Tough Year Lies Ahead For The U.S. Coal Industry

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

Summary

Implementation of MATS will weigh on thermal coal demand and prices.

Thermal coal demand in the U.S. will decline by more than 20 million tons due to retirement of coal-fired plants.

U.S. coal companies need to aggressively make efforts to reduce operational costs, boost liquidity and cut supply to survive.

The U.S. coal industry has been negatively affected in recent years by low natural gas prices and environmental regulations. In 2015, weak coal demand and strict environmental regulations are likely to put more pressure on the industry. Coal market fundamentals will remain weak next year, as the coal market is oversupplied and demand is weak. Also, the fact that Australian and Canadian currencies weakened against the U.S. Dollar will encourage international coal producers to keep supply high despite weak coal prices, which will prove to be a hurdle in a coal price recovery. Thermal coal demand in the U.S. will be hampered by the implementation of the Mercury and Air Toxic Standards (MATS) in April 2015. Separately, weak Chinese met coal imports and excess supply will keep a lid on a met coal price recovery in the near future.

Weakness in Coal Market Fundamentals to Persist
2015 will be another challenging year for the U.S. coal industry, as the weakness in coal market fundamentals is likely to continue. Drops in natural gas prices and strict environmental regulations have taken a toll on the thermal coal market in the recent past. The U.S. Environmental Protection Agency (EPA) is targeting to bring down carbon emissions by 30% through 2030, mainly by discouraging coal-fired electricity generation. The implementation of MATS will begin in April 2015, which will discourage U.S. electricity producers from operating coal-fired electricity plants. As a result of the implementation, approximately 15GW of coal-fired electricity generation capacity will retire in 2015 and 2016. And from 2017 through 2020, an additional approximately 20GW of coal-fired electricity generation capacity is expected to retire, according to announcements made by U.S. utility companies. As a result of the retirement of coal-fired plants, U.S. thermal coal demand will decline by approximately 22 million tons in the next two years. According to the Energy Information Administration (EIA), U.S. coal-fired electricity generation is expected to drop to 38.9% in 2015 from 39.4% in 2014 and 39.1% in 2013. The following chart shows U.S. electricity generation by fuel type.


Source: eia.gov

However, in 2015, thermal coal demand could get some support from inventory rebuilding efforts by U.S. electricity producers, as coal stockpiles have dropped to historic lows. U.S. coal stockpiles at electricity producers have dropped to 129 million tons in December 2014 from 148 million tons in December 2013. Also, improvements in rail issues will positively affect thermal coal consumption. The following graph shows the low coal stockpiles at U.S. electricity producers.

Source: eia.gov

The met coal market is also expected to remain weak in 2015 due to weak demand and excess supply in the global market, which have weighed on met coal prices. Weak Chinese coal imports have adversely affected met coal prices. In the first 11 months (January-November) of 2014, China's coking coal imports dropped to 54.74 million tons, down 8.75% year-on-year. Also, the strengthening of the U.S. Dollar has been encouraging Australian and Canadian met coal producers to keep met coal supply high regardless of low met coal prices. Met coal producers have announced more than 30 million tons of met coal supply cuts in 2014, year-to-date, but the market remains oversupplied. I believe that in the first half of 2015, an additional 5-7 million tons of met coal supply cuts will be announced to support met coal prices. I believe supply rationalization remains critical for a future met coal price recovery. The following chart shows the downward trend for the met coal quarterly benchmark price; recently, the met coal benchmark price for 1Q'15 settled at a seven-year low of $117/ton.

Source: snl.com

Both thermal and met coal markets are expected to remain weak in 2015. U.S. coal companies, including Peabody Energy (NYSE:BTU), Alpha Natural Resources (ANR), Arch Coal (ACI) and Walter Energy (NYSE:WLT), should aggressively work to cut their operational costs, and should target to boost liquidity in 2015 to strengthen their credit outlooks and survive the industry downturn. However, in the long term, a rise in natural gas prices, increase in coal consumption by Asian markets, and better coal supply management have the potential to support the coal market.

Conclusion
As the coal market fundamentals remain weak, challenges await the U.S. coal industry in 2015. The implementation of MATS in April next year will result in coal-fired electricity capacity being retired in the U.S., which will weigh on thermal coal demand and prices. Due to the retirement of coal-fired plants, thermal coal demand in the U.S. will decline by more than 20 million tons. Also, met coal markets will continue to remain weak in 2015 due to weak Chinese coal imports and excess supply. In this challenging industry environment, U.S. coal companies need to aggressively make efforts to reduce operational costs, boost liquidity and cut supply to survive the ongoing industry downturn.

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.

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