Coal Outlook Improving This Summer

Sterne Agee analysts Michael S Dudas and Satyadeep Jain, in their report of July 28, 2014, share their take on the state of the coal industry based on information gleaned from earnings calls, media releases and company filings.

coal industry

Coal demand and supply

Coal industry players still expect strong improvement in domestic demand for thermal coal, though estimates have been revised somewhat lower.

A milder than expected summer has dampened demand for thermal coal, as well as natural gas, the latter seeing record injections into storage over the past few months.

Peabody Energy Corporation (NYSE:BTU) has lowered its expected increase in 2014 coal demand from 35-45 MT to 30-40 MT. Even so, coal stockpiles at utilities continue at subnormal levels.

“Low stockpiles, combined with gas prices that are just south of $ 4.00, and utilities’ desire to maintain adequate stockpiles should lead to a continued strong coal burn through 2014-15,” says Sterne Agee.

CSX Corporation (NYSE:CSX) that the declining trend in exports, particularly of thermal coal, would continue due to soft global prices.

Teck Resources Ltd (NYSE:TCK) (TSE:TCK.B) observed that only 3 MT of met coal production cutbacks have been implemented out of the total announcements of 20 MT cutbacks and closures, and believes 10 MT of additional cuts are needed to bring the market back into balance.

Globally, however, met coal could see improved demand, primarily due to the likelihood of higher imports by China in the second half. The recent jump in the Flash manufacturing Purchasing Managers Index reported by China for the month of July shows that government’s stimulus measures are likely gaining traction. This, together with the better balance in the country’s pig iron and steel production, as well as its increasing iron ore imports, indicate that China may step up met coal imports later this year.

Rail bottlenecks

Unfortunately, subpar performance by the railways has cost the industry dearly in terms of lost shipments during the first half of this year.

Peabody Energy Corporation (NYSE:BTU) estimates that 15 MT of PRB shipments were likely lost because of inadequate rail service resulting in poor deliveries to utilities. Understandably, utilities launched various coal conservation measures that further crimped demand.

According to the analysts, though rail companies are boosting manpower as well as locomotive capacity, these measures would take a while to kick in. Meanwhile, Union Pacific Corporation (NYSE:UNP) continues to suffer the hangover of its weather-related setbacks, though services are expected to normalise “eventually.”

Coal prices

“Coal pricing has not picked up despite higher demand and below normal inventories,” observe the analysts, attributing the phenomenon to a mild summer and record natural gas storage inventory. Meanwhile, 2014 contracted shipments are still trickling in, and this is an overhang on the over the counter (OTC market). The analysts expect that prices could firm up once rail infrastructure bottlenecks subside and buyers can plan purchases for 2015 and 2016.

Met coal prices are likely to continue to be weak through the rest of the year unless a rebalancing of demand and supply is affected through production cuts or closures.