guy over the last year.

I still like Peabody, I told him. And this time around, the coal demand supercycle should be a great catalyst.

Coal Demand Supercycle

Global demand is exploding. In China and India, electricity demand is up 14% and 8%, respectively; European coal generation jumped some 13% over the last year following Japan's nuclear nightmare, all of which helped drive Peabody's strong Q2 earnings growth and guidance.

While global supplies continue to fall, demand is expected to spike even more...

China was using 3.25 billion tons of coal last year, up 5.9% year over year, and that figure is likely to increase by 4.24% a year from 2011 to 2015. Coal consumption in India is expected to run another 20% higher over the same period.

Plus demand from emerging markets — especially for metallurgical coal needed for steel — is exploding. Global steel demand is expected to run another 6.5% to 7% this year on strong growth in developing countries. 

And yet, in these early stages of coal's supercycle, not everyone is enthused about coal mining stocks...

As Tadeusz Patek and Greg Croft explain in Energy, the seven billion tons of coal "the world is now mining and burning each year is about the best it can do." The pair predicts coal will peak not because supplies are running out, but "because remaining deposits are increasingly difficult to find."

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The Best Way to Play Coal Upside

If shares of Peabody can break above $60 resistance, the sky's the limit — especially with China running into peak production.

You see, if the Middle Kingdom can't increase domestic production levels, upping imports to meet demand may be tough, especially as coal prices run even higher.

One of the best ways to trade BTU upside is with call options. (I've covered this before, here and here.)

With BTU, I'd rather you buy the January 2012 BTU 62.50 call options (BTU120121C00062500), trading just above $5 as I write this. It has open interest of 868 contracts and a delta of 0.5166. You can also buy the underlying stock up to $61.

If you want exposure to the larger coal group, you can take a position in the underlying Market Vectors Coal ETF (KOL) at or near $50, or for greater profits, the KOL January 2012 50 call options (KOL120121C00050000) trading just above $3. It has a delta of 0.5256.

We'll update the positions as we move forward.

Stay Ahead of the Herd,

Ian L. Cooper
Analyst, Wealth Daily


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