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Winter's timely arrival puts coal on firmer 2018 footing

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Winter's timely arrival puts coal on firmer 2018 footing

Cold temperatures through the Midwest and Northeast put heating demand for natural gas into overdrive, widening the storage deficit and pushing prices to levels more favorable for coal generation. The winter weather extended to the Southeast, giving a boost to electric demand for heating there as well. While domestic coal shipments tapered during the month, prices appear poised to remain firm through the winter months, with the upcoming spring shoulder season drawing support from inventory deficits in both coal and natural gas.

Coal markets mostly rallied on improved prospects for demand, with ongoing strength in export markets adding support. The NYMEX CAPP benchmark actually lost 75 cents/ton (1.3%), while the PRB benchmark gained 50 cents/ton (1.1%) through January. CAPP physical benchmarks were up 2.5-3.5% for the month, with other markers essentially flat.

Severe winter weather hit the Eastern U.S. the first half of January, spiking natural gas prices. Spot supply availability has remained high however, causing prices to crash as soon as the weather abated. Henry Hub spot prices opened January at $2.97/MMBtu, and moved as high as $7.54/MMBtu, before easing to close the month at $3.60/MMBtu. The persistent cold weather expanded the natural gas storage deficit by 400 Bcf over a four-week period. If deficits can remain at this level through the end of winter, it will provide demand support to refill storage in the spring.

Coal inventories began seasonal building in October, with the Energy Information Administration estimating stockpiles at 141 million tons. S&P Global Market Intelligence estimates 2017 year end stockpiles at 145 million tons, providing modest demand pressure to rebuild inventories in 2018.

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, or PRB, is expected to be driven by domestic demand dynamics, with a potential boost in exports due to strong spreads the first half of the year. Flat pricing is expected in the near-term as higher demand from positive spreads against natural gas and against export markets is offset by retiring coal-fired generation, particularly PRB coal plants in Texas. Long-haul PRB is resilient to gas generation priced from $2.85-3.00 per MMBtu, but with the current strip for natural gas trending lower through 2019, PRB 8800 is forecast to remain below $13/ton. Looking past 2018, higher prices for PRB will be supported by upward movement in natural gas prices, offset by the continued demand drag of coal retirements and natural gas conversions in the West, Texas and the Midwest.

Higher natural gas prices coupled with low storage levels should support bituminous markets through the first half of 2018. Bituminous markets have held firm due to strong seaborne prices, and a higher natural gas price domestically provides headroom for that to continue. Demand for natural gas storage refill in the spring may provide a bridge of supportive pricing that sustains coal demand ahead of summer.

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The above chart forecasts flat-to-lower pricing in Central Appalachia as pricing pressure from natural gas builds into 2019, along with modest growth in Northern Appalachia and Illinois Basin coal prices as surplus inventories are cleared. S&P Global Market Intelligence projects that a combination of low and stable natural gas prices and a further wave of coal retirements will pressure generation demand in 2018-2019, with overall demand falling by 158 million tons from 2017-2021.

Coal production and demand

For the four weeks ending Jan. 27, coal shipments averaged 13.9 million tons, with improved demand at coal plants not immediately translating to shipments. Winter weather may have impacted some coal shipments as well. Production levels in eastern bituminous regions (Central, Northern, and Southern Appalachia) are forecast lower from 2017 by over 9% in 2018. An easing of metallurgical export markets combined with lower domestic steam demand drive this outlook. The markets for Illinois Basin and Southern PRB are also projected to grow by 12 million tons this year, with better export spreads than eastern coal and more resilience to natural gas prices.

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 616 million tons in 2018, coming under further pressure in 2019. A surge in announced coal retirements over the next four years combined with flat-to-lower natural gas prices is projected to push coal generation demand to nearly 500 million tons per year over the forecast. This year's boost in demand is forecast to be temporary, with the overall coal market (domestic demand and exports) projected to decline by 135 million tons from 2017-2021.

Production outlook — Powder River Basin

Inventories of subbituminous coal at generators are close to normal, with supportive natural gas pricing in store for the first half of the year. S&P Global Market Intelligence projects modestly lower production in the PRB compared to 2016, with total PRB production (Northern and Southern) projected at 337 million tons. Retirement of coal generation in the Midwest and Texas, along with flat natural gas prices, will tend to shrink the market over the next couple of years. Modest growth opportunities include displacement of smaller western coal producers and export markets. Overall, a small decline of 3 million tons is forecast for the PRB for 2018, with a further decline of 23 million tons forecast 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, which has been offset to a degree by export volumes. Production reports to close 2017 indicate total production of 103 million tons, just 5 million tons greater than 2016. S&P Global Market Intelligence forecasts 2018 ILB production at 114 million tons, with most of the growth occurring the first half of the year. Natural gas prices are expected to move downward by 2019, with shale gas deliverability into the Midwest driving coal volumes back down. A decline in production of 14 million tons is forecast in 2019 as long-haul volumes come under increasing competitive pressure and additional coal plants retire.

Production outlook — Appalachian basins

While much of Appalachian basin coal production has been reduced to core metallurgical, local steam and export steam markets, long-haul thermal markets finished 2017 at sharply higher levels than 2016. Production reports indicate 2017 production will total 198 million tons. Production levels in 2018-2019 are projected to decline by 14 million tons and 19 million tons, respectively, due to lower natural gas prices, intrabasin competition with the Illinois Basin, and further coal retirements in the region. The growth in 2017 metallurgical exports is forecast to taper by 2018 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.