Whitehaven Coal Shows That Commodities Remain Profitable

Coal is in a slump. Big mining companies are losing millions because of plunging commodity prices. Some are even saying energy sources like oil and coal are dead. And they have good reason to say so. Oil prices have been extremely volatile lately, and coal is going nowhere but down.

Surely you’d think that a business model surrounding a declining commodity can’t work. Yet somehow it does. Whitehaven Coal [ASX:WHC] has been able to grow profits in a declining industry. Today, Whitehaven announced net profits of $7.8 million; this was coming off a loss of $77.9 million. The amazing turnaround is staggering. Yet investors don’t think so.

Whitehaven’s share price dropped 6.7% on open. Even with the profit increase, investors still associate mining with negative connotations. But we shouldn’t dismiss Whitehaven’s achievements.

They’ve been able to increase cash generated from operations, while reducing net debt and decreasing unit cost per tonne. Most of their improvement was driven by production within the big Maules Creek mine. Not only has it increased Whitehaven’s revenues, the mine is expected to double production by 2018.

How could investors not like this company?

Whitehaven CEO, Paul Flynn said ‘the results are particularly pleasing because they have been achieved at a challenging time for the industry, meeting all our commitments we have made to the market’. Flynn is referring to falling export prices out of Newcastle. And falling coal prices could be the number one problem investors have about getting into mining stocks.

From the Newcastle port, coal prices have fallen by 25% over the past year. And in the past five years, coal is down around 40%.

The graph below shows coal prices over the last five years.

Index Mundi

Source: Index Mundi

It’s not hard to see why investors would have no confidence. But Mr Flynn commented on something interesting today. He told the market:

The strength of growth in Asian energy demand combined with production cutbacks from key exporting countries suggest that Asian coal markets will return to balance over the course of 2016 and provide the basis for a price recovery commencing in 2017.

The main takeaway from Flynn’s comment is towards the end: ‘a price recovery commencing in 2017.’ Everyone is trying to predict where the demand will be in the immediate future. China, who has always strongly demanded commodities, has cut mineral imports.

But China has one major problem they need to address: meeting future energy demands.

A surge in energy could resurrect commodities

China needs energy and lots of it. Just two years ago China accounted for 43% of the world’s oil consumption. Cutting it out cold turkey seems like an unrealistic expectation. The same goes for coal. Yes it’s dirty and pollutes the air. But it’s cheap and readily available.

There is such an abundance of minerals like coal that miners are saturating the market. If prices go down then they’ll just produce more.  And even though demand might slightly be declining, China consumes coal at an astonishing rate.

The graph below represents the consumption of fuels by China.

fuel consumption china

Source: US Energy Information Administration

China is investing in greener technologies. But with how things look now, China will keep using cheap coal to fuel energy needs. Drastic changes are taking place to remove their dependence from fossil fuels to greener sources. However, right now China can’t afford to significantly reduce their dependence on coal. Diversifying their fuel sources will take time, and for now China will keep on burning coal.

Härje Ronngard,

Junior Analyst, Money Morning

PS: Mining stocks are getting cheaper and cheaper. It’ll be only so long before they’re due for a rebound. But not all of them will make it out alive. According to Money Morning’s resource analyst, Jason Stevenson, there are 10 mining stocks worth looking at for 2016.

In his free report, ‘The Top 10 Australian Mining Stocks for 2016’, Jason will tell you the perfect time to buy.  He’ll also tell you the trigger for the next great commodities boom. To get your free report today, click here.

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