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CEO: Dynamics of coal 'permanently changed' as varying demand becomes new normal

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Essential Energy Insights - September 17, 2020

Essential Energy Insights September 2020

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CEO: Dynamics of coal 'permanently changed' as varying demand becomes new normal

Cloud PeakEnergy Inc.'s pure-play Powder River Basin and low-debt businessmodel has kept it from the worst punishmentsbeing doled out in the coal sector, but the company is still for a fundamentally marketplace.

Cloud Peak reporteda first-quarter net loss of $36.4 million on April 28, citing a slow start tothe year exacerbated by one of the mildest winters on record. The companytrimmed its 2016 shipment guidance from between 64 million and 70 million tonsto between 60 million and 65 million tons.

President and CEO Colin Marshall said on an April 28earnings call that in the foreseeable future, coal will now compete withnatural gas on marginal power demand "rather than providing reliable lowcost base load power as historically done."

"As we look forward, it is clear that the dynamics ofthe coal industry have permanently changed," Marshall said. "Wherecoal used to provide base load generation, it is now much more variabledepending on power demand, renewable output and the price of natural gas. Weare currently adapting to operating in an environment where shipments varysignificantly from quarter to quarter."

FBR & Co. lowered its rating on Cloud Peak from "marketperform" to "underperform" in a note following the company'searnings report.

The first quarter has proven for coal producers the board. U.S. MineSafety and Health Administration data showsthat production fromthe low-cost Powder River Basin is downby roughly one-third from the year-ago period. Despite "clear positives"to be found in management decisions, FBR analyst Lucas Pipes wrote he isconcerned market headwinds will weigh more heavily on Cloud Peak than expected.

"While we remain constructive on 2017 natural gasprices, we believe that elevated PRB coal inventories and a challenging (somesay nonexistent) contract market for U.S. thermal coal make further erosion inEBITDA expectations more likely," Pipes wrote.

BMO Capital Markets maintained its "market perform"rating on Cloud Peak.

Marshall said Cloud Peak is forecasting Powder River Basindemand will fall from around 405 million tons in the previous year to just 320million tons in 2016, a 21% reduction. He expects that as utility stockpilesnormalize and natural gas prices rise, coal demand from the basin will reboundto about 350 million tons.

The company reduced its contracted positions for 2016 by onemillion tons in the first quarter and did not make any new sales for 2017 inthe period due to low prices and a lackof demand for coal contracts. Cloud Peak said it is also indiscussion with several of its customers regarding compensation for coal thatwas contracted, but not taken by the utility due to oversupply.

"There is a growing acceptance among our customers thatthey must pay compensation if they do not take the contracted tons which willreduce the impact on our adjusted EBITDA," Marshall said.

Cloud Peak is adjusting its operations to reduce costs,including limiting its use of contractors, adjusting retiree benefits and notfilling vacant positions. Despite preparing for a structurally lower demand forcoal, Marshall said there is belief in "significant long-term U.S. coaland international thermal coal demand even with proposed anti-coal around the world."

"It is encouraging to see the [metallurgical] coalprices start to recover with increased Chinese steel production, as they'veeffectively put a cap on thermal coal prices for some time," Marshallsaid. "Overall, we continue to believe that international thermal coalprices will rise as supply and demand come into balance and we'll look torestart exports when they become economic."