Image source: Getty Images.
The past several years have been awful for coal companies. Sinking demand, high costs, and too much debt forced several top producers into bankruptcy. While bankruptcy has not been a worry at Alliance Holdings GP (NASDAQ: AHGP), or at its MLP Alliance Resources Partners (ARLP -0.33%), both companies have still struggled amid the weak coal market. That said, according to Alliance Holdings GP CEO Joseph Craft, things are starting to look up for the coal sector. Here's what that means for the two companies he oversees.
Cautious optimism
Craft provided his outlook on the coal market on Alliance GP Holdings' recent third-quarter conference call. He commented:
Looking to the fourth quarter of 2016 and beyond, assuming normal weather patterns, we currently anticipate the recent improvement in the domestic and thermal coal markets should continue as higher natural gas prices spur an increase in demand for coal and supply for domestic consumption will be reduced due to increased shipments of U.S. coal into the export markets. Even though the industry supply-and-demand balance is becoming more favorable and prices are on the upswing, we believe coal pricing still needs to show more strength before we begin increasing production.
As Craft notes, the coal market was noticeably better during the third quarter. In fact, demand improved to such a degree that Alliance Resources Partners cleared out nearly half of its inventories and signed several long-term volume contracts securing future deliveries. The company expects that improvement to continue because natural gas prices have been on the rise, which should fuel more demand for low-cost coal.
That said, even though the coal market is getting better, the company is not yet ready to start boosting output. That is partly because there's still a pretty wide gap between its 2016 coal sales estimates and the firm sales contracts it has in place for 2017 and beyond. Currently, the company estimates that it will sell between 36.5 million to 37 million tons of coal this year. However, it only has secured coal contracts for 29.1 million tons next year, which declines to 17.4 million tons in 2018 and 8.9 million tons in 2019. Until the company has obtained additional volumes for 2017 and beyond, it just doesn't make sense to start ramping up production.
Image source: Getty Images.
Cautious approach
Instead, Craft said that the company will:
Continue our strategy of matching ARLP's 2016 production levels to contracted sales and commitments. In 2017, production is currently planned to be at our revised 2016 sales volume guidance ranges as we continue to optimize our lowest cost mines. This strategy led us to our decision to cease production at our Patiki mine by the end of this year, and to increase production at our Hamilton mine with the goal to get this longwall mine to full capacity in 2017.
In other words, the company plans to produce about 37 million tons in 2017, even though it only has 29.1 million tons under contract. It is doing so under the assumption that the strengthening coal market will enable it to secure contracts for that remaining volume. However, it will not boost capacity beyond that level until it is clear that the market needs more coal. Because of that, it is winding down production at the Patiki mine and switching that output to the Hamilton mine, which will reduce its cost per ton in the Illinois Basin next year. That shift will also improve the company's margins, enabling it to generate more cash flow even if the coal market does not get any better.
Investor takeaway
Alliance Holdings GP is growing more optimistic that the recent rebound in the coal market is sustainable. That said, the company wants to see more evidence of this, with it particularly interested in seeing higher prices before it commits to increasing its output capacity in 2017. That is why it is taking a cautious approach, focusing only on its best production options so that it can improve its margins just in case the recent rally fizzles out.
