Peabody Energy Bucks The Trend, Or Hopes To

Summary

• Bankruptcy exit involves increased coal production for Peabody Energy.
• Early analysis of post-COP21 coal outlook by Wood Mackenzie indicates a 40% decline in world thermal coal by 2035.
• Part of bankruptcy exit by Arch Coal involves setting aside collateral for its self-bonding obligations. Pressure on Peabody Energy to do the same?

Those who remain convinced that coal is a commodity in a cyclical market that is poised to return, will be excited by what has happened to coal prices in the last 6 months. To say that a lot is happening in the coal industry both in the US and worldwide is probably an understatement.

We live in extraordinary times and a major driver for short term price recovery is undoubtedly the fact that China threw the brakes on too hard with a goal of reducing coal production by 250 million tons in 2016. By August it had cut production by 150 million tons and a shortage was evident, leading to an uptick in imports.

However it is important to understand that there is no change in China's plan to reduce dramatically its coal consumption to address massive pollution. To reinforce this China (along with the US) has ratified the COP21 climate agreement, which requires major reduction in greenhouse gas emissions.

Here I address recent actions by Peabody Energy (BTUUQ) as it moves towards exiting bankruptcy, and give an international context about the global coal industry. My conclusions are a different from those who see "business as usual" returning to the coal industry.

Peabody Energy expects to keep growing

I've written a lot about Peabody Energy in the recent past. When they filed for bankruptcy, I expected that working through this process would require acknowledgement of the new situation for the coal industry and the development of a business plan that aligned with the new reality.

The plan to exit bankruptcy shows no signs that Peabody yet acknowledges the current state and direction of the coal industry, both in the US and internationally.

In particular Peabody's business plans are predicated on a growing coal industry in the US (coal demand up 20-25 million tons between 2018 and 2020) and internationally (metallurgical coal up 50-55 million tons between 2016 and 2021, thermal coal up 50-60 million tons especially in SE Asia). These are very optimistic numbers to use as a cornerstone of their post-bankruptcy planning.

Indeed some details of the underpinning logic of this position would make interesting reading. In a debate it is fine to play games with numbers, but in the real world reality intrudes.

For example, I assume that the increased US coal production predicted in Peabody's assumptions is based on the expected 2016 figures as the baseline. It is perhaps relevant to note that 2016 US coal production is expected to be 164 million tons less year on year, a staggering 18% decline compared with 2015 and the biggest decline for more than 65 years. The year to date figures for Peabody US production are down 35%.

Note also that the anticipated US electric power sector coal stockpile is likely to be 158 million tons at the end of 2016; for June 2016 stockpiles are 20 million tons higher than the previous 10 year average.

The EIA does project an increase of 32 million tons in the US in 2017, much of it due to a suggested increase in coal fired power generation because of projected gas price increase and increased electricity consumption. Even if that happens, the decline compared with recent coal production will still be massive. This is not a growing industry.

Even accepting US coal demand increasing (Peabody's numbers) by 20-25 million tons by 2018 (or 2020), which I doubt in the light of COP21 ratification, Peabody's business plan seems to assume that Peabody will account for all of this increase and so other coal producers won't benefit. Other coal companies may disagree with Peabody's optimism about its ability to dominate coal production.

I've written elsewhere that the IEA projections on substantial expansion in SE Asian coal consumption seem shaky.

There is not a word about COP21 or indeed any of the structural changes in the coal industry. The focus of Peabody management is on safety, low cost operations, being the best, having capital discipline and focus, being the leading voice for the industry.

Indeed Peabody is still trying to fight the EPA Clean Power Plan, which has been overtaken by US plans to ratify COP21.

Self-bonding may get resolved

In bad news for Peabody Energy, which along with Arch Coal (ACIIQ) and Alpha Natural Resources (ANRZQ) collectively had a total of $2.2 billion of self-bonding liabilities when they filed for bankruptcy, Arch Coal has agreed to set aside collateral to cover its $485 million self-bonding cleanup obligations. This is part of Arch Coal's plan to exit bankruptcy.

Arch tried initially to avoid setting aside money to pay for cleanup because it said this obligation was onerous. Peabody's obligation is for $1.14 billion of self bonds. Perhaps the threat of having permits for active mines blocked might have focused the minds of the coal company managements. The pressure is on for Peabody to follow Arch's lead.

Coal Industry analysis

Wood Mackenzie provides deep analysis of the coal industry, which is literally mine by mine. Because of this deep connection with the industry, analysis of the coal industry outlook from Wood Mackenzie has been more optimistic than most. So it is interesting to see what Wood Mackenzie says the COP21 agreement is going to do to the industry.

An initial comment from Wood Mackenzie, after China and the US announced ratification of the COP21 agreement, was that there is likely to be a dramatic fall in coal production and consumption.

They estimate that thermal coal exports worldwide will fall from 900 million tons in 2016 to 527 million tons in 2035. Note that, in contrast to Peabody's projections (based on EIA reports) about growth of coal in Asia, Wood Mackenzie projects Asian coal imports to fall from 673 million tons in 2016 to 433 million tons in 2035. In Wood Mackenzie's view, European imports will fall from 170 million tons in 2016 to 80 million tons in 2035 and the Americas will fall from 39 million to 15 million tons over the same period.

Regarding coal prices, Wood Mackenzie views prices in a carbon constrained world to be difficult to predict, but they do suggest that prices will "undoubtedly be lower" perhaps less than $US50 for Australian coal ex-Newcastle after 2020.

Wood Mackenzie acquires renewable energy expert group Greentech Media

To indicate how things are changing, Wood Mackenzie recently acquired Greentech Media, which is a leader in the solar, grid and the energy storage space. Just as Wood Mackenzie has deep connection with the fossil fuel industry, Greentech Media brings that kind of connection to the renewables industry. Wood Mackenzie states that they want to stay at the forefront of the energy space and so they are moving into low carbon energy. The point is made that investment in renewables has increased 7.4 fold from $38 billion a decade ago to more than $280 billion in 2015.

Wood Mackenzie research indicates at least 180% growth in renewables by 2035 and with new policies and cost improvements the increase could be as much as 5 times existing renewable power supply. Indeed a figure in their report shows even greater than 5 fold increase in renewable energy by 2035 in a COP21 carbon constrained scenario.

Of course such dramatic growth in renewable energy will impact on fossil fuel use, especially coal, as is required under the COP21 agreement.

Conclusion

I've recently written that ratification of the COP21 agreement is likely to have a dramatic effect on fossil fuel use. Here I report the first expert industry commentary that I have seen concerning the coal industry. It is not reassuring for any coal company.

I've been waiting in vain for some sign that Peabody Energy is acknowledging the new situation for the coal industry. It seems that their plan to exit bankruptcy is seeking to avoid any mention of the new conditions as a result of ratification of COP21. Indeed Peabody continues to fight the EPA Clean Power Plan, which is yesterday's fight. Peabody is still insisting that it is going to keep growing its coal output.

Be very cautious about investing in the coal industry as several major coal companies exit bankruptcy, especially those who refuse to acknowledge the new reality.

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