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Coal prices surge ahead of the shoulder season

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Coal prices surge ahead of the shoulder season

Stronger January demand for coal combined with low year-end inventories boosted February spot prices to highs for the year, as stockpile rebuilding gets underway. Overall shipments remain moderate, however, and a slump in natural gas prices heading into March appears likely to test coal's rally. Prospects for 2018 coal pricing and demand now hinge on the market pull of winter demand, offset by expected coal retirements and the return of competition from low-priced natural gas.

Most coal markets continued their uptick from January. The NYMEX CAPP benchmark was the exception, losing 25 cents/ton (0.4%), while the PRB benchmark surged $1.10/ton (9.2%) to the end of February. Higher-quality CAPP physical benchmarks were up 3.5-5.0% for the month, Northern Appalachian markers up nearly 5% and Illinois Basin moved up 3%.

January's cold weather gave way to an unusual heat wave in February, bringing warm temperatures to the Atlantic seaboard and rain to the Midwest. Gas supply remained strong during the month, causing spot natural gas prices to crash even as storage remained tight. Henry Hub spot prices opened February strong at $3.34/MMBtu, but crashed below $3/MMBtu only four days later, slumping further to close the month at $2.59/MMBtu. The storage deficit remains high at 372 Bcf through mid-February, which may help support prices if winter weather returns. Otherwise, the combination of higher coal prices and lower gas prices may act to suppress coal demand to a greater degree than normal during the spring.

Coal inventories declined to close out 2017, with the Energy Information Administration estimating stockpiles at 137 million tons. S&P Global Market Intelligence estimates normal year end stockpiles at 152 million tons, suggesting demand pressure coming out of winter to rebuild inventories through the spring.

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 export markets is offset by lower natural gas prices and retiring coal-fired generation. 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 move modestly lower from current levels, and 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.

The need to refill coal stockpiles following solid December-January demand should support bituminous markets through the first half of 2018. Bituminous markets have held firm due to strong seaborne prices, but the sudden weakness in natural gas prices presents a challenge to volumes. While natural gas storage levels may provide a boost to demand in the spring, high supply levels may keep spot prices depressed, putting a dent in second quarter coal volumes.

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The above chart forecasts flat-to-lower pricing across all bituminous coal types, as pricing pressure from natural gas builds into 2019. 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 171 million tons from 2017-2021.

Coal production and demand

For the four weeks ending February 17th, coal shipments averaged 15.5 million tons, with volumes gaining strength against low inventories. 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 projected essentially flat this year, with better export spreads offset by lower coal demand from retired capacity and renewed competition from natural gas.

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 596 million tons in 2018, before 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. Last year's boost in demand will be tested, with the overall coal market (domestic demand and exports) projected to decline by 143 million tons from 2017-2021.

Production outlook — Powder River Basin

Inventories of subbituminous coal at generators are close to normal, although natural gas prices are again trending lower. As coal plant demand in Texas rolls off due to deactivation, demand is expected to decline by about 3 million tons during the second quarter, with another 3 million tons of displaced demand due to competitive natural gas. S&P Global Market Intelligence projects modestly lower production in the PRB compared to 2016, with total PRB production (Northern and Southern) projected at 335 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 5 million tons is forecast for the PRB for 2018, with a further slump of 52 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 105 million tons, essentially flat. Natural gas prices are expected to move downward by 2019, with shale gas deliverability into the Midwest driving coal volumes down modestly. Natural gas basis declines in the Midwest are expected to impact demand in the second quarter, potentially displacing 3 million tons of bituminous coal overall. With low natural gas prices persisting beyond 2018, Illinois Basin production is projected to grow modestly from 103 million tons per year in 2020.

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. Demand drag due to coal retirements for the upcoming quarter is estimated at 3 million tons, while competitive natural gas may displace an additional 3 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, intra-basin 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 and 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.