Coal is far and away the world’s most-important source of electric power and has been for decades. There are two good reasons for this: Coal is more abundant than oil or gas, and it’s cheap.

Coal is a greater pollutant than either natural gas or emission-free nuclear power. But new scrubbing technologies and plant designs can minimize that pollution. And there’s no way the world could replace all its coal-fired plant capacity in any reasonable time frame.

China, for example, is building nuclear plants at the most rapid pace of any country on Earth; most analysts believe, however, the country will actually see its reliance on coal increase in the next two decades. Bottom line: Coal is here to stay.

Coal stocks had a rough run in the latter half of 2006. But they’re cheap and pricing in a great deal of negative news flow on coal prices. It’s time to increase our exposure to the group.

In This Issue

In this issue, I’m adding Consol Energy and reiterating my buy recommendation on Peabody Energy in light of that company’s recent strong earnings report.

Also in this issue, I’m adding Novozymes to the biofuels field bet. This company is a global leader in enzymes used to make ethanol. Even better, the company is working directly with the US government on research for second-generation cellulosic ethanol.

Comprising the largest percentage of global electricity generating capacity, coal is still the biggest play on energy. One company of which I’ve long been a fan not only makes a great model for I’ve been noticing in the industry but a great forecaster as well. See Global Supplier.

As China and India continue to grow, the need to import coal will also increase as consumers demand more electricity for such new items as TVs and refrigerators. What better way to capitalize on this than Asia’s nearest neighboring continent—Australia. See Bull Market Down Under.

The US isn’t completely without hope; there are still ways to make money on the local coal market. I’m adding one such opportunity, which has exposure to both East Coast mines as well as natural gas, to my Gushers Portfolio. See Local Opportunity.

Ethanol is a great alternative to coal; however, there’s not enough agricultural supply to create the supply necessary for energy consumption, as the ingredients for ethanol are also widely consumed for food. However, there are some new advances in other ethanol products that don’t take away nearly as much from agricultural produce. I’ve found a new speculative play for my biofuels field bet that should be able to help such fuels along. See Going Alternative.

In this issue, I’m recommending or reiterating my recommendation on the following stocks:

• Peabody Energy (NYSE: BTU)
• Consol Energy (NYSE: CNX)
• Novozymes (Copenhagen: NZYMB; Frankfurt: NZMB; OTC: NVZMY )

Global Supplier

There’s no single technology or power source that will be a magic bullet for meeting the world’s electricity and energy demands. Certainly, nuclear power will play a role and will account for a growing slice of global power generation. Long-time subscribers know that we’ve been profitably playing the nuclear theme for some time now.

And natural gas and renewables will also play a part. But when you get right down to it, coal still rules the grid globally. Talking about electricity generation without mentioning coal is a bit like ignoring the elephant standing in the corner of the room. Check out the chart below.


Source: Energy Information Agency

This chart shows Energy Information Agency (EIA) data for current and future electricity-generation capacity broken down by the source of that power. Note that this figure is based on capacity, not production.

Coal currently accounts for roughly 30 percent of global generating capacity; the EIA projects that coal will roughly maintain that share over the next 23 years. Because electricity demand globally is rising quickly, maintaining that steady share for coal means a 79 percent jump in global coal-fired capacity during this time frame. And global coal capacity is already higher than for any other single type of plant.

But it’s important to note that the figure above massively understates the importance of coal to the global grid. As I’ve highlighted before in this newsletter, there’s a huge difference between capacity and generation: Just because a utility may own a plant with 1,000 megawatts of capacity doesn’t mean that plant is operating at that capacity at all times. In fact, that’s highly unlikely to be the case.

This brings us to the important distinction between baseload and peaking power. Baseload power refers to the base demand of electricity that needs to be available for around-the-clock usage. In other words, even at 3 am, there’s some demand for power and generators must meet that usage.

Of course, power demand varies throughout the day. When demand exceeds baseload levels, generators fire up peaking plants to meet those surges of demand. This capacity can be shut down again when power demand slackens.

Although this is a slight overgeneralization, coal and nuclear plants are examples of common baseload capacity generators. Both types of plant can be run around the clock and produce predictable, continuously available electricity supply. In contrast, natural gas is often used in peaking plants.

Gas-fired turbines can be more easily and quickly switched on and off than coal or nuclear facilities; capacity can be quickly brought to bear when demand rises. But gas-fired power tends to cost more than coal or nuclear power; it’s perfect for meeting those demand spikes but not for 24-hour generation.

Wind and solar power, at least in reference to the modern grid, aren’t ideal baseload power sources either. That’s because the power outputs from such plants aren’t constant; those outputs depend largely on weather conditions in a given area.

The long and short of this is that baseload power plants are run more consistently and continuously than peaking plants. Therefore, the actual output from baseload plants tends to run closer to their maximum rated capacity than for peaking plants.

This is why coal plants account for only 32 percent of US installed capacity but produce more than 52 percent of the nation’s power. Meanwhile, gas-fired capacity in the US is more than 40 percent of total generating capacity; however, gas-fired plants account for less than 20 percent of US power output.

The key point to note here is that it’s important to distinguish between a country’s electricity capacity and actual output. Some countries in Europe, for example, boast wind capacity of 20 percent or higher of total grid capacity. However, output from these plants is usually less than 10 percent of total electricity production. Although there are exceptions, most countries around the world rely on the coal workhorse for a large chunk of actual electricity production.

This is precisely why coal and coal producers have been and will remain a key investment theme within The Energy Strategist. My favorite play on coal remains Wildcatters Portfolio holding Peabody Energy (NYSE: BTU). The company’s recent earnings release and conference call highlighted some major trends at work in the coal industry.

The first point that struck me in listening to Peabody’s call is just how much this company has morphed in the past five years. Management pointed out that five years ago only 1 percent of the company’s earnings base came from international operations; now that figure is closer to 33 percent. That’s a massive jump in just the past few years.

Just as with natural gas, oil or any other energy commodity, it’s important to make the distinction between the situation in North America and factors at play globally. The fundamentals of these markets couldn’t be more dissimilar.

Consider that the US is the Saudi Arabia of coal. The nation has gigantic, high-quality coal reserves; US domestic demand is met by domestic production, not by imports. Therefore, US coal prices are most heavily influenced by US supply-and-demand factors. In fact, some of the same forces that have been at play in the US natural gas markets during the past year are also working in the coal markets.

The warm winter of 2005-06 reduced demand for electricity and heat. As I’ve outlined on several occasions, including in the most-recent issue of TES, More Bullish Signs, this resulted in a major buildup in US natural gas inventories. It was these excess inventories that put pressure on prices last year. A similar scenario developed in the coal markets.

At the end of 2005, US coal inventories at utilities were at dangerously low levels. There were legitimate concerns that some utilities would have to partly shut down plants to conserve supplies.

The only producers that seemed able to meet their production targets were Western-focused miners such as Peabody and Arch Coal; miners in Central Appalachia were routinely falling behind their targets. But a real bottleneck in the nation’s railroads was making it extraordinarily difficult to transport that coal from Western mines to Eastern coal plants.

The warm winter of 2005-06 changed all that at a stroke. Check out the chart below.


Source: EIA, Bloomberg

Unfortunately, EIA data on coal inventories is available only with a considerable time lag, unlike data on natural gas inventories. But you can clearly see on this chart how quickly coal inventories jumped in the first several months of 2006. Inventories topped out at the beginning of this year; the warm weather in December and January gain this season had an effect on demand.

This had a profound effect on coal prices. The chart below depicts the price of a benchmark East Coast coal price known as Big Sandy Barge coal.


Source: Bloomberg

Although Eastern coal prices remain well above the levels that prevailed in 2002 and 2003, there’s a notable sharp decline that began in early 2006. Coal prices fell from more than $60 per short ton to less than $40 per short ton earlier this year.

In the most-recent issue of TES, I discussed my bullish thesis on oil services stocks. Although the North American drilling market remains weak, the stocks have already priced in a lot of bad news.

Investors are well aware of the problems in this region, leaving scope for an upside surprise. Since that issue, we’ve seen that basic scenario play out. I’ll offer more concrete examples later on in this week’s report.

The same basic story is playing out in the coal stocks. Absolutely no one who follows the coal mining stocks with any degree of regularity is unaware that coal prices have fallen sharply in the past 12 months. And the rise in coal inventories nationally remains a cause of much concern; analysts have already factored this bearish picture into their earnings estimates.

Meanwhile, just as the market has priced in all that bad news, there are apparent signs of a turn in the tide. Consider the following bullish factors:

Declining Production In The East–Recall that the region known as Central Appalachia (CAPP) is a major, important, coal-producing region of the US. It’s also very mature and has been exploited for more than a century. Coal seams in the region are getting thinner, and a more-specialized and skilled labor force is needed to exploit the underground mines common in the region. Bottom line: Production costs are relatively high.

As coal prices soared in 2004 and 2005, companies started up more marginal, high-cost mines. A host of smaller operators in the region struggled to bring production on-line and take advantage of rising prices.

But many of these Eastern mines and the smaller, undercapitalized producers started bleeding cash when coal prices began falling last year. Mines that made economic sense at $60 per short ton were big money-losers under $40 per short ton. To make matters worse, labor, energy and raw materials costs continued to rise last year; that made mining operations more expensive in general.

The final result of this is that a number of these smaller, higher-cost producers folded and abandoned their mines. This has resulted in a meaningful production decline from the CAPP region. Overall, Eastern mine production is off more than 7 percent over the past year; this more than offsets a small increase in Western Coal production.

Mountaintop Permitting Decision–Many mines located in CAPP are underground mines; miners actually enter a network of shafts. But some operations are what are known as mountaintop mines; producers simply scrape the earth and rock from the top of a mountain to expose the coal seams. The economic benefit of this practice is that it’s often cheaper than underground mining.

The problem traditionally has been that all that dirt and rock—known as overburden—must be put somewhere. Typically, miners would get permits to dump this material into a neighboring valley. As you can imagine, environmental groups aren’t terribly enthralled with this idea; one group recently sued and challenged the validity of such mountaintop removal permits.

The judge ruled that the permits granted to several mining firms were invalid because the overburden would permanently destroy streams. This has knock-on effects for other mining projects that now won’t be able to get permits. Bottom line: This decision will further limit production from CAPP and tighten coal supplies. That’s bullish for coal prices and for some coal-mining firms that weren’t seriously or directly affected by the decision.

Seasonal Strength–The peak demand season for natural gas is the wintertime, when consumers look to heat their homes. This is when we typically see gas inventories decline.

In recent years, gas has become more heavily used in power plants, which has resulted in a second period of high demand–the heat of midsummer. But, at this time, the winter heating season trumps the summer cooling season when it comes to gas.

Not so with coal. Coal, as noted above, is the workhorse for the US electric grid. When electricity demand is high, utilities tend to draw down their coal stockpiles. Summer brings heavy cooling demand and high electricity usage.

Some will remember that, last summer, electricity demand soared to record levels during the hottest days of July. This is a key time for the coal market. Coal stocks have historically tended to rally heading into summer in anticipation of this period of high demand.

Inventories Likely Declining–As I noted above, coal inventory data from the EIA is less timely than for natural gas. In the inventories chart above, it appears that stocks are just coming off their highs.

But the coldest weather this year was in February and March–a period for which we don’t yet have complete inventory data. It’s likely, however, that the cold snap brought with it higher demand for coal just as it brought higher gas demand. And with production down in much of the US, inventories have likely continued to decline.

Finally, it’s worth mentioning that current coal inventories only look excessive when compared with the past few years’ worth of data–years when coal stocks were considered ultra-low. On a historical basis, coal stocks in the US really aren’t all that high for this time of year.

Peabody management’s comments backed up this constructive outlook for the US coal market. It highlighted that US electricity demand is up more than 5 percent so far in 2007, while coal production is off by 2 percent. It also highlighted the fact that a serious March blizzard in the Powder River Basin (PRB) coal-producing region in Wyoming affected production and transportation infrastructure in that region, further depressing supplies.

A few other comments are worth noting. First, Peabody noted that there is a huge difference between the published spot prices–the price of coal for immediate delivery—for coal and the prices it can garner under longer-term contracts. Peabody doesn’t sell much, if any, coal on the spot markets; instead, utilities contract for supply over multi-year periods at a negotiated price. These prices for forward delivery are currently much higher than current spot levels.

Peabody has noted in the past that it tends to get a premium to prevailing forward prices because it’s a reliable producer. While many CAPP producers have struggled to produce enough coal to meet their contractual obligations, utilities feel they can rely on supply from Peabody. This reliability is worth paying a premium price.

Specifically, Peabody announced that it’s signed contracts for PRB coal at prices a full 50 percent above current levels. The company is also signing $50-plus contracts for its Eastern coal for delivery in 2008, significantly above the current quote in the mid-$40s.

In spite of these premium contract signings, Peabody is being extraordinarily conservative about signing new contracts. In particular, the company stated that it lost most of its bid for coal supplies; Peabody announced that it only received contracts for about 10 percent of the bids it made in the quarter.

Basically, when a utility wants to secure coal, it announces its needs and asks for bids. A producer like Peabody can then offer to supply the needed coal at a certain price. The fact that Peabody was missing bids means that management wasn’t willing to offer a lower price to grab the business. In response to an analyst’s question, Peabody’s management stated that it wasn’t comfortable with the prevailing prices offered during the quarter and was quite willing to let contracts go away.

As a result, Peabody signed fewer-than-normal coal supply contracts in the first quarter. Because Peabody is a low-cost producer, I have no doubt it could have signed contracts that would have produced a positive economic return at the lower prices offered during the quarter. Management simply chose not to sign these contracts or get aggressive in bidding for them.

I can’t think of a more bullish commentary on coal pricing. Peabody is willing to remain patient because it expects coal prices to rise.

The firm expects it will be able to grab far-more-attractive terms on new contracts later this year. Because the company is undercommitted and has plenty of production left to sell, it’s leveraged to any increase in coal prices during the next six to nine months.

Another strikingly bullish comment is that Peabody has been fulfilling some of its contracts by buying, not mining, coal. Peabody has contractual obligations to fill with utilities; these contracts specify the type and grade of coal to be delivered.

For example, Peabody might be obliged to deliver a certain number of tons of low-sulphur coal with a specified British Thermal Unit (Btu) content. The company might also have the flexibility to deliver an equivalent amount of another type of coal.

Peabody often signs contracts with a certain mine in mind. But just because the company has a mine that produces coal that could be committed to a certain contract doesn’t mean it needs to source coal from that mine. Peabody can instead choose to buy coal from a third-party producer to meet its obligations.

There are two reasons why a miner might choose to buy coal. One reason is very bad for investors. Specifically, there have been several instances during the past couple of years where Eastern miners have failed to generate an intended production target from their existing mines. In other words, they haven’t managed to produce the coal from their ageing mines that they were contractually obligated to sell. Therefore, these miners were forced to buy coal from third-party miners, often at sky-high prices.

Oftentimes, these deals resulted in huge losses; the cost of buying coal exceeded the value of the contracts. This is one reason I’ve consistently advised avoiding miners focused on production from Appalachia, such as James River Coal and International Coal Group.

But this definitely isn’t the issue with Peabody. This company could ramp up production at its existing mines and easily meet its contractual obligations. However, management has chosen to buy coal because it believes the current prices are attractive; current coal pricing is too low.

In such instances, as Peabody pointed out during the call, it makes sense to leave its own coal in the ground and take advantage of the low-price opportunity on the spot markets. The company has a large trading operation: It buys and sells coal as part of its day-to-day business. Therefore, it’s particularly well positioned to take advantage of this sort of opportunity.

When a huge seller of coal such as Peabody starts buying up coal, you sit up and take notice. This is yet another direct comment from Peabody’s management that it’s looking for higher coal prices. The company has a well-respected management team and is clearly a huge player in the coal business. This team is better positioned than any analyst to forecast coal prices in my view.

The part of the call that probably garnered the most attention in the financial media was Peabody’s current strategic review process for its Eastern mining operations. This will most likely result in a spinoff of these operations into a new pure-play firm. This spinoff would include Peabody’s operations in West Virginia and Kentucky.

I spoke at some length above about mining difficulties in the Eastern US and the reasons I’ve been avoiding investments levered to CAPP. This has also been an important point in several prior issues of TES, including the Jan. 11, 2006, issue, Playing It Safe, and the Oct. 18, 2006, issue, Turning Up. I won’t belabor these points here.

My opinion remains unchanged. CAPP will remain an important coal-producing region for the foreseeable future, but high costs, safety and environmental concerns, and maturing reserve bases will make it necessary for investors to be extraordinarily careful in this region.

Peabody’s operations in the East are among the best in the region. They’re relatively low cost, and less than 10 percent of these mines would be affected in any way by the recent mountaintop decision. That said, Peabody is concentrating its attention and capital spending on the PRB and overseas operations, particularly in Australia.

This makes perfect sense to me; these two regions need to be managed separately and in different ways. In fact, I’ve spoken before in the newsletter about how I expect companies such as Peabody to seek reduced exposure to the CAPP region. From Peabody’s perspective, such a deal will free up management time and spending plans to concentrate on where the real growth is.

Back To In This Issue

Bull Market Down Under

As I noted above, international operations are becoming an ever-larger part of the Peabody story, moving from 1 percent to 30 percent of profits in just five years. While the picture in the US is rapidly improving and there are signs that Peabody is betting on continued strength, the situation internationally is even more bullish. International markets are on fire.

The key production market internationally is Australia. The nation’s proximity to important Asian markets, including China and India, makes it a natural for meeting rapidly rising coal demand.

Peabody has always had some operations there, but it recently beefed up its presence by purchasing Excel Coal, an Australian producer with a large Asian export business. Australia is the major international production market for Peabody, and the company has highlighted the nation as a key focus for its future capital spending.

In the US, coal demand growth is relatively slow and predictable; it grows alongside demand for electricity. Inventories of coal and commodity prices are heavily influenced in the short term by the weather.

It’s worth noting that US electricity demand is projected to grow around 1.6 percent annualized in the next 25 years, significantly faster than the 1.2 percent growth in motor gasoline demand projected during the same time period. This is partly a function of the electrification of the US economy because the proliferation of electric-powered devices such as computers, TVs and refrigerators electricity makes up an ever-greater share of the energy we use.

China and India are, in contrast, more secular growth stories. With their economies growing in the upper-single to low-double digits, you can imagine the wall of new demand for electricity every year. Literally millions of new consumers are buying their first TVs and refrigerators each year, which adds up to more power demand. Check out the chart below.


Source: EIA

This chart illustrates Chinese and Indian demand for electricity going back to 1990 with projections out to 2030. As you can see, demand for power from both countries is exploding and that trend is likely to continue in the future.

Electricity demand is a simple function of economic growth. And just as is the case in the US, electricity demand is growing faster than oil demand in both countries. Chinese and Indian electricity demand is growing annually by 4.8 percent and 4.6 percent, respectively; overall demand for oil is growing annually at around 3.8 percent for China and just 2.4 percent for India.

The point of all this is that both nations are heavily reliant on coal for their electricity needs. Coal accounts for about 80 percent of electricity generated in China and some 75 percent in India. And despite plans for a rapid ramp-up in nuclear, natural gas and renewable energy capacity in both countries, the EIA projects that, in 2030, coal will actually account for 81 percent of China’s grid and nearly 60 percent of India’s.

The simple fact is that China isn’t building nuclear and gas capacity fast enough to offset its growing needs. Although nuclear will likely gain a share in both countries, coal remains the workhorse.

China is a gigantic coal producer, second only to the US. But even China’s massive domestic coal production isn’t enough to keep pace with the country’s domestic demand. Peabody’s management team pointed out in its most-recent conference call that, just four years ago, China exported some 80 tons of coal.

This year, however, China will likely be a net importer. All those Chinese exports are now gone, and the country’s appetite for coal is growing stronger still.

Even more interesting, Peabody mentions that last year just more than half of Chinese coal imports came from Vietnam. But Vietnam’s economy is booming, and so is coal demand; the country has to pare back coal exports. That means that China will need to look elsewhere—which increasingly means Australian seaborne imports of coal.

A similar situation is brewing in India. The Indian energy minister recently stated that Indian coal demand could quadruple in the next 25 years. And unlike China, India produces considerably less coal than it consumes; it’s already depending on exports.

Consider the current situation in Australia. As a result of booming coal demand and insufficient export infrastructure, Peabody announced that there’s now a queue of roughly 160 ships waiting in the ports of Dalrymple Bay in Queensland and Newcastle in New South Wales for coal loadings. That represents as much as 10 percent of the world’s coal-carrying fleet.

The current waiting time is more than a month, and companies looking to export coal–including Peabody—are escalating fees. Despite these problems, the market is so strong that exporting coal remains highly profitable. Sometimes, a picture really is worth a thousand words. Check out the chart below.


Source: Bloomberg

This chart shows Asian benchmark coal prices in dollars per ton. The contrast with US coal prices couldn’t be more obvious: Asian prices are soaring back to levels last seen a year ago. While the US market is just turning higher, the Asian coal market is booming.

In fact, it’s not just Asia. As I noted earlier, the US is a rather domestic-oriented insular market when it comes to coal. The reason is simply that the US is energy independent when it comes to coal supplies. The European market tends to reflect better the international supply and demand for coal. Check out the chart of European benchmark coal prices below.


Source: Bloomberg

The rise in European coal prices isn’t nearly as dramatic as that of Asian coal. However, European coal prices are recovering faster than in the US. That’s because huge Asian demand for seaborne coal is having a profound effect on the amount of coal available for export to Europe.

Peabody is now a huge producer in Australia. And there’s plenty of scope for the company to make improvements to Excel’s mines and generate more output. This coal will be in high demand for export to Asia.

I see Peabody as an excellent play on both a recovering US coal market and the growing trade in coal between Australia and the rest of Asia. Despite its rise during the past few weeks. Peabody remains a buy. I wouldn’t be surprised to see this stock challenge its 2006 highs in the $70s later this year.

It’s also worth noting that, just as with Pride International–a stock I outlined in the most-recent issue of TES–there’s been significant buying of out-of-the-money Peabody Energy call options. These constitute a relatively aggressive bullish bet on further upside for Peabody. Although I’d never base my analysis solely on this point, when you couple strong bullish options activity with a favorable fundamental backdrop, it makes for an even-more-compelling story.

Back To In This Issue

Local Opportunity

I’m also adding another play on coal, Consol Energy (NYSE: CNX) to the Gushers Portfolio this issue. Consol is a major player in the Northern Appalachian and Illinois coal-producing basins of the US.

The company owns more than 2.7 billion tons of coal reserves in the Northern Appalachia Basin, 719 million tons in the Illinois Basin, 315 million tons in the PRB and 424 million tons in CAPP. Roughly 81 percent of the company’s annual production comes from Northern Appalachia. Much of the company’s production is high-Btu, high-sulphur coal.

The Northern Appalachia area (NAPP), like CAPP, is a mature coal-producing region of the US. As I discussed earlier this issue, it’s more expensive to mine coal from the Eastern US than from the PRB in the West. Growing production from Eastern mines is also much harder as coal seams become thinner and thinner over time.

However, within Appalachia, NAPP hasn’t been as pressured as CAPP in terms of costs. Consol just hasn’t experienced the production shortfalls and labor cost inflation that have become common in CAPP. Its mines are among the lowest production cost mines in the NAPP region. I see costs and reserve quality as far less of an issue for Consol as for companies like James River Coal and International Coal Group.

And NAPP does have one advantage over the PRB: It’s extremely close to its key end markets. While the West has become the nation’s most-important center of coal production, the majority of the country’s coal is consumed east of the Mississippi.

This is important because transporting coal is expensive. Coal must be transported by rail, and rail transport rates have been rising rapidly. It’s a much shorter distance from Appalachia to East Coast power plants than from the PRB.

For Consol, the situation is even better on the transport front because many of its big mines are located near rivers. Consol owns a fleet of more than 600 barges and tow boats with as much as 24 million tons per year of transport capacity. River transport offers a relatively convenient and cheap means of getting its coal production from mines to power plants.

In addition, there’s another catalyst for Consol’s coal. The company produces very high-quality coal in terms of Btu content; a ton of Consol’s coal contains a relatively large amount of energy, far more than your average ton of CAPP or PRB coal. Btu content is what ultimately determines how many tons of coal a utility must burn in its boilers. Higher-Btu-content coal tends to be more valuable.

Unfortunately, this coal is also high in sulphur. Sulphur is a pollutant that mixes with oxygen to form sulphur dioxide (SO2) when burned in a plant. Under the Clean Air Act, the government regulates SO2 using a cap-and-trade system. Utilities that generate excess SO2 must buy credits, which can get expensive at times. Therefore, coal with high-sulphur content tends to be less valuable than coal with low-sulphur content.

However, utilities are increasingly installing scrubbers to help remove SO2 from their plant emissions. Advanced scrubbers can actually strip out more than 90 percent of SO2 emissions. Fully scrubbed utilities can, therefore, burn high-sulphur coals and still remain compliant with the Clean Air Act.

This gradually reduces the valuation discount of high-sulphur coals to low-sulphur coals. Bottom line: The more US capacity is scrubbed, the higher the value of Consol’s coal.

One of the factors that’s weighed on the company’s share price in the past is delays to scrubber capacity build-out. It’s not so much that the utilities don’t want to build scrubbers into their plants. It’s just that there isn’t enough capacity to build out scrubbers fast enough to meet growing demand.

It’s an ongoing process, and scrubber capacity should continue to gradually rise in the next five to 10 years. This is a tailwind for Consol as it will mean an expanding base of potential customers.

It’s also worth noting that Consol is the largest coal exporter in the US. The company has a huge export terminal in Baltimore, Md., capable of handling some 18 million tons of coal annually. This allows the company to take advantage of stronger coal prices available in Europe. For 2007, Consol has plans to export 4 million tons of steam coal and 4 million tons of high-grade metallurgical coal, used mainly in steel production.

Consol also has plenty of exposure to rising coal prices—a boon if US prices continue to recover from their late 2006 swoon as I expect. The key metric to look at here is unpriced tons–the percent of production for each year not already committed under long-term contracts. As of the beginning of April, Consol had about 40 percent of 2008 production, 67 percent of 2009 production and 80 percent of 2010 production unpriced. As coal prices rise, Consol has plenty of scope to lock in attractive prices for these uncommitted tons.

Finally, far too many investors ignore Consol’s natural gas business, CNX Gas Co. Although CNX Gas is traded separately, the company is more than 80 percent owned by Consol, giving the company exposure to natural gas prices.

CNX Gas produces coal-bed methane gas (CBM). CBM is gas that’s produced from underground coal deposits. Much of the company’s production comes from coal deposits it owns in Virginia, West Virginia and Pennsylvania. In total, CNX Gas has just less than 1.3 trillion cubic feet of proved reserves.

CBM reserves tend to be relatively high cost. This was a problem late last year and early this year when gas prices spiked to the downside. However, as I pointed out in the most recent issue of TES, I’m turning increasingly bullish on gas prices.

I see this as yet another positive for Consol Energy. Consol Energy is added to the Gushers Portfolio as a buy under 48.

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Going Alternative

As I’ve noted in recent issues of TES, I’m always looking to add more stocks to my field bet plays. Recall that I use these bets as a way to play some of my favorite long-term energy themes.

Right now, I recommend three separate field bets: uranium, alternatives and biofuels. The uranium and alternatives plays were reviewed most recently in the April 4 issue of TES, Oil, Nuclear And Alternatives. I last examined the biofuels field bet in the March 7, 2007 issue, When Asia Sneezes.

To summarize, I see all three trends as long-term stories that will offer outsized returns to investors for years to come. There will undoubtedly be setbacks along this path. We’ve seen and will continue to see pullbacks in these stocks.

But these are secular themes–multi-year cycles that can produce outstanding returns for investors well placed to benefit. The uranium field bet picks are, for example, up close to 100 percent on average since I inaugurated the play last summer.

I place stocks in these field bets to offer targeted exposure to these trends. Instead of just picking one or two highly leveraged plays on biofuels or uranium, however, I recommend casting a much wider net. By buying several plays of differing risk levels, we can diversify our risk and maximize our chances of hitting a few big winners.

The key here is to keep your position sizes reasonably small and to get into all the plays in each group. I recommend putting about a fifth of what you’d normally put into a TES recommendation into each field bet play; if you normally put $10,000 in each of my recommendations, consider putting $2,000 or so into each field bet play.

Subscribers often ask me how to handle recommended field bet stocks that have seen big run-ups. The key here is to remember that you don’t need to put all your cash to work immediately.

To start, consider placing a small amount in each pick to get some exposure. When there’s a notable pullback–case in point being the late February pullback for the uranium stocks—I’ll highlight those names that look like good buying opportunities. This would be an opportune time to add more exposure.

Similarly, after a big run to the upside, I’ll often recommend reducing exposure to take some cash off the table in big winners. That doesn’t mean to sell out of your entire position; rather, consider pulling 25 percent to 50 percent of your position to guard against a pullback.

If I think a company is no longer worth buying or owning at all, I’ll recommend selling it outright in the newsletter or via a flash alert. Partial sales, scaled purchases and protective puts are risk management tools I recommend from time to time. (See the February 21 issue, All Eyes On Gas.)

In this week’s issue, I’m adding Denmark-based Novozymes (Copenhagen: NZYMB, Frankfurt: NZMB, OTC: NVZMY) to the biofuels field bet. Novozymes is a world leader in the manufacture of enzymes, which are nothing more than proteins that catalyze chemical reactions.

Currently, most of the world’s ethanol is produced from two crops: corn and sugar. Ethanol is an alcohol, so anyone familiar with the production of distilled spirits would be familiar with its basic process as well. Corn is ground into a powdery substance, which is mixed with a liquid and heated; this liquid is known as mash.

Mash is composed of carbohydrate starch and sugar molecules of various lengths—long chains of carbon, oxygen and hydrogen molecules. To make ethanol, these long molecules must be broken down into a simple sugar molecule known as glucose.

This process is performed using enzymes. These specialized proteins catalyze the breaking down of long carbohydrate chains into individual glucose molecules.

This key intermediate step is where Novozymes fits in. The company produces more than half the enzymes used for ethanol production in the US. Novozymes has a huge share in not only the US market for enzymes but in Europe and South America as well.

Agricultural products such as corn and sugar currently dominate the global ethanol production scene. This is known as first-generation ethanol. But there’s a problem with first-generation ethanol: The world also relies on these very same agricultural commodities as foodstuffs either directly or indirectly as livestock feed.

The rapid growth in demand for food in the developing world, coupled with the growth in biofuels, has been powering the global bull market in agriculture during the past few years. These powerful twin trends are also behind the strong performance of the stocks in the biofuels field bet.

Longer term, however, there’s considerable interest in developing so-called second-generation biofuels. These biofuels could be made from products like prairie grass and weeds or corn stover (the stalks left over after corn is harvested). Ethanol produced from such products is known as cellulosic ethanol.

The advantage is that producing ethanol from cellulosic biomass doesn’t take key agricultural products out of the global food chain. But there are also drawbacks. Breaking cellulosic biomass down into simple carbohydrate chains is more difficult and consumes more energy. The technology isn’t really commercial at this time, at least not on any large scale.

However, one of the keys to developing cellulosic ethanol will be designing specialized enzymes that can make the process of breaking down these materials more efficient and cost-effective. The global leader here: Novozymes.

The company has been partnering with the US government and Dept of Energy (DOE) on research projects involving enzymes for cellulosic ethanol production. In fact, President Bush visited the company’s North Carolina plant back in February for a panel discussion a DOE/Novozymes collaborative research project to produce enzymes capable of efficiently breaking down corn stover. In other words, Novozymes is already at the cutting edge of what could become the next big biofuels revolution—cellulosic ethanol.

Of course, there’s more to the company than just ethanol and research on cellulosic ethanol. The company also makes enzymes used in detergents that can remove stains without harming fabrics or colors, as well as enzymes used in food production, animal feed and even pharmaceutical production. Although these markets might sound boring, they’re not.

Enzymes are gaining ground versus chemicals in detergents, and the detergent market is also growing at a slow-but-steady pace because of growing use in the developing world. Food and animal feed are also growth markets: Consumers in countries such as China are increasingly eating more meat and processed foods. Novozymes is a leader in enzyme production for these markets.

I also like the fact that Novozymes is no fly-by-night company. It has a market capitalization well north of $6.5 billion, it has real sales and earnings, and it even pays a small 0.8 percent dividend. Novozymes is added to the biofuels field bet; see table below for price recommendations.

One quick note for investors: Novozymes trades in Copenhagen, a market that’s difficult for most US-based investors to access, but European subscribers shouldn’t find it terribly difficult. However, the stock also trades in euros in Germany. Most investors will have no trouble buying this stock there either over the telephone with a broker or, in some cases, online.

For those unable to buy either the Copenhagen- or Germany-listed shares, the US over-the-counter symbol is NVZMY. The American Depositary Receipts don’t trade much every day, but if you use a limit order, you should be able to get a decent execution. You can pull up the current price on Yahoo! Finance by typing in NVZMY.PK.

Below is the full biofuels field bet table as it currently stands.

Biofuels Field Bet
Company Name (Exchange: Symbol)	Change From Recommendation (%)	Advice
Potash Corp (NYSE: POT)	79.7	Buy under 185 (see 04/23/07 Flash Alert)
Mosaic (NYSE: MOS)	77.1	Buy under 31 (see 04/23/07 Flash Alert)
Syngenta (NYSE: SYT)	30.4	Buy under 40 (see 04/23/07 Flash Alert)
MP Evans (London: MPE)	27.9	Buy under GBP4
Anglo-Eastern Pl. (London: AEP)	31.9	Buy under GBP4.25
Monsanto (NYSE: MON)	24.2	Buy under 60.50 (see 04/23/07 Flash Alert)
Sipef (Belgium: SIP)	67.9	Buy under EUR300
Earth Biofuels (OTC: EBOFE)	-83.2	Hold
PowerShares Deutsche Bank Agriculture (AMEX: DBA)	-2.8	Buy under 28
Novozymes (Copenhagen: NZYMB, Frankfurt: NZMB, OTC: NVZMY)	NEW	Buy under USD120*

*Equivalent to 660 krona or EUR88.20

Source: The Energy Strategist