The U.S. thermal coal market has rebounded from its low point in the spring of 2012 when coal reached its lowest proportional level of electricity generation in four decades, and nationwide utility inventories peaked at an estimated 213 million tons due to weak winter 2011-2012 burn and natural gas prices that were briefly below $2 per thousand cubic feet (MCF).
“However, the improvement has been gradual, and inventories remain elevated, falling to 191 million tons by the end of September, a level still well above the historical average,” said major coal producer Alpha Natural Resources (NYSE: ANR) in its Nov. 2 earnings report for the third quarter. “Despite the inventory drawdown, an improvement in coal’s share of electricity generation into the upper 30 percent range, and the expectation of a return to $4 per MCF gas in 2013, the domestic market for steam coal remains weak. Alpha estimates that, if all domestic steam coal were re-priced at today’s spot market prices, over two-thirds of all shipment volumes would be uneconomic.”
The company added: “In light of this market environment, Alpha announced plans in September to curtail production in the Powder River Basin (PRB) and Central Appalachia. In the PRB, the company plans to continue to ship those tons that are currently committed and priced to provide acceptable profit levels until the market comes back into balance. In Central Appalachia, where Alpha believes steam coal demand has been structurally reduced due to plant retirements and competition from natural gas, the company is idling high cost thermal coal production to create a sustainable thermal coal business that can profitably dispatch throughout the business cycle.”
Alpha reported a third quarter loss of $46m or $0.21 per diluted share, compared with net income of $63m or $0.28 per diluted share in the third quarter of 2011. Excluding special items, the third quarter adjusted net loss was $36m or $0.16 per diluted share, compared with adjusted net income of $76m or $0.34 per diluted share for the third quarter last year.
“Market conditions for both metallurgical and thermal coal have been challenging throughout much of 2012, and continued in the third quarter,” said Alpha Chairman and CEO Kevin Crutchfield. “In the face of these market headwinds, Alpha has taken swift and decisive actions to right-size our operational footprint and our cost structure. In September, we announced a plan to reduce our annualized production rate by an additional 16 million tons. These actions are being taken in a pricing environment where we estimate that the majority of U.S. thermal coal would be uneconomic to produce at today’s spot market prices and, similarly, metallurgical coal has fallen to levels at which a significant percentage of worldwide supply is uneconomic.”
Production cuts coming in the PRB, Appalachia
To ensure that Alpha’s operations and cost-base are aligned with the current market environment, about 50% of the planned reduction in tonnage will come from the PRB, where the company plans to adjust production to match currently committed and priced volumes for 2013. Alpha has the mid-Btu Belle Ayr and Eagle Butte mines in the Wyoming end of the PRB.
Another 40% of the reduction will come from the higher-cost Eastern thermal coal production base in Central Appalachia, and the remainder of the cutbacks will comprise lower-quality metallurgical coal that is uneconomic in today’s market. These restructuring actions began in September and will be phased in through early 2013. Once fully implemented, all of the production cutbacks and restructuring actions are expected to result in a $150m annual reduction in the company’s recurring overhead costs, in addition to other cost of coal sales reductions due to mine idlings and production curtailments.
Alpha said its recent financing activity is a significant step in the company’s plan to strengthen Alpha’s position within the industry. In October, the company successfully issued $500m of 9.75% senior notes due in 2018. A portion of the proceeds were used to repurchase about $123m of the 2015 3.25% convertible senior notes, and the remainder, net of fees, serves to improve the company’s liquidity and financial flexibility. As of Oct. 26, the date Alpha’s convertible senior tender offer was closed, Alpha had total liquidity of $2.0bn, including approximately $900m of cash and marketable securities.
Alpha’s total revenues in the third quarter were $1.6bn compared with $2.3bn in the third quarter of 2011, and coal revenues were $1.5bn compared with $2bn in the third quarter last year. The decrease in coal revenues compared with the year-ago period was driven primarily by lower met coal revenues due to a 23% decline in average per ton realizations and an 18% decrease in shipment volumes, as well as a 23% decrease in Eastern steam coal shipment volumes. Those decreases were partially offset by a 13% increase in Western coal revenues on higher volumes and higher per ton realizations compared with last year.
During the third quarter of 2012, Alpha shipped 13.2 million tons of PRB steam coal, 9.8 million tons of Eastern steam coal and 4.9 million tons of met coal. Average per ton realization for PRB shipments rose to $12.87 in the third quarter of 2012, compared with $11.98 in the year-ago period. The average realization per ton for Eastern steam coal was $66.40, compared with $67.07 last year, and the average per ton realization for met coal decreased to $129.96 in the third quarter of 2012, compared with $168.49 in the third quarter of 2011.
Adjusted cost of coal sales in the East, which excludes various items, averaged $75.93 per ton, compared with $74.21 in the second quarter of 2012 and $76.38 in the third quarter last year. The sequential increase in Eastern cost of coal sales per ton primarily reflects the impact of lower overall Eastern shipment volumes and a proportionally smaller contribution from the Pittsburgh #8 longwall mines (Cumberland and Emerald in southwest Pennsylvania) due mainly to a September longwall move at Cumberland and miner vacations during the quarter. These factors were somewhat offset by a lower cost mix of operations in Central Appalachia due to restructuring and related efficiency enhancements. The year-over-year decrease in adjusted cost of coal sales per ton in the East is primarily the result of the impact of lower met coal prices on variable costs and lower purchased coal costs and volumes, as well as restructuring and related efficiency enhancements, somewhat offset by lower overall shipment volumes.
The cost of coal sales in the West averaged $9.40 per ton, down from $11.01 in the second quarter of 2012 and $10.34 in the third quarter of 2011. The sequential and year-over-year decreases in Western costs of coal sales per ton were primarily attributable to higher shipment volumes and decreased overburden movement due to Alpha’s revised near-term production outlook.
Net loss comes to $2.3bn for the year so far
For the first nine months of 2012, Alpha reported total revenues of $5.4bn, including $4.7bn in coal revenues, compared with total revenues of $5bn and coal revenues of $4.4bn during the first nine 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 Energy operations (bought in June 2011) for a full nine months in 2012, compared to four months in 2011, which more than offset production cuts implemented during the first three quarters of 2012 and lower average realizations per ton for metallurgical coal.
During the first nine months of 2012, Alpha’s coal shipments totaled 82.9 million tons, compared with 75.2 million tons in the year-ago period. Met coal shipments were 15.4 million tons year-to-date, up 11% compared to the 13.9 million tons shipped during the first nine months of 2011. Shipments of PRB coal and Eastern steam coal were 35.2 million tons and 32.4 million tons, respectively, during the first nine months of 2012, compared with 36.1 million tons and 25.3 million tons during the first nine months of 2011. With the exception of shipments of PRB coal, these year-over-year increases are primarily due to inclusion of the former Massey operations for full nine months in 2012, partly offset by 2012 actions to reduce production.
For the first nine months of 2012, the company-wide average realization was $56.24 per ton and the adjusted average cost of coal sales was $47.79 per ton, resulting in a $8.45 per ton (or 15%) adjusted coal margin. By comparison, company-wide average realizations in the first nine months of 2011 were $58.46 and the adjusted average cost of coal sales was $43.19, resulting in a $15.27 per ton (or 26%) adjusted coal margin. The decrease in coal margin was primarily attributable to lower per ton realizations and therefore lower margins on metallurgical coal shipments.
Year-to-date, Alpha recorded a net loss of $2.3bn or $10.49 per diluted share, including the pre-tax impact of goodwill and asset impairment and restructuring charges totaling $2.6bn. Excluding various items, Alpha’s adjusted net loss was $165m or $0.75 per diluted share for the first nine months of 2012, compared with adjusted net income of $308m or $1.82 per diluted share for the first nine months of 2011.
Much of the seaborne market is underwater on coal output costs
The global seaborne met coal market has been characterized by excess supply, weak demand and falling prices which, based on spot market transactions, are below production costs for much of the world’s supply, Alpha noted. “This market weakness has driven a rapid supply response, and producers in the U.S., Australia and elsewhere have curtailed up to 30 million tons of annualized production, representing more than 10 percent of the global seaborne supply of metallurgical coal,” it added. “Taken together with renewed expectations of increasing infrastructure spending in China, we expect this recent supply response may restore the market to a more balanced supply/demand picture in the near-term. Alpha has responded to the deterioration in market conditions, reducing our production of lower quality metallurgical coal by three to four million tons on an annual run-rate basis through a series of cutbacks announced throughout 2012. When the market rebounds from its recent weakness, Alpha has the capability to ramp up its metallurgical coal shipments and take advantage of opportunities in this highly cyclical market.”
In terms of exports, the U.S. is on pace for a record year with volumes reaching 88 million tons by the end of August, including 40 million tons of steam coal, a 66% year-over-year increase, and 48 million tons of met, which is a more modest 3% year-over-year increase, Alpha added.
“However, slack demand and ample supply have resulted in lower seaborne prices, and, as expected, U.S. exports have slowed since mid-year in the face of these cyclical market headwinds,” Alpha said. “Looking past the current market downturn, seaborne demand for both met and thermal coal is expected to grow in the mid-single digits in 2013 and beyond. Alpha is well-positioned to take advantage of future growth in the seaborne market with more export terminal capacity than any other U.S. producer, at 25 million to 30 million tons of potential annual throughput, and the company is on pace to more than double thermal exports in 2012 to approximately five million tons. Alpha will seek to expand its export thermal business while ensuring that it has sufficient capacity to take advantage of the relatively higher-margin export opportunities for its metallurgical coal, with Alpha already ranking third globally in annual shipment volumes.”
Alpha sticks with prior 2012 coal shipment guidance
For 2012, Alpha’s guidance for total shipment volumes remains unchanged at 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 third quarter of 2012, Alpha priced 950,000 tons of met coal for delivery in 2012 at average realizations of about $96 per ton. As of Oct. 25, based on the midpoint of guidance, 91% of Alpha’s 2012 Eastern met coal shipment volume was committed and priced at an average per ton realization of $133.20, and 5% 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 $66.02, and 100% of Alpha’s 2012 Western steam coal shipment volume was committed and priced at an average per ton realization of $12.89. Guidance for adjusted cost of coal sales in 2012 also remains unchanged and is anticipated to range from $74 to $78 per ton in the East and from $10.50 to $11.50 per ton in the West. Alpha’s guidance for 2012 capital expenditures is unchanged in the range of $450m to $600m.
As of Oct. 25, Alpha had 2.9 million tons of Eastern met coal committed and priced for 2013 at average per ton realizations of $129.78 and 11.2 million tons of Eastern met coal committed and unpriced. As of the same date, Alpha had 16.7 million tons of Eastern steam coal committed and priced at average per ton realizations of $66.30 and 3.2 million tons committed and unpriced. In the West, Alpha had 37.9 million tons committed and priced at average realizations of $12.87 per ton.
With $7.1bn in total revenue in 2011, Virginia-based Alpha ranks as America’s third-largest coal producer by revenue and third-largest by production. Alpha is the nation’s largest supplier of met coal used in the steel-making process and is a major supplier of thermal coal to electric utilities and manufacturing industries.