U.S. thermal coal consumption in 2012 is expected to decrease by more than 120 million tons compared with last year, and spot prices for thermal coal in Central Appalachia and the Powder River Basin (PRB) have languished at levels below each basin’s typical cash production costs, said coal producer Alpha Natural Resources (NYSE: ANR) in its Aug. 8 earnings report.
“However, the domestic thermal coal market is showing signs of gradual improvement,” Alpha said. “Natural gas prices have risen approximately 50 percent from their recent lows. Domestic utility inventories, which peaked at approximately 212 million tons in April, inflected and decreased slightly in the month of May, demonstrating the impact of production cutbacks implemented by U.S. producers in the first half of 2012. Inventories stood at an estimated 204 million tons at the end of June, a level that implies the drawdown was slightly greater than the historical average due to reduced production and a heat wave throughout much of the country. While stockpiles have fallen and thermal coal spot prices have begun to improve, inventories remain elevated, new contracting is limited, and spot pricing remains unattractive, both domestically and in the Atlantic market. As expected, the need for baseload coal-fired generation and an uptick in natural gas prices drove a quick resurgence in PRB shipments, which have recently returned to more historically normal levels for Alpha. Despite the signs of improvement in the domestic thermal coal market, conditions remain challenging. In this environment, Alpha will continue to assess expected demand and adjust its thermal coal production accordingly.”
Alpha, a leading U.S. coal producer, reported a second quarter loss of $2.2bn, compared with a loss of $50m in the second quarter of 2011. Excluding impairment and restructuring charges, expenses related to the Upper Big Branch mine explosion in 2010, net amortization of acquired intangibles, changes in fair value and settlement of derivative instruments, merger-related expenses, certain other items, and related tax impacts of these items and other discrete tax items, the second quarter adjusted net loss was $72m, compared to adjusted net income of $152m last year.
In the second quarter, Alpha recorded restructuring and long-lived asset impairment charges totaling $1bn, primarily associated with current market conditions and the continued optimization of Eastern operations which included reductions in operating levels and idling of several operations, as well as actions to streamline Alpha’s organizational structure. The $991m reduction to long-lived asset carrying values is anticipated to reduce non-cash depletion, depreciation and amortization expense by approximately $80m on an annualized basis.
In addition, Alpha recorded a non-cash goodwill impairment charge of $1.5bn, reflecting the current coal market conditions, and lower expected production and shipment levels. None of these charges are anticipated to materially impact the company’s liquidity position or the future operation of its business.
Kevin Crutchfield, Alpha’s Chairman and CEO, said: “These are extremely challenging times in the U.S. coal industry, with softness in both the thermal and now the metallurgical coal markets and the pace at which the fundamentals changed. Alpha has taken decisive actions to ensure that our business is both well-suited to today’s demand environment and efficient enough to provide us with the flexibility to ramp-up our world-class asset base once market conditions improve. We have continued to optimize our Central Appalachia operations by adjusting our footprint, idling high cost thermal coal and lower-quality metallurgical coal production while focusing on our higher-margin metallurgical products.”
Alpha’s total revenues in the second quarter were $1.8bn compared with $1.6bn in the second quarter of 2011, which included one month of legacy Massey operations. Alpha acquired Massey Energy, the top Central Appalachia coal producer, in June 2011. Coal revenues were $1.6bn compared with $1.4bn in the second quarter last year. Coal revenues were 11% higher than the year-ago period primarily driven by a 40% increase in Eastern thermal coal revenue due to the inclusion of a full quarter of legacy Massey operations in the second quarter of 2012, which more than offset a 7% year-over-year decrease in revenues from metallurgical coal and production cutbacks implemented in the first half of 2012. The decrease in metallurgical coal revenues was mainly attributable to lower average per ton realizations in the second quarter of 2012, more than offsetting increased metallurgical coal shipments which increased 28% compared to the year-ago period.
Average realization for PRB coal actually up from a year ago
During the second quarter of 2012, Alpha shipped 10.2 million tons of PRB steam coal (out of the Belle Ayr and Eagle Butte mines), 11 million tons of Eastern steam coal and 5.6 million tons of metallurgical coal. Average per ton realization for PRB shipments rose to $12.96 in the second quarter of 2012, compared with $11.92 in the year-ago period. The average realization per ton for Eastern steam coal shipments was $65.05, compared with $66.65 last year, and the average per ton realization for met coal decreased to $127.83 in the second quarter of 2012, compared with $176.08 in the second quarter of 2011.
Total costs and expenses during the second quarter of 2012 were $2bn, excluding the $1bn restructuring and long-lived asset impairment charges and $1.5bn goodwill impairment charge, compared with $1.6bn in the second quarter of 2011. Cost of coal sales during the quarter was $1.4bn, compared to $1.1bn in the second quarter of 2011.
Adjusted cost of coal sales in the East averaged $74.21 per ton, compared with $76 in the first quarter of 2012 and $70.88 in the second quarter of 2011.The second quarter 2012 per ton cost of coal sales in the East has been adjusted for merger-related expenses of $30m and Upper Big Branch charges of $13m. The sequential decrease in adjusted cost of coal sales per ton is largely attributable to productivity enhancements and a reduction in Alpha’s coal inventory which had been written down to market in previous quarters, as well as the impact of lower met coal prices on variable costs and the cost of purchased coal.
The year-over-year increase in cost of coal sales per ton in the East is primarily the result of a mix shift due to the inclusion of a full three months of legacy Massey operations in the second quarter of 2012 which decreased the proportional contribution of the lower-cost longwalls this year, as well as general inflation and regulatory-driven cost increases, including the impacts of U.S. Mine Safety and Health Administration and environmental compliance. These cost drivers were somewhat offset by the impact of lower met coal prices on variable costs and lower purchased coal costs and volumes. Cost of coal sales in the West averaged $11.01 per ton in the second quarter of 2012, compared with $10.96 in the prior quarter and $10.66 last year.
For the first six months of 2012, Alpha reported total revenues of $3.8bn, including $3.2bn in coal revenues, compared with total revenues of $2.7bn and coal revenues of $2.4bn during the first six months of 2011. The year-over-year increase in both total revenues and coal revenues is primarily attributable to the inclusion of the former Massey operations for a full six months in the first half of 2012, which more than offset production cuts implemented in the first half of 2012 and lower average realizations per ton for met coal.
During the first six months of 2012, Alpha’s coal shipments totaled 54.9 million tons, compared with 44 million tons in the first half of 2011. Met coal shipments were 10.5 million tons year-to-date, up 31% compared to the 8 million tons shipped during the first six months of 2011. Shipments of PRB coal and Eastern steam coal were 21.9 million tons and 22.5 million tons, respectively, during the first six months of 2012, compared with 23.5 million tons and 12.5 million tons during the first six months of 2011.
During the first half of the year, the company-wide average realization was $58.33 per ton and the adjusted average cost of coal sales was $49.50 per ton, resulting in a $8.83 per ton (or 15.1%) adjusted coal margin. By comparison, company-wide average realizations in the first six months of 2011 were $54.48 and the adjusted average cost of coal sales was $38.52, resulting in a $15.96 per ton (or 29.3%) adjusted coal margin.
Alpha works it way through historically weak coal market
The domestic market for thermal coal has been extraordinarily weak in the first half of 2012, as the combination of low-priced natural gas and mild winter weather led to a sharp reduction in coal burn and a rapid increase in utility stockpiles. “Exacerbating the situation is a regulatory environment designed to constrain the mining and use of coal for electricity generation and promote the use of natural gas and heavily-subsidized renewable sources, raising the prospect of higher electricity prices in the future,” Alpha said. “Court decisions suggest that environmental regulation has gone too far, demonstrated by the recent decision to reject the EPA’s overreaching efforts to direct the process of mine permitting that rightfully belongs to the states, and the decision to overturn the EPA’s veto of the Spruce No. 1 permit.”
In light of the burgeoning utility inventories in the U.S., producers, traders and some utilities have attempted to move thermal coal onto the seaborne market. As a result, U.S. exports are on pace for a record year, with thermal coal exports in the first five months of 2012 up about 77% to 25 million tons. Given this significant increase in supply, primarily into the Atlantic basin, seaborne prices for thermal coal have fallen, and opportunities for additional near-term export business have diminished, Alpha noted. Met coal export volumes have remained relatively healthy by historical standards but are down approximately 6% year-over-year through May at 28 million tons. Alpha’s met coal exports during the second quarter of 2012 increased to just over 4 million tons, a 17% increase from the first quarter.
“While export volumes have held up reasonably well, the global market for metallurgical coal has been softening across the board recently,” Alpha said. “Spot pricing for benchmark quality coals in Asia has disconnected from the third quarter benchmark of $225 per tonne and is reportedly under the $200 per metric tonne mark due to slowing steel production in China and the expected recovery of Australian export volumes following the reported resolution of recent labor disputes. In the face of European economic weakness, year-to-date European steel production is down approximately 4 percent compared with 2011. Given the challenging conditions in Europe, metallurgical coals are being contracted at a discount to similar qualities sold into Asia, and the market is awash with lower-quality metallurgical coals, placing significant downward pressure on pricing. In the near-term, Alpha has pared back production of its lower quality metallurgical coals, but the company believes it is well-positioned to capitalize on improving global market fundamentals for metallurgical coal with up to 30 million tons of export terminal capacity and the ability to rapidly increase metallurgical coal shipments in the future.”
In 2012, Alpha anticipates total shipment volumes of 100 million-115 million tons, including 20 million-23 million tons of Eastern met coal, 38 million-44 million tons of Eastern steam coal, and 42 million-48 million tons of Western steam coal.
During the second quarter of 2012, Alpha priced 2.4 million tons of met coal for delivery in 2012 at average per ton realizations of about $105. As of July 18, based on the midpoint of guidance, 86% of Alpha’s 2012 Eastern met coal shipment volume was committed and priced at an average per ton realization of $136.06, and 10% was committed and unpriced. Also based on the midpoint of guidance, Alpha’s 2012 Eastern steam coal shipment volume was 100% committed and priced at an average per ton realization of $66.22, and 100% of Alpha’s 2012 Western steam coal shipment volume was committed and priced at an average per ton realization of $12.89.
Adjusted cost of coal sales in 2012 are anticipated to range from $74 to $78 per ton in the East (metallurgical and steam), down from the previous range of $75 to $79 per ton, and in the West the range is unchanged from prior guidance at $10.50 to $11.50 per ton.
As of July 18, Alpha had 2.7 million tons of Eastern met coal committed and priced for 2013 at average per ton realizations of $125.24 and 11 million tons of Eastern met coal committed and unpriced. As of the same date, Alpha had 14.6 million tons of Eastern steam coal committed and priced at average per ton realizations of $68.48 and 4.9 million tons committed and unpriced, and in the West, Alpha had 36.8 million tons committed and priced at average realizations of $12.99 per ton.
The 2012 shipment range for Eastern steam coal reflects the impact of longwall moves at the Cumberland mine in April and at the Emerald mine in March, as well as anticipated longwall moves at Cumberland in September and at Emerald in December/January. Both mines, located in southwest Pennsylvania, produce high-sulfur Pittsburgh-seam coal.
With $7.1bn in total revenue in 2011, Alpha ranks as America’s second-largest coal producer by revenue and third-largest by production. Alpha is the nation’s largest supplier of metallurgical coal used in the steel-making process and is a major supplier of thermal coal to electric utilities and manufacturing industries.