Understanding The Summer For Powder River Basin Coal

| About: Arch Coal (ARCH)
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When the Summer kicked off with a Memorial Day heat wave the Powder River Basin coal producers let out a little sigh of relief. An abysmally pleasant and mild winter left utilities with thermal coal to spare and worse yet, natural gas to spare. Stockpiling gas from overly zealous drillers sent the price of gas plummeting, falling so much that any utility that could use gas instead of coal went ahead and did just that. The coal producers got slammed.

"One of the worst downturns we've seen since at least 2003" Arch Coal Inc. (ACI) CEO John Eaves said on the 2012 first quarter conference call. An upbeat conference call all things considered. Upbeat because air-conditioning season is coming, and upbeat because hey, things can't get much worse. Many utilities don't need fuel and even if they did natural gas would eat that along with coal's lunch. Things can't get much worse.

With the Summer's arrival, however, things can get much better. That's one of the possibilities anyway.

Mr. Eaves' Arch Coal - along with Cloud Peak Energy (NYSE:CLD), Peabody Energy (NYSE:BTU), and Alpha Natural Resources (ANR) - is one of the biggest coal miners in Montana/Wyoming's Powder River Basin, the largest coal supply region in the nation. The Powder River Basin is special for its biblical proportions of cheap, low-sulfur, easily-mined sub-bituminous coal. The PRB's sub-bituminous coal: cheap, clean, easy. Popular on Match.com no doubt.

Ms. Sub-bituminous has an intrinsic problem though: her address. Montana/Wyoming. The girl next door she is not. The PRB's sub-bituminous is a mail order bride and postage is a doozy.

The PRB is served by rail. Trains have to travel long distances from the basin to coal-fired power plants as far away as Atlanta. By the time the sub-bituminous gets to its destination the cost of the diesel powering the locomotive that took it there is routinely 2, 3, 4, and 5 times the cost of the coal. The diesel can be 5 times the cost of the coal! The utilities pay through the nose for the transport and it's all part of the plan.

So that's what's afoot in the PRB. The Powder River Basin's coal producer's fate this Summer will have three major influences: weather, natural gas prices, and diesel prices.

(1) Weather

Coal hearts air conditioning. "I would think a normal summer weather pattern would help clearly" Arch Coal's John Eaves said. PRB producer Cloud Peak Energy executives echoed the same on their first quarter conference call. Both companies emphasized that they don't need divine intervention, both used the phrase "normal Summer weather." It's hard to blame executives for subtly reminding us just how uncooperative weather has been lately, this past Winter was the 4th warmest on record.

(2) Natural Gas Price

A glut of natural gas has priced as much PRB coal out of the market as possible, every power plant that could switch did. Without the price of natural gas increasing the PRB cannot reclaim its old market share for the Summer.

(3) Diesel Price

The PRB is just plain not near the people. If the cost of diesel is around 3 times the cost of the coal it carries and the price of diesel doubles...or gets cut in half...yes, indeed that is a major league concern for the producers.

These are the factors that set-up the Summer in the Powder River Basin. To understand how the PRB producers are faring this Summer we will need to monitor the critical areas of the country where the PRB sends its coal and hence needs cooperative weather most, what price points are critical for gas and diesel, and how much impact each of these factors will have at different levels. Setting metrics to monitor this success will be the subject of our next article on the PRB.

Disclosure: I am long ACI.