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New met coal mine developments will meet bulk of growing demand, analysts say

New metallurgical coal mine developments will fill in the bulk of supply to meet growing demand for the commodity, analysts say.

"We believe that the low-hanging sources of U.S. supply are mostly back in the market and that the greatest potential for additional supply is coming from new mine developments, primarily from private companies," said Lucas Pipes and Ted Beachley with FBR & Co. in a June 2 note.

By the first quarter of 2017, they said most existing mines and hot idled capacity had been turned back online in the U.S., and additional supply growth in excess of 5 million tons is unlikely from these areas.

"In a best-case scenario, we believe that sweating the existing mine portfolio further, U.S. output could be increased by up to 2 million to 5 million short tons," they said. "Capacity that was hot idled during the downturn could potentially increase output by another 1 million to 3 million short tons. In total, we believe it is reasonable to expect another 3 million to 6 million tons of additional production from existing U.S. met coal mines over the next 12 months."

Ramaco Resources Inc. and some private producers have plans for new metallurgical capacity, and Pipes and Beachley estimated that at least 7 million to 10 million tons of new production could jump into the market in the next 12 months to 18 months. Added together with the existing and hot idled mines output, the total new capacity might be 10 million to 16 million tons.

The analysts said that while the metallurgical coal industry in the U.S. has deconsolidated, with more medium-sized producers than two years ago, greater consolidation might give the industry some discipline when it comes to bringing supply online.

"Greater consolidation in the industry could alleviate concerns of undisciplined supply addition while boosting valuations on higher multiples and operational synergies," Pipes and Beachley said, adding that mergers and acquisitions could also improve price stability.

In terms of supply discipline, FBR said many mines categorized as idled in the second quarter of 2016 appear to have permanently closed since then.

Mine idling of both thermal and metallurgical coal slowed during the second half of 2016 compared to the first six months of the year.

Pipes and Beachley said FBR was lowering its price deck and estimates for metallurgical coal for 2017 to $190 per tonne in the second quarter, $150 per tonne in the third quarter and $145 per tonne in the last quarter. This is a decrease from previous estimates of $255, $170 and $155, respectively.

"We are lowering our 2018 met coal benchmark price assumption to $135 per tonne from $140 per tonne. Our long-term price assumption continues to be $130 per tonne," they said.

FBR's preferred risk-adjusted exposure to metallurgical coal is Arch Coal Inc. and Contura Energy Inc.