TUESDAY, December 20, 2011

With Henry Hub prices getting ready to breech the $3.00/mmbtu mark and sub-$3 prices already prevalent in some regions, I am frequently asked how the coal sector will fare.  Is $3.00 natgas any worse than $3.75 natgas?  The answer, of course, is yes.  Quantifying the damage is beyond my ability.  The most difficult questions are how low will natgas prices go and for how long?  Some coal companies are more insulated than others due to contracts that were booked when prices were more attractive.  Some coal companies are more insulated than others due to the contribution from coking coal.  Some coal companies are blessed with low mining costs.  However, to paraphrase Warren Buffet, “When the tide goes out, we will see who has something to hide.”  High market prices can hide a variety of sins including high mining costs.  The longer or the lower coal prices, the tougher it will be to delay the day of reckoning.

$3.00 natgas – only a few weeks after the beginning of the withdrawal season, no less – is an unwelcome event for coal producers.  The biggest battleground (SERC) might be close to saturated as far as displacement is concerned, but natgas can displace coalgen in other NERC regions if the price is low enough.  In many ways, the US coal market has dodged bullet after bullet in the past few years.  The regulatory agencies have made sure that the market was not oversupplied.  Weather has played a very bullish role (heat, cold, tornados and floods).  China’s surprising demand in 2009 prevented a catastophe in the seaborne market.  The ex-China seaborne market returned the favor in 2010 & 2011 with resounding demand (Japan’s quake/tsunami notwithstanding) and was supported by plentiful supply problems in every corner of the globe. Without this vital outlet for US coal, the US coal sector would be in a world of hurt.

It is looking increasingly probable that in spite of an economic recovery (however lame) and the positive impact from new coal-fired generation, domestic coal demand will be ‘hounded’ by low natgas prices and the current regulatory climate.  Low natgas prices will enable steel mills to displace a few million tons of PCI coal.  $3.00 gas will presumably displace several million tons of incremental coal burn in 2012 and will keep the electricity curves in the dumps.  Low electricity prices will embolden utilities to maintain even leaner stockpiles and to shift even more coal buying into the prompt market.  Until high cost coal production is shuttered, coal prices will suffer and will probably overshoot conventional wisdom as to how low they can go. As Ted pointed out, ACI reportedly furloughed 200 miners at its Dugout Canyon mine in Utah and at some of its steam coal mines in Eastern Kentucky.  Considering the prevailing low coal prices and the weak utility demand, more closures will surely come from coal companies with high cost steam coal mines.  Railroads and low cost producers will have to work double-time in order to defend coal’s market share, but until natgas prices rebound, they will surely have to engage in some ‘tactical retreats’.

To paraphrase Ebenezer Scrooge’s conversations with the Spirit of Christmas Future, “Are you showing me the shadows of things that have not happened, but will happen in the time before us?  …  But if the courses be departed from, the ends will change. Say it is thus with what you show me.”  The seaborne market can be fickle, but if it continues to absorb almost 10 percent of US coal production, the coal sector might be able to ‘hang in there’ until natgas prices increase.  While supply ‘events’ are unpredictable, they have been a regular occurrence and a continuation of such events (quakes, floods, heavy rains, heavy snows, terrorism, etc.) will also serve as ‘life lines’ to the US coal sector.  And, of course, the coal sector’s perennial friend (weather) could support demand, but I fear we have already ‘worn out that welcome’. Needless to say, if there are no supply ‘events’ and/or if the seaborne thermal market takes a breather from US coal and/or if the seaborne coking coal market takes a pause and throws 10 – 15 million tons of ‘cross-over’ coal back into the domestic steam coal market, the market will not be a friendly one for low cost coal producers and will be a downright dangerous one for high costs producers.