Coal markets weakened in the fourth quarter of 2011 as abnormally mild weather and limited economic growth caused U.S. power generation to decline slightly for the full year, said major coal producer Arch Coal Inc. (NYSE:ACI) in its Feb. 10 earnings statement.
Domestic coal consumption declined 5% in 2011, resulting from the decrease in power generation as well as fuel switching by power producers due to abnormally low prices for natural gas and high hydroelectric availability. As a result, coal stockpiles at U.S. generators rose to an estimated 180 million tons by the end of 2011, which is a seasonal build that is above historical norms.
In 2012, Arch currently estimates that domestic coal consumption for power generation could decline by 50 million tons or more from 2011 levels, as mild weather has reduced power demand and the current oversupply of natural gas could induce more coal displacement. Given anticipated declines in domestic coal use as well as U.S. generator stockpile builds, Arch said it believes that coal production and capital spending levels industry-wide are in the process of significant rationalization, which should set the stage for the next market upswing.
Arch Coal reported fourth quarter 2011 net income of $70.9m, compared with net income of $47.8m in the prior-year period. Fourth quarter 2011 revenues topped $1.2bn, an increase of 47% versus the prior-year quarter on significantly higher sales prices and the addition of the former International Coal Group (ICG) operations acquired in June 2011. Fourth quarter adjusted earnings before interest, taxes, depreciation, depletion and amortization (EBITDA) also grew 41% versus a year ago to reach a record $270m.
“Arch delivered solid quarterly financial results despite weakening coal market conditions as the fourth quarter progressed,” said Steven Leer, Arch’s Chairman and CEO. “In particular, our Powder River Basin operations rebounded from flood-related disruptions earlier this year. Also, higher realized prices and solid cost control across our diverse operating platform helped to expand our per-ton operating margins versus a year ago.”
For the full year, adjusted net income was $205.2m. Annual EBITDA reached $921.1m in 2011, marking the highest level in company history. Arch also set a new record for sales revenue of $4.3bn, a 35% increase versus 2010, despite lower overall sales volume.
“Arch achieved a strong year in 2011 as measured by its core values – employee safety, environmental stewardship and financial performance,” said Leer. “These achievements are notable considering that we completed, and swiftly integrated, the largest acquisition in our history, overcame geologic challenges in one region and weather disruptions in another, and confronted weakening coal markets by year end. Clearly, our strong portfolio of metallurgical and thermal mines drove our success last year – and will continue to do so in 2012 and beyond.”
“Looking ahead, near-term market conditions have softened and we are reducing our planned production volumes to better align with weak generation and coal demand trends,” said Leer. “These actions preserve our reserve base and increase our flexibility to respond as global and domestic energy markets evolve. At the same time, we will continue to maintain the development timetable for our metallurgical coal growth projects while generating positive free cash flow.”
Arch puts projects in play for the future
In June 2011, Arch completed the ICG acquisition for $3.5bn, financing the purchase with a combination of debt and equity offerings during the second quarter of 2011. The transaction established Arch as the second largest U.S. – and a top 10 global – metallurgical coal producer. The acquisition also expanded Arch’s pipeline of low-cost, high-quality metallurgical coal development projects, which are geared toward serving both domestic and international steel markets. That includes the in-development Tygart No. 1 longwall mine in Taylor County, W.Va., and other mines in the works nearby.
During the past year, Arch also bolstered its U.S. coal export capabilities through a combination of direct investment, throughput arrangements and expansion of sales offices overseas. Early in 2011, Arch secured port capacity on the West Coast via a 38% equity interest in Millennium Bulk Terminals in Washington state and a guaranteed throughput contract with Ridley Terminals in British Columbia, Canada. Both will facilitate movements of western U.S. coals into Pacific Rim seaborne markets. Arch also signed a long-term throughput agreement to move coal from any operating region through Kinder Morgan‘s Gulf Coast and East Coast port terminals. Supporting this strategy of meaningfully growing its coal exports, Arch in 2011 announced new company offices in Singapore and London.
In December, Arch lodged a successful bid with the U.S. Bureau of Land Management for the 222-million-ton South Hilight coal lease. This lease added high-quality, ultra-low-sulfur coal reserves that are contiguous to the flagship Black Thunder mine, which will help serve both growing export coal markets and expanding domestic demand for ultra-low-sulfur coals.
“Our operations turned in good performances in the fourth quarter of 2011 – with cash costs declining and per-ton margins expanding in each core region versus the third quarter,” said John Eaves, Arch’s President and COO. “In fact, our fourth quarter Appalachian cash costs fell by nearly $4 per ton versus the prior quarter, benefiting from an improved longwall performance at Mountain Laurel, ongoing realization of synergies from the ICG integration, and a continued emphasis on cost containment.”
When compared with the third quarter, consolidated per-ton operating margin in the fourth quarter of 2011 rose nearly 17% on higher overall sales volume. While consolidated average sales price declined over the same time period, it was more than offset by lower overall cash cost in each operating basin. A larger percentage of Powder River Basin coal in Arch’s overall volume mix during the fourth quarter of 2011 also contributed to the decline in consolidated sales price and operating cost per ton versus the third quarter.
Internal estimates suggest that a significant portion of Central Appalachia’s estimated 125 million tons of thermal coal production is uneconomic at current index price levels, Arch said. These are the types of markets where Arch’s low-cost mining portfolio really stands out as a competitive advantage, noted Eaves. The ICG acquisition represented a major expansion of Central Appalachia production for Arch.
Global coal demand helps around the edges
Offsetting weak domestic coal trends at the moment is continued projected growth in global energy demand. The seaborne coal trade exceeded 1.2 billion tons in 2011, and that growth is expected to continue in 2012. Roughly 470 GW of new coal-fueled capacity is planned to start up by 2015, resulting in an estimated 1.6 billion tons of additional coal demand during the next three years. Since 2010, approximately 350 new coal plants have begun operating around the world.
Moreover, pricing in met coal markets could strengthen in subsequent quarters as global steel capacity utilization increases, the pace of economic activity improves around the world, and coal supply disruptions resurface. Global crude steel production reached 1.5 billion tonnes in 2011, and steel industry projections call for additional growth of 5% to 6% during 2012. Arch anticipates continued growth in met seaborne coal demand through 2015, with the U.S. expected to play an even larger role in the market during that time frame.
Tight met coal markets and growing seaborne thermal demand should increase U.S. coal exports in 2012 versus record 2011 levels. Domestic coal exports reached 108 million tons in 2011, and Arch expects that total to grow another 5 million to 10 million tons in 2012.
“Supply rationalization, slowly improving economic activity in developed economies and growing demand in emerging countries should help coal markets rebalance in the near term,” said Leer. “Over the long term, our views on global coal markets remain unchanged. Since 2000, coal has been the fastest growing major fuel source in the world, with consumption up 50 percent. We expect this long-term trend in coal use to continue as countries seek to build, and in some cases re-build, their economies with this affordable, reliable and essential resource.”
Arch trims 2012 CapEx spending
Arch is reducing its discretionary capital spending in 2012 due to the market slump. The company expects to spend $450m to $490m in total, comprised of growth projects, maintenance capital and existing reserve commitments. Roughly half of the projected spending will be for metallurgical coal growth projects, including the Tygart No. 1 longwall mine, which is scheduled to start up in mid-2013, and advanced planning for additional met coal mines in West Virginia.
“In 2012, Arch is reducing its planned capital expenditures by targeting a lower level of spend for some of our thermal assets,” said John Drexler, Arch’s Senior Vice President and CFO. “But, we will continue to aggressively develop our low-cost, high-quality metallurgical reserves, and still generate free cash flow to further de-lever our balance sheet.”
Arch is expecting 142 million to 158 million tons of thermal coal sales in 2012, and 9 million to 10 million tons of met coal sales, for a total of 151 million to 168 million tons. Arch sold a total of 42.5 million tons in the fourth quarter of 2011 and 161.3 million tons in all of 2011.