Coal Companies Face Problem Of Oversupplied Markets As They Look To Survive

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Includes: ANRZQ, ARCH, BTU, KOL, WLT
by: Equity Watch

Summary

Soft Chinese met coal demand and strong supply from Australian producers means met coal quarterly benchmark price for 4Q14 to remain weak.

U.S. coal companies’ efforts to preserve cash through reduction in operational and capital expenditure likely to help in short term.

Aggressive and consistent production cuts needed to address problem of oversupplied met coal market.

U.S. coal producers have been going through difficult industry conditions, as met and thermal coal markets remain weak. Excess met coal supply has kept the global met coal market weak. Soft met coal demand due to economic slowdowns in key global markets has made industry conditions difficult for coal producers. Also, the depreciation of the Australian Dollar has prompted Australian producers to keep met coal production high, despite the weak prices. In response to an excess in the met coal market, coal producers, mainly in the U.S., have been undertaking production cuts; however, I believe more and consistent met coal production cuts are required to address the problem of the oversupplied market and initiate a recovery in prices.

As coal market conditions remain difficult, U.S. coal producers have aggressively been working to reduce their operational costs and capital expenditure. Also, coal companies have been taking measures to extend their debt maturities and improve their financial flexibility, by preserving cash to navigate through the tough industry conditions. Furthermore, U.S. coal companies, including Walter Energy (NYSE:WLT) and Arch Coal (ACI), are considering the option to sell their non-core assets to boost their liquidity positions. I believe efforts to cut costs, sell non-core assets and extend debt maturities will help U.S. coal companies in the short term, but to ensure survival in the long term, aggressive production cuts need to be observed, which will result in a met coal price recovery. The following table shows the negative stock price performance of leading U.S. coal companies and coal ETF (NYSEARCA:KOL) since the start of 2014.

Peabody Energy (NYSE:BTU)

Alpha Natural Resources (ANR)

WLT

ACI

KOL

Stock Price Performance YTD

-33%

-60%

-83%

-48%

-9%

Source: googlefinance.com

The met coal benchmark price for 3Q14 settled at a six-year low of $120 per ton. The spot met coal prices have dropped to approximately $115 per ton since the start of September 2014. Also, strong supply from Australian suppliers and weak Chinese met coal demand is likely to weigh on the met coal benchmark price for 4Q14, which is likely to be determined in the coming week. Due to weak met coal market fundamentals, Goldman Sachs has lowered its met coal benchmark forecast for 4Q14 from $132 per ton to $120 per ton. Also, Cowen & Co.'s analyst, Anthony Rizzuto, recently said, ''A decline in fourth-quarter prices appears imminent." The following chart shows the dropping met coal quarterly benchmark price in recent quarters.

I believe met coal prices will remain weak in the near term due to excess supply, as production from Australia stays strong. Australian met coal exports have increased by 36 million tons, from 2011 through 2013. Also, Australian exports are likely to further increase by 8-12 million tons and 8-10 million tons in 2014 and 2015, respectively. The increase in met coal production by Australia is likely to keep a lid on demand for U.S. met coal exports. According to the EIA, U.S. coal exports are likely to drop to approximately 96 million tons in 2014, as compared to 126 million tons and 118 million tons in 2012 and 2013, respectively.

Coal producers, mainly in the U.S., have been cutting their met coal production, and approximately 25 to 30 million tons of global output cuts have been announced so far in 2014; however, the global met coal market is believed to be 35 to 40 million tons oversupplied, which calls for more production cuts to address the concerns of excess supply and to start a recovery in met coal prices.

Conclusion
U.S. companies have been going through difficult industry conditions, as the market for met coal remains oversupplied, which has kept a lid on a met coal price recovery. Due to soft Chinese met coal demand and strong supply from Australian producers, the met coal quarterly benchmark price for 4Q14 (which is likely to settle in the coming week) is likely to remain weak; already the met coal quarterly benchmark price for 3Q14 settled at a six-year low of $120 per ton. U.S. coal companies' efforts to preserve cash through reduction in operational and capital expenditure is likely to help in the short term, but I believe more aggressive and consistent production cuts need to be observed to address the problem of an oversupplied coal market and ensure survival in the long term.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.