Throughout 2013, thermal coal demand was held in check because utilities had ample supplies on hand. Now that they've burned through that extra fuel, look for coal miners to see increased demand. But, there are industry changes that could mean a more volatile future for coal than in the past.
Burn baby burn
According to the U.S. Energy Information Administration, the amount of coal at electric utilities peaked in early 2012 at about three months of supply. That's the high end of the range over the last five years. It fell a little through that year, but peaked again at three months supply in early 2013. The reason? Historically low natural gas prices through that period made it more economic to burn gas than coal.
Then things changed; natural gas prices started to move higher and coal was price competitive once again. As a result, utilities burned more coal, stockpiles fell through 2013, and now inventories are at the low end of the five-year range. In response, utilities have just about tripled their coal purchases on the spot market.
Loving the change
This is exactly what Peabody Energy (NYSE:BTU) and Arch Coal (NASDAQOTH:ACIIQ) have been talking about. Peabody Energy CEO Gregory Boyce noted in his company's fourth quarter earnings call that the Powder River Basin (PRB) coal market had strengthened "considerably." Peabody is one of the largest PRB miners in the country. Arch Coal CEO John Eaves noted during his company's fourth quarter earnings call that, "Some of our customers have raised concerns about potential stockpile shortages if these trends continue." Arch Coal also claims a large position in the Powder River Basin.
Both Boyce and Eaves noted that spot prices for PRB coal were up around 40% at that time. That was music to their ears, however PRB-focused Cloud Peak Energy (NYSE:CLD) is probably even happier to see this reversal. While Peabody and Arch have operations in other regions and in metallurgical coal, all Cloud Peak does is PRB thermal coal.
The future could look different than the past
While Peabody, Arch, and Cloud Peak are pleased to finally see the coal market recover, it's important to remember that the broader utility market is undergoing important changes. The shift to natural gas is one such change. For example, Southern Company (NYSE:SO) has installed so much natural gas capacity that CEO Thomas Fanning recently noted, "We now are the second or third largest gas consumer in the United States."
In 2013, natural gas made up 42% of Southern's output and coal 38%. Price will likely push those two back and forth on the margin, which could have a big impact on Southern's coal stockpiles. This type of shift is taking place across the utility industry. Remember, low gas prices were a big reason for the stockpile build up—that could conceivably take place again.
But increased use of renewable power is another important trend. For example, Xcel Energy (NASDAQ:XEL) plans to increase its use of wind power from around 5% of its supply in 2005 to 22% by 2020. Even after that change, however, coal will still make up over 40% of Xcel's fuel. The company's future coal use could very well be as variable as the wind, which it doesn't control. The same is true of hydro power and solar, two other big renewable sources.
In the end, the coal industry could see lower volumes locked in under long-term contracts and more coal sold on the spot market. This would provide utilities the flexibility to take advantage of the balance between natural gas and coal prices, as well as handle shifts in non-controllable power from renewable sources. This wouldn't be a bad equilibrium point for coal, but it would be a big change from the past. In the end, you shouldn't expect the thermal coal market to just go back to what it once was.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool recommends Southern Company. 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.