In a coal market this bad, shifts happen

Get ready for some potentially seismic shifts in the U.S. coal industry, with talk of bankruptcies and the sale of “non-core” coal assets dominating a business that is suffering through a cataclysmic downturn in steam coal demand from U.S. power generators, and also a lighter and probably less protracted downturn in the export metallurgical coal market.

The export met market over the last two or three years has been a huge boon to eastern U.S. coal producers, allowing companies like Alpha Natural Resources (NYSE: ANR) to expand production of high-quality met coal, and companies like CONSOL Energy (NYSE: CNX) to shift marginal, high-vol steam coals into the met market, usually by doing some extra coal cleaning to get the right met coal specs. But, with some offshore economies in slowdown right now, the met market has cooled off, though it will probably rebound more quickly than the steam coal market.

Keep in mind that the U.S. for years has been a swing producer of met export coal, called on when coal of the right quality is not available elsewhere. Rapid met coal demand expansion in burgeoning economies like India and China, plus coal supply and transportation disruptions in countries like Australia, has pushed a lot of demand in this direction of late. But the U.S., due to its relatively high production costs, will always tend to be the last to see new demand and first to see that new demand slacken in any downturn. Peabody Energy (NYSE: BTU), which has mostly steam coal mines in the U.S. and mostly met coal mines in Australia, has been saying that there is an ongoing coal “super cycle” going on worldwide that should keep underlying demand for seaborne coals very strong for years to come.

The domestic steam coal market bloodbath – caused by coal-to-gas switching by power generators, a warm winter of 2011-2012 and a still-lackluster U.S. economy – has already been well documented. Hardly a day goes by without a coal company, power producer or somebody with a study pointing out those facts, with the unknown question being how long the downturn will last. If this summer is a hot one, that will help the coal industry a lot. Some coal-fired generators might not even mind so much the higher coal prices that hot summer demand would bring, as long as they can fire their under-utilized coal plants more consistently and work down burgeoning coal stockpiles.

Smart coal procurement executives also worry about whether a downturn like this will shake out the weaker coal producers, leaving those power companies more vulnerable to dominant survivors after the downturn is over.

What the coal industry will exactly look like when this downcycle is over is another open question. The usual big guns, like Peabody, Arch Coal (NYSE: ACI) and CONSOL Energy, seem likely to remain intact. Though Arch is hinting, and Bloomberg is reporting, that Arch has some of its coal assets up for sale. Some of those unnamed assets are probably more marginal operations that Arch got in a June 2011 buy of International Coal Group, but word is any sale may include all or some of Arch’s three longwall mines in Utah, which Arch has owned for many years. Arch’s Sufco mine, the biggest coal mine in Utah and the Arch mine in Utah with the most remaining coal reserves, may be safe from sale, with the more marginal Skyline and Dugout Canyon mines looking like the more probable sale targets. Considering it’ll certainly keep its mainstay mines, like the giant Black Thunder strip mine in Wyoming, even if Arch sells a number of mines it may not even move down in the rankings of top U.S. coal producers.

Also, Alpha in June 2011 bought Massey Energy, which at that point was Central Appalachia’s biggest coal producer. Alpha CEO Kevin Crutchfield, during a May 3 earnings call, was asked whether Alpha might be willing to sell coal reserves, particularly some of the more marginal reserves it got in the Massey buy. “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,” he said. “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.”

With at least Arch and Alpha willing to shed assets, another logical question is whether those assets might get sold in scattered pieces to various parties, including established coal producers? Or is there a major new coal producer out there waiting to be formed from these assets? Also, since met coal is still fashionable, and steam coal isn’t, assets to be sold are more likely to be steam coal operations. Any takers for them right now? Though, if something is seen as a relative bargain, there’s pretty much always a taker or two out there.

Speculation around new coal producers tends to focus around former chief executives of major coal producers, since outside equity investors like to hire them to ramrod their investments. For example, Don Brown, the head of Cyprus Amax Coal in the 1990s, recently resurfaced in the news as the potential buyer of a shut coal mine in Alabama. That doesn’t mean he’s looking to get back into the big-time production game, but it does give rise to speculation. Former Massey Energy head Don Blankenship is sometimes rumored to be looking for a way to get back into the game, as well.

Patriot Coal (NYSE: PCX) is an example of a relatively new company put together out of the pieces of some other companies, including some ex-Arch Coal operations in southern West Virginia and some former Peabody Energy assets in West Virginia and western Kentucky. Patriot has had some financial problems lately and there have been rumors of bankruptcy on Wall Street. While the company has said it can work through these problems, Patriot has gone the unusual route of shaking up its top management team.

Patriot said May 29 that Irl Engelhardt has been named CEO. He succeeds Richard Whiting, who is leaving Patriot after serving as President and CEO since 2007. Engelhardt, 65, served as Chairman of the board of Patriot since its spin-off from Peabody Energy in 2007, and previously served as Chairman and CEO of Peabody from 1990 to 2005. Also, Patriot named company COO Bennett Hatfield as its new President.

There are no firm names of any coal companies out there that might seek bankruptcy. But the concerns are there. Georgia Power, for example, at the urging of Georgia Public Service Commission staff, recently agreed to create an “ultra high risk” category for coal suppliers, on top of its current “high risk” category. Power companies like Georgia Power put high risk producers through more financial scrutiny, and tend to limit their purchases of coal from such companies in order to mitigate portfolio risk if some or all of them can’t perform. Georgia PSC staff was particularly concerned about the financial stresses that coal suppliers in Central Appalachia are going through.

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.