The coal industry is in the midst of a painful market correction. There are positive signs beginning to emerge, but Arch Coal (NYSE:ACI), one of the industry's biggest players, isn't ready to call the upturn. Is management being too conservative?
Some good news
Powder River Basin, or PRB, coal "is competitively positioned versus natural gas," according to Arch Coal's management. Through August, the average price per million BTUs for gas was $3.65. PRB coal can compete with gas priced as low as $2.50 per million BTU. Even better, "the natural gas forward price curve is well above [$3.65]..."
That's a good long-term indication that miners with PRB exposure, like Arch, Cloud Peak Energy (NYSE:CLD), Peabody Energy (NYSE:BTU), and, to a lesser extent, Alpha Natural Resources (NYSE:ANR), have a bright future. And based on supply and demand trends, Arch believes "coal markets could become much more dynamic next year..." And that's true even if demand is flat.
Cloud Peak, however, is the only company noted above that is 100% in the PRB. That gives it an edge and helps explain why the miner hasn't posted a quarter of red ink through the industry downturn. Alpha Natural Resources, which only does 10% of its business in the PRB, is at the opposite side of the spectrum.
In fact, Alpha has notable exposure to Central Appalachia, or CAPP, where Arch Coal notes that mine closures are picking up. That region is suffering because it is higher cost than the PRB and nearby Illinois Basin, or ILB, which is competitive with gas in the $3.50 per million BTU range.
More than thermal warmth
Of the quartet noted above, only Cloud Peak is focused on thermal coal. Peabody Energy, Arch Coal, and Alpha Natural Resources all have notable metallurgical coal operations. On that front, Arch notes, "it's no secret that we are in the midst of a global cyclical downturn..." With its two main markets under stress, it's no wonder that the coal industry is such a pariah.
Unlike domestic thermal coal, however, which is feeling pressure from cheap gas and government regulations, met coal is more an oversupply problem than a demand issue. Here, Alpha expects improvement "...driven by continued rebound in demand and ongoing supply rationalization." Basically, high cost met mines are getting shut because of low prices despite still increasing demand. The company highlights domestic strength, demand from Asia, and an expected strengthening in Europe as positives over the next year.
That's definitely good news for met miners since price in this industry segment is more important than volume to the top and bottom lines. Any uptick could quickly lead to a notable improvement at Arch and Alpha where met coal makes up about 45% of their businesses. Peabody only mines met coal in Australia, accounting for around a quarter of its top line, so a met rebound would have less of an impact.
In the end, however, Arch concludes: "So while we are seeing some signs that coal markets are poised to improve, we aren't ready to predict that turnaround will occur." With so many positive signs, is the company erring on the side of being too cautious?
Arch got burned by a transformational met coal purchase at the top of the met market, leaving it with an uncomfortably heavy debt load when the coal sector started to deteriorate. And the purchase was a very public bad call on the market. It looks to me like Arch is a little gun shy after that ill-timed purchase. At the end of the day, it's better to be publicly cautious in a rising market than too positive in a falling one.
There's no question that 2013 was a transition year, in which coal miners have had to focus on rationalizing their operations after a period of industry-wide excess. Although cost cutting will linger into 2014, the impact of such efforts is likely to start taking shape next year. Watch for a metallurgical coal price recovery to be the driving force to the upside at Arch and Alpha.
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Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.