Alliance Resource Partners, L.P. (NASDAQ:ARLP) has had a rough go of it recently, with its units down 66% from the highs reached in 2014. The coal-focused limited partnership, however, has held up relatively well compared to peers, some of which ended up taking a trip through bankruptcy court. That said, the U.S. Energy Information Administration (EIA) recently came out with coal demand projections through 2050 that suggest coal demand will flatline -- Here's why that's good news for 12% yielding Alliance and its unitholders.
The EIA forecast
In its 2018 Energy Outlook report, the EIA makes projections for energy supply and demand across the entire energy landscape out through 2050. Coal has long been a key component of the Outlook report because it is so important in the generation of electricity. However, it's worth noting that, with such a long-term look at things, the EIA can sometimes miss the mark. For example, it's overestimated coal demand for years.
That caveat in mind, here's what the EIA is projecting for coal's future today: Demand continues to dip through the early 2020's and then essentially flatlines for 25 years. The trend of falling demand is driven by the shift toward cleaner energy sources (like renewables) and competition from relatively cheap natural gas. Essentially, utilities are shutting the least efficient and dirtiest plants in the their fleet. That's expected to pick up over the next couple of years, with 25 gigawatts of coal-fired electric capacity set to be retired between 2018 and 2020.
However, after those coal power plants are shut down, the EIA's base case expects plant closures to fall off and utilization at the remaining plants to increase and offset the demand drop from closing plants. Utilization is projected to increase from 56% in 2017 to 70% by 2030. Essentially, there will be fewer coal power plants but they will be run much more efficiently.
How Alliance wins in this scenario
Frankly, this isn't a great forecast for coal miners when you look at the big picture. However, there are some important fine details that need to be reviewed. For example, the falloff in coal demand has largely been hitting the Western and Appalachian coal regions. That's set to continue into 2020, but at a less severe rate. The relatively small Interior coal region, on the other hand, has actually seen demand head slowly, but steadily higher. The EIA expects that trend to continue because of the nature of the region's coal quality and logistical advantages.
This is where Alliance comes in. The coal miner's main focus is on the Illinois Coal basin, which is in the Interior region. That's why the miner was able to increase production for years while peers like Cloud Peak Energy, which operates in the Powder River Basin in the Western region, were curtailing production. That trend lasted until 2015, with 2016 production falling off for Alliance. However, 2017 saw production pick up again, partly thanks to an uptick in exported coal. And the partnership is currently looking for coal production to rise nearly 8% in 2018.
If the EIA is right about the interior region, even though coal demand may continue to fall overall for a few more years, Alliance's well-situated mines should do relatively well. The current trend toward higher production at Alliance largely backs the EIA's forecast on that front. And once coal demand stabilizes overall, after plant closures slow and utilization at remaining plants pick up, demand for Alliance's coal should hold steady for decades. Clearly, coal prices will be the ultimate determinant of Alliance's top- and bottom-line success, but stable demand will go a long way toward supporting stable prices.
In fact, even if the EIA is wrong and coal demand continues to fall overall, history suggests that the pain will be largely felt in the Western and Appalachian regions, not the Central region in which Alliance is focused. In fact, even in the EIA's downside for coal scenario, the dotted lines in the EIA graph above, the Interior Region remains the standout performer. That's a function of the unique attributes of the Illinois basin and its coal, which indicate that it will likely remain in high demand even as other power sources, like natural gas and renewables, continue to gain share on the grid. In other words, Alliance is well positioned even if coal's pain is worse then currently expected.
Just do what you do for me
This isn't a recipe for material growth, of course. But it is one in which a partnership focused on returning value to shareholders through distributions can continue to support its distribution well into the future. And with a distribution yield of 12%, which is currently backed by a robust 1.3 times coverage ratio, investors will benefit from double-digit returns even if Alliance's unit price doesn't increase a single penny between now and 2050.
Although the overall coal landscape isn't rosey, Alliance is a unique case because of its regional focus. It has already proven it can survive in a difficult coal market while continuing to return cash to unitholders. And if the EIA's projections are close to the mark, it should continue to do fine in the future. Unitholders, meanwhile, will get to continue collecting the partnership's generous 12% yield.