Markets

Westmoreland Coal Is A Unique Opportunity

Summary

  • Westmoreland Coal's entry into the MLP space signals a new direction for the company.

  • The MLP is perfectly suited to Westmoreland Coal, and we should expect additional asset drop-downs.

  • Expect other coal companies to try to raise capital through all available methods if coal prices stay low.

  • Many coal companies could benefit from the MLP structure although none are currently as well-suited as Westmoreland for the transition.

  • Peabody Energy is the best potential candidate for MLP usage.

Westmoreland Coal (NASDAQ:WLB) is an almost forgotten player in a distinctly distressed industry. It's also uniquely positioned with a business model that offers significant benefits in the industry's current environment. Westmoreland's purchase of a controlling interest (77%) in Oxford Resource Partners (NYSE:OXF), a Master Limited Partnership (MLP), on October 16th is a game-changer for both companies. This deal, which should be finalized in 4Q14, may lead other coal producers to investigate similar transactions. No other coal miner is as well-positioned for entry into the MLP space, though.

 

Westmoreland primarily utilizes a mine-to-mouth business model. This model is centered on mines delivering fuel to nearby power plants. These plants are specifically designed to use the supplying mine's thermal coal. Some mines feed coal directly into a single customer's power plant via a conveyor belt. Other Westmoreland mines have multiple customers, with one power plant typically adjacent to the mine. Ten of Westmoreland's twelve mines fit into this business model.

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Market Volatility

Volatility in the financial markets has occasionally been dubbed "The New Normal" (or something similarly frightful) by the business media.  This type of declaration typically occurs at the peak of a cycle of volatility, thus implying that the writers and pundits are behind the curve.  The most important word in that last sentence, though, is "cycle."  Volatility, like asset prices, is cyclical.  For a visual of equity market volatility as calculated by the VIX index, see:

The VIX over time  (http://quotes.wsj.com/VIX/index-interactive-chart)

Notice that the chart above also layers in news stories written about the VIX.  Two of the sharpest VIX peaks were preceded by a spike in VIX-related articles.  We'd argue that the 2008-09 VIX run-up wasn't covered significantly by the media for two reasons:  1. The VIX wasn't as widely known 5-6 years ago.  2.  Other topics, including Lehman Brothers, unemployment, Fed bailouts and the presidential race pulled journalists in other directions.

The critical point here is that we've had over two years of low equity market volatility.  While the VIX has jumped off its low, we're not even close to spooky levels.  Based on the already declining level of VIX-related articles, you might expect that the cyclical peak has already passed.  We're not ready to make that statement just yet, but December "window dressing" among investment funds and traders will likely keep a lid on end-of-year volatility unless we have an exogenous event (terror attack, war, natural disaster etc.).  January's market could be more erratic, though, as earnings season begins anew, 2015 guidance is released and everyone on Wall Street returns to work.  Stay tuned...