The Coal Market Will Rebound In The Long Term

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

Summary

Performance of U.S. coal companies will remain challenged in the near term.

The coal market will rebound in the long term as coal demand improves through 2035.

Announced supply cuts by coal companies will be realized in upcoming quarters, improving the coal market.

Expected increase in natural gas prices will portend well for coal demand.

Announcements in upcoming earnings releases related to coal supply, cost cuts and asset sales will impact stock prices.

The U.S. Coal Industry has been on a bumpy ride in the recent past. Leading U.S. coal companies, including Peabody (NYSE:BTU), Alpha Natural Resources (ANR), Arch Coal (NYSE:ACI) and Walter (NYSE:WLT), have lost significant amounts of market capitalization. Lower natural gas prices, lower exports and strict environmental regulations have adversely affected U.S. coal companies. Despite the ongoing challenges in the coal market, I believe coal will remain an important component of the global energy portfolio in the long term, and coal market conditions will improve in the future, as oversupply will be removed from the market and due to the expected increase in natural gas prices. Below I will briefly discuss the recently released quarter coal report by the Energy Information Administration (EIA) and earnings outlook for U.S. coal companies; the U.S. coal companies are scheduled to report 1Q15 results later this month. U.S. coal companies, in the upcoming earnings season, are likely to update on the announced production cuts and on their cost-cut efforts.

Despite the ongoing challenges in the coal market, I believe coal markets will rebound in the coming years. Also, coal will remain an important part of the global energy portfolio. Currently, coal has a 30.1% share in the global energy portfolio. Moreover, demand for coal is expected to continue to grow from 2015-2035, and coal will continue to hold the second highest share in energy portfolio after oil, as shown in the graph below.

Source: minerals.org.au

Last week, the EIA published its quarterly coal report for 4Q14. U.S. producers have been cutting their production in response to the weakness in the coal market. In 4Q'14, U.S. coal production totaled 253 million short tons, approximately 1% lower as compared to 3Q'14. However, production for full year 2014 increased slightly as compared to full year production in 2013. Coal producers have announced approximately 30 million tons of met coal supply cuts in recent quarters, which will be realized in 2015, as coal mines take some time to close operations; supply rationalization will portend well for U.S. coal companies. During the upcoming earnings releases later this month, given the weakness in coal prices, I expect U.S. coal companies will provide updates on the already announced supply cuts and could also announce incremental supply cuts to address the challenge of the oversupplied market; any incremental supply cuts will positively affect the stock prices of coal companies. The following chart shows the declining U.S. coal production trend.

Source: eia.gov

According to the recent quarterly coal report, U.S. coal exports have dropped by 1.6% in 4Q'14 quarter-on-quarter. The drop in U.S. coal exports can be mainly attributed to a slowdown in global economic activity and rail issues in the U.S. Going forward, an improvement in rail issues in the U.S. will portend well for U.S. coal exports. The following graph shows U.S. coal exports and imports.

Source: eia.gov

An important factor that led to the downturn of the coal market was the drop in natural gas prices, which encouraged electricity producers to reduce coal-fired electricity generation and increase natural gas-fired electricity generation. However, according to EIA estimates, natural gas prices are expected to increase from the current level of $2.7 mmBtu to more than $3.5 mmBtu by mid 2016. I believe the increase in natural gas prices will encourage coal-fired electricity generation, which will positively affect coal demand. Coal-fired electricity in the U.S. is expected to remain in a range of 36% to 38% in 2015 and 2016. The following graph shows the expected increase in natural gas prices and U.S. electricity generation by fuel mix.


Source: eia.gov

Also, coal companies including BTU, WLT, ACI and ANR have been making efforts to improve performance in the current coal market downturn. In this regard, the coal companies are closing their high cost mines, which will help lower costs. The U.S. coal companies are scheduled to report 1Q'15 earnings later this month, and during the earnings call, I believe the companies will provide updates on cost cut progress and potential asset sales, which will portend well for their liquidity positions. I recommend investors to keep track of the upcoming earnings calls, as potential asset sales, production cuts and cost cuts can impact the stock prices of coal companies. The following table shows analysts' EPS estimates for the coal companies for 1Q'15.

BTU

ACI

ANR

WLT

Analysts EPS est. for 1Q'15 ($)

(0.33)

(0.48)

(0.78)

(1.49)

Source: Yahoofinance.com

Conclusion
The U.S. Coal Industry has been on a bumpy ride in the recent past. Given the low natural gas prices and excess supply in the market, the performance of U.S. coal companies will remain challenged in the near term. However, in the long term, the coal market will rebound, as coal will remain an important part of the global energy portfolio, and coal demand is expected to improve through 2035. Also, as the announced supply cuts by coal companies will be realized in the upcoming quarters, the coal market will improve. The expected increase in natural gas prices will portend well for coal demand. Moreover, I recommend investors to keep track of the upcoming earnings releases of coal companies, as announcements related to coal supply, cost cuts and asset sales will impact stock prices.

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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