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Coal’s Future in Doubt as Industry Headwinds Continue to Mount

  +Follow March 28, 2014 11:30AM
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Concerns of coal's prospects have been growing louder and louder over the past several years, leading to recent downgrades from Bank of America and Goldman Sachs to lower their outlook for the industry, citing concerns about the overcrowded market.

According to analyst Timna Tanners, metallurgical coal prices will hit their lowest levels since 2010 over the next several years, fetching a price between $130 to 150 per ton.

Coal companies traded lower as a result of the Bank of America downgrade. Shares of Walter Energy, Inc. (WLT) tumbled about 20 percent lower as a result but other coal stocks like Peabody Energy Corp. (BTU)  and Alpha Natural Resource (ANR)  were among those to trade lower as well.

The downgrade comes on heels of a Goldman Sachs downgrade earlier this month, further indicating that the coal industry is suffering one of the bleakest periods in recent memory.

The Environmental Protection Agency (EPA) predicted that coal production will slide to a new low in 2016, but then gradually pick up. Nevertheless, the Appalachia region, once representing the heart beat of coal mining industry, faces an uphill battle. Kentucky miners must deal with high shipping costs and a low percentage of surface mines.

In central Appalachia, where more than 10,000 mining jobs have evaporated since 2010, mining costs continue to rise as surface mines are running out. Compared with West Virginia and Wyoming, which are rich in high-sulfur coal, Kentucky’s low-sulfur coal is usually buried deep underground, requiring higher labor costs.

While detractors from the coal industry blame the Obama administration’s relentless carbon regulations for wreaking havoc and eliminating jobs, the broader picture here may be that overall demand for coal has been trending lower—and that trend may be permanent.

The overseas market consumes more than 70 percent of Virginia’s output on average, meaning the industry depends heavily on exporting. Over the past 10 years, foreign countries drove a 13-percent growth in metallurgical coal production across Appalachia. So when smog-choked China vowed in January to reduce coal consumption to under 65 percent of its total energy use, American producers were rattled.

On the domestic front, power plants from some of the largest coal-consumer states have been less willing to utilize coal to generate electricity. The transition is motivated by both regulatory and economic reasons.

In order to meet the EPA’s carbon dioxide standards, utilities providers now burn a mixture of coal, wood sawdust and natural gas. This significantly reduces their reliance on coal. The U.S.’s fracking boom has made shale gas abundantly cheap, and as a result, made coal less attractive. The most noticeable drop is in Georgia, where coal’s use to generate electricity has fallen to 50 percent from 65 percent in 2001.

The EPA is also churning out the toughest regulations on coal-fired plants this year, compared with the current carbon pollution standards. The proposal from the EPA to tackle greenhouse emissions will affect 600 power plants and possibly close hundreds of them, according to The New York Times.  

Meanwhile, bigger miners are increasingly relying on debt to fund operations. As an example, Walter Energy recently issued $200 million in senior notes to finance old debt. The company has one of the highest debt-to-equity ratios in the industry at 3.69. Like the rest of the sector, Walter Energy’s stock price has been on a three-year slide from as high as the $140 level.

Shares of Alpha Natural Resource, the country’s largest coal producer, have also fallen from the $60 area to hover around $5 currently. For the fourth quarter of 2013, net losses widened to $358 million despite the company’s effort to cut spending and close down operations. Peabody Energy’s stock has tumbled from $72.63 in mid-2011 to around $15 per share. With revenue declining though 2013, the firm is diverting to developing markets like China and India.

While the near-term pictures look cloudy, coal companies are fighting hard to make a full-come back in the long run. Under attack by environmental group for years, coal wants to prove itself to be an economic driving force in developing country, and a reliable source of power in the U.S.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.


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  +Follow March 28, 2014 11:30AM
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