Is Coal Ready for Comeback?

Coal is having a bad year. Both thermal and metallurgical coal prices have fallen by at least 30 percent on the evaporation of demand from China, the US and Europe. At the root of this decline are rising costs across the coal mining industry and a global economy that lacks confidence in its near-term future.

A clear case of these events taking hold is the bankruptcy of Patriot Coal (OTC Pink:PCXCQ), which cited rising production costs, falling demand and record-low natural gas prices for its failure. The costs of keeping operations running in an increasingly expensive atmosphere at a time when coal prices were reaching multi-year lows was not feasible for the company.

The case has been much the same in Australia, where rising operational and labor costs alongside weaker Chinese metallurgical coal demand have pushed as much as a third of the industry into the red.

In a report obtained by The Australian Financial Review, mining consultancy Booz & Company suggests that “[l]ow productivity and high costs will magnify the impact of falling commodity prices on Australian mining profits,” while “a 20 per cent price drop from current levels would make 30 per cent of Australia’s coal production unprofitable.”

US-based CONSOL Energy (NYSE:CNX) has suffered more from the fall in demand within the market. The company closed several coal mines earlier this year in response to the slowdown and said its earnings will be hit well into the fourth quarter and likely in 2013. Declining prices for metallurgical coal, which accounts for 13 percent of CONSOL’s overall sales volume, have impacted companies globally.

Canadian coal miner Teck Resources (TSX:TCK.B,NYSE:TCK) hasn’t fared any better this summer, as the company’s quarterly report, released this week, indicates. Teck’s third-quarter adjusted profit fell to $349 million compared to $742 million in the same period of 2011. Revenues fell significantly on the back of “significantly lower coal prices, reduced sales volumes and higher total unit costs.”

The average coking coal price fell by a third, down to “US$193 per tonne in the third quarter compared with the same period last year reflecting weaker steelmaking coal market conditions,” the company reported.

In all, so far this year coal companies haven’t had much to brag about. But is the market ready to turn around?

Signs of a comeback?

Despite the grave proclamations, some voices are suggesting that coal has started to bounce back from the bottom it reached earlier this year.

Peabody Energy (NYSE:BTU), one of a number of American companies that cut production earlier this year, has begun to see demand return and has the profits to prove it.

The third-quarter report released by the firm earlier this week announces full-year adjusted EBITDA targets of between $1.75 billion and $1.85 billion, with adjusted per share earnings between $2.10 and $2.30.

The figures surprised analysts, who had projected that per share earnings would fall to around the $1.78 level. Peabody credited “expanded U.S. margins, record Australian volumes and aggressive cost control” for its strong resurgence and believes a turnaround is near for the market as a whole.

“While the global coal environment remains challenged, there are indications that markets are stabilizing through U.S. gas-to-coal switching, higher European coal-fueled generation and increased China infrastructure spending,” CEO Gregory Boyce said.

The rise of natural gas above $3 per million Btus (MMBtu) has been a significant breaking point for the interchange between gas and coal. Seeking Alpha columnist Paulo Santos suggests that $3 is a breaking point for dispatch — switching — from coal to gas or vice versa. When gas is below the $3 mark, coal is priced out of utilities portfolio. When above $3, coal becomes competitive again.

Earlier this week, gas for November delivery traded at $3.617 MMBtu — well above Santos’ breaking point. If gas prices remain elevated at these rates, US thermal coal companies may begin to gain ground on their gas counterparts and coal could price itself back into the game.

The news of a turnaround would be welcomed by many in the industry. But for now, coal companies continue to look for strong signs of resurgence in infrastructure spending and positive manufacturing growth in places like China, India and Brazil. While a comeback in US thermal demand could help redeem parts of the industry, coal’s future will continue to rest heavily on emerging economies.

Securities Disclosure: I, James Wellstead, hold no direct investment interest in any company mentioned in this article.