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Export coal demand bridges domestic lull

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Export coal demand bridges domestic lull

Coal prices for export markers increased during May, even as low shoulder-season demand took a bite out of domestic production. Natural gas prices moved higher during the month on a slow start to the storage injection season. Coal and natural gas inventories both remain low, which may support prices into summer and set up more robust demand.

Coal prices increased for markers associated with export markets during May, while domestic markers remained mostly unchanged. The NYMEX CAPP benchmark gained $1.85/ton (3.1%) with Pittsburgh Seam coal showing similar gains. The NYMEX PRB benchmark eased by 5 cents/ton, and Rockies coal lost 15 cents/ton. Illinois Basin markers closed the month unchanged.

Natural gas rallied during the month as storage injections did little to reduce the storage deficit and as the market anticipated higher electric generation demand this summer. Henry Hub spot prices opened May at $2.75/MMBtu and rallied to a high of $2.89/MMBtu before easing to $2.83/MMBtu at month-end. While storage injections began in May, injection levels largely mirrored historical averages and therefore did little to narrow deficits arising from April's net withdrawals. The storage deficit remained at 498 Bcf through May 25. This demand pressure for refill should translate into firm natural gas prices, although Henry Hub price levels ended the month well below this time in 2017. Moreover, the expansion of natural gas supply out of the Permian Basin and continued penetration of shale gas into the Midwest means most of the country now prices at a discount to Henry Hub. These discounts widened during May, with Chicago at 30 cents below Henry Hub and SoCal Border discounted by 85 cents, to go along with much lower natural gas prices in the Marcellus and Permian basins. The expansion of discounted natural gas to regions beyond the Marcellus shale will continue to pressure domestic coal demand and restrain price growth.

Coal inventories grew in March, with the Energy Information Administration estimating stockpiles at 126 million tons. S&P Global Market Intelligence estimates normal year-end stockpiles at 152 million tons, suggesting ongoing demand pressure through spring to rebuild inventories, independent of natural gas competition.

The chart below shows the current price forecast for the PRB 8800 and 8400 markers.

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Pricing for the Powder River Basin is expected to be driven by domestic demand dynamics, with a potential boost in exports due to strong spreads the first half. Flat pricing is expected in the near term as higher demand from export markets is more than offset by lower natural gas prices and retiring coal-fired generation. While long-haul PRB is resilient to gas generation priced from $2.85/MMBtu to $3.00/MMBtu, the current strip for natural gas and associated regional prices trend lower through 2019, putting a hard cap on coal demand. This creates surplus capacity in the Powder River Basin, tending to reinforce current price levels over the next few years.

The need to refill coal stockpiles following winter demand should support bituminous markets through the first half. Strong seaborne pricing supported bituminous markets through March, but a softening of export markets during April caused near-term prices to ease.

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The above chart forecasts flat pricing across all bituminous coal types as pricing pressure from natural gas builds into 2019, with modest price growth thereafter as natural gas prices again move up. As with the Powder River Basin, the ongoing low natural gas price creates a ceiling for coal price, restricting price growth. S&P Global Market Intelligence projects that the combination of natural gas prices and coal retirements will pressure generation demand through 2021, with overall demand falling by 185 million tons from 2017 to 2021.

Coal production, demand

For the four weeks ending May 26, coal shipments averaged 14.1 million tons, with volumes easing due to lower seasonal demand. Production levels in eastern bituminous regions (Central, Northern, and Southern Appalachia) are forecast lower from 2017 by 7% in 2018. An easing of metallurgical export markets combined with lower domestic steam demand drive this modest decline. Southern PRB is projected to grow by 1%, with stronger exports offset by lower coal demand from retired capacity and competition from natural gas. Illinois Basin is expected to grow production by 4% due to higher steam coal exports.

The chart below compares the current production forecast with recent history. Electric-sector demand is projected to decline from 675 million tons in 2017 to 600 million tons in 2018 and come under further pressure in 2019. A surge in announced coal retirements over the next four years combined with lower natural gas prices is projected to push coal generation demand to a low point of 487 million tons per year by 2022. 2017's boost in demand will be tested, with the overall coal market (domestic demand and exports) projected to decline by 163 million tons from 2017 to 2021.

Production outlook — Powder River Basin

Inventories of sub-bituminous coal at generators started to rebuild in March, providing some demand to offset low natural gas prices. As coal plant demand in Texas rolls off due to deactivation, demand is expected to decline by about 3 million tons during the second quarter, with another 3 million tons of displaced demand due to competitive natural gas. Exports and restocking are projected to offset these losses. S&P Global Market Intelligence projects modestly higher production in the PRB compared to 2017, with total PRB production (Northern and Southern) projected at 343 million tons. Exports remained firm through March. However, retirement of coal generation in the Midwest and Texas, along with lower natural gas prices, is projected to shrink the market through 2021. Modest growth opportunities include displacement of smaller western coal producers, along with further expansion in export markets. Overall, PRB is forecast to increase production by 4 million tons in 2018 before losing 66 million tons in 2019.

Production outlook — Illinois Basin

Increased availability of Marcellus/Utica shale natural gas into the Midwest has maintained downward pressure on spot coal prices and has cut into domestic demand for ILB coal. This demand pressure has been offset by export volumes, keeping overall production levels stable. S&P Global Market Intelligence forecasts 2018 ILB production at 107 million tons, nearly 4% higher than 2017. Export markets are helping to drive this modest growth, although recent seaborne prices have been weaker. As in other coal regions, natural gas prices are expected to move further downward by 2019, with shale gas deliverability into the Midwest driving coal volumes down modestly. Natural gas basis declines in the Midwest are expected to impact demand in the second quarter, potentially displacing 3 million tons of bituminous coal overall. With low natural gas prices persisting beyond 2018, Illinois Basin production is projected fall below 100 million tons per year and remain relatively flat thereafter.

Production outlook — Appalachian basins

Appalachian basin coal production has increasingly shifted to metallurgical and export steam markets, with long-haul thermal domestic markets continuing to erode. Demand drag due to coal retirements for the second quarter is estimated at 3 million tons, while competitive natural gas may displace an additional 3 million tons. Production levels in 2018 through 2019 are projected to decline by 18 million tons and 8 million tons, respectively, due to lower natural gas prices, intra-basin competition with the Illinois Basin and further coal retirements in the region. The growth in 2017 metallurgical exports is forecast to hold firm in 2018 before easing by 2019 as competition from international producers cuts U.S. volumes.

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Coal forecast methodology overview

Market-indicative coal forecasts produced by S&P Global Market Intelligence represent forward curves for spot-traded instruments, analogous to a strip of contracts, with the shorter tenors (current year, prompt year, plus additional years if available) driven by the observed/assessed market and the longer tenors (typically years 3-20 for physically assessed markers and NYMEX futures) driven by fundamental estimates of cash costs of production, accepted returns to capital, regional productive capacity, and forecast supply and demand. For the long-tenored portion of the curve, S&P Global Market Intelligence forecasts prices for specific coal markers and defines the remaining markers via historical spreads.