How Important Is The Powder River Basin To ANR?

Mar.21.13 | About: Alpha Natural (ANRZQ)

Alpha Natural Resources' (ANR) thermal coal division has had a rough set of quarters due to low natural gas prices and increasingly stringent environmental norms, which are causing coal demand to slump across the United States. While the firm has adopted measures to offset the slump by focusing on its metallurgical coal business and also on increasing thermal coal exports, the results have been quite marginal at best. However, we believe that ANR's operations in the Powder River Basin (PRB) in Wyoming could provide some respite since PRB coal has lower emissions compared to other varieties of coal and is becoming an increasingly attractive fuel as natural gas prices continue to rise.

ANR's Presence in The Powder River Basin

Alpha Natural Resources produces two varieties of thermal coal: PRB coal and eastern steam coal, which is mined in the Appalachian region. PRB is the largest source of coal in the United States. The firm's production from the region was around 47 million tonnes in 2012, contributing to over 43% of the firm's total coal volumes. PRB coal is relatively cheaper and has better environmental profile compared to other varieties of thermal coal produced in the U.S. In 2012, the average realized prices for PRB coal were around $13, compared to around $66 for eastern steam coal. Powder river basin coal prices are relatively low, partly because the mines are located further from a majority of U.S. coal-fired power plants than other mines such as Appalachian region. PRB coal accounts for about 10% of the firm’s total revenues in 2012 and around 43% of the firms tonnes sold.

Why PRB Coal Is Attractive

Low Prices and Production Costs: Although PRB coal has a lower calorific value (energy content) in comparison with other varieties of thermal coal, it has an advantage on a energy content per dollar basis even after factoring in the the higher transportation costs per ton. Extraction costs for PRB coal are also among the lowest in the U.S., with cost of extraction per ton in the mid-single digits on an average, compared with costs of above $50 in the Appalachian region. This is primarily because coal in the Powder River basin lies much closer to the surface, making it easier to mine. This reflects on ANR's EBITDA margins as well -- margins for the firm's PRB operations were around 10% while the eastern coal operations had negative margins. Pricing for PRB coal, although still quite low, have shown some growth over the past year. In 2012, the ANR's average realized prices for PRB coal grew by around 8% as compared to relatively flat prices for eastern coal.

Increasingly Competitive With Gas: Over 90% of coal consumption in the U.S. comes from the electricity sector. However, low gas prices, stricter environmental norms and higher capital costs associated with pollution controls are causing utilities to move away from the fuel to cheaper alternatives such as natural gas. Over the past five years, coal consumption from the electricity sector has dropped from around 1 billion tonnes in 2007 to around 615 million tonnes in 2012. However, an increase in gas prices could partially reverse or slowdown this trend making PRB coal more competitive with natural gas. It is interesting to note that when gas prices breached the $3 mark last year, there was a slight reversal in coal to gas switching trend. Over the past year, gas prices have increased from around $2 /MMBtu to around 3.6/MMBtu. If gas prices continue to rise higher, it could help to boost PRB coal’s demand and pricing.

Lower Emissions Compared to Other Coal Varieties: PRB coal is among the cleanest burning coals since it has the lowest levels of sulfur and heavy metals such as mercury. This could make it a more attractive option compared to other coal varieties as power plants need to comply with increasingly stringent emission laws such as MATS (mercury and air toxins standards).


Exploiting Resources Quickly in Comparison to Reserves: While ANR operates two mines in the PRB region, its presence is quite small when compared to some of the other coal firms such as Peabody (BTU) and Arch Coal (NYSE:ACI). The firm's PRB coal reserves are also relatively small making up just about 23% of its overall proven reserves. However, PRB coal accounted for almost 43% of ANR's volumes last year, meaning that it has been tapping into these reserves a lot faster than for other coal varieties, and this may not be sustainable in the long term.

Coal Less Competitive With Gas in Terms of Emissions and Capex: While PRB coal has lower emissions of sulfur and mercury compared to other coal varieties, it still does not match the low overall emission of natural gas. As stricter carbon emission norms are implemented, all varieties of coal could be disadvantaged, as they emit a greater amount of CO2 than natural gas. Additionally, coal-fired power plants are much more expensive to install per mega watt, compared to modern natural gas-fired power plants.

PRB Could Cannibalize Eastern Coal Sales: Given PRB coal's lower prices and environmental advantages, growth in PRB sales could come at the expense of a decline in sales for higher priced eastern coal, potentially impacting ANR's revenues.

Disclosure: No positions.