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Sliding demand is forcing US coal producers to reassess their future after several American miners shut down capacity and shifted focus abroad.
By James Wellstead — Exclusive to Coal Investing News
Despite massive reserves and active participation in the ongoing coal rush of emerging markets, US coal producers are facing a period of sustained lower prices and stalled output. While 2012 is looking bleak, expect a retooling within the industry as companies adapt to the changing marketplace.
The announcement that Alpha Natural Resources (NYSE:ANR) will immediately idle four mines in Kentucky and West Virginia, with plans to idle two more in early 2013, is a clear indication of the current market reality. The Wall Street Journal reported that Alpha will cut some four million tons (MT) of production, of which 2.5 MT are thermal and 1.5 MT are metallurgical.
Other firms are also being affected. Arch Coal, Inc. (NYSE:ACI) CEO Steven Leer said at the company’s mid-February 2011 Q4 presentations that Arch is expecting US thermal coal demand to fall by as much as 50 MT this year, with the expectation of “more supply cuts in Appalachia and elsewhere in the near term.”
As a result, companies are reacting to changing conditions and are actively looking beyond US borders for customers. Leer said Arch is looking to shift its focus from US markets by “expanding [its] presence in the seaborne [thermal] market.”
However, European thermal markets (the primary customer of the US) are already at full capacity in many facilities, despite record cold weather across the much of the continent. As a result, many thermal contracts are trading lower in Europe, with March-loading South African cargo traded at US $105/tonne earlier this month.
US thermal demand was already down eight percent this year, thanks in part to warmer winter weather, and it is expected that this year coal-fired electricity generation will hit its lowest levels since 1992. But besides warm weather, other structural changes also appear to be taking a toll.
Why the decline?
So why, despite the growing role that US coal has come to occupy in recent years, are US coal operations slowing down at a time when global demand is set to double in less than ten years’ time? A number of factors are at play.
First, the US is one of the highest-cost coal producing regions in the world, and it is only getting more expensive. This is true of the Appalachian seams in particular. Walter Energy (NYSE:WLT) recently reported that its consolidated average cash cost per ton for hard coking coal has risen over the last year, up from US $91.14 in 2010 to US $131.74 in 2011.
While the cost of thermal production was lower for Walter on the year, operational cost inflation from retrofitting existing coal-fired power plants has been high, with many operators choosing to shut down facilities instead of upgrading. Building new plants with 40 year life spans is also incredibly challenging at a time when there is little appetite for large-scale infrastructure.
Second, alternative fuel sources are continuing to cut into coal’s energy and electricity market share. Natural gas is clearly the leading alternative crowding out coal demand, with growth projected at 5.6 percent in 2012, and prices likely to stay low when further supply comes online this year.
Even renewable energy is becoming cost competitive. A report released by the Michigan Public Service Commission has projected that based on a 40 year lifecycle cost, renewable energy in Michigan is now cheaper on average to produce than energy from a new advanced-supercritical pulverized coal facility.
As a result, many US thermal producers are becoming increasingly eager to revitalize their operations, and are looking outside of these operations for help.
Implications for junior miners
While the short-term prospects of these confluent forces are strong for many US companies, the coming year will likely see merger and acquisition activity by firms seeking to reduce production costs or gain access to markets with more promising growth prospects.
Access to Asian markets will likely be one priority for US firms in the coming years. Bloomberg recently reported that seaborne coal trade will likely become the third commodity shipped by sea to surpass the one billion metric ton mark this year. Both China and India are the main players in this market, with China dominating seaborne trade last year and India increasing its coal imports by 35 percent to 85 MT last year.
For these reasons, Seeking Alpha author Peter Epstein recently wrote that companies will likely be acquiring producing assets which can offer revenue streams in order to use them as collateral to borrow against. This will make it easier to make larger, more strategic plays to hedge against market disruptions or reduce infrastructure costs associated with accessing seaborne markets.
As such, Pacific Basin producers are likely targets for activity from US producers who are quickly backing up against a wall in domestic thermal markets.
Securities Disclosure: I, James Wellstead, hold no direct investment interest in any company mentioned in this article.