Policy Change Creates An Opportunity In This Energy Market

I have said before and I’ll say it again, despite Donald Trump’s best efforts the coal industry in this country is in long-term, probably terminal decline. Those best efforts were to the fore this week, when Trump rolled back Obama era regulations designed to force utilities to move away from the black stuff and towards cleaner power production. For various reasons that may irrelevant when it comes to the long-term future of U.S. coal, but it may be enough to cause a tradeable, short-term bump in the fortunes of some coal stocks.

I would, however, stress the words “short-term”. The fact is that while the Obama regulations didn’t help, just as imposing them was done to please his base, repealing them is more about political optics than anything. The switch to natural gas and renewables is not just a U.S. phenomenon, it is happening all over the world, and it is driven by market dynamics and considerations of the next few decades rather than years. Power companies may welcome more time to switch over their remaining coal powered plants but switch they will. Apart from anything else, in the current tit for tat political environment it is fair to assume that the old regulations will be back when the White House changes hands, whether that is in two years or six.

Still, the temporary relief gives coal companies some breathing space, and there is always the chance that some use that to diversify, either geographically or in other ways. That should be enough to change the market sentiment, and it wouldn’t take much of a change to cause a pop in the hardest hit coal shares such as Cloud Peak (CLD).

(Click to enlarge)

Okay, so I know that the two-year chart above hardly inspires confidence. Every rally has been followed by a collapse that took the stock even lower than the starting point, but the relevant point here is that there have been multiple strong rallies. That volatility is what makes a long position here interesting.

The trajectory of the stock reflects the market’s long-term view that bankruptcy could be on the horizon for Cloud Peak and under normal circumstances that would reduce the efficacy of stop loss orders. If the stock goes to zero overnight, no order is going to save you from total loss. That is still a possibility of course, but it looks a lot less likely now than it did quite recently. Cloud Peak’s debt/equity ratio is a massive 41.97, but they do show positive levered free cash flow of over $82 million and a book value of $13.30 per share.

Still, as unlikely as I think it is that CLD gives up the ghost in the near future, this is a trade that still has the specter of total loss hanging over it. That means that positions should be kept small, and that time is an important factor in making position management decisions. You should be looking for a quick bounce back towards $4 and looking to take a profit of around fifty percent at around $3.80. However, if CLD languishes around these levels or dips below $2, cut and run. Even when the risk of total loss is factored in that makes for a decent risk/reward ratio.

One of the hardest things for long-term investors to grasp when they try their hand at trading is that it is quite possible to take advantage of short-term conditions that go against your long-term base case. Buying CLD is a case in point. This week’s policy change won’t halt the relentless march of history away from coal, but it may be enough to cause a volatile stock to jump over the next few weeks and that is an opportunity regardless of what the next few years hold.