Coal Fundamentals: Straight From The Experts

by: Peter Epstein

Last week I wrote a coal outlook piece for which I received a lot of hits and handful of emails. Here's the link to last week's article. The gist of the emails I received was, "Pete, you say that coal fundamentals are poor, but can you give concrete examples." Looking back through company earnings, press releases, news articles and commentary by Steve Doyle at I aggregated a handful of direct quotes.

I tried to find some uplifting quotes to balance the negativity, but the only thing readily available was Peabody Energy's typically bullish remarks, which I include below. Despite a lack of suitable sound bites, I can summarize the bull case; 1) global quarterly coking coal prices are bottoming around $200-$225 per metric tonne, 2) domestic thermal coal prices will find support due to recently announced production cuts by Peabody Energy, (BTU), Patriot Coal, (PCX), Arch Coal, (ACI), and Alpha Natural Resources, (ANR) 3) domestic thermal and coking coal demand will find support as the U.S. economy picks up, 4) the 2nd half of the year will be stronger than the 1st half.

CEO of Arch Coal, Steve Leer: Quote, "As you know, the coal industry will face some headwinds in domestic thermal markets in 2012. Power demand is down approximately 8% through the first week in February, a function of the exceptionally mild winter to-date and a tough comparison versus 2011. Heating degree days are off 20% from normal which has contributed to the glut of natural gas and depressed prices for that fuel as well. As a result, we are taking a conservative view of 2012 and expect U.S. coal consumption to decline by approximately 50 million tons or so from 2011 levels."

Peter Epstein: 50mm tons is a big number compared with announced cuts to date.

CEO of Peabody Energy: Greg Boyce: Quote, "Global generation rose 12% on average in the key nations of China, India and South Korea, which more than made up for the modest declines in Japan and the U.S. Global coal imports rose 6% in 2011 and topped 1 billion metric ton mark. China was again a major story in seaborne coal, accelerating imports through the year. After records in the last two months, China set a new mark in 2011 for net coal imports, 14% above the 2010 record."

"India was the fastest growing coal importer last year, increasing thermal imports 35% to 85 million tons. In 2012, we look for greater global reliance on coal and the seaborne market. It is clear that the world's fastest growing economies continue to increase coal use to drive economic activity, create jobs, and improve quality of life. We expect the seaborne coal market to expand again in 2012, driven both by steel production and electricity generation."

"Projections call for growth in steel production in 2012 that would equal a 50 million ton increase in met coal use just this year. We have begun to see steel prices stabilize recently after de-stocking activities, and are looking for seaborne met coal demand to rise 10% to 15%, to as much as 300 million tons. Nearly 90 gigawatts of coal-fueled generating plants are expected to come online in 2012, representing more than 300 million tons per year of coal at normal utilization rates. We expect thermal seaborne coal demand to rise another 5% to 10% in 2012, led by growth in China and India."

Peter Epstein: This commentary from the CEO of Peabody was unlike any I could find going back about a month. While some pundits are calling for a 2nd half rebound, Boyce doesn't appear to acknowledge the clear decline in fundamentals over the past few months.

CEO of Patriot Coal, Richard Whiting: Quote-- "Likewise, given our view that the domestic thermal coal market is likely to remain depressed for an extended period, we have conducted a rigorous review of our Central Appalachia thermal mine portfolio," continued Whiting. "As a result, we made the decision to idle the Big Mountain complex in Boone County, West Virginia, effective today. Big Mountain produced 1.8 million tons of thermal coal in 2011. This decision effectively positions Patriot with no remaining uncommitted Appalachia thermal coal in 2012."

"Metallurgical coal demand has trended downward in recent weeks, particularly in export markets," added Whiting. "As previously announced, we have taken actions to match our met production with expected sales volume. We are reducing production at both our Rocklick and Wells complexes, with particular emphasis on higher-cost operations, and delaying certain of our met expansion plans."

Peter Epstein: Patriot reiterated this negative view on its conference call where the CEO said that domestic thermal coal prices will be weak for at least the remainder of 2012.

CEO of Alpha Natural Resource, Kevin Crutchfield: Quote-- "Alpha subsidiaries in Kentucky and West Virginia will idle four mines immediately and two others between now and early 2013, while several other mines will alter work schedules or reduce the number of production crews. Altogether 10 mining operations are affected, four in eastern Kentucky and six in southern West Virginia."

"When completed, the adjustments are expected to reduce annual coal production by approximately 4.0 million tons, most of which originates on the CSX rail system. The total includes approximately 2.5 million tons of thermal coal and 1.5 million tons of lower quality, high-volatility metallurgical coal. Eastern Kentucky operations will scale back thermal coal production by about 1.5 million tons while the remaining reductions will occur in southern West Virginia."

"A business decision like this is so difficult because it impacts people and their families, but adverse market conditions left us no choice," said Kevin Crutchfield', Alpha's CEO. "Several mines are encountering weak demand for their products. We examined all options but in the end these operations had to do what was necessary to preserve a sustainable business plan in a challenging environment."

Peter Epstein: Coal companies hate to lay-off people because it can cause serious problems when its time to re-open mines. Yet, the CEO of ANR is laying off 320 people, signaling that he doesn't believe that pricing in central Appalachia is coming back anytime soon.

February 10th Reuters article: Quote, "Prompt physical coal prices slipped by around 75 cents for the third day running, despite freezing European weather that has boosted gas and power values due to a surge in heating demand, because utilities have little available storage space. European utilities are running out of stockpile space at the key import hub of Amsterdam-Rotterdam-Antwerp and so are hesitant about taking the opportunity of buying prompt cargoes, which are $10 a tonne cheaper than forward, and placing them on stocks to use later in the year."

"If anybody was to be buying actively right now, it ought to be the big utilities who can play the contango, if they've got space to stockpile, one European trader said. But this is not an option, utilities said, because they have too much coal on their books which they will not need even if the freeze continues for another few weeks."

"We're not looking at buying now and stockpiling - everybody's nearly full up and we're more worried about what to do with what's due to arrive," one European utility source said. "It's almost all high-sulphur U.S. coal coming in now and everybody, traders, utilities, you name it, is long and they're going to need to start shifting it," another trader said."

Peter Epstein: Inventories are high in Europe despite a prolonged cold spell. If an extended cold spell doesn't spark demand for thermal coal, what will?

Qinhuangdao Stockpiles surge to over 8mm tonnes, Reuters: Quote, "Coal stocks at China's main coal hub Qinhuangdao have exceeded the 8.0 mm MT mark for the first time since August 6th and prices at the port are near 10-month lows. Stockpiles briefly breached the 9.0 mm MT mark in 2008, but 8.0 mm tends to be the high end of the range. The Chinese thermal markets have been weak recently in the absence of strong seasonal burn and weak industrial electricity demand as factories closed for the Chinese New Year celebration."

Peter Epstein: Stockpiles in China are quite ample as well. China is experiencing a relatively mild winter and hydro-electric production rebounded somewhat from last year's drought impacted conditions.

Doyle Trading Consultants Commentary on February Coal Conference: Quote, "The thermal market in the U.S. is expected to remain very weak through at least the end of 2012 due to cheap natgas, low power prices, weak electricity demand, growing utility stockpiles and crossover met returning to the thermal market. Prices for met coal, while far from robust, appear to be bottoming, with a lot of chatter about a vessel of mid-vol sold into Europe in Jan at $220/MT FOB East Coast."

"Sentiment was expectedly bearish, as natgas competition prices many coal units in the U.S. well out of the money. Following necessary production cuts, U.S. producers will be increasingly reliant on the export market, and the rails are keeping rates competitive to move as much into the export market as necessary. The long-term bull case remains intact, but readily available coal in the Atlantic Basin is more than enough to fill weak demand, even as Europe experiences a cold blast."

Peter Epstein: Doyle Trading Consultants picked up on another risk to the domestic thermal coal market. If export demand for the lowest quality coking coal (sometimes referred to as "crossover coal" falls materially, then these crossover coals could be stuck in the U.S.

Veteran coking coal industry expert, Gerard McCloskey, Quote, "The coking coal market is currently oversupplied and prices are poised for further declines. A variety of new projects and expansions will continue to swell global supply for the foreseeable future, although the largest new tonnages will not make their appearance until the next decade. Australia and China remain the keys to supply and demand respectively."

"There is an oversupply. If Australia comes back to the sort of levels it was doing in the first half of 2010, another 30 million tonnes will come onto a very balanced market," Gerard McCloskey of McCloskey Group said this week in a presentation at the annual Investing in African Mining Indaba conference in Cape Town, South Africa."

"There will be a correction of prices down towards $200," McCloskey predicted. "It's still a great price. Until two years ago we had not had prices above $200 except for one brief period in 2008."

Peter Epstein: Gerard McCloskey nailed the decline in coking coal prices last year. When coking coal prices were up at $330 per metric tonne, he correctly predicted that the price would fall to the low-to-mid $250's.

As can be seen from these quotes the outlook for both thermal and coking coal is bleak, even if coking coal prices may be bottoming. I fully recognize that it's often best to buy coal stocks when it appears that things can only get better, but I think things can still get worse. At the very least, we still have several more 1st quarter earnings releases to get through. Thus, despite a modest pullback in the coal stocks since last week, I remain on the sidelines for now.

Disclosure: I am long ACI, BTU, PCX, ANR, CNX. I'm a consultant for SouthGobi Resources.

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