Despite the recent rise in coal prices, shares of coal producers such as Alpha Natural Resources and Arch Coal continue to fall. Looking forward, will the recovery in coal prices provide some tailwind to coal companies by increasing their sales and improving their profit margins? Let's start by examining the latest developments in the coal market.
Is the coal market heating up?
The rally in natural gas prices has also led to a rise in demand for coal from utility companies such as FirstEnergy, which mostly uses coal to generate its electricity. But this utility, much like other power companies, is shifting its attention to greener power generators such as natural gas. Nonetheless, in the coming months, the ongoing high natural gas prices are likely to steer utility companies back to coal. This could also explain the rise in coal consumption in the first few months of the year and the rise in prices.
On an annual scale, the Energy Information Administration estimates that demand for coal will rise by 2.8%, year over year. But in 2015, the EIA projects the demand for coal will change course and fall again by 2.8% due to the following: the expected drop in natural gas prices, slow growth in demand for electricity, and because more coal-powered plants will shut down on account of the implementation of the U.S Mercury and Air Toxics Standards.
Moreover, coal prices for 2014 are also projected to remain elevated compared to 2013 at $2.39 per Mmbtu -- a 1.7% gain, year over year.
These slightly favorable market developments should have put coal companies in a good position to show some growth in sales this year. But this won't be the case.
The recent rise in coal prices isn't enough to make coal producers profitable again. Furthermore, even if prices remain higher than last year's levels, coal companies are likely to keep showing little to no profits. The main reason is the thin profit margins per ton they currently have.
Let's consider Alpha Natural Resources as an example. The company expects to reduce its coal shipments by roughly 5%, year over year. The expected higher prices and sharp drop in metallurgical coal output are likely to bring the company's average realized prices of coal per ton to their highest level in recent years. At the same time, however, the cash cost per ton is also expected to pick up. In total, the margin per ton is projected to reach $5.12 per ton in 2014, which is a bit higher than last year, but the profit margin will slide down to 7%. The table below summarizes these figures.
Source: Alpha Natural Resources
Even when the profit margin per ton was 16% back in 2012, the company's operating profit, after deducting the one-time provisions, showed a modest loss. And unless the production costs come sharply down, or prices spike by double digits, Alpha Natural Resources isn't likely to show any gains. Arch Coal isn't much different; even when its coal profit margin per ton was more than 20% back in 2012, it was close to breakeven.
Takeaway
The coal market is heating up, mainly due to the spike in natural gas prices. But coal producers aren't likely to benefit from this rally and will continue to post losses in the coming quarters.
