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Powder River Basin coal output snapped back in Q3, but 2018 may depend on winter

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Essential Energy Insights - September 17, 2020

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Powder River Basin coal output snapped back in Q3, but 2018 may depend on winter

After coal production snapped back to year-ago levels in the third quarter, Powder River Basin producers are eagerly watching demand in the coming months for opportunities to place tons.

The highly productive basin has its own challenges compared with other coal competitors, including transportation and quality. However, mines in the region are also among the most flexible to respond to changes in demand, and the region's volumes can fluctuate widely. Weather and other factors are being watched closely by analysts and coal producers trying to predict the future of the region.

Coal production from the basin had been as low as 75.9 million tons in the second quarter of 2017 but rose to 91.2 million tons in the most recent period. Travis Deti, executive director of the Wyoming Mining Association, recently said the industry has begun "leveling out" at a production rate it is likely to maintain for "the next few years."

However, Seaport Global Securities LLC analyst Mark Levin said in an early November note he had been "struck by how many tons" large Powder River Basin producers had yet to commit to 2018. Assuming flat shipments, he estimated Peabody Energy Corp., Arch Coal Inc. and Cloud Peak Energy Inc. are 72%, 59% and 59% priced, respectively. That would imply about 92 million tons would need to be priced for volumes to be flat in 2018 compared to 2017, something he said has not been typical.

"Peabody is comfortable with its overall priced position in the U.S., with 75% to 80% priced as of Sept. 30 (assuming 150 million tons) and an even higher share committed," Vic Svec, senior vice president of global investor and corporate relations for Peabody, the largest coal producer in the U.S., told S&P Global Market Intelligence. "This is largely in line with prior years at that time."

Seaport projects 2018 Powder River Basin volumes "will be flat at best." Peabody CFO and Executive Vice President Amy Schwetz noted on a recent earnings call that the company is going through its production planning for 2018 and will soon round out more concrete guidance.

"What you can expect from Peabody from a contracting approach is that we like to go into the year very well committed," Schwetz said. "And so certainly, our approach has been that we like to give our miners strong production plans that they can look out over the course of the year to both maximize the margins under certain contracts and keep our costs as low as we can."

Levin said the key factor for 2018 will be the weather.

"[T]he upcoming winter looks neutral to coal burn with some regions better than others," he wrote Oct. 30. "Will that be enough to get utilities off the sidelines? We aren't so sure."

Arch, Cloud Peak and Contura Energy Inc. did not respond to a request for comment on their current sales positions in the Powder River Basin. Arch President and COO Paul Lang said on a third-quarter earnings call that Arch had effectively sold out its lower-energy 8,400 Btu coal because that was the "segment that concerns me most" and "that's best we put it to rest." The company is hoping to get better prices on its higher-quality 8,800 Btu coal from the Black Thunder mine.

"I think, we're looking at '18 coming in pretty well right in line with 2017," Lang said. "The only thing I may add to that is I think there is a good chance the higher-quality mines will continue to chip away at lower-quality mines."

Cloud Peak President and CEO Colin Marshall acknowledged the market for 8,400 Btu coal is currently weak and that is why the company reduced production at the Cordero Rojo mine from its 40 million-ton peak to just 16 million to 18 million tons this year. While he expects prices to firm up for both qualities of coal enough to be profitable, how long that takes is unknown, but is "obviously years" away.

"The reality is that closing a mine and mothballing is very expensive and there are things like advancement and royalties that come in as well as just the cost of actually stopping production," Marshall said on an Oct. 26 earnings call. "Whilst the prices aren't great, we're a ways from that at the moment."

Levin also noted railway Union Pacific Corp. expects flat year-over-year coal-related traffic, which he said "doesn't appear to jibe with" what the four largest producers in the Powder River Basin are guiding for the quarter. Assuming midpoints of full-year volume guidance ranges, Levin said fourth-quarter volume from the Powder River Basin could be down by 13% year-over-year.

Meanwhile, John Hanou of Hanou Energy Consulting LLC pointed out in a recent note on the Powder River Basin that the U.S. Energy Information Administration reported subbituminous coal stocks dropping to 81.7 million tons in July, more than 25 million tons lower than March 2016. He said subbituminous stocks need to "drop below 50 million tons for producers to see any real price increases."

The recent rise in production, Hanou wrote, has created "mostly winners," but also a couple of losers. "With the exception of Contura and Westmoreland Coal Co., Powder River Basin producers are most likely to see higher production in 2017 compared to 2016." Westmoreland's first-half problems, he wrote, largely came from challenges with customers of its Absaloka mine. Contura, meanwhile, has likely been squeezed by Peter Kiewit Sons' Inc.'s Buckskin mine.

"Their inability to expand production probably came as a result of the Kiewit Buckskin mine's success in expanding markets (and production) from 7.1 million [tons] in 2016 to a projected 14.8 million in 2017," Hanou wrote.