The long-term outlook for metallurgical coal remains "very attractive," B. Riley FBR analyst Lucas Pipes said on a call with the American Coal Council.
There are various reasons to expect higher demand for metallurgical coal while the supply-side response remains muted, Pipes said during a Sept. 19 webinar. Developing regions such as India are expected to continue to contribute to demand levels supportive of prices around $160/tonne. Pipes said the current supply-demand picture offers attractive valuations on North American coal stocks covered by FBR.
"We'll see where prices shake out over the next few quarters — it's always hard to tell where the bottom is," Pipes said. "But from a long term perspective, we think met coal remains favorable. The high cost of capital, in our opinion, will likely continue to hold back a broader supply response."
Pipes estimated that most coal equities are discounting prices at or below $140/tonne. With capital allocation toward the coal sector relatively limited and most large coal companies redirecting their cash back to shareholders in the form of stock buybacks or dividends, a large amount of new supply from the U.S. is unlikely to materialize.
While there are a few new metallurgical coal projects in the pipeline from companies including Consol Energy Inc. and Arch Coal Inc., that is unlikely to change the overall supply picture that much, Pipes said. There could even be more production cuts coming from U.S. producers soon.
"We believe that at current prices, a number of higher-cost mines in the U.S. are likely cash flow negative," Pipes said. "We believe that despite almost three years of strong met coal prices from 2016 through mid-2019, the supply response in the industry appears to be very muted. ... This is a dramatic change from a decade ago when the sector had much greater access to capital to respond to the higher price signal at that time."
While India is expected to be one of the largest importers of metallurgical coal in the coming years, China is now the biggest driver of those coal markets, Pipes said. China's high level of coal imports, however, have been determined to be more than desired by Chinese officials, leading to more stringent restrictions on coal imports.
"China has really been the thread on by which the global met coal market has been hanging on in the first half of the year, and it has been so supportive of these higher prices," Pipes said. "These restrictions have, unfortunately, provided a significant headwind to spot prices here in the short term."
How exactly restrictions will play out splits the investment community, the analyst added. Bullish investors say reduced import limitations will lead seaborne prices to snap back to higher levels. More bearish observers are concerned that current Chinese steel demand is not sustainable and their appetite for metallurgical coal imports will drop, Pipes said.
