Monday, June 18, 2012

Coal Industry

This evening, I was reading a primer on the coal industry. I've never written a post about coal before, but it competes with natural gas and so is obviously learning more about. Plus, the natural gas glut has severely hurt the coal industry and even resulted in potential capital structure opportunities in some of the smaller companies. Keep in mind that the primer is dated, but still interesting/useful.

Demand sources are coal-fired generation and steel mills. Historically, the high transportation costs have resulted in coal users concentrating near production sources. The rise of western U.S. coal production (e.g. the Powder River basin) is not geographically matched to the eastern U.S. demand base. The vast majority of U.S. coal is used for electrical power production. As a result, demand is driven by weather and coal/gas switching.

Coal used for electical generation is "steam coal", as opposed to metallurgical coal (which has fewer impurities and higher BTU content). These coal sales occur via fixed purchase contracts with utilities. The result of this is that coal inventories will pile up at power plants when demand falls or generation switches to natural gas, as it has to a great degree so far in 2012. This has already resulted in record coal stockpiles, which to some degree will act as a cap on the natural gas price. More efficient gas-fired power plants (combined-cycle) have made natural gas more competitive and lowered the breakeven for coal to gas switching.

There are two coal benchmarks in the U.S.: the Central Appalachian (CAPP) coal, and the Powder River basin (PRB) coal. PRB coal has taken share from other regions - especially in the Midwest. Spot prices won't affect the short term earnings of coal producers who have long-term contracts (which is the industry standard). CAPP coal is the premium priced coal because of its high heat content and proximity to users. PRB trades at a huge discount because of lower heat content (about 0.75x) and greater distance to market. The per-ton price of CAPP is currently 6x the price of PRB coal.

Slide 27 shows the top holders of U.S. coal reserves. Ownership of U.S. coal is fragmented: the government owns a third of the estimated reserves, and the next ten largest holders account for only 20 percent. The second largest holder is Great Northern Properties LP, a private company that I have never heard of. It looks like it is owned by Corbin Robertson, a grandson-in-law of Texas wildcatter Hugh Roy Cullen. Apparently, Robertson went all-in on coal when it was cheap in the mid-1980s.

The CEO of GNP testified in front of congress last year and gave some background on GNP. "GNP is a privately held limited partnership that in 1992, acquired all of the former Northern Pacific Railroad (now Burlington Northern Santa Fe Railroad (“BNSF”)) land grant lands in Montana and North Dakota within the Northern Powder River Basin and Northern Lignite coal fields, respectively. GNP lands obtained in this transaction contain more than 20 billion tons of coal and lignite..."

The coal reserve holders are fragmented, but the coal producers are consolidated: the top 10 account for 70% of coal production. Despite the image of coal mining as underground, about 70% of coal mining in the U.S. is surface mined. The PRB coal is cheaper to mine but more expensive to transport (because of distance and lower energy density) than CAPP coal. PRB is cheaper to mine because it's close to the surface.

Most coal is transported via rail - and coal is the rail industry's most important customer. Barge transport is cheapest but obviously limited by availability of waterways.

China is the larges producer and consumer of coal. It also recently became a net importer of coal. 

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