Coal Conundrum For Transportation ETFs

The Market Vectors Coal ETF KOL declined yesterday on heavy volume, but the lone equity-based exchange traded fund dedicated to moribund coal equities did not hit a new low. Still, KOL has lost nearly two-thirds of its value over the past two years and slumping demand for the commodity is hampering other ETFs beyond KOL.

For example, as KOL has plunged 56.6 percent over the past year, the iShares Transportation Average ETF IYT has tumbled more than 23 percent over that period. Figuring out the iShares Transportation Average ETF's coal conundrum is not difficult.

IYT, which tracks the widely followed Dow Jones Transportation Average Index, devotes 21.5 percent of its weight to railroad stocks, making that group the ETF's second-largest industry allocation. U.S. railroad operators have experienced declining shipping volumes and share prices due in part to what has become a lengthy bear market for coal.

“The Association of American Railroads (AAR) reported that total US rail carload traffic in 2015 declined by 2.5% from 2014 levels. 2015's overall rail traffic was below levels not seen since the rail traffic recovery began in 2009. AAR reported that 2016 is off to a mixed start as well. Overall carload traffic in January was 16.6% lower than January 2015. However, a closer look at the long-term annual data indicates that the majority of the declines are due to lower coal shipping. If coal is excluded from 2015 data, rail volume is comparable to levels seen in 2013 and 2014, on the strength of intermodal container traffic,” said Fitch Ratings in a recent note.

Three of IYT's top 10 holdings – Kansas City Southern KSU, Union Pacific Corp. UNP and Norfolk Southern Corp. NSC – are railroad operators.

The coal industry has been drubbed in recent years. Many U.S. utilities have moved away from coal as natural gas prices have plummeted because natural gas burns cleaner than coal. Slack demand has forced past and current KOL constituents into bankruptcy with market observers forecasting more to come.

Several of KOL's 26 holdings sport sub-$4 price tags. If there is a bright spot, it is that the rapid decline of the U.S. coal industry is not expected to hamper IYT's other industry exposures.

“Recent declines in rail traffic are unlikely to spread to other modes of transportation as the declines are primarily attributable to coal shipping, which mainly relies on rail transportation, Fitch Ratings says. However, rail traffic declines will persist into the midterm,” said Fitch.

Coal usage is expected to decline four percent this year and one percent in 2017, adds the research firm.