Observers could devote a lot of time to talking about issues in the domestic steam market, but the long and short of it is this: utility inventories have risen rapidly and now exceed 200 million tons, which is near record highs, and coal-fired generation has recently fallen below 40% of U.S. electricity generation, said Alpha Natural Resources (NYSE: ANR) CEO Kevin Crutchfield during a May 3 earnings call.
Alpha, like a number of U.S. coal producers, is slashing steam coal production this year due to a slack market caused by factors like a record warm winter and record low natural gas prices that have prompted power generators to displace coal-fired generation.
“The change in the steam coal market occurred abruptly, considering that inventories entering the fall of 2011 were in the 150 million ton range, and utilities were still in the market buying coal for 2012 deliveries,” Crutchfield added. “Given where we stand today, our best guess is that U.S. steam coal production will be reduced by at least 100 million tons in order to balance supply and demand. Assuming this to be the case, announced cutbacks so far are roughly halfway there, suggesting that further cutbacks are likely to occur. In fact, in a worst-case view of the situation, one could annualize reduced first quarter coal production of 14 million tons, first quarter growth in utility inventories of about 22 million tons and a year-over-year increase in steam coal exports of approximately 3 million tons and come up with a number approaching 160 million tons in total.”
This would be too dire a forecast due to the impacts of abnormally warm weather during the first quarter, but it does provide a sense for the magnitude of the falloff in first quarter domestic demand, Crutchfield said. “So, depending on producer actions, weather and economic activity, the process of working inventories down to more normal levels is likely to last well into 2013,” he added.
The metallurgical coal market, on the other hand, has also experienced some relative weakness, particularly for lower quality coals on the export market, but the market environment for met coal is way more positive than the environment for domestic steam coal, Crutchfield said. Until very recently, the combination of recovering met coal production levels in Australia, declining steel production in Europe due to the ongoing debt crisis and slowing economic growth in China has led to steadily decreasing benchmark prices and widening discounts for lower quality coking coals.
On Feb. 3, Alpha announced a 4 million ton reduction in its 2012 Eastern shipments, including 2.5 million tons of steam coal and 1.5 million tons of lower quality coking coal. “It’s now clear that additional adjustments will be necessary,” Crutchfield said. “We’re evaluating how best to trim our portfolio in order to maximize free cash flow with minimal dislocation, and we expect to undertake additional production adjustments in the near future.”
Alpha cuts 2012 expected shipments again
In the revised guidance issued May 3, Alpha has reduced 2012 expected shipments by an additional 7.5 million tons compared to prior guidance. In addition to these actions, Alpha is exploring all possible avenues to preserve margin and move its coals. In 2012, Alpha expects to roughly double its direct thermal exports to about 4 million tons, and it estimates that a total of 10 million tons of its thermal coal production will ultimately find its way onto the export market when third-party transactions are included. “In fact, we’ve recently succeeded in shipping thermal coals to destinations as far away as India and China,” Crutchfield said.
CFO Frank Wood said that during the first quarter, Alpha shipped 28.1 million tons of coal, including 4.9 million tons of met coal, 11.5 million tons of Eastern steam coal and 11.8 million tons of Powder River Basin coal. This compares to 31.1 million tons shipped in the prior quarter, including 5.3 million tons of met, 11.9 million tons of Eastern steam and 13.9 million tons of PRB coal.
Average realizations for metallurgical coal were $145.51 per ton in the first quarter compared to $141.76 in the first quarter of 2011 and $156.48 in the prior quarter. Eastern steam coal realizations were $67.48 compared to $66.89 last year and $66.93 in the prior quarter. Realizations in the PRB were $12.95, up from $11.91 in the year-ago period and $11.96 in the fourth quarter of 2011.
Paul Vining, Alpha’s President and Chief Commercial Officer, said there have been some signs of life in the met market in recent days. Alpha has concluded some spot low-vol sales for some small tons. It is getting requests, particularly from Asian customers, for advancement of shipments. That’s usually the precursor to some additional sales and while not a “groundswell,” it is at least a shifting in the momentum relative to pricing, Vining said.
Vining said that to date, Alpha has gotten requests for steam coal shipment deferrals that range anywhere from about 6 million to 9 million tons, some of which Alpha has resolved. In some cases, Alpha is rolling tons into next year for additional consideration and a higher price. It has agreed to roll some tons over a two-year period with certain customers. There have been some swaps with customers for different types of coal. “What we’re trying to do is work with them as they get more visibility around their burns and their stockpile situations sort out,” Vining added. “We’ve had what I’d say is a disciplined stand relative to the contracts and the value, and some customers have been fairly cooperative. And others are struggling, and we’re trying to find solutions that work for both of us.”
Crutchfield, asked whether Alpha might be willing to sell coal reserves, particularly some of the more marginal reserves it got in a June 2011 buy of Massey Energy, said: “Part of our strategy, as we’ve outlined before, is a three-pronged strategy, which is protect and preserve the met franchise and, out of the rest of the portfolio, create a long-term durable and lasting thermal franchise that can be competitive both here and internationally. Assets that don’t fit that profile are non-strategic. It’s not that they’re bad assets, we’re just going to declare them non-strategic to us. So the question becomes then, what do you do with them and when? I wouldn’t want to be in the marketplace right now with thermal assets. But I think that we’ll take our time and work through this process diligently and thoughtfully. But longer term, we do need to figure out what we’re going to do with that, whether it’s an outright sale, disposition, joint venture, whatever. We’re still working our way through that. And admittedly, we knew we were going to have to do this. We just thought we had a little longer period of time to work through it. But given the market dynamics, it’s moved that forward about a year or two.”