A year ago coal was a dull market after a warm winter in 2005-2006 generated record inventories and sent coal prices plummeting. As a result, most coal stocks saw declines of 50 percent or more from late 2006 to early 2007 and few buyers could be found. However, the situation has now greatly changed as the ongoing tightening of supply and demand in the US coal market has caused coal prices (and stock prices) to skyrocket. So, what are the forces behind this move and where are the opportunities in this sector these days?

Spot prices for coal, which is the price of a ton of coal for immediate delivery, are trading at new highs while US coal supplies have tightened due to a series of new environmental laws and safety regulations. These new regulations were primarily targeted at the east coast and forced many smaller mining operations to shut down as they simply could not afford the cost of compliance. Meanwhile, larger players were forced to scale back their operations due to the increased cost of doing business. At the same time, coal demand surged as a result of demand abroad.

China is the source of most of this demand after it became a net importer of coal in 2007. The country is already the largest producer and consumer of coal, but is now seeing its consumption grow even more rapidly. In fact, the Chinese government even banned exports of coal in China to help keep costs down and ensure there was enough to go around. All of this demand from China is eating up the supply that was traditionally earmarked for Europe, which is forced to import the majority of its coal. Now, Europe is turning to the US in order to fill this need.

There have also been several recent events that have helped boost prices. First, heavy rains in South Africa have impacted their coal exports while the fourth-largest coal exporter in the world also stated that it would need to keep more of its own mined coal for domestic consumption. Secondly, Austrialia has also been suffering from heavy rains that has disrupted coal production for the largest exporter. And finally, Indonesia is expected to become the world’s largest coal producer, but no longer believes it will be able to supply as much as previously expected.

So, what stocks are worth watching to take advantage of these circumstances? One of the most successful coal stocks this year has been Patriot Coal (NYSE: PCX), which spun off from its parent Peabody (NYSE: BTU) in October. Since then, the stock is up a healthy 56.59% as a result of strength in the coal market and a compelling future development in the Appalachians where it has 446 million tons in reserves alone that represent some of the lowest sulfer (highest quality) coal in the market. Combined, its 9 million ton reserve base dwarfs that of competitors and are in strategic locations that enable them to easily export abroad and ship domestically.

Investors looking for a more diversified play on the entire sector may want to check out the Market Vectors-Coal ETF (NYSE: KOL) that offers a sort of “mutual fund” focused on just coal companies. The ETF’s top 14 holdings - or 70% of its portfolio -are all up and midstream producers that are marginal producers and should give good exposure to the sector. The only problem with the ETF is its stake in Huaneng Power (NYSE: HNP), which is a power-generating consumer of coal and not a producer.

Other coal stocks to watch include Consol Energy (NYSE: CNX), Peabody Energy (NYSE: BTU), Arch Coal (NYSE: ACI), Joy Global (NDAQ: JOYG), Bucyrus International (NDAQ: BUCY), Transalta (AMEX: TA), and James River Coal Company (NDAQ: JRCC). All of these companies should benefit from the rise in coal prices, but the extent of which depends on how many long-term contracts they can ink while prices are high. For now, many of them are struggling as they export cheap coal under old contracts. Regardless, these are all stocks that are definitely worth watching!

Related Companies
Peabody Energy Corporation (BTU)
Alliance Resource Partners (ARLP)
International Coal Group, Inc. (ICO)
Massey Energy Company (MEE)
Arch Coal, Inc. (ACI)
James River Coal Company (JRCC)
Foundation Coal Holdings, Inc. (FCL)
Penn Virginia Resources (PVR)
Evergreen Energy Inc. (EEE)
National Coal Corp. (NCOC)