An Ever-Darker Outlook for Coal

by Aaron Levitt | August 15, 2012 7:00 am

It’s been roughly a month since InvestorPlace took a look at beleaguered U.S. coal industry. At that time, Appalachian miner Patriot Coal (PINK:PCXCQ[1]) had filed for bankruptcy protection in an effort to improve its long-term prospects. Patriot became the industry’s first major casualty[2] as it succumbed to the mounting pressures facing coal.

Those pressures include the virtual ocean of natural gas that has been unlocked by the advances in hydraulic fracturing and horizontal drilling. Prices for natural gas now hover around decade lows, and scads of utilities are switching to it from coal. At the same time, the Obama administration and the EPA have issued sweeping new rules designed to limit carbon-dioxide emissions from new power plants. These rules effectively block the construction of new coal-burning plants and make natural gas even more attractive.

Combine these two major factors with slowing global growth, and it’s no wonder the coal industry continues to be hit hard.

With earnings from many of the major coal producers now in the books, the trend toward more trouble appears to be on the horizon.

Awash in Exports

One of the few bright spots for the U.S. coal industry has been its ability to export much of its bounty — specifically regarding metallurgical coal, or the kind used in steel production. However, the worldwide slowdown is also changing that position. According to the second-largest U.S. coal producer, Alpha Natural Resources (NYSE:ANR[3]), the world is currently “awash with lower-quality metallurgical coals, placing significant downward pressure on pricing.”

This led Alpha to lower its metallurgical coal sales forecast for 2012[4]. It says the main culprits are falling steel production in both Europe and China. Prices for low-volatility metallurgical coal averaged just $207 a ton in the second quarter. That’s roughly 35% lower than a year earlier.

No wonder Alpha reported a second-quarter net loss of $2.2 billion, or $10.14 a share. That’s a big fall from the company’s $50.1 million, or 32 cents, loss a year earlier. So far, Alpha’s shares have plunged more than 69% this year.

Despite being the largest metallurgical coal exporter in the U.S. — due to its $7.1 billion purchase of Massey Energy — Alpha isn’t alone in feeling the export pain. Global coal giant Peabody’s (NYSE:BTU[5]) Australian unit’s earnings slipped more 39% as coal exports to China have begun to slow.

Overall, Peabody’s second quarter[6] was equally as disappointing as Alpha’s. The largest coal miner by revenue saw its latest earnings fall by 30%. More troubling was the firm’s third-quarter outlook as it now expects its per-share earnings to be between 20 cents and 45 cents. That’s well below current analyst estimates from Thomson Reuters of 65 cents. (Peabody represents Wyoming[7] in InvestorPlace‘s Real America Index[8].)

Not to be outdone, major producer Arch Coal (NYSE:ACI[9]) cut its sales estimate for metallurgical coal as it posted a second-quarter loss. Arch has already idled plenty of mines, but is considering selling some noncore assets or reserves in order to further cut costs.

And it’s not just the metallurgical side of the coal business — thermal coal continues to struggle as well. Following a relatively mild U.S. winter, electricity demand dropped, and stockpiles of coal at power plants rose. That caused prices to fall 24%. The U.S. benchmark, Central Appalachian thermal coal, averaged just $59.41 a ton during the second quarter.

That prompted many miners to idle more production capacity. Alpha Natural Resources alone said it would reduce thermal-coal shipments by 2 million tons this year and 4 million tons in 2013, cutting about 150 jobs.

The Pain Continues

While there have been some bright spots, such as James River (NASDAQ:JRCC[10]) reporting a less-than-expected loss due to cost-cutting, the coal sector is still seeing heartache. That pain could continue for quite awhile because none of the pressures squeezing the sector have abated.

Natural gas remains both plentiful and dirt cheap[11], and the EPA’s new regulations aren’t going away anytime soon. Likewise, dwindling global steel production due to anemic economic growth will continue to crimp the industry.

In general, all the evidence mounting against the coal sector points to more of a long-term decline, rather than a short-term drop. I argued last time I wrote about coal that the industry will continue to consolidate and undergo a shakeout of sorts as these long-term pressures take hold. We aren’t there yet, and I’d rather wait and see before buying into any names in the sector.

As of this writing, Aaron Levitt doesn’t hold any securities mentioned here.

Endnotes:
  1. PCXCQ: http://studio-5.financialcontent.com/investplace/quote?Symbol=PCXCQ
  2. Patriot became the industry’s first major casualty: http://investorplace.com/2012/07/patriot-coal-minings-canary/
  3. ANR: http://studio-5.financialcontent.com/investplace/quote?Symbol=ANR
  4. metallurgical coal sales forecast for 2012: http://www.bloomberg.com/news/2012-08-08/alpha-cuts-steelmaking-coal-outlook-as-export-market-awash-2-.html
  5. BTU: http://studio-5.financialcontent.com/investplace/quote?Symbol=BTU
  6. Peabody’s second quarter: http://www.marketwatch.com/story/peabody-energy-profit-off-30-firm-cuts-outlook-2012-07-24
  7. Peabody represents Wyoming: http://investorplace.com/real-america-index/wyoming-peabody-energy-btu-mining-coal-under-big-skies/
  8. InvestorPlace‘s Real America Index: http://investorplace.com/real-america-index/
  9. ACI: http://studio-5.financialcontent.com/investplace/quote?Symbol=ACI
  10. JRCC: http://studio-5.financialcontent.com/investplace/quote?Symbol=JRCC
  11. plentiful and dirt cheap: http://investorplace.com/2012/07/natural-gas-finally-shows-some-spark/

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