When Arch Coal (NASDAQOTH:ACIIQ) reported first quarter earnings it highlighted its West Elk operations as a bright spot. However, it just lost a legal dispute over expansion plans for this region. Is this yet another nail in coal's coffin or just a roadblock that will, eventually, be circumvented?
The legal eagle
In 2010, Arch Coal asked the government if it could expand its mining operations in the West Elk region. After a review, the U.S. Forest Service and the Bureau of Land Management approved the request. However, environmental groups promptly sued.
It took until June 27, 2014 for a verdict, and it's not a good one—for Arch Coal anyway. U.S. District Court Judge R. Brooke Jackson essentially said the government didn't take the environmental impact of the proposed expansion into consideration. Commenting on the decision Arch Coal spokesperson Kim Link noted that the miner was disappointed by the ruling, but that, "today's ruling will not necessitate any immediate changes at the mine."
That's good news, since in the first quarter Arch Coal CEO John Eaves highlighted that West Elk was running at roughly 5 million tons a year—25% higher than the expected run rate at the start of the year. And the impact of this "extra" production was notable: "This positive development is the driving force behind our $2 per ton cost guidance reduction for the region in 2014."
That said, Arch Coal's Link noted that, "Coal mining requires complex, long-term planning and today's ruling complicates our efforts in that regard. We are still analyzing parts of the ruling and evaluating our options." That could mean an appeal or further environmental analysis of the expansion project.
The big issue here is that mining companies have only a limited supply of what they pull from the ground. So every ounce of coal that Arch Coal mines is one less ounce it has to mine in the future. That's why coal miners are constantly building new mines and expanding existing ones.
And the impact of new and expanding mines can be huge. For example, Arch Coal still has around a decade of coal that it can mine at West Elk. But, if it can't expand there, it would have to find another mine site and build from the ground up. Not having to do that would save the company a huge amount of time and money.
Another example is Rhino Resource Partners (NASDAQOTH:RHNO). This relatively tiny coal miner just opened a new mine in the Illinois Basin. It already has a contract in place for 800,000 tons of coal. However it believes that production could be expanded to two million tons. If production at this one mine reaches that level, Rhino's overall production would increase by more than 60%.
Such a ramp up would take time, but it shows that Rhino Resource Partners' expansion via a new mine has serious potential to augment the miner's performance both now and well into the future. Note, too, that Rhino Resource Partners recently paid off substantially all of its debt with an asset sale. So unlike more heavily indebted miners, such as Arch Coal, it can afford to wait for new coal contracts at this vital expansion project.
Expand or die
To be sure, Arch Coal has plenty of room to run before it has any financial trouble. In fact, the miner has over $1 billion of cash on hand. And the West Elk mine permits it has now don't run out for years. So this ruling is bad, but not the end of the world.
That said, if Arch Coal can't expand its operations, like Rhino Resource Partners just has, it will die a slow death. The bigger picture, then, is that Arch Coal will live to mine another day—but expansion efforts throughout the coal industry may be facing a more difficult future. Listen for a West Elk update when Arch Coal reports its second quarter results.