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Scheduled coal plant retirements will take a big bite out of US customer base

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Scheduled coal plant retirements will take a big bite out of US customer base

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A coal truck drives across Cloud Peak Energy Inc.'s Antelope coal mine in September 2017. U.S. utilities have continued to shut down coal-fired power plants, keeping competition between U.S. coal producers fierce even as supply tightens.
Source: S&P Global Market Intelligence

This is part two of a two-part series in which S&P Global Market Intelligence analyzed federal data to determine the pace of U.S. coal-fired power plant closures and their impact on U.S. coal producers. Part one focused on the domestic utilities that burn coal to generate electricity, while this installment looks at the companies that produce coal for power generators.

Competition among coal producers for U.S. utility market share will likely get even tougher as power generators continue to reduce their reliance on coal generation.

In 2017, coal companies delivered 617.1 million tons of coal to domestic electricity generators; 23.2% of that coal went to power plants that are scheduled to retire within two decades, according to an S&P Global Market Intelligence analysis of federal data. Several companies delivered a substantial amount of the coal they produced to power plants expected to soon be turned off, while at least eight coal mines reported 100% of their deliveries to U.S. utilities in the first half of 2018 went to retiring power plants.

The problem for U.S. coal producers is exacerbated by a lack of new coal generation projects coming online.

"Unfortunately, utilities continue to announce coal plant closures as they install subsidized renewables and supporting natural gas generation," lamented Cloud Peak Energy Inc. President and CEO Colin Marshall on a third-quarter earnings call after projecting that 2019 demand for Power River Basin coal would be flat to "maybe up a little." Cloud Peak recently announced a strategic review that includes mulling a potential sale of the company.

About 22.8% of Cloud Peak's coal production in the first half of 2018 went to power plants scheduled to retire, according to combined U.S. Mine Safety and Health Administration and U.S. Energy Information Administration data. Westmoreland Coal Co., which filed for bankruptcy reorganization in October, delivered 66.2% of the coal it produced in the first half to plants that have announced a retirement date.

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With a sharp decline in coal equity prices since the beginning of November, it seems a secular decline in coal may be weighing down coal producers who otherwise have plenty to be excited about. Some thermal coal producers are hoping utilities are getting nervous about their coal inventory levels as natural gas prices rise and export markets continue to pull domestic tons out of a market that otherwise is struggling to hold on to its customer base.

"What makes this selloff so notable is that while international steam coal prices have weakened, met coal prices have barely budged, and the outlook for U.S. steam coal is the best it's been in some time," Seaport Global Securities LLC analyst Mark Levin wrote in a Nov. 27 note. "Equally important, the balance sheets and free cash flow profiles of publicly traded U.S. coal companies are in their best shape in decades."

The pace of coal plant retirements in 2018, according to S&P Global Market Intelligence's analysis, is just shy of matching the capacity retired in 2015, the year mercury emission regulations went into effect and pushed several older coal plants offline. While that period was characterized by an oversupply of coal that could not shrink fast enough to meet dwindling demand, now cautious coal companies that held on to their capital may find themselves unable to increase production enough to meet any potential increases in demand from a cold winter expected to boost electricity demand.

Supply constraints cap potential response to demand

While every 25-cent change in the Henry Hub natural gas price theoretically equates to about 22 million tons of incremental electric utility coal demand, Levin wrote in a Nov. 20 note, those sort of gains will be impractical due to production and transport limitations.

"We suspect there simply isn't enough excess capacity for U.S. steam coal production to increase much more than 6%-8% year over year," Levin wrote.

Hallador Energy Co. President and CEO Brent Bilsland said his Illinois Basin coal mining company has been seeing more business from U.S. utilities as export markets draw competitors' coal into the booming overseas market. While he notes his company has some capacity to increase production to meet demand, he also said that is generally not the case across the sector.

"In general, there's been so little investment in this space," Bilsland said on a Nov. 6 earnings call. "We think it's going to be hard for most people to ramp up production."

The Central Appalachia coal producers have primarily turned their focus to higher-margin metallurgical coal as thinning seams make it tougher for the region to compete in thermal coal markets. While Murray Energy Corp. had a "reasonably strong production year" in Northern Appalachia, producers such as Consol Energy Inc. and others in the region are essentially already mining at capacity, Levin wrote, though Illinois Basin producers may have some excess capacity. He estimated that even a 5 million to 10 million ton increase in coal production capacity from coal producers east of the Mississippi River could be pushing it.

Producers in the Powder River Basin, where large operations can mine coal more cheaply, have more capacity, but producers such as Arch Coal Inc. and Peabody Energy Corp. likely have little motivation to increase production without higher pricing, Levin wrote.

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"If they decide to ramp up sales without getting [improved] price, we suspect their investor base would be seriously disappointed," Levin wrote. "While there may be as much as 20 million to 30 million tons of capacity that could come online in the PRB in relatively short order, we don't see that happening unless the price rises."

US coal buyers remain hesitant

Despite supply constraints, declining utility inventory and other bullish factors for coal demand, some coal producers are reporting utilities are still largely on the sidelines when it comes to buying coal.

"Look, the inventories are correcting; at some point things will have to start picking back up," Arch President and COO Paul Lang said on an Oct. 23 earnings call. "But right now, I don't see a lot of pressure on the side of utilities."

Peabody Energy, the largest coal company in the U.S., is also by far the largest supplier of coal to power plants that have announced plans to retire. Though it also has extensive mining operations in Australia, about 24.2% of the company's U.S. coal production — 18.0 million tons — in the first half was delivered to power plants that have announced retirement dates.

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The company has been advocating for investments in carbon capture, use and storage technologies to transition to an "ultimate goal of near-zero emissions" from coal-fired power plants. Many U.S. utilities have expressed skepticism around the costs of such technologies, and many have increasingly carved out more space for natural gas and renewable generation in their portfolios. Peabody points to projections for an increase in coal-fueled generation in places like Asia where growing economies are looking for cheap sources of power.

"With global coal demand remaining strong and new coal-fueled generating plants being built in substantial numbers around the world, Peabody believes coal will continue to be an essential part of the energy mix," a Peabody spokesperson said.

Several of the top coal mining companies by exposure to retiring power plants did not respond to a request for comment.