Met Coal Market Will Make A Turnaround In Long Term, But Early 2015 To Remain Challenging

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

Summary

Met coal market fundamentals will improve in long term.

Supply rationalization by global met coal producers will help remove excess supply from market.

Coal will continue to remain important part of global energy portfolio despite tough environmental regulations.

Improvement in met coal market fundamentals will positively affect U.S. coal companies’ stock prices in long term.

Met coal market fundamentals have been adversely affected by weak economic conditions and a strong U.S. Dollar, which have resulted in excess met coal supply. As the met coal market remains oversupplied, met coal prices have been adversely affected; recently, the 2Q'15 met coal benchmark price settled at a new six-year low of $109.5 per ton. In the near term, as the met coal market remains oversupplied, the performance of leading U.S. coal companies with exposure to met coal, like Alpha Natural (ANR), Walter Energy (NYSE:WLT), Arch Coal (NYSE:ACI) and Peabody Energy (NYSE:BTU), will be pressurized. However, as the announced met coal supply cuts will be realized in the second half of 2015, along with the strengthening of Chinese met coal imports, I believe met coal demand and prices will start to stabilize and will positively affect U.S. coal companies' stock prices. Also, despite the ongoing environmental regulations, coal will remain an important component of the global energy portfolio in future years.

Met Coal Market to Improve in Long Term
The met coal market, in recent years, has been adversely affected by weak global economic conditions, which weighed on met coal demand and resulted in a met coal price drop. As the met coal market remains oversupplied, the met coal price recently dropped to a new six-year low of $109.5 per ton for 2Q'14, down from $117 per ton for 1Q'15. Despite the ongoing weakness in the met coal market, I believe met coal prices will start to stabilize and show an improvement in second half of 2015 and early 2016, due to supply rationalization and demand improvement.

High Australian production in recent years, despite weak met coal prices, was mainly responsible for the excess met coal supply. A strong U.S. Dollar prompted Australian coal producers to keep production high despite weak prices, and Australian met coal exports increased in high-single digits since 2012. In recent quarters, approximately 30 million tons of met coal supply cuts have been announced, most of which will be realized by the second half of 2015 and will help address the problem of excess supply. Also, in the given weak met coal price environment, high-cost mines in Australia are expected to shutdown by the end of 2015, as approximately 25% of Australian coalmines are operating at a loss. As the unprofitable Australian coal operations/mines will shut down, Australian met coal supply growth is expected to drop to approximately 2% through 2019, which will portend well for met coal market fundamentals, and will allow a met coal price recovery in future. The following graph shows that Australian met coal exports growth is expected to slow down in future.

Source: minerals.org.au

The expected slowdown in Australian met coal exports growth will help in removing excess supply from the market and portend well for met coal prices and U.S. coal companies' stock prices. Also, any improvement in met coal prices will help reduce cash burn for WLT, ACI, ANR and BTU. Currently, in the weak coal market conditions, BTU, ACI, ANR and WLT are burning cash. The following table shows total liquidity and cash burn for the leading four U.S. coal companies.

 

Total Liquidity

Cash Burn in 2014

BTU

$2.3 billion

$(180) million

ANR

$2.3 billion

$(390) million

WLT

$0.65 billion

$(350) million

ACI

$1.25 billion

$(200) million

Source: Annual Reports

In addition to supply rationalization, improving Chinese coal imports will portend well for met coal prices in the long term. Met coal exports dropped by approximately 15% in 2014, but in 2015 met coal imports are expected to improve, which will support met coal prices; met coal imports for February 2015 increased by 12% year-on-year to 3.96 million metric tons.

Also, despite tough environmental regulations, coal will continue to remain an important component of the global energy portfolio. The following graph shows that global coal demand is expected to grow from 2015 through 2035.

Source: minerals.org.au

Conclusion

Met coal market fundamentals will improve in the long term. Supply rationalization by global met coal producers will help in removing excess supply from the market. Also, as the announced production cuts will be realized by the second half of 2015, met coal prices will start to show signs of stabilization and improvement. Also, the strengthening of Chinese met coal imports will portend well for met coal prices. Moreover, coal will continue to remain an important part of the global energy portfolio despite tough environmental regulations. Therefore, I believe that in the long term, improvement in met coal market fundamentals will positively affect U.S. coal companies' stock prices. However, in the near term, in 2015, prices of U.S. coal companies will remain pressurized until supply rationalization starts to be realized.

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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