Last year I wrote that coking coal producers like Walter Energy (NASDAQOTH:WLTGQ), Alpha Natural Resources (NASDAQOTH:ANRZQ), CONSOL Energy (NYSE:CNX), and Peabody Energy (NYSE:BTU) were in a world of pain. Further I saw no near-term catalyst to drive coking coal prices higher. Fast forward a year, and we are in an even more dire market. From about $150 per tonne, the benchmark coking coal price is now at $120 per tonne. That's 64% below the 2011 high of $330 per tonne.
This depressed level is widely believed to be below the marginal cost of production of roughly $160-$170 per tonne. However, spot prices have been below that level for quite some time, suggesting that the true marginal cost might be closer to $140-$150 per tonne.
One thing that's certain, U.S. coking coal production is in dire straights at a global benchmark price of $120 per tonne. In the U.S., Walter Energy is most exposed to coking coal prices, followed by Alpha, Peabody, and CONSOL. Since my last article, CONSOL has sold some of its coal assets and is more of a natural gas player.
U.S. coking coal producers falling back to swing producer status?
In 2010-11 there was great excitement as stronger global coking coal prices allowed U.S. producers to make a mark in the seaborne market. Prior to that, the U.S. industry was a swing producer, i.e. only a meaningful factor when coking coal prices spiked like they did in 2008. By mid-2011, most coking coal players believed the U.S. would continue to be a top producer and exporter and no longer a swing producer.
All of that changed when coking coal prices fell below $200 per tonne in 2012. The U.S. needs $175-$200 per tonne pricing to be relevant. Some analysts believe that coking coal prices will bounce back significantly in the next 6-9 months. That appears unlikely. Unless there is an exogenous event, such as severe flooding in Queensland, Australia, coking coal prices are probably stuck below $175 per tonne for at least the next year.
Walter and Alpha: too much debt, U.S. zombies?
Walter Energy is the only sizable pure-play coking coal producer in the U.S. It too made a mistake in 2011: Walter acquired high-cost Canadian coking coal assets. However, Walter has some of the best quality coking coal in the world in its Alabama mines. Like Alpha, Walter needs higher coking coal prices to survive.
Alpha also made a top-of-the-market acquisition of Massey Energy in 2011. Although a meaningful component of equity was used, Alpha remains heavily indebted to this day. Alpha has over 20 million tons of coking coal export capacity, but not all of its coking coal is top-tier quality.
Peabody Energy used to be without question the bellwether U.S. coal company. Yet, by expanding into Australia to play with the big boys, Peabody bit off more than it can chew. The company is the largest producer of thermal coal in the U.S., but it's being weighed down by debt and by loss-making operations in Australia at the moment.
What's your hurdle rate?
Walter, Peabody, and Alpha are very high-risk plays. In order to make an investment, one should have a high hurdle rate, i.e. a return expectation of 50%-100% over the next 12 months. I don't believe that's a good bet to make at this time.
An important investment attribute has been lost with these names. When coking coal prices were at $300 per tonne, there was the hope that prices were headed to $400+. Now, even returning to $200 tonne seems like a long, long way off. And, per tonne production costs have not moved lower to sustain margins. Without that big upside potential in coking coal prices, the chances of Walter, Peabody, or Alpha doubling or tripling are way lower than it once was.
U.S. coking coal producers remain in a world of pain. Despite aggressive efforts to cut costs, current benchmark pricing is just too low. Investors who expect coking coal prices to rebound above $175-$200 per tonne anytime soon could be disappointed. Most of the U.S. coking coal players mentioned will likely make it through the next 12-24 months, but they're not good investments at this time.