CSX, Union Pacific, and Norfolk Face a Challenging Road Ahead

Coal production was low in 2013 due to oversupply from 2011 and 2012, creating a reverse bottleneck of sorts. Even with the onslaught of environmental campaigns and regulatory pressure, coal production is expected to increase slightly in 2014, according to the U.S. Energy Information Administration (EIA), before falling again in 2015. This rise will likely not be enough to save those in the industry that count on its revenues, however.

Coal is CSX's (NYSE: CSX  ) largest commodity group by revenues, accounting for 24% of revenue in 2013. Last year, CSX took a hit from its coal transportation operations. The 10K reports:

Over the past few years, production of natural gas in the U.S. has increased dramatically, which resulted in lower natural gas prices causing a negative impact on CSX. As a result of sustained low natural gas prices, coal-fired power plants have been displaced by natural gas-fired power generation facilities. If natural gas prices remain low, additional coal-fired plants could be displaced, which could further reduce the Company's domestic coal volumes and revenues.

Just to be clear, the company is blaming the issue on:

  1. The increased production of natural gas in the U.S. which lowered natural gas prices.
  2. The displacement of coal-fired power plants by natural gas-fired power plants.

In 2013 CSX reported railway operating revenues of $11.2 billion, up from $11 billion in 2012. However, coal revenues were down; these coal losses were offset by chemical gains. If the trend continues, coal may become a losing game for CSX. First it needs to diagnose the problem correctly, though. It is the general consensus by the EIA that utility coal consumption is on the rise, if only temporarily, due to increases in natural gas prices.

The following chart was published by the EIA to show the increase in spot market purchases as a percentage of total purchase receipts over time. Clearly, spot purchases were on the rise throughout 2013.

The EIA also said that exports have been growing due to increased environmental regulation in the U.S. and growing demand in China. However, CSX experienced a decline in exports in 2013:

Export declines were driven by decreased shipments of U.S. thermal coal, as a result of global oversupply and lower coal prices. Shipments of domestic coal declined due to continued low natural gas prices and utility stockpiles above target levels.

Regarding shipments of domestic coal, maybe CSX is just referring to the front half of the year. The graph below shows utility stockpiles are as low as they were in 2011.

These disconnects make it hard to imagine that CSX is prepared for the upcoming paradigm shift.

Source: EIA

At Union Pacific Corp (NYSE: UNP  ) , coal accounted for 19% of freight revenue in 2013. Most of the business originates from the Southern Powder River Basin in Wyoming. Union Pacific's freight revenues increased by 5% year over year, despite declines in coal. Shipments from the Southern Powder River Basin declined 10% from 2012 due to the loss of a customer contract, and tighter coal inventory management by utilities.

At Norfolk Southern Corp (NYSE: NCS  ) , coal is the largest commodity group at 23% of revenues. "Our coal franchise supports the electric generation market, serving approximately 100 coal generation plants," remarked the company in the 2013 10K. Net income increased 9%, and EPS increased 12%. Coal is the only market that declined in revenues by 12%. The company attributes the loss to fewer shipments of utility and domestic metallurgical coal. For 2014, coal revenues are expected to decrease, "although more modestly," the company said.

Takeaway
Coal is clearly a large part of the business at CSX, Union Pacific, and Norfolk Southern, and they are all suffering from a decline in usage from their largest customer: electric utility companies. The EIA predicts that 2014 will see a slight bump in utility receipts due to the drawdown in 2013, but in the long term more electric companies are expected to turn to natural gas. Those railway companies that don't have a strategy in place to make up for those lost revenues may not be around in five years.

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