We have been following Arch Coal (ACI) in our articles and noting that we like Arch because it is the largest coal producer in the powder river basin. A couple of weeks ago we examined the powder river basin coal producers' summer and decided it depended on three things:
Coal hearts air conditioning. "I would think a normal summer weather pattern would help clearly" Arch Coal's John Eaves said. PRB producer Cloud Peak Energy (NYSE:CLD) executives echoed the same on their first quarter conference call. Both companies emphasized that they don't need divine intervention, both used the phrase "normal summer weather." It's hard to blame executives for subtly reminding us just how uncooperative weather has been lately, this past Winter was the 4th warmest on record.
(2) Natural Gas Price
A glut of natural gas has priced as much PRB coal out of the market as possible, every power plant that could switch did. Without the price of natural gas increasing the PRB cannot reclaim its old market share for the summer.
(3) Diesel Price
The PRB is just plain not near the people. If the cost of diesel is around 3 times the cost of the coal it carries and the price of diesel doubles ... or gets cut in half ... yes, indeed that is a major league concern for the producers.
As the third quarter begins lets see if we can set up a scoring system to track these three things for Arch and the PRB producers. Let's begin with the weather.
Oh Brother, Where Art Thou's Weather Most Important?
So for Arch, Cloud Peak, and other coal producers of note in the PRB - Peabody Energy (BTU) and Alpha Natural Resources (ANR) - the weather looms large. But where does it loom largest?
The powder river basin is just plain not near the people. Have a look at this population map of the United States. Isn't this a great map?
If you had to put an X on that map that was farther from where the people are it would be hard to do. That's why the price of the diesel that's powering these coal-bearing trains is so important. The coal has to be price-competitive with natural gas by the time it gets to its destination. Let's take a look at CO2 emissions (coal of course plays a big part):
That matches up pretty well, not surprisingly, with where the people are. But the powder river basin's sub-bituminous coal has to go to utilities that have coal-fired power plants designed to handle this type of hydrocarbon. Let's see where they are (red circles):
Now we are getting somewhere. It looks like the West and Northeast get by sans sub-bituminous, but the middle of the country, ooooh partner. That's where the PRB's coal gets consumed, and that is where the weather matters most.
So if we want to keep score of the heat, we'll want to identify the most important cities to track. Let's look at both the population map and the "Reach of PRB Coal" map.
Starting at the top center of the maps and working clockwise, it looks like Minneapolis has both a good sized population and the right kind of power plants. The Chicago area is not dominated by PRB at all, but there are just so many people there that PRB coal-use looks significant. St. Louis and Kansas City both score high.
From St. Louis and Kansas City there is a trapezoid shape we could draw extending out to Southern Company's (NYSE:SO) Georgia Power in Atlanta and down through the south of Texas in Houston.
Both Atlanta and Houston have enormous populations and help us to account properly for the South's exposure to PRB coal.
California's massive population enjoys an organic cucumber smoothie as it thumbs its nose at sub-bituminous coal.
Seattle is borderline and gets an honorable mention but the city of liquid sunshine just is not as relevant to air conditioning season.
Notice the coal is also burned right at the source in the PRB on map 2. The first map however shows us that until bears start blow-drying their fur, there is little demand.
Denver and Salt Lake are nearby with nice population bases but there are natural resources a-plenty out there and they are not hip to the PRB (come on Denver and Salt Lake, what do you need, a refresher course?).
We have identified six cities whose weather should give us a good indication of heat-related demand from customers of the PRB: Atlanta, Chicago, Houston, Kansas City, Minneapolis, and St. Louis. In our next edition we will examine natural gas and diesel prices as they hurt or help the PRB producers at different price points. Then we will quantify the three factors into a point system to give us a measure of how things are going in the third quarter and we will track that going forward.
The PRB coal producers have gotten slammed lately but if you have watched the news you know that the summer has been blazing so far in the Midwest and South. That is great news for these companies, and now natural gas is starting to cooperate and diesel prices have dropped and may drop further. Its very early, last year air conditioning season lasted until October in some parts. But so far the PRB coal producers have gotten off to a very good start.
Disclosure: I am long ACI.