It's Catch-up, Not New Coal Demand, on the Rails

The major railroads are seeing an increase in coal carloads, but that's not as exciting as it first sounds.

Apr 22, 2014 at 8:35AM

The price of coal from the Powder River Basin recently hit-two year highs, and now the major railroads are seeing increased coal carloads. This isn't an issue of one supporting the other, however, so don't get too excited by the good news from the rails.

Getting it where it needs to go
Coal gets moved around the country in various ways, but one of the most easily tracked is the railways. This side of the rail business has been in decline for a number of years as utilities continue to shift toward natural gas. That said, a huge amount of coal still gets carted by railways like CSX Corp (NASDAQ:CSX).

However, a harsh winter has had a big impact on railways like CSX. In CSX's fourth quarter conference call COO Oscar Munoz made reference to the impact that an outdoor railroad eventually faces. Weather was number one, but there are tap-on effects, such as "a couple of derailments in critical spots."

Bewegliches

(Source: Qualle, via Wikimedia Commons)

CSX CEO Michael Ward noted that, "We had severe weather across the north end of our railroad. A lot of freight was backed up." The winter weather didn't get any better, with severe cold and storms lasting well into the new year. And it wasn't just CSX that got hit -- the entire railroad industry felt the sting.

That's why the news that railroad shipments of coal being up an impressive 4% year over year shouldn't get you too excited about a rebound in coal. For the most part, utilities contract the bulk of their coal purchases well in advance. If bad weather stops them from getting scheduled coal shipments, it doesn't mean that the shipments disappear. It just means that those volumes will be made up at a later date.

So the uptick in coal shipments that's taking place right now is really just making up for the shortfalls during the winter. That's supported by Cloud peak Energy's (NYSE:CLD) fourth quarter comments.

Bad timing
While discussing Cloud Peak Energy's 5.5% domestic coal volume decline last year, CEO Colin Marshall made specific mention of "an early snowstorm in October which snarled things up in the PRB just as we [were] looking to increase our shipping rates." To be fair, weather wasn't the only problem Cloud Peak was dealing with, but it was a big one, and it didn't get any better in the early part of 2014.

Train

(Source: Elmer and Tenney, via Wikimedia Commons)

That said, the cold weather has been beneficial to the coal industry, too. For example, CSX's Ward specifically noted that the impact of bad weather would be that, "utility stockpiles will continue to draw down." While some of that comes from delayed coal shipments, it's also because cold weather leads to increased electrical demand, which will help to balance out supply and demand.

That, in turn, will help boost coal prices, which is something that is starting to happen right now in some regions. Specifically, Powder River Basin (PRB) coal prices are at their highest point since November of 2011. Cloud Peak mines exclusively out of the PRB, which makes it a pure play on that price uptick.

However, the price uptick has less to do with rail delays and more to do with supply and demand starting to find a new equilibrium point. The U.S. Energy Information Administration, for example, specifically pointed to a likely demand increase for PRB coal when it reported on 2013 coal demand. That was based on data largely from before the extended period of foul weather. In fact, the high end of Cloud Peak's domestic coal volume range calls for an increase of up to 7.5%.

Neutral, definitely not bad
The first quarter results at CSX and Cloud Peak are likely to show light coal volumes because of severe weather. The second quarter will probably show a rebound since those problems are now behind the pair. That, however, is neutral news, not good news. For CSX it's just the ebb and flow of business. For Cloud Peak, volume will likely average out over 2014, making the price of PRB coal the real issue to watch when looking for a coal industry turnaround.

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Reuben Brewer has no position in any stocks mentioned. The Motley Fool owns shares of CSX. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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