For the last two years, the March/April transition season has proven challenging for coal producers, as a combination of low natural gas prices, high inventories and low electricity demand drove large drops in tonnage moved. While many of the same factors are at play in 2017 — a surplus of natural gas in storage and a modest coal inventory overhang — firmer natural gas prices going into the shoulder season should support firmer coal demand. Weekly coal shipments eased during March on warmer weather but still showed substantial year-over-year gains. The NYMEX CAPP prompt-month benchmark closed unchanged, halting February's substantial slide, while the NYMEX PRB gained $0.43/ton (3.9%). Physical marker prices were mixed and showed slight movement, with the exception of NAPP physical markers. These fell by $1.15/ton (2.7%), potentially signaling a cooling off in high-rank bituminous markets.
Late winter weather featuring snowstorms in the Northeast supported natural gas prices throughout March. After opening the month at $2.54/MMBtu, Henry Hub spot prices moved up, retracing February losses to close March at $3.08/MMBtu. Natural gas prices gained steadily on lower production, even as the storage surplus grew from 156 Bcf in mid-February to 250 Bcf by mid-March, reaching a weekly high of 395 Bcf over that period. While current storage levels represent a potential headwind going into the shoulder season, overall results this winter suggest natural gas prices levels exceeding $3.50/MMBtu if storage works back to normal. This price level would support both price and volume growth on the coal side.
Although coal inventories remain in surplus, inventories shrank by nearly 15 million tons from November to January. Inventories closed 2016 at 164 million tons, an estimated 8% above normal levels, given shrinkage in the coal fleet via retirements. Inventories have likely been stable since January, with growth in February offset by draw downs in March. As noted above, spot coal prices have held mostly stable during this time. Ordinarily, lower demand during the second quarter would drive a decline in production of about 1.8 million tons per week, or 21 million to 23 million tons below first quarter levels. Included in this estimate is approximately 3,500 MW of coal plants expected to retire during the second quarter, which will reduce demand by 1.5 million to 2.0 million tons. Natural gas prices represent both an upside and downside risk going in to the shoulder season. While forward natural gas prices are firm above $3/MMBtu, current surpluses indicate downward pressure on prices. On the other hand, if the injection season gets off to a slow start, effectively reducing the storage surplus, we could see natural gas prices rise further during the spring.
The chart below shows the current price forecast for the PRB 8800 and 8400 markers.
The Powder River Basin has been the most vulnerable to losing volumes to gas switching over the last two years, and is likely to remain so as it accounts for an increasingly higher proportion of coal markets. Penetration of competitive shale gas into the Midwest has further increased the risk of displacement by gas. However, PRB demand can also recover rapidly when spreads to natural gas are favorable, as they were the second half of 2016. On a forward basis, the current strip for natural gas trends lower than current prices through 2018, keeping a lid on PRB 8800 price levels at $13/ton. PRB appears to have used much of its pricing "headroom" against the natural gas strip, after factoring in transport costs to plants in Texas and the Midwest. Looking past 2018, higher prices for PRB will be supported by upward movement in natural gas, but offset by coal retirements in the West and Midwest, which limits demand growth.
Higher natural gas prices at Henry Hub, along with tightening basis relationships in the Northeast shale regions, have supported higher bituminous demand through this winter, at least compared to the 2015-2016 winter. Shipments to mid-February indicate continued support reflecting higher international and domestic demand. The pricing rally in high-rank coal has slowed somewhat, potentially indicating natural gas and coal are back in close competition, with interdependent price/demand affecting both fuels. This is expected to bring Central Appalachian pricing back into line with bituminous markers in Northern Appalachia and Illinois Basin, with sustainable pricing expected in 2018. Price growth beyond 2018 will be limited by more competitive natural gas, intra-basin competition, and declining steam generation demand driven by additional coal retirements through 2021.
The above chart shows the expected easing of import-driven pricing impacting bituminous markets through 2017, with the physical NAPP and ILB markers seeing price growth in 2017. S&P Global Market Intelligence projects that electric generation demand will come under pressure in 2018-2019, with net demand falling 42 million tons from 2017-2021.
Coal production and demand
For the four weeks ending March 25, coal shipments averaged 14.7 million tons, a normal ramp down in production associated with the transition to spring and nearly 19% above the same period last year. While inventories remain above normal, firmer natural gas prices should help bring them in line over the quarter. The CAPP and NAPP coal regions are now projected to equal 2016 production levels, boosted by a firmer natural gas strip and somewhat fewer coal retirements during the year. The markets for Illinois Basin and Southern PRB are projected to rebound by 38 million tons this year on improved price competitiveness, a boost from forecasts in January-February.
The chart below compares the current production forecast with recent history. Electric sector demand is projected to grow from 657 million tons in 2016 to 673 million tons in 2017, before coming under additional pressure beginning next year. Lower natural gas prices combined with additional coal retirements will tend to keep coal generation demand levels at or below 640 million tons per year 2019-2024. The boost in demand is expected to be relatively short-lived, with the overall coal market (domestic demand and exports) projected to decline by 33 million tons by 2021, compared to 2017.
Production outlook — Powder River Basin
S&P Global Market Intelligence projects 21 million tons of new production in the PRB compared to 2016, with surplus coal inventories reduced compared to last year. Winter's mild end and the low-demand shoulder season will tend to reduce production through the second quarter, but higher natural gas pricing should limit the overall drop. Powder River Basin 2017 production (Northern and Southern) is projected at 338 million tons, 7% higher than 2016. Demand levels for non-PRB western and interior (Texas and Upper Midwest lignite) coal have held firm, limiting further growth opportunities for PRB mines.
Production outlook — Illinois Basin
Increased availability of Marcellus/Utica shale natural gas into the Midwest is becoming an entrenched feature in the market, re-creating conditions currently faced by coal generators in Appalachian regions. But higher natural gas prices through the first quarter of 2017 has supported higher tonnage. Export markets appear to be stronger as well based on reporting through January. S&P Global Market Intelligence forecasts 2017 ILB production at 115 million tons, 17 million tons higher than 2016. Coal and natural gas prices are expected to re-align by 2019, with shale gas deliverability into the Midwest tending to limit further market growth. Growth in Illinois Basin volumes post-2018 will depend principally on displacing Appalachian coal and on export market growth.
Production outlook — Appalachian basins
Growth in natural gas takeaway capacity from the Appalachian shale regions is beginning to support higher regional natural gas prices, although significant discounts to Henry Hub prices remain. While much of Appalachian basin coal production has been reduced to core metallurgical, local steam, and export steam markets, long-haul thermal markets have stabilized so far this year. S&P Global Market Intelligence expects 2017 production will total 181 million tons, one million tons higher than 2016 levels. Reverse-switching due to higher natural gas prices in 2017 is expected to supplement firm metallurgical exports. Production levels in 2018-2019 are projected lower due to lower natural gas and further coal retirements, with declines in Central Appalachia offset by slightly higher volumes in Northern Appalachia. The boost in metallurgical coal exports during the second half of 2016 has continued, and metallurgical production has held firmer than production for domestic steam markets.
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.