A Mine is a Terrible Thing: Why Coal Continues to Crash

August 1, 2015

NRDC Switchboard:

Over the past year the Big 3 of the US coal industry (Peabody Energy, Arch Coal, and Alpha Natural) have seen their combined market cap fall from $6bln to $350mln and their funding rates soar from 8% to 65%.

“War on coal” or something else entirely?

Big Coal’s Nemesis: Bad Bets on the Market

For years now, Big Coal has tried to blame its woes on a government “war on coal” but the truth is the market and a series of bad decisions by coal producers are what has put coal stocks in the toilet. Since we can expect more “war on coal” hype next week when EPA announces its landmark Clean Power Plan, now is a good time to lay out the facts.

The biggest cause of Big Coal’s loss of value is that Big 3 management bet big on a global coal boom and lost big when it went bust.

Here are the five reasons why Alpha Natural, Arch Coal, and Peabody Energy are on the brink of bankruptcy:

1. Bad bets

As recently as 2011 the Big 3 coal companies were doing very well indeed. The market cap of Peabody Energy, Arch Coal, and Alpha Natural was a combined $35bln, coal was powering 46% of US power plants, and a global commodities boom was lifting the value of US coal exports to an all time high of $15.8bln.

Betting on large growth in coal demand, the Big 3 decided to go on a buying spree. Peabody Energy bought Australia’s McArthur Coal, Arch Coal acquired International Coal, and Alpha Natural Resources purchased Massey Energy. In total the Big 3 spent $16bln at the top of the market in 2011 on acquisitions to add 1.7bln tons of metallurgical (met) coal and 4.3bln tons of thermal coal to their reserves.

Before long, the big bets made by the Big 3 looked like a big mistake. By late 2011, the supply/demand imbalance that had lifted prices to record highs started to reverse due to rising supply out of Australia and Indonesia and slowing demand in China. By early 2012 global coal prices were in free fall, forcing Alpha Natural Resources to write down the $1.7bln premium it paid for Massey Energy by the end of the year and all three companies suffering due to their ill-timed purchases.

2. Big debts

In order to purchase competitors for $16bln, the Big 3 needed to borrow a lot of money. In total Peabody Energy, Arch Coal, and Alpha Natural Resources borrowed $11bln to fund their purchases, nearly tripling their outstanding debt and locking themselves into a “growth at any cost” strategy that would prove to be their undoing.

In order to justify the large debt they were incurring, these companies needed to projected large growth in revenues. But as it turned out, this growth did not happen.

3. Weak Mets

The Big 3’s acquisitions were primarily all-in bets on the future of met (metallurgical) coal, which had increased to 55% of US coal company earnings in 2011.

5 met earnings.png

After spending $16bln on acquisitions to help bolster their met coal reserves, however, the Big 3 watched as the bottom fell out of the met coal market. Prices collapsed from $350/ton in 2011 to a low of $125/ton in 2014. Revenues from met coal sales and overseas operations underperformed forecasts by an estimated $8.9bln.

6 met losses.png

The distinction between met coal and thermal coal is critical. Thermal coal is burned in power plants, while met coal is used in steelmaking. While EPA safeguards to cut deadly coal power plant pollution have had some impact on domestic thermal coal markets, the biggest single driver of the Big 3’s woes is the collapsing met coal market, which has nothing to do with EPA’s power plant standards.

4. Cheap Gas

In addition to the bad bets made by Peabody Energy, Arch Coal, and Alpha Natural Resources on strong met coal growth, the Big 3 were also betting their futures on the price of natural gas.

In early 2011, natural gas prices were nearly $6.00/MMbtu and Congress had failed to enact limits on carbon pollution. So the Big 3 bet there would be clear sailing for continued growth in thermal (power plant) coal demand.

By the end of 2011, however, the math had changed as a surge in US natural gas output had lowered the price of natural gas to $4.00/MMbtu and cut the power dispatch cost of natural gas to roughly half that of coal.

7 dispatch cost.png

From the 2011 high to the end of 2014, natural gas prices fell by nearly 50%, reducing cumulative forecasted coal revenues (which had already included some reductions from coal retirements in response to EPA’s air toxics standards) by an estimated $10.3bln; with $7.3bln coming from lower thermal coal volumetric sales and $3bln coming from lower thermal coal prices.

8 cheap gas.png

Further, lower cost natural gas supplies and new pipeline builds encouraged utilities to build more new natural gas power plants than are needed to replace retiring coal plants, putting further pressure on coal producers going forward.

9 new gas.png

5. Energy Efficiency (or “Stopping Waste is a Terrible Thing for Mines”)

In 2011 industry analysts were looking for US power demand to grow by a modest 1% annually from 2011 to 2014. Relying on these forecasts was another Big 3 mistake, as significant investments in energy efficiency kept power demand largely unchanged during this timeframe.

10 demand drop.png

Using less energy saved consumers a lot of money, it was bad news for the Big 3’s bottom line, reducing their forecasted revenues by an estimated $1.9bln from 2011 to 2014.

11 ee loss.png

Conclusion

In sum, bad bets at the top of the market, weak met coal prices, cheap natural gas, and lower power demand due to energy efficiency reduced cumulative forecasted coal revenues for the Big 3 by approximately $21bln over the past four years. This is a big hit for companies as highly leveraged as Alpha Natural, Arch Coal, and Peabody Energy and the reason why these companies are struggling to stay afloat today.

12 summary.png

Motley Fool:

Last year, James River Coal filed for Chapter 11 bankruptcy. This year, Patriot Coal filed for Chapter 11 again, just 18 months after it emerged from its previous Chapter 11 filing.. Furthermore, Arch Coal (NYSE: ACI) recently began talks with advisors to restructure its large debt load. The company maintains it is not looking at bankruptcy, although that is far from certain. Because of the massive fall in the company’s share price, it has received a notification from the New York Stock Exchange that it no longer satisfies the requirements to be listed on the NYSE.

This has occurred as a consequence of the company’s crumbling business. Arch Coal lost $558 million in 2014, and lost $641 million the previous year. Such significant losses seriously impair the company’s ability to satisfy its creditors. At the end of the first quarter 2015, Arch Coal held more than $5.1 billion in long-term debt, which is a huge concern given that the company continues to lose money.

Similarly, Alpha Natural Resources (NYSE:ANRZ) is also bleeding. The company lost $875 million last year, which was only a modest improvement from the $1.1 billion loss the year before.

At its core, the problem for many coal companies is their geographic and product focus. Arch Coal, Alpha Natural, and the other struggling coal companies are major players in Appalachian coal and Powder River Basin coal. These regions have been the hardest hit by the emergence of cheap and abundant domestic natural gas. This was the key motivating factor behind Alpha Natural’s recent closing of a mining facility in West Virginia.

There was some hope that coal exports would save the day, but metallurgical coal has suffered too. Exports are slowing to emerging markets such as China and Brazil, as their economic growth has leveled off. And, exports are growing from nations like Russia and Brazil, which is resulting in lower prices.

Reuters:

Bringing coal use to a peak by 2020 could save China billions of dollars in environmental costs, slash water consumption by nearly 30 percent and prevent tens of thousands of deaths from coal-related illnesses, a study released on Thursday said.

China’s coal demand fell for the first time in over a decade in 2014, and production also dipped 5.8 percent in the first half of this year, largely as a result of a slowdown in major downstream sectors like power, steel and cement.

But without specific measures to rein in growth, coal consumption could continue to increase until 2030, aggravating public health risks and putting pressure on China’s already strained water supplies, experts with the Natural Resources Defense Council (NRDC), a U.S. environmental think tank, warned in a study released in Beijing on Thursday.

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17 Responses to “A Mine is a Terrible Thing: Why Coal Continues to Crash”

  1. Andy Lee Robinson Says:

    Another benefit – they won’t be able to pay their trolls!

    • dumboldguy Says:

      The Kochs have enough $$$ to shift some over to the coal trolls. Even on top of the $900+ million they’re going to spend to try to buy the 2016 election.

      • Andy Lee Robinson Says:

        Rich people know better than most when to jump from a sinking ship, but sabotaging everyone else’s lifeboats is unforgivable.

        • dumboldguy Says:

          Nearly everything about the Kochs is “unforgiveable”. They are truly infected with the Wetiko disease, and the way they use their $80+ billion net worth to damage just about everything of value on this planet is as serious as any Nazi war crime.

          Comes the revolution, they will be tried and sentenced to death, and the line of those willing to serve as executioners will be VERY long. I myself will be on the OTHER long line—-the one for those with ideas about cruel and unusual ways to put them to death—-with luck, they may allow the one with the “winning” idea to be on the executioner team as well, so I might get to double dip, so to speak, if my execution plan is chosen.

          (And the constitutional and its guarantees be damned. The Kochs haven’t paid much attention to it and step on it whenever they can twist it to their profit-seeking ends, why should anyone else care where they are concerned?).

  2. dumboldguy Says:

    Finally! A “good news” post. A string of great graphics, and my smile widened as I perused each one. I am always cautioning about reading too much into numbers and making bright-sided “projections”, and there are some economic factors that may turn around a bit and prolong coal’s death throes, but the weight of evidence is clear. Coal in the USA is in a terminal state

    To the coal companies—-Eat coal and die, maggots! All you “capitalists” that bought coal stocks can eat them too. We will all be dancing and getting drunk at your funerals (and peeing CLEAN water on your graves). OOH-Rah!

    • andrewfez Says:

      There was an article on seeking alpha a while back that had some fun comments. The article was called ‘The Ultimate ‘Get Paid While You Wait’ Investment Strategy For The Turnaround In The Coal Industry’.

      http://seekingalpha.com/article/3258845-the-ultimate-get-paid-while-you-wait-investment-strategy-for-the-turnaround-in-the-coal-industry?v=1434444995&commenter=1

      The premise is that you can buy a coal bond for 16 cents on the dollar and if Arch makes good on its debt, then you can make a little spare change, and if it doesn’t go into bankruptcy by 2019 (recovery in coal prices), there is a big payout.

      One of my favorites was:

      How bad would bankruptcy likely be for bondholders? Presumably, we would not expect to get $1000 in stock in the post-BK company for $1000 face value of debt. Would it be reasonable to expect $200? $100? Or would we just get bonds in the new company with a haircut? 0.10 on the dollar? 0.25 on the dollar? Or is nothing a reasonable estimate?

      Woe unto those that paid that full $1000 for 7% interest, when several REITs who’ve mostly priced in the upcoming rate hike, will get you 7% without the messiness of trying to make noise to appeal to some bankruptcy judge.

  3. jimbills Says:

    Long article, worth reading in conjunction to this:
    http://www.bloomberg.com/news/articles/2014-12-11/coal-provocateur-sees-profits-in-coal-s-long-slow-death

    U.S. coal isn’t going to crash and burn overnight. It’s going to be around for quite a while. However, even its most fanatic, foaming at the mouth supporters believe it’s in terminal decline.

    There’s some interesting stuff about Boehner in there, too.

    • ubrew12 Says:

      Another worthwhile read: Carl Pope did an opinion piece about the coming Market response to fossil energy in HuffPo the other day: http://www.huffingtonpost.com/carl-pope/markets-are-about-to-deal_b_7883478.html
      A quote: “In the last five years, a coal company has gone bankrupt on the average every month…. Alpha… was just dumped from the [NYSE]… because its price fell below $1.00…. Peabody… traded in 2011 at $73, is now selling at $1.29… bond markets have abandoned… All coal company debt is now graded “junk.”… Coal, as an investment class, is effectively finished… Outside the U.S., 1/6th of Australia’s coal mines now operate at a loss… “

      • jimbills Says:

        The facts you quote are good, but I don’t get Pope’s spin. He’s all but actually saying that the market is going to solve climate change, and in the near-term. That’s a really dangerous thing to even imply to me if it’s untrue. It’s a primrose path.

        The major reasons, by far, why coal is hurting right now are natural gas, faltering economic growth, rising production costs, governmental policies, and efficiencies – roughly in that order. Renewables replacement takes up a very, very tiny portion of its decline. At this point, it’s negligible. Pope is looking at a trend in the market (decline in coal), but he’s drawing the wrong conclusion – that the free market is solving climate change. Many of the reasons for coal’s problems right now (assuming growth in China isn’t permanently declining) are temporary phenomena and are not strong longer-term trends that indicate a truly positive move towards climate change mitigation.

        Pope also talks about oil prices going down – but this has absolutely nothing to do with oil replacement, as his telephone land lines to cell phones analogy implies. We aren’t going to see renewables dominate fossil carbon within 1-2 decades, also as that analogy implies. There’s a lot of fantasy going on with this stuff.

        I worry about the messages sent to the general public. Here, the head of the Sierra Club is saying ‘Markets Are About to Deal With Climate’. He might as well be Milton Friedman. If he’s wrong, and he’s drawing very weak cause-and-effect conclusions in that article, then he’s telling the public another false message. Additionally, the message that the market is dealing with climate change is one that is far likelier to cause the public to relax its urgency to address climate change than to engage with it.

        • ubrew12 Says:

          The way I read it, it seemed he was taking more the role of an observer. And, in particular, observing the way the Market deals with change: with hatchets. Those hatchets are out for Big Fossils, now. Perhaps prematurely, he senses the ‘stench of death’ around this entire class of investment. To the extent market behavior is predictive, this may be due to what is going on in the renewable’s sector. But I think the market is mostly reactive: Pope is pointing out yet another sign of changing times.

          • jimbills Says:

            But the hatchets themselves are not renewables right now – it’s a combination of other things, many of which have nothing to do with renewables and are temporary. Coal is going to be around for many decades, although there are many very indicative signs that its use has peaked in the U.S., and will likely peak in the world in the next few decades. The ‘stench of death’ is a gross exaggeration, very premature, and very misleading to the public.

            We can take coal’s decline as a great sign, but then to say, well, ‘Markets Are About to Deal With Climate’ – that’s a whole other ballgame. The market won’t kill coal on a dime. We use it in a bunch of different ways, and our current installed capacity is massive. The developing world won’t shun it, either – they’ll increase their usage of it over time.

            We can steer coal’s decline further, though, by placing tighter restrictions on it, denying its extraction, and by subsidizing and encouraging renewables, which would speed up the process of decline, and are not market approaches. Or, we can sit back and assume the market’s doing just fine on its own, which is the message I’m getting from Pope’s opinion piece. We’d better have really good reasons to do that option, though.

            What we’re perceiving here is that coal is being destroyed quickly by market forces. We have very good reasons to WANT to believe that, but it’s not an accurate perception. What’s happening is it’s trying to adjust to current realities in the energy game. The top is being shaved off and it’s trying to figure out how to survive with little to negative demand growth and lower profits. Companies will merge, new strategies will evolve, and the business will be fine, although likely shrinking as a whole over time.

          • omnologos Says:

            well said jimbills. for a number-rich analysis of the situation, this is interesting

            http://online.barrons.com/articles/coal-supply-overhang-aggravated-by-u-s-dollar-1427914796

            With our price deck, we expect all companies in our coverage universe to exit 2016 with sufficient liquidity in hand. (We expect Walter Energy (ticker: WLT ) to exit 2016 with only zero to $25 million in liquidity, but expect all others to have $1 billion or more in liquidity at the end of 2016.) At current met and thermal prices, we expect all companies in our universe, except Walter, to have sufficient liquidity at the end of 2016.

          • dumboldguy Says:

            “Well said, jimbills”, says Omno? LOL—-Omno needs a dictionary and thesaurus to even read most of what jimbills and the rest of us with brains say on Crock. Omno is just brown-nosing and sucking up to jimbills, and without a trace of shame. He badly needs a friend—he has NONE on Crock and is getting desperate. Sad!

            Omno is again cutting and pasting things he likely does not understand, and his “interesting and number-rich” citation doesn’t appear to add anything much to the great info Peter has already included in this post. To top it off, if anyone wants to see what the blind mouse found, you won’t be able to, because it’s behind a freakin’ paywall. That’s right, Omnomoron spends a dollar a week to access Barron’s on line, believe it or not, and if you want to see more than the inane snippet he quoted here or the come on below from the link, it will cost you.

            “Coal Supply Overhang Aggravated by U.S. Dollar

            “The extraordinarily strong greenback relative to coal-producing currencies, especially Australia’s, is a concern.

            “We have lowered our 2015-2016 U.S. thermal-coal price deck on mild weather, lower natural-gas prices and higher-than-expected coal stockpile build with utilities during the winter season.

            “We have lowered our average 2015-2016 international thermal-coal price forecast by $10-$15 per ton. Despite Indian coal imports growing annually at almost 16%, strong production in Indonesia coupled with Australian…

            Wow! HOw “interesting”!!!!


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