In a long-rumored move, Patriot Coal (NYSE: PCX) said July 9 that it and substantially all of its wholly owned subsidiaries have filed voluntary petitions for reorganization under Chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court for the Southern District of New York.
This is the biggest coal industry bankruptcy in many years, with the last one nearly this big occurring in 2002 with coal operator Larry Addington’s Horizon Natural Resources filing at a federal bankruptcy court in eastern Kentucky. Horizon was eventually dismembered through a series of bankruptcy asset sales, though, which is not a direction that the Patriot case seems to be going in.
If the Patriot case goes anything like the Horizon case, any power generator with a below-market contract with Patriot will need to brace for Patriot to go to the court and ask to get out of that contract. If a bankrupt company can make a case to the judge that a contract, whether a coal supply deal or a union labor contract, endangers the company’s future finances, the judge will terminate that contract. A power generator can then file a claim over the terminated contract with the court, but will usually have to wait years to get cents on the dollar on what that termination has cost it. One point of note is that the current coal market is so low in price that it might be hard to find a coal contract that Patriot has that is currently below that market.
“Patriot has taken this action in order to undertake a comprehensive financial restructuring,” the company said July 9. “Patriot expects its mining operations and customer shipments to continue in the ordinary course throughout the reorganization process. Patriot believes that the protection afforded by a court-supervised reorganization process, including the ability to access new financing, will provide the Company with additional time and flexibility to address its financial challenges and position Patriot for long-term viability and success.”
In conjunction with its reorganization, Patriot has obtained a commitment for $802m in debtor-in-possession (DIP) financing from Citigroup Global Markets Inc., Barclays Bank PLC, and Merrill Lynch, Pierce, Fenner & Smith Inc. as joint lead arrangers. Upon approval by the bankruptcy court, the new financing and cash generated from Patriot’s ongoing operations will be used to support the business during the reorganization process.
“The coal industry is undergoing a major transformation and Patriot’s existing capital structure prevents it from making the necessary adjustments to achieve long-term success,” said Patriot Chairman and CEO Irl Engelhardt. “Our objective is to use the reorganization process to address important issues in an orderly way and make the Company stronger and more competitive.”
Patriot President and COO Bennett Hatfield added: “We remain firmly committed to serving our customers and to being a good employer by maintaining safe, productive operations as we undertake this process. The skills of our employees and the quality of our service provide an excellent platform for Patriot’s future success. We appreciate the ongoing dedication of our employees, whose hard work is critical to our success and the future of our Company.”
Patriot said May 29 that Engelhardt had been named CEO. He succeeded Richard Whiting, who left Patriot after serving as President and CEO since 2007. Engelhardt, 65, served as Chairman of the Board of Directors of Patriot since its spin-off from Peabody Energy (NYSE: BTU) in 2007, and previously served as Chairman and CEO of Peabody from 1990 to 2005. Hatfield at that point was named as President of Patriot and continued to serve as the company’s COO.
Crummy U.S. thermal coal market a big factor in bankruptcy need
Patriot said in the July 9 statement that its business outlook has been impacted by a number of challenges that are affecting the coal industry, including reductions in U.S. thermal coal demand due to competition in the power plant market from low priced natural gas, challenging environmental regulations affecting the cost of producing and using coal, and weaker international and domestic economies. The company has reacted to the lower domestic demand by reducing production and increasing sales into the export markets. The recent cancellation of customer contracts, lower thermal coal prices and rising expenditures for environmental and other liabilities have severely constrained the company’s liquidity and financial flexibility.
Patriot has filed motions with the bankruptcy court in support of its reorganization, including requesting authorization to continue paying employee wages and providing health care and other benefits. Patriot has also asked for authority to continue existing customer programs and intends to pay suppliers in full under normal terms for goods and services provided after the filing date of July 9. It filed 99 separate bankruptcy pleas for various of its companies and has asked for combined consideration of them all.
Davis Polk & Wardwell LLP is serving as legal advisor, Blackstone Advisory Partners LP is serving as financial advisor, and AP Services LLC is providing interim management services to Patriot in connection with the reorganization. Ted Stenger, a Managing Director at AlixPartners LLP, the parent company of AP Services, has been named Chief Restructuring Officer of Patriot, reporting to the Chairman and CEO.
Patriot mines coal in West Virginia and western Kentucky
Patriot Coal is a producer and marketer of coal in the eastern United States, with 12 active mining complexes in southern and northern West Virginia and in western Kentucky.
As of the end of 2011, it had mining complexes located in Boone, Clay, Lincoln, Logan and Kanawha counties in southern West Virginia. In northern West Virginia, it had the Federal No. 2 longwall mine in the Pittsburgh seam in Monongalia County, W.Va. In Appalachia, it sold 23.9 million tons of coal in 2011. In January, Patriot announced the idling of and production curtailment at certain metallurgical coal mines in response to weaker demand. In February, it announced the closure of the Big Mountain mining complex in response to weaker thermal coal demand.
It has three mining complexes (Bluegrass, Dodge Hill and Highland) located in Union and Henderson counties in western Kentucky. It sold 7.3 million tons of coal out of these operations in 2011.
In 2011, Patriot sold 31.1 million tons of coal, of which 76% was sold to domestic and global electricity generators and industrial customers, and 24% was sold to domestic and global steel and coke producers. Export sales were 29% of total volume in 2011.
Is Peabody in line for some risk in this case?
One interesting point here is whether there is risk to Peabody in the Patriot bankruptcy case. Said Patriot in its Feb. 23 annual Form 10-K report: “In 2011, approximately 78% of our coal sales were under long-term (one year or greater) agreements. We expect to continue selling a significant portion of our coal under long-term coal supply agreements. Our approach is to selectively renew or enter into new coal supply agreements when we can do so at prices we believe are favorable. We continue to supply coal to Peabody under a contract that existed at the date of spin-off with terms into 2012. As of December 31, 2011, approximately 12% of our current projected 2012 total production was committed under this pre-existing customer relationship with Peabody, which supplies thermal coal.” It isn’t clear from that mention if this a long-term contract to supply the Tennessee Valley Authority out of the Highland complex in western Kentucky that Patriot was known to have gotten in the 2007 spinoff from Peabody.
A major factor in Patriot’s finances is its heavy United Mine Workers of America union obligations. It is basically a repository for the primary UMWA obligations of two major coal producers: Peabody Energy, from which it was spun off in an IPO in October 2007; and Arch Coal (NYSE: ACI), which sold off unionized mines in Central Appalachia last decade to other parties, with Patriot then acquiring those operations in a July 2008 buy of Magnum Coal. Part of Magnum was non-union, basically some former coal mines in southern West Virginia of coal operator Chris Cline, so Patriot is not entirely a unionized operator.
Said the Form 10-K about the company’s labor situation: “As of December 31, 2011, we had approximately 4,300 employees. Approximately 50% of our employees were represented by an organized labor union. Our represented employees work at various sites in Appalachia and at the Highland complex in the Illinois Basin. In the third quarter of 2011, certain of our subsidiaries signed new agreements with the UMWA, which were effective July 1, 2011 and generally extend through December 2016. The new agreements are substantially the same as the National Bituminous Coal Wage Agreement negotiated in mid-2011 between the Bituminous Coal Operators’ Association and the UMWA. We refer to this as the 2011 National Bituminous Coal Wage Agreement (2011 NBCWA).”
In connection with the 2007 spinoff, a subsidiary of Peabody assumed certain of Patriot’s pre-spin-off obligations associated with the Coal Industry Retiree Health Benefits Act of 1992 (the Coal Act), the 2007 NBCWA and certain salaried employee retiree healthcare benefits, the Form 10-K noted. As of the end of 2011, the present value of the liability assumed by Peabody at spin-off was $696.8m. Certain Patriot subsidiaries remain jointly and severally liable for the Coal Act obligations and remain secondarily liable for the 2007 NBCWA obligations and the salaried employee obligations.