Thanks to some solid GDP numbers from China earlier this week, coal investors had reason to celebrate. Alpha Natural Resources (NYSE:ANR), Arch Coal (NYSE:ACI), and Peabody Energy (NYSE:BTU) saw their share prices soar as traders placed confidence in the return to growth of China's economy.
This optimism may be short lived, however, as coal prices continue to decline.
The coal pricing environment has been weak for some time now. Metallurgical coal prices are still bouncing around their lows, but steam coal prices have recovered strongly. Steam coal prices have recently weakened following a rally, however, and this could signify inventory restocking. If inventories are stocked then demand is falling, and this could cause the recent weakness.
Fortunately, around 16 million tons per annum of coal production capacity has been taken out of the market during the past year or so; this is good news for the market. These production cuts are expected to flow through the system over the next few months.
No relief in sight
According to Moody's Investors Service, most U.S. production is unprofitable at current prices, and as much as half of global output is making a loss. The market for metallurgical coal was oversupplied by about 30 million metric tons at the end of the first quarter, pushing benchmark prices to a six-year low of $120 per ton.
According to Moody's, U.S. coking coal miners won't be profitable until the benchmark price reaches $160 to $170. The group of miners could supply over 50 million metric tons this year, while burning more than $1 billion in cash; that's an unsustainable level of cash burn.
While capacity is falling out of the market, the coal industry's existence is still under threat, especially within the U.S. New legislation announced by the U.S. Environmental Protection Agency is set to flatten demand for the black mineral as coal-fired power plants disappear from existence.
The EPA's rules will make it virtually impossible to build new coal power plants within the U.S. without carbon capture and sequestration technology. Many coal-fired plants are too old to bother with this technology, so owners are planning to close their doors. Around 15% of existing U.S. coal burning capacity is due to shut down by 2016.
With around 90% of coal produced within the U.S. being used for electricity generation, even a small reduction in demand will have a significant impact on prices. A decline in demand of 15% will really hit coal prices.
On life support
It remains to be seen if Arch, Peabody, and Alpha will actually be able to survive a 15% decline in demand. Unfortunately, the fact of the matter is that each company will benefit if another goes under.
As miners collapse under low prices, the supply of coal into the market will fall. This should push prices back up, but it will be too late for some.
Cliffs Natural Resources is already feeling the pain. As the company fights an expensive proxy battle and suffers from a fall in the price of iron ore, the company has been forced to idle its Pinnacle metallurgical coal mine in West Virginia.
Cliffs does not give per-mine cost figures. However, the company reported that each ton of coal it produced during the first quarter cost $100 to mine. The same ton of coal sold for just $89. Including depreciation, the company reported a loss per ton in excess of $30. This is likely to be the first of many large coal mine closures.
The bottom line
The fact of the matter is that the coal industry is struggling, and there appears to be no letup in sight. The price of coal continues to decline, and the declines have only been compounded by rising oversupply within the market. It would appear that a significant supply will need to be taken out of the market before prices stabilize.
Rupert Hargreaves 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.