Coal producers in North America will see a decline in EBITDA of more than 3% over the next year, triggering Moody's Investors Service to change its outlook on a sector facing an export market showing signs of weakness.
A substantive decrease in seaborne coal prices combined with mostly open contract positions for several producers in 2020 will drive lower EBITDA for the sector for the second half of 2019 and into 2020, Moody's analyst Benjamin Nelson wrote in an Aug. 21 note on the coal industry. The steel industry is also weakening, which will drive lower earnings for metallurgical coal producers even though pricing remains relatively healthy compared to recent historical levels.
"A confluence of economic, environmental, and social factors also increase our concerns about the industry's longer-term demand prospects, as pressure on the industry is mounting, which makes numerous coal mines uneconomic in a reduced demand environment, especially smaller, higher-cost mines that are highly vulnerable to retirement of specific coal-fired power plants," Nelson wrote.
As recently as early June, Moody's was projecting a stable outlook for the U.S. coal sector. That stable outlook largely depended on an export market that served as an outlet for coal supply that outpaced demand for coal at home. With the ongoing trend to retire coal-fired power in the U.S., producers increasingly have fewer customers at home to turn to when export demand cycles take a downward turn. Moody's projected in July that coal could be as little as 11% of U.S. power generation by 2030, and that only accounts for plants that have announced retirement or are likely to close based on factors such as age.
Weaker export markets are expected to drive tons back into a U.S. market that has already seen a sharp decline in demand as low natural gas prices continue to drive coal plant retirements and lower utilization of coal-fired power plants, Nelson wrote. Several companies reported on their recent earnings calls that their strategy in the coming months could include trying to capture local market share from their higher-cost competitors.
"If these export markets aren't there, then we're poised to take domestic share," Foresight Energy LP President and CEO Robert Moore said on an Aug. 7 earnings call. "And that's what we're going to do."
Moody's view on metallurgical coal is that some of the factors driving recent price weakness are temporary and are even likely to remain at levels that support reasonable earnings for producers.
"Over a longer horizon, we remain concerned that demand for metallurgical coal could tip into secular decline as the steel industry continues to shift toward electric arc furnaces, which recycle scrap steel, rather than basic oxygen furnaces, which make steel from pig iron from a blast furnace, which uses raw materials including metallurgical coal," Nelson wrote.
While several companies have already booked coal sales through much of 2019, only a few coal companies, such as Consol Energy Inc., are substantially contracted in 2020, Nelson wrote. The analyst also pointed out that several U.S. coal companies are heavily concentrated in the domestic thermal coal space, including Consol, Foresight, Alliance Resource Partners LP, Murray Energy Corp. and Wolverine Fuels LLC.
Nelson noted that companies such as Peabody Energy Corp., which mines for metallurgical and thermal coal in various regions in the U.S. and Australia, are more diverse operationally, geographically and across coal types.