Peabody (BTU +0.00%) is one of the stronger coal miners today, yet in the first quarter of 2014 it posted an adjusted diluted EPS loss of $0.19. Management expects that the second quarter will be worse, with adjusted diluted EPS loss between $0.14 and $0.39. These numbers come at the same time that estimates of medium-term Chinese coal demand have been cut. Even with all of these negative results, it is important to take a long-term view and focus on the variables that we can be certain of.
Coal's challenges vary throughout the world
Peabody's first quarter 2014 results were crushed because its Australian gross margins fell to $0.22 per ton. Its U.S. gross margin only fell slightly to $5.30 per ton. In the context of Australia's coal mining industry, Peabody's results are not too surprising. The Queensland Resources Council recently reported that 25% of the coal produced in Queensland was produced at a loss.
Even within the U.S. coal margins vary widely
Cloud Peak Energy (CLD +0.00%) is a pure play on the Cloud River Basin, one of the better-positioned coal producing areas in the U.S. In the first quarter, it had gross margins of $2.39 per ton or 18.4%. Even its operating income before taxes and interest was a positive $16 million. If it was not for $38 million in interest payments Cloud Peak Energy would have had a much easier time making an overall profit.
While the diversified Peabody was able to post a negligible operating profit of $3 million and Cloud Peak Energy posted a stronger operating profit of $16 million, many other U.S. miners were not as lucky. Alpha Natural Resources' (NYSE: ANR) operating loss grew year over year from $131 million to $194 million in the first quarter of 2014. Arch Coal (NYSE: ACI) saw its operating loss increase from $51 million to $73 million in the same time frame.
Alpha Natural Resources' Powder River Basin had gross margins of 16.6% in the quarter, but its eastern operations brought its overall per ton gross margin down to 7.3%. 7.3% does not leave enough room for other expenses. After taking out depreciation and other standard expenses, its overall operating income is far from positive.
Arch Coal has more challenges. Its Powder River Basin cash margin per ton was $1.28 in the quarter, or 10.6%. Its biggest cash margin problems, however, come not from its thermal operations, but from the Appalachia region where its cash margin per ton was a minuscule 3.3%. The bad news is that after accounting for normal operating costs, even Arch Coal's Powder River Basin posted an operating margin of -2%.
Alternative fuels must be put in context
Amid all of the negative news, it is easy to forget that global coal use is still expected to rise 2.3% per year until 2018. At the same time, it makes much more sense for U.S. utilities to put their money into cheaper wind or natural gas.
U.S. coal demand is expected to fall 0.1% annually until 2018. This is great news for natural gas drillers like Chesapeake Energy (CHK +0.00%). Thanks to the existing natural gas infrastructure, it is not hard to sell U.S. utilities on natural gas power plants that cost 30.6% less per megawatt hour than a conventional coal plant. The key is that the U.S. market does not have to deal with LNG infrastructure, making it more profitable and easier for utilities to acquire significant supplies of natural gas.
In the first quarter of 2014, Chesapeake was able to increase its natural gas production 4% year over year. Even though Chesapeake is focused on developing oil rich plays, natural gas is still very important for the company. In the quarter, natural gas comprised 54% of its Southern Marcellus production, 60% of its Utica production, and 21% of its Eagle Ford production. Chesapeake's debt is worrying, but strong U.S. utility demand for natural gas should give the company more time to put its house in order.
The end of (expensive) coal
In a world with cheap wind energy and cheap U.S. natural gas, it is hard to turn a profit on expensive coal deposits. While Peabody and Cloud Peak Energy are able to produce operating profits in the current environment, lower-quality miners like Alpha Natural Resources and Arch Coal have a challenging future ahead. At the end of the day, the unconventional driller Chesapeake is on much stronger footing than second-rate coal miners.
