Historically low natural gas prices will continue to bring serious harm to a large segment of the coal industry here and elsewhere in Appalachia for at least two more years.
That’s the opinion of financial data provider Morningstar Inc., which warned investors this week that two large coal firms with operations in Letcher County — Arch Coal Inc. and Alpha Natural Resources — “may fall into distress in the next two or three years.”
“We expect Central Appalachian (companies) will face tremendous headwinds for at least the next two years,” Morningstar senior equity analyst Mike Tian wrote this week. Noting that the spot-market price for a ton of steam coal used in power production “has plunged to $60 per ton” and is expected to rise to $70 by mid-2013, Tian said those prices “do not make for economic production.”
“We estimate that average cash production costs for Central Appalachian thermal coal are about $60-$65 per ton today,” Tian wrote in the Morningstar report. “Therefore, based on the current curve, producing thermal coal is money-losing today and will be barely profitable a few years hence. Given the very high capital intensity of the industry, these cash margins do not allow producers to reinvest in efficiency or to replace depleting mines.”
According to Tian, the current glut of natural gas is serving “as a cap” on steam coal prices. “With gas at $2 per thousand cubic feet, Central Appalachian coal is deeply out of the money in its core markets,” he wrote in the Morningstar report. “Given current production costs, we estimate that gas needs to rise to at least $4.50 per thousand cubic feet before (companies) can produce coal and earn an adequate cash margin, which we set at $10 per ton. Given current prices, the coal-to-gas switch will continue, albeit at a slowing pace, for the next several years.”
Tian points to Arch Coal and Alpha Natural Resources in the Morningstar report as two firms that may face harder times in 2013 than in 2012. Noting that Arch and Alpha already have contracts in place giving them markets for nearly all of their steam coal production for 2012, Tian cautioned “the picture changes dramatically for 2013.”
“For example, Alpha sold its Eastern steam coals for $68 per ton in 2012. That will probably fall below $65 next year,” Tian wrote. “Metallurgical coal (used in steelmaking) may fare worse. (Alpha) locked in most of its 2012 metallurgical production at $127 per ton. We estimate this will fall to $105 in 2013, given current spot pricing. Arch faces declines of a similar magnitude in its Appalachian portfolio.”
The outlook for Central Appalachian coal domestically and abroad still could improve if summer weather is very hot and the economy in China doesn’t falter as badly as some fear, said the Morningstar report.
“An extraordinarily hot summer that burns down existing coal and gas stockpiles would be extremely beneficial,” Tian wrote. “… On the other hand, with a mild summer, gas prices may decline further, which would mean an even worse 2013. The same goes for the Chinese economy, the health of which … is vital to the metallurgical coal market. We’ve seen anecdotal signs that China may be slowing, and met coal has fallen partly as a result. On the other hand, economic conditions may change quickly and another round of stimulus is also possible.”
With Arch and Alpha already cutting their capital budgets by at least $100 million, the Morningstar report cautions that further cuts “could easily have far-reaching consequences.”
“Coal mining, especially in Appalachia, is a game where you invest a lot just to stay in place,” Tian wrote. “If a miner doesn’t invest, its mines can quickly deplete or its costs will become uncompetitive with the market. It can be very difficult to climb out of this hole. … The risk for Arch and Alpha, the most at-risk large miners that (Morningstar covers), is that events in the next several years end up hurting their structural competitive positions.”