Cloud Peak Energy: Falling Oil Prices Are A Boon To Production Costs And Railway Availability

| About: Cloud Peak (CLD)
This article is now exclusive for PRO subscribers.

Summary

Lower oil prices will help Cloud Peak save on diesel costs. The potential savings is $25 million per year if diesel prices end up falling as much as gasoline has.

Low oil prices will help dampen production in the Bakken Shale, alleviating the railway congesting issues that have plagued Powder River Basin coal.

Improving Powder River Basin coal prices will mainly impact 2016 results.

Cloud Peak Energy is worth $15 to $16 per share based on projected 2016 results.

Cloud Peak Energy (NYSE:CLD) was caught up in the energy selloff triggered by OPEC's decision not to cut oil production. However, falling oil prices are actually quite beneficial to Cloud Peak. Cloud Peak uses a lot of diesel in its operations, so current diesel prices would result in approximately $15 million per year in savings, increasing to $25 million per year if diesel prices fall as much as gasoline has. As well, railway availability has been a major issue for Powder River Basin coal, due to competition with Bakken Shale oil. Prolonged weaker oil prices will dampen production in the Bakken Shale, freeing up space for coal and other freight.

Powder River Basin prices have also shown improvement, which will impact 2016 results more than 2015 due to the fact that nearly half of Cloud Peak's coal is already in fixed-price contracts over a year in advance.

Powder River Basin Prices Have Shown Improvement

Howard Weil's weekly coal report shows that Powder River Basin spot prices have generally been going up since mid-2012. Although prices dipped in Q3 2014, they have gone back up to an average of $12.13 per ton in Q4 2014, with the most recent spot price at $12.65 per ton.

Quarter

Avg Per Ton

Q3 2011

$14.42

Q4 2011

$13.53

Q1 2012

$9.58

Q2 2012

$8.30

Q3 2012

$8.99

Q4 2012

$10.09

Q1 2013

$10.37

Q2 2013

$10.67

Q3 2013

$10.87

Q4 2013

$11.01

Q1 2014

$11.61

Q2 2014

$13.22

Q3 2014

$11.68

Q4 2014

$12.13

Source: Platts via Howard Weil (see weekly coal report link)

Higher spot prices also correlate to improved futures prices. The average 2015 price for Powder River Basin coal is at $13.61 per ton, while the 2016 prices have reached above $14 per ton.

Cloud Peak contracts out and fixes the prices for much of its coal well in advance, so the improvement in prices will affect 2016's results more than 2015's results. Below is a table outlining the percentage of Cloud Peak's sales that were under fixed-priced contracts. By the end of Q3 2012, Cloud Peak already had fixed price contracts for 87% of its 2013 volume and 51% of its 2014 volume. At the end of Q3 2014, Cloud Peak has fixed-price contracts for 72% of its expected 2015 volume and 43% of its expected 2016 volume. As prices are generally improving, I'd expect 2016 realized pricing to be better than 2014 or 2015 since many of the 2014 and 2015 contracts were signed when Powder River Basin coal was at significantly lower prices.

 

Q3 2012

Q1 2013

Q3 2013

Q1 2014

Q3 2014

2013 Sales

87%

99%

100%

   

2014 Sales

51%

58%

81%

99%

100%

2015 Sales

   

35%

47%

72%

2016 Sales

       

43%

Falling Diesel Prices Benefit Cloud Peak's Cost Of Production

From looking at Cloud Peak's financial reports, it appears that it spends approximately $105 million on diesel per year when wholesale diesel prices were approximately $3.00 per gallon. Wholesale prices had fallen to approximately $2.81 per gallon by September, while retail prices have fallen an additional $0.25 per gallon since then. It seems likely that the price of diesel will fall even more if oil price prices stay below $70 per barrel for a lengthy period of time, as some diesel demand is tied to oil operations that will eventually be producing less if oil prices remain at these levels.

If wholesale diesel prices fall to $2.25 per gallon, it would result in a savings of over $25 million per year for Cloud Peak Energy, which is around $0.30 per ton of coal produced. While a 25% drop might seem like a lot for diesel, gasoline prices are already 22% below 2013 averages.

It should be noted that Cloud Peak hedges its fuel costs via collars involving WTI oil, so other than with diesel prices narrowing the gap between it and gasoline prices, Cloud Peak may not gain additional benefit from 2015 oil prices going below current levels. Continued low oil prices should allow it to lock in good prices for 2016 though.

Estimating Cloud Peak's Cost Of Production

Cloud Peak's average cost per ton sold has been going up in recent years due to reduced production volumes and higher stripping ratios. Excluding the cost of one-time items such as insurance deductible costs for a flood at the Cordero Rojo mine and additional non-income based tax accruals, the average cost per ton sold so far in 2014 was quite similar to 2013 though, as weak coal market have resulted in an emphasis on cost control.

Here's a look at how average cost per ton could look over the next couple years. In 2015, the average cost per ton sold will likely go up due to reduced production volumes (guidance calls for 78 million to 84 million tons in 2015 and 2016). Lower diesel costs will partially offset that increase. With prolonged lower oil prices dampening the growth of Bakken Shale oil, I'd expect increased railway availability to allow Cloud Peak to ship coal at the high end of its guidance by 2016 though. Higher production volumes will help push the cost of production per ton down slightly.

 

2011

2012

2013

2014

2015

2016

Tons Sold (Million)

95.6

90.6

86

85

81

84

Average Cost Per Ton Sold

$9.12

$9.57

$10.23

$10.27

$10.35

$10.20

2015 and 2016 Outlook

Cloud Peak's medium-term guidance in September mentioned expectations for $120 million EBITDA for 2015. It noted that a $1 increase in domestic Powder River Basin prices would improve EBITDA by $21 million, while a $10 increase in benchmark Newcastle thermal coal pricing would increase EBITDA by $34 million. Since that time, domestic Powder River Basin prices have increased by $1, but Newcastle prices have fallen by $10. Therefore, 2015 EBITDA should be around $107 million. However, that does not factor in decreasing diesel prices, which at around current prices should result in a savings of approximately $10 million per year versus early September.

I've modeled what 2015 will look like for Cloud Peak based on current prices. Cloud Peak is going to make decent margins on its domestic sales. However, current Newcastle prices are at around $62 per ton, well below the $85 per ton that Cloud Peak suggested was its approximate breakeven point on export sales. Cloud Peak's realized price for export sales is a percentage of Newcastle pricing, so it isn't actually losing $23 per ton at current prices. However, it is likely losing $10 to $15 per ton on unhedged export sales at current prices.

The outlook for 2016 looks better due to the improvement in domestic pricing that I mentioned earlier. As well, the improved pricing and reduced railway congestion should allow for increased production, which would help lower cost of production per ton slightly. As well, Bank of America Merrill Lynch's forecast is for Newcastle prices to average $72 per ton in 2016. This would reduce Cloud Peak's losses on exports to approximately $30 million, after accounting for reduced hedging.

 

2015

2016

Tons Sold (Million)

81

84

Average Price Per Ton Sold

$13.10

$13.50

Average Cost Per Ton Sold

$10.35

$10.20

Gross Margin ($ Million)

$222.75

$277.20

     

SG&A ($ Million)

$50.00

$50.00

Export Margin ($ Million)

-$55.00

-$30.00

     

EBITDA ($ Million)

$117.75

$197.20

Risks and Challenges

2015 will likely be a negative year cash flow wise, with $60 million in capital expenditures, likely around $50 million to $60 million in interest payments, and lease payments of $69 million. This would cause Cloud Peak to burn approximately $65 million to $70 million during 2015 if EBITDA is around $118 million. However, the lease payments end in 2015, and $20 million of the 2015 capital expenditures is for a one-time movement of a dragline. Therefore 2016 cash flow could be positive $100 million at current Powder River Basin prices and $72 per ton Newcastle coal.

Cloud Peak is committing itself strongly to coal exports, having purchased additional capacity at Westshore Terminals with additional take-or-pay commitments. This could work out extremely well for it if Newcastle prices rebound significantly. However, if Newcastle prices remain at current levels or below then Cloud Peak is going to be losing a lot of money on exports while being forced to continue exporting due to the take-or-pay arrangements.

As well, there have been reports that the government is seeking to collect larger royalty amounts on exported coal. The royalty calculations are a debated issue, but theoretically it could cost Cloud Peak an additional $20 million per year (based on 6 million tons and a 12.5% tax on $40 per ton instead of $13 per ton) depending on how the calculations are changed.

Conclusion

2015 will likely be a challenging year for Cloud Peak due to low Newcastle prices and the fact that much of its 2015 volume was contracted out when Powder River Basin coal prices were weaker. The current improvement in domestic prices should be seen more strongly in 2016 realized pricing.

Falling oil prices should benefit Cloud Peak by resulting in diesel fuel savings of over $25 million per year, as well as increased railway availability from less competition with Bakken Shale oil. Increased railway availability and improving Powder River Basin prices allows for some upside in shipment volumes, which would further reduce the cost of production.

At an EV/EBITDA multiple of 6.5x to 2016 results, Cloud Peak would be worth $15 to $16 per share. Additional upside would be driven by improvement in Newcastle prices above the $72 per ton forecast for 2016. Each $10 increase in Newcastle prices would increase Cloud Peak's estimated value by around $4 per share.

Disclosure: The author is long CLD.

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.