UP works through coal slump, eyes coal export moves through Mexico

Union Pacific Corp. (NYSE: UNP), one of two major western U.S. railroads, is trying to work through a slump in coal moves for the domestic U.S. market, but is still seeing strong current demand and major long-term interest in coal exports.

UP CEO Jack Koraleski, CFO Rob Knight, Executive Vice President of Operations Lance Fritz, and Eric Butler, the new Executive Vice President of Marketing and Sales, fielded questions during an April 19 earnings call. Those analyst questions were dominated by inquiries about the slumping coal business.

Butler said that although Energy volume declined 8% in the first quarter, a 14% improvement in average revenue per car produced revenue growth of 5%. “We indicated, going into this year, that with a couple of contract losses, growth for the Southern Powder River Basin was expected to be slow to negative,” he added about coal moves out of the nation’s top coal-producing region. “Our expectation was that new business across our Energy portfolio would help offset those losses.”

While business wins and losses play a role, volume decline in the Energy business during the first quarter was largely the result of a dramatic weakening of demand for coal, driven by a “near-perfect storm” of a very mild winter and low natural gas prices that, together, lowered electrical use in the U.S. by 4% and electricity generated from coal by 16% during the quarter, Butler noted.

UP’s weekly coal car loadings fell as the first quarter progressed, coming down 19% in March. “The most significant impact has been in the Southern Powder River Basin, where tonnage declined for the quarter 8%,” Butler said. “The rapidly changing market conditions are reflected in rising coal stockpiles for which the Powder River Basin were an estimated 17 days above normal in February, quite a swing from the level several days below normal as recently as October. Colorado/Utah tonnage fared better, declining 3% as strong international demand and new business helped offset the impacts of utility outages, increased use of fuels other than coal by utilities in the Southeast and the mild weather.”

UP serves several giant strip mines in the southernmost Wyoming PRB on a joint line shared with BNSF Railway. Its other major coal origin sources are several, mostly longwall-equipped deep mines in Utah and Colorado, including several mines of Arch Coal (NYSE: ACI).

“External forecasts for the U.S. economy have improved slightly since the start of the year, but the overall outlook still points to a continued slow recovery,” Butler said. “Clearly, the biggest challenge to our growth is the significant weakening of coal demand. With coal stockpiles well above normal, near-term prospects for improvement in the domestic market seem low without unseasonably hot weather or a higher price for natural gas. As a result, coal volumes are expected to be down throughout the year. With normal softening of demand and the mild spring months, our second quarter decline is expected to be in the low to mid-teens. The good news is that our diverse franchise provides a wide range of opportunities for growth that help offset the weakened demand for coal.”

UP won’t cut rates to drive up business

Koraleski addressed a question about whether UP could or would cut coal transportation rates to drive up coal demand. “For the most part, transportation rates are not going to make or break the productivity and the efficiency of coal electric utility generation,” he said. “If there is a utility that is so close to the edge that the transportation rates are making the difference, we’re probably not going to be in a position of being able to save that utility, nor would we go down that path with our pricing strategies.”

Another question fielded by Koraleski was a variation of that same question about price cutting to stimulate coal demand. “You know that our strategy has been to ensure that every piece of business that moves on our railroad is re-investable,” he said. “So we’re going to continue to go down that path. [I]f you have a utility that is on the edge of economic viability, we don’t believe transportation rates are going to save that utility, and it has further implications for us in all of our other customers. So we don’t want people trading on the basis of transportation contracts. We want them trading on the basis of their own productivity, efficiency and manufacturing capabilities. So we would stay with my earlier answer.”

Butler answered a question about whether utility coal customers have take-or-pay contracts with the UP that would compensate the railroad for lost coal moves. “We do have a small percent of our coal customers that are running at minimums, but it’s a very small percent of our coal customers that are doing that,” said Butler. “So we typically don’t have a large portion of take or pay contracts.” Koraleski added on that point: “So we have customers that are operating at their minimum, but they’re not falling below and then paying us the economic penalty.”

West Coast export terminals run into problems

There are several coal export terminals that various parties have proposed in Washington state and Oregon to meet what is expected to be an ever-stronger, long-term market for export coal moving into Asian markets. One problem is that the U.S. Environmental Protection Agency has shown an interest in at least one of those terminals. “The one that we were probably most excited about was the one up in Longview, Washington,” Koraleski said. “That’s kind of run afoul of some of the EPA concerns. We’re actually kind of watching that whole decision for the EPA to be kind of taking a more broad or blanket look at potential environmental situations. But certainly, the one at Longview was important to us. We’ve been moving quite a bit of export coal now down through Houston, and we think there’s some additional capacity there. We’ve been working with mines and the Ferromex railroad and looking at the Port of Guaymas down in Mexico. All of those things are still in play. The newly added challenge or wrinkle for us is what happens with the EPA reviews.”

Butler followed that with the point that the list of projects would expand export coal capacity by a total of about 100 million tons annually. “That’s a huge number,” he said.

Butler, when asked about whether interest in the coal export terminals has cooled, said: “We have not seen any cooling, and I would say, perhaps, the opposite. We’ve seen some real time higher level of interest for export coal out of Mexican ports that do not seem to have the same permitting process requirements, perhaps, that we have in the Pacific Northwest ports.”

Kansas City Southern also eyes Mexico-routed coal exports

The idea of exporting U.S. coal through Mexico is taking hold. Kansas City Southern (NYSE: KSU), another railroad in the western U.S., had said in January that it is working with U.S. coal producers to route trains south into Mexico headed for the new port of Lazaro Cardenas on Mexico’s west coast.

Kansas City Southern (KCS) operates in Mexico through Kansas City Southern de México, S.A. de C.V. (KCSM). KCSM’s rail lines provide exclusive rail access to the U.S. and Mexico border crossing at Nuevo Laredo, Tamaulipas, the largest rail freight interchange point between the United States and Mexico.

“KCSM provides exclusive rail access to the Port of Lazaro Cardenas on the Pacific Ocean,” said Kansas City Southern’s Feb. 8 annual Form 10-K report. “The Mexican government is developing the port at Lazaro Cardenas principally to serve Mexican markets and as an alternative to the U.S. west coast ports. KCSM is the sole provider of rail service to this port, which provides an alternate route for Asian and South American traffic bound for North America.”

About Barry Cassell 20414 Articles
Barry Cassell is Chief Analyst for GenerationHub covering coal and emission controls issues, projects and policy. He has covered the coal and power generation industry for more than 24 years, beginning in November 2011 at GenerationHub and prior to that as editor of SNL Energy’s Coal Report. He was formerly with Coal Outlook for 15 years as the publication’s editor and contributing writer, and prior to that he was editor of Coal & Synfuels Technology and associate editor of The Energy Report. He has a bachelor’s degree from Central Michigan University.