Coal movements in the first quarter by the CSX Transportation unit of CSX Corp. (NYSE: CSX) slumped sharply, particularly for utility coal, giving rise to issues for CSX like whether to seek liquidated damages from power generators that didn’t move their contracted volumes of coal.
CSX officials discussed the coal market during an April 18 earnings call. There are two major railroads in the eastern U.S., CSX and Norfolk Southern, and a big chunk of CSX’s business is tied into coal production and consumption in that region.
Clarence Gooden, the company’s Chief Sales and Marketing Officer, said that coal revenue in the first quarter decreased 5%, driven by weaknesses in utility coal volume that more than offset the strength in export and industrial coal. Domestic utility tons declined 28% as overall electrical generation was down in the eastern U.S. In addition, natural gas prices remained at low levels, which led to the continued displacement of coal at some utilities, Gooden noted.
Partially offsetting this weakness, industrial coal tons grew by 11%, driven by increased domestic steel production, while export coal tons grew 17% as demand was strong for U.S. thermal coal shipments. Looking ahead, demand for export coal should remain strong with the increasing demand for thermal coal being offset by weakness in the metallurgical shipments, Gooden said.
Overall, CSX still expects export volumes similar to the 2011 levels. In addition, strength in shipments of industrial coal is expected to continue due to the increased steel production. At the same time, domestic utility volumes are expected to face continued challenges due to the low gas prices, above-normal coal inventory levels and environmental regulations. “Headwinds should be strongest in the second quarter and then moderate throughout the balance of the year,” Gooden said.
Oscar Munoz, the CSX Chief Operating Officer, said that on the bright side, with overall coal volumes declining, service and productivity are up with the average train length increasing to 106 cars. At the same time, with the increased fluidity in the coal network, CSX was able to deliver 12.5 million tons to the export market.
Gooden said the split between thermal and met coal in the first quarter was almost 50-50. He said CSX has taken its tariff rates down as it tries to price to the market. He said metallurgical coal will not have the same pricing characteristics this year that it had last year due to pricing flexibility on this traditionally short-term business. “The thermal coal is mostly all under contract, under an annual contract, and has already been priced and it’s in place,” he added.
CSX picks up more Illinois Basin, Northern App movements
Gooden was asked if the ongoing “secular” shift, due to cheap gas and environmental regulations, of coal from being baseload generating capacity to more of a surge or supplemental capacity, affects CSX pricing for coal movements. “I can’t discuss publicly any of our provisions in our contracts with our customers as to how the rates change and move up or down,” Gooden responded. “I can tell you that if this is, in fact, a secular change in the natural gas, that the railroads and the utilities will have to sit down because what we can’t do is build a church for Easter Sunday, if you’ll pardon the cliché. And … Oscar has to be able to resource his operations here to some practical level in order to handle this. So I think that will end up being a common ground reach between the carriers, the coal suppliers and the utilities as we move forward.”
Another questioner said that if you annualize the 12.5 million tons of export coal in the first quarter, CSX was effectively operating at the high end of what it has indicated is the annual capacity of its export coal network. Gooden responded that last year CSX was using numbers of 45 million to 50 million tons in annual export capacity. But, CSX people who’ve been handling this coal have gotten more experienced as certain handling equipment was replaced, so the company feels very comfortable in the current export range.
Another question had to do with the “secular” decline in Central Appalachia coal production that has been going on for years as coal companies run out of workable reserves and what impact that would have on CSX. The question also related to long-term utility coal demand in the face of waves of old coal plants being retired by power generators.
Said company Chairman, President and CEO Michael Ward about Central App: “The Illinois Basin and the Pittsburgh seam coals [out of Northern Appalachia] are growing in prominence because of their cost characteristics. So we think we will see some shifting, have been seeing shifting from Central App over to Illinois Basin and to the Pittsburgh seam over the last several years. We expect that to continue.”
As for the part of the question about coal plant retirements, Ward added: “We think that will stabilize at some point because there will be the need for the generating capacity to meet the electrical demand. So a lot of the fall we’re seeing right now has been largely these plants that were built in the ’50s and ’60s that were going to go out, in our view, by 2014 or ’15 anyway. It’s just been accelerated by the weak demand due to the weather and the natural gas prices. So I think you’re right, it was envisioned, it’s happened a little quicker, but I think there’s going to be a strong base of regular business out there just to meet the electrical demands in the eastern half of the United States.”
Gooden added at that point: “I agree with you, Michael. And plus, I’m not so sure that natural gas is going to stay at $1.95 [mmBtu], where it is now, because I do think the gas companies can’t afford to allow that to happen and justify the drilling.”
Gooden was asked if any power generators have come to CSX talking about possible liquidated damages they might be charged for failure to ship contract coal. “We have had very little negative feedback or pushback from any of the utilities that we work with,” Gooden said. “Now having said that, we’ve had a couple of utilities that called that understand that with the way things are going in their particular situation, that they may be looking at some potential liquidated damages. And what they’ve said is, ‘hey, let’s stand out here and try to work together and solve our problems.’ And it’s been all very positive. Now how that is going to impact 3, 4, 5 years from now? To your point, I’ve been doing this a long time and…my crystal ball gets cloudy when I get out there 3, 4 years.”