Last year was a remarkable year for the U.S. coal industry. It witnessed record spot coal price levels, reaching levels not seen since the 1970s. Contract prices also rose to levels that have not been seen for more than a decade. Coal inventories at electric generating plants reached a new low in days supply with little rebuilding likely in 2005. The coal industry continued its march toward consolidation as Arch Coal acquired Vulcan Coal Holdings and Horizon Natural Resources disappeared as a result of bankruptcy. The coal industry also continued its march toward public ownership. Coal is a current darling of Wall Street with momentum moving coal company stock prices to new highs. What does the coal market have in store in 2005 as an encore?
When the books are closed for 2004, they are not likely to show that coal use increased substantially. The tight market was not driven by a sharp increase in demand for coal. Although electricity generation was up by 2.5% through September, coal-fired generation had increased by only 0.8%, according to the Energy Information Administration (EIA). Coal use increased by less than 12 million tons or 1.5% over the same period as the average heat content of steam coal continued to decline. The cool summer and warm winter are likely to translate into an increase in burn for power generation of less than 15 million tons for the year. (Note that because 2004 was a leap year, there was one more day’s consumption in 2004, accounting for about 3 million tons or about 20% of the increase in burn.) Other domestic markets changed little from 2003. Metallurgical coal exports (including Canada) are likely to have increased by 5 million tons in 2004 while steam coal exports (including Canada) are likely to be nearly unchanged from 2003. Steam coal imports are likely to have increased by more than 2 million tons, for an increase in net exports of just 3 million tons or less for 2004.
Coal production is likely to have increased by more than 37 million tons nationally in 2004 from its 2003 level, based on EIA’s weekly coal production estimates. Quarterly coal production has varied within a narrow band since 1998, but that production in the first three quarters of 2004 appears to be above 2003 levels, as shown in Figure 1. Most of the 2004 increase was in the West, with production increasing by more than 20 million tons in Wyoming and Montana. The Powder River Basin (PRB) shipped more coal during the third quarter of 2004 than during any previous quarter, as shown in Figure 2. Eastern production appears to have increased by nearly 16 million tons, with Northern Appalachia accounting for roughly half of the increase. Central Appalachia turned in a lackluster performance given the increase in prices for coal from this region. Shipments of spot and contract coal to electric generators and total production by quarter
compared with average mine prices for spot and contract coal shipped to electric generators from 1998 through the middle of 2004 are shown in Figure 3. Note the supply response that occurred when spot prices spiked in 2000 and 2001. When prices started to climb during the second half of 2000, Central Appalachian production increased by 2 to 3 million tons per quarter beginning in the first quarter of 2001 and running through the first quarter of 2002. The recent spike in prices beginning in mid- 2003 led to only a 2 million tons increase in Central Appalachian production for the entire year of 2004 over 2003. Eastern Kentucky actually saw its output decline by more than 1 million tons in 2004.
The problems faced by the coal industry have been many, particularly in Central Appalachia. Coal miners have been difficult to recruit, and many new hires require extensive training. Permitting and bonding of new mines also continue to be problematic. It is indicative of the supply problem that Massey Energy noted in its 10-K for 2003 that it planned to sell 45 to 47 million tons of produced coal in 2004 and had volume commitments under existing contracts of 47.8 million tons for 2004. Yet in Massey Energy’s third quarter 2004 results, the company reported that Massey’s cumulative produced tons sold stood at 30.9 million tons or just over 41 million tons on an annualized basis. This shortfall in anticipated production against committed tonnage is indicative of the supply problems that occurred in Central Appalachia in 2004.
Appalachian producers moved tonnage from the steam market into the much more lucrative metallurgical coal market. While the volumes involved probably totaled less than 10 million tons, the increase in revenue was substantial with metallurgical coal selling at prices $20 to
$50 per ton higher than steam coal prices over the year. For example, Massey Energy reported third quarter sales of produced coal at 10.1 million tons in 2004 compared with 10.0 million tons in 2003. Utility sales declined by 500,000 tons while metallurgical sales increased by 500,000 tons, with industrial sales showing an increase of 100,000 tons. The average price of utility sales in the third quarter reported by Massey was $32.34 while the average price of metallurgical sales was $45.98. Both average price values are heavily influenced by long-term sales commitments and do not reflect the true marginal price differentials available between these two markets.
While coal stocks reached a new low of 37.5 days supply nationally in July, only those generating stations that are heavily dependent upon Central Appalachia saw their stock levels reach dangerously low levels. Nationally, coal stocks at generating stations fell by 20 million tons from the end of 2002 to the end of 2003. The increase in production in 2004 largely met the increased burn requirements for the last two years, and coal stocks probably finished 2004 down by only one or two days burn (i.e., 3 to 6 million tons) from the 40.8 days supply at the end of 2003. Inventories were less than 30 days in only three census regions at the end of July: Middle Atlantic, South Atlantic, and East South Central. While stock levels have been coming down generally for legitimate cash management reasons, stocks reached unusually low levels in July in Pennsylvania (15 days), South Carolina (23 days), Tennessee (24 days), Delaware/Maryland (28 days), North Carolina (29 days), and New Jersey (30 days). Generating plants in these states generally depend heavily upon Central Appalachia for their coal supply.
Further concentration and public ownership of the coal industry appears to have tightened supply. The 10 largest coal companies accounted for 64% of national production in 2003 compared with 41% in 1994 and 36% in 1989. Current and about-to-be publicly traded coal companies account for more than 550 million tons of production or roughly half of the nation’s coal supply. Wall Street analysts are scrutinizing these companies closely on a quarterly basis and want to see strong earnings growth. The coal industry did not perform well in recent years, particularly following the spot price spike of 2000/2001. Productivity declined and mining costs increased since then. Many companies saw their operating margins shrink and some companies went into bankruptcy as a result of the ensuing financial squeeze. Coal producers are now more wary about increasing production in response to short-term increases in prices and are holding out for higher contract prices before adding new production capacity.
What is the encore to 2004? For 2005, supply likely will remain tight and spot prices high as capacity slowly increases to meet incremental demand and allows for some rebuilding of stocks. The coal market balance is a delicate one, with only a few million tons in a billion ton market able to drive pricing. A nuclear outage or a strong spurt in coal use related to a surge in industrial activity could keep coal prices at record levels. However, a decline in burn could lead to a fall in spot prices as dramatic as the rise. Yesterday’s spot coal price may no longer be a good predictor of tomorrow’s transaction price since volatility means that prices can go down as well as up over a given period. The encore is very likely to be as exciting as was 2004.
