Despite media headlines and coal industry hand-wringing, reports of coal’s death have been greatly exaggerated, to adapt Mark Twain’s famous (but misquoted) comment. What’s more, some of the coal sector’s current suffering is the consequence of self-inflicted wounds.
Throughout the dog days of summer, the financial pages in dozens of U.S. newspapers have run headlines heralding the death of old King Coal. The rather sudden, stunning drop in coal producers’ market value is grabbing media attention. If it bleeds, it leads.
And there is definitely blood in the water. When Alpha Natural Resources (Figure 1), the third-largest U.S. producer, filed for bankruptcy in early August, much of the national media, generally no friend to coal, piled on. The New York Times almost cheered: “King Coal, Long Besieged, Is Deposed by the Market.” Causes of mortality: “the explosion of cheap natural gas, the rising costs of new environmental and worker safety regulations, and a simple geological reality—the industry has already mined out the majority of all economically recoverable coal.”
|1. Diminishing returns. Many of Alpha Natural Resources’ underground operations mine in thin seams like this one using conventional continuous miner equipment. Costs are high, and returns are increasingly lower. Courtesy: Lee Buchsbaum|
Truth be told, if you simply look through Wall Street’s lens, its easy to assume that the whole coal industry is knocking on the door of history. Larry Shapiro, associate director of the Rockefeller Family Fund and president of the board of directors of the Institute for Energy Economics, declared that not only is Big Coal “not so big anymore” after its stocks tanked some 80% in the past few years, but “Big Coal doesn’t exist.”
Indeed, the total combined market capitalization of publicly traded U.S. coal companies in a June analysis was roughly $12.94 billion—down by nearly one-half since June 2014 and down more than 80% since April 2011. A month later, according to SNL Energy data, the market cap had fallen to just under $9.30 billion—more than 40% of which is attributable to the coal and natural gas producer CONSOL Energy. At of the end of August, storied Peabody Energy, the largest U.S. producer in terms of tonnage, and for decades the largest private sector coal company in the world, had a market capitalization of only $420 million, down 95% since 2010. Arch Coal, the nation’s number two producer, had a market cap of less than $100 million after having lost more than 99% of its value.
Overall, coal producers’ revenues have dropped at least 25% over the past three years. Alpha Natural Resources, which lost $875 million in 2014, is the most visible, recent casualty of this contraction. And there will be more blood to come. According to Bloomberg New Energy Finance, another 23 GW—or 7% of U.S. coal capacity—will be taken offline this year alone. But then again, as summer turns to fall, analysts have realized that, because of the lack of alternatives, until more natural gas–fired power generation comes online, coal will continue to supply roughly a third of U.S. generation (see sidebar).
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Echoing statements by CSX railroad, Alliance Resources CEO Joe Craft III, and others, a recent research note by analysts from JPMorgan Chase & Co. places that floor at above 30%, or roughly coal’s electrical generation share in April. “We believe grid inflexibility makes reducing coal’s share below this level difficult until more is spent on the grid, pipelines and more gas power plants,” John Bridges and Anant Inani, analysts at JPMorgan, said in the report.
Coal may even see slight increases in demand before President Barack Obama’s Clean Power Plan begins to take effect in 2022. “It’s reasonable to assume that once the U.S. gas market begins to balance, and the gas price picks up, that coal’s market share will recover to the mid or even high 30’s percent prior to” the law’s implementation, they said.
According to Craft, “there appears to be deliverability issues, must-run coal plants or other factors” that keep coal’s floor at 30% or more. “I can’t pin point it precisely, because when you look at the spreadsheets, it would suggest that there should be more competition. But in reality, what we are seeing, is that when the coal share gets closer to 30%, there seems to be a floor to where, no matter what the gas price is, the coal plants are running.”
But let’s not forget, from a utility perspective, having King Coal around holds Prince Gas’s feet to the fire. Fuel flexibility and competition keep both industries in line.
The Coal Market Bubble
So, is the coal industry really dying? No. It’s contracting and transforming itself, but reports of its death are an exaggeration, especially if you assume that the mines are closing, the bulldozers are parking, and the last coal train has already pulled out of the station.
Though stock values are tanking, Wall Street isn’t Main Street. In the coal fields where miners go to work every day, and in the hundreds of power plants that still rely upon the black rock that burns, the King, albeit a little dazed and confused, is still standing.
How do we know the end is far from over for the coal age? Some of the same folks noisily accused in right-wing political circles for killing off the industry are actually betting on coal to stay. Though it’s subject to both legal challenges and market vicissitudes, President Obama’s Clean Power Plan calls for coal’s share of electrical generation to be 27% of U.S. power supply by 2030 (down from nearly 50% a decade ago and about 39% today). Though much reduced, coal’s allotted share will still require the extraction of hundreds of millions of tons annually. And as long as there’s a market for that coal, there will be a host of producers ready to mine it.
When you look more closely, what we are seeing is King Coal’s demise in Central Appalachia (CAPP), where coal has been heavily mined since the 1860s. Though this collapse appears sudden, CAPP production has been shrinking for decades, and the fundamentals eroding CAPP’s market share were well understood within the industry. When Arch and Peabody divested much of their holdings in the region to form the now-bankrupt Patriot Coal, they did so with the implicit understanding that the best days for this region were already behind it.
However, like excited surfers, a decade ago Patriot, Arch, Alpha, and others in the industry rushed to ride a gnarly wave of demand for premium metallurgical (met) coal (used to make steel)—still found in West Virginia and parts of eastern Kentucky. Several of the largest banks and financial institutions worldwide were more than happy to lend billions to the industry as it chased hungry Asian and other export met and thermal coal markets, creating a large, though short-lived, bubble. Once trading at nearly $300 a ton, the benchmark price of the highest grade met coal has dropped 72% since April 2011. Third-quarter prices are hovering around $93 a ton, further crushing the earnings of met producers.
The companies that have recently gone bankrupt either produce most of their coal in CAPP, were betting heavily on selling sustained high volumes of met coal, or both. Today these markets have gone away—once again rendering CAPP coal too expensive to mine for it to successfully compete with either natural gas or other types of coals for power generation. As Alpha submitted in its bankruptcy filing, “The U.S. coal industry as currently structured is unsustainable.”
Just the same, CEO Kevin Crutchfield believes that “neither Alpha nor the U.S. coal industry should be thought of in the past tense—while the sector will likely get smaller, coal will continue to play a critical role in providing affordable and reliable electricity and in the production of steel for infrastructure.”
“It’s premature to say the industry is dead,” said Anthony Young, an analyst with Macquarie, in The New York Times. He estimated the industry needs to shrink by about 25% to meet current demand. But as coal companies “go through bankruptcy, their assets aren’t going to shut down.” As the industry restructures around a new “negative growth” paradigm, several more companies may file for bankruptcy, especially those that heavily leveraged themselves in order to gain access in CAPP—think Arch.
But as the industry stands at this crossroads, it’s important to take a deeper look at what’s really going on, why certain companies are failing, and why a few are actually thriving in the midst of this chaos.
How Alpha and Other Coal Producers Got Throttled
Wall Street and the general public often treat all coal companies as equal—and all coal as fungible, like oil. But this is far from the case.
The pain the industry is feeling is mostly coming out of Central Appalachia. Nationwide, 1,061 mines produced a total 984.8 million tons in 2014. In excess of 380 million of those tons were extracted from just two counties in Wyoming’s Powder River Basin (PRB). Though plentiful and fairly easy to mine, this subbituminous coal has a much lower heating value than Appalachian and Midwestern bituminous coals (8,400 Btu/lb vs. 12,000 Btu/lb vs. 11,500 Btu/lb respectively), so it takes considerably more PRB coal to generate the same calorific heat as eastern coals. Therefore, PRB mines have to produce much more product to stay competitive—which is partially why most PRB mines yield massive volumes (Figure 2).
|2. Large-scale operations. Operators in the Powder River Basin (PRB) have a huge resource base to extract from, but they need the huge amounts to remain competitive against higher-Btu eastern coals. Courtesy: Lee Buchsbaum|
Peabody and Arch both have several large PRB mines that are helping buoy their financial returns in this difficult market. In fact, the two largest mines in the U.S, one each owned by Peabody and Arch, are helping keep both companies afloat.
Though it has two relatively small mines in the PRB, Alpha is still primarily an Appalachian producer. When it purchased Massey Energy for some $7.1 billion in early 2011, the combined company, with more than 150 operating mines and facilities (almost all located in CAPP) became the third-largest met coal miner in the world. Prior to merger, during the frenzied market run-up, both Massey and Alpha had already heavily leveraged themselves to rapidly expand and access even more met coal. Outside of Appalachia, beyond the two PRB mines, Alpha only has a few operations in Northern Appalachia (NAPP) but nothing in the growing Illinois Basin (ILB).
Unlike Peabody, Alpha itself is a fairly new company, cobbled together beginning in 2002 from the assets of several other (troubled) CAPP producers. The company rapidly expanded by purchasing the mines of the more diversified Foundation Coal, which was really just a brief repackaging of operations once owned by other mining conglomerates. Foundation itself only existed for five years until Alpha borrowed heavily to purchase it. In the end, Alpha’s debt-fueled expansions proved to be its undoing.
Alpha, of course, was not the only company to rapidly jump into the growing met and exports market. Also in 2011, Arch Coal paid $3.4 billion to acquire the International Coal Group (ICG), only a few years after its components, largely owned by Horizon Natural Resources, had just emerged from bankruptcy too. Arch bought ICG to secure its own met position. Ironically, only a few years before, Arch had spun off much of its CAPP resources, including quite a bit of union-represented met mines, into the now-bankrupt Patriot Coal. Instead of investing domestically, Peabody Energy, after also spinning off its met assets in Appalachia to Patriot, bought a majority stake in Australia’s MacArthur Coal for $5 billion—largely in the hopes of securing an export met and thermal position to China.
Arch, which earlier that year had lost its bid for Massey, was determined to compete in the seaborne met game. In the ICG merger press release at the time, management anticipated metallurgical sales of 11 million tons in 2011, vaulting Arch into second place in terms of U.S. met production. Going forward, “By capitalizing on expansion opportunities, Arch expects to boost its metallurgical coal output to nearly 15 million tons by 2015 to serve under-supplied, growing global metallurgical markets,” it boasted (emphasis added). According to the company’s latest 2015 guidance, it is hoping to sell only 6.5 million met tons this entire year, and the company is taking a loss on each ton sold. So much for early predictions.
Fueled by a widely held faith in China’s steel mills and appetite for electricity, Alpha, Peabody, Arch, and several other producers also built, bought, or improved their own coastal export coal terminals too—another incentive to push their product overseas. But those moves only flooded the market with cheap coal. Chinese demand eventually sputtered, and the domestic markets withered. “Someday this is going to be a fascinating case study in what happens when an industry invests at the top of the market,” said David Gagliano, an analyst who tracks coal companies at BMO Capital, a bank.
Collectively, the deals left all three companies saddled with debt. Alpha still owes its creditors almost $3.2 billion—let alone what it owes federal and state regulators for admitted violations of the Clean Water Act and other environmental infractions. With a looming debt payment of $109 million due in August, Alpha chose instead to seek bankruptcy protection. On August 1, 2008, stock in Alpha had reached $104 a share. Seven years later, the company was valued at only 24¢. As of early September, Arch, which is desperately trying to avoid bankruptcy itself, through a series of financial legerdemain, owes its creditors upwards of $4 billion.
Those high debt loads have further affected coal producers who might otherwise simply cut back on production to realign supply and demand curves. But with debt payments to make, miners need to produce. For companies in a precarious financial position, running a mine at a loss is preferable to closing it.
For example, Wood Mackenzie estimated that it may cost $44 million to shut down a 4 million ton per year CAPP coal mine. A company like Alpha might rather run that mine at a loss of $5 per ton ($20 million per year) instead of paying the equivalent of over two years’ worth of losses at one time, and perhaps encounter physical, financial, and regulatory hurdles in eventually reopening that mine if market conditions were to improve. So the company becomes something like the proverbial snake swallowing its own tail.
PRB Coal Also Is Subject to Market Forces
While eastern export options are low, so are prospects for growth in the Powder River Basin.
The trickle of exports from that region never grew into the flood that many producers forecasted. The much-ballyhooed West Coast export terminals Arch, Peabody, and several other miners were cheerleading have not been built and, even if they were to come online, what markets would they serve? If China actually does begin to retrench, that only leaves India—a much longer sail from the Pacific Northwest.
At its height, “In 2012 the U.S. exported 114 million metric tons (mmt) of coal (126 million short tons)—12 percent more than the previous high set in 1981. The rapid rise of U.S. coal exports exceeded the Department of Energy’s forecast, published in the 2012 Annual Energy Outlook, by 30 percent,” John Hanou of Hanou Energy Consulting told POWER. “Exports this year are likely to be around 75 million metric tons in 2015. They are likely to drop by another 10 million in 2016 and another 10 in 2017,” said Hanou.
Though Peabody and Arch’s mammoth PRB mines (Figure 3) help to generate positive cash flow as mines elsewhere lose money, Alpha’s mines in the region are more costly to run. Output there has trended down over the past five years. “It would not surprise me if Alpha lowers production, mainly to avoid what we call shutdown economics,” said Hanou.
|3. Supplying 10%. Arch Coal’s Thunder Basin PRB mine is one of the largest in the world. A company brochure says it supplies 10% of all U.S. coal and fuels 6% of the electricity generated. Courtesy: Lee Buchsbaum|
Closing a mine, he noted, also means reclaiming it, and reclamation is expensive. Alpha’s reclamation costs in Wyoming alone are over $411 million, according to the Casper Star-Tribune, not including what it has promised both the federal government for past violations of the Clean Water Act and other obligations in CAPP.
With mounting debts, regulators nationwide are worrying whether Alpha and the rest of the industry can actually come up with the necessary funds to clean up their collective messes. This is a nontrivial concern, especially in the wake of the August release of ugly, orange, toxic wastewater into the Animas River that flowed through southern Colorado and northern New Mexico. Though that incident involved a gold rather than a coal mine, the whole of Appalachia is a similar environmental time-bomb. Much of future and current reclamation and oversight costs are paid by royalties on today’s mined tonnage. But whether the coal is mined or not, the environment is deteriorating daily (Figure 4).
Where Will the King Make His Last Stand?
Historically, coal mining has always been subject to boom and bust cycles. The last bust came during the phasing in of the Clean Air Acts in the 1990s and 2000s, when the industry underwent a wave of restructurings and bankruptcies, particularly for mines that produced higher-sulfur Midwestern and Appalachian coals. In response to the Clean Air Acts, however, many power generators simply switched fuels while slowly installing pollution controls and scrubbers.
But overall coal demand continued to increase through the end of the 20th century into this one, and that’s what is fundamentally different today. Few, certainly not Wall Street experts, believe there’s much growth left within the industry. “This is the worst cycle since 1982 and perhaps since the early 1950s when the railroads switched from coal-power to diesel power,” said Hanou. With an aging U.S. coal fleet and no new plants being built, post 2025 “the impact of retirements—both announced and unannounced—will take effect. By 2040 the U.S. coal industry will likely be half or worse of what it is today,” Hanou predicted.
As the U.S. appetite for coal shrinks, no doubt PRB coal will be around for decades to come, but the remaining growth areas in the industry—and some of the most stable producers—are actually in NAPP and the ILB.
The best, low-cost, easily accessible, and high-heat coals remaining in the U.S. are there—as well as some of the most advanced underground longwall mining operations (Figure 5). The April combination of Robert (Bob) Murray’s Murray Energy and Foresight Energy—both of which rely heavily on advanced longwalls—may redefine the industry for the 21st century. Murray/Foresight is competing against Alliance Resources Limited Partners (Alliance), a steady—though by Wall Street standards boring—risk-averse company. Both Murray/Foresight and Alliance are taking advantage of excellent geology and new technologies to use larger, highly efficient longwall machines to produce more coal with fewer workers—another blow to coal industry jobs, from within the industry. At the end of the day, the low-cost producers will be the last ones standing. And Bob Murray himself has repeatedly vowed to be that person.
Producers like Peabody and Alpha are also competing with Murray/Foresight and Alliance. Faced with increasing competition in the area, Peabody has actually pulled back its ILB production by several million tons over the past few years, and other producers have curtailed their expansion plans. The reason: They simply cannot compete with the low-cost, high-quality tonnage being produced by Foresight, CONSOL, and the recent Alliance/White Oak combination. Overall, an estimated 45 longwalls will produce 210 million tons of coal this year, or about 24% of total estimated U.S. production.
As Hanou points out, “Now that Murray controls Foresight as well as the former CONSOL Pittsburgh Seam longwall mines in NAPP [that he acquired in 2014], he can price his NAPP and ILB coal against higher-cost competition. Murray’s total production now is around 45 mmtpy of NAPP production and around 35 mmtpy of ILB production.
Prudent Producers Are Still Making a Profit
Murray’s combined company will be competing squarely against Alliance, which uses a combination of highly efficient super-section continuous miner operations (Figure 6) and some longwalls to produce high amounts of ILB and NAPP coals.
Alliance largely stayed out of the chase for met and refused to take on significant debt in order to grow. The 29 steady quarters of dividends the company has paid out are indicative of the wisdom of its prudence. While other companies are struggling, Alliance just reported another record earnings quarter. Despite its recent combination with the White Oak Coal Co., compared with its distressed peers, Alliance isn’t burdened by high debt levels. A brand new longwall operation, the White Oak mine in southern Illinois, may become one of the most efficient operations in the nation as it eventually hits its stride.
As King Coal, saddled with debt and battered tools, slowly loses power in Central Appalachia and nationwide, he’s far from vanquished. Efficient surface miners out West and new high-tech longwallers will ensure that the low-cost producers keep the King alive for decades to come. ■
—Lee Buchsbaum (www.lmbphotography.com), a former editor and contributor to Coal Age, Mining, and EnergyBiz, has covered coal and other industrial subjects for nearly 20 years and is a seasoned industrial photographer.