One of the big concerns in the domestic coal market is the ongoing displacement of coal power by natural gas plants. Regulations set to take effect in 2015 are partly responsible for that. Train operator CSX (CSX -3.02%), however, believes that the big impact of those pending rules has already been felt. It sees brighter days for domestic coal once current, abnormally large utility stockpiles get worked off.
Still troubled, but getting better
There's no doubt that coal is still facing a difficult future. CSX definitely sees 2014 as another tough year, but expects the real difficulty to be on the export side, particularly for metallurgical coal. Since met coal tends to have higher profit margins, that will remain a big issue for miners with exposure to steel making coal. However, CSX is far more positive about the domestic thermal market.
For example, the power industry has been working toward compliance with the Mercury and Air Toxics Standards since 2011. That's why CSX delivered 25% less coal year over year in 2013 to plants scheduled to shut when the rules take effect in 2015. In fact, those plants have seen shipments fall a whopping 70% since 2008. Analyzing the trend, CSX believes "a lot of the impact that we were expecting to feel in 2015 has really been pulled forward to the last few years."
CSX now expects "minimal impact in 2014 and 2015 from these plants shutting down..." Interestingly, the company has seen a 1% increase in shipments to coal-fired plants it expects to remain open after 2015. Fellow coal hauler Kansas City Southern (KSU), meanwhile, notes that its utility customers have adjusted to low natural gas prices, and 2014 is likely to be "the new normal," with flat year-over-year demand after notable declines in 2013.
Good news
This is good news for coal companies that operate mainly in the low-cost Powder River (PRB) and Illinois (ILB) coal basins. These two regions are cost competitive with natural gas today, which is one of the reasons why CSX has been shifting its mix so that 50% of its coal business comes from those two regions. Kansas City Southern, meanwhile, appears hopeful that "not too much more can be done on the negative side for [its] coal franchise." Luckily, coal only makes up about 8% of Kansas City Southern's business.
Assuming 2014 represents the "new normal," then all that's needed for domestic thermal coal to see better days is for utilities to burn down their bloated stockpiles—something that has been taking place all year as natural gas prices have moved higher. So now could be a good time for you to look at Cloud Peak Energy (CLD) and Alliance Resource Partners (ARLP -0.05%). Both have remained profitable throughout coal's difficulties and both operate almost exclusively out of the PRB and ILB, respectively.
Of the two, Alliance has been the better performer, posting record results for over a decade. Increased coal volumes have allowed the miner to more than offset recently low prices. That strength comes from its heavy focus on the ILB, which has been gaining market share from more expensive coal out of the Central Appalachian coal basin.
Cloud Peak hasn't performed as well as Alliance, but unlike most other miners it has managed to stay in the black—even if that meant earning just $0.08 a share in the second quarter. (The bottom line bounced back to around $0.30 a share in the third quarter.) Although domestic volumes have been weak, Cloud Peak has been able to keep costs in check and maintain a solid export business.
Better days ahead?
A key distinction for Alliance and Cloud Peak is their heavy exposure to cheap thermal coal. If CSX and Kansas City Southern are right about the utility market, it won't take long for coal stockpiles to burn down and domestic thermal demand to pick up. Although that would be good news for most U.S. coal miners, this pair has shown they can hold up even during the tough times.
