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Analyst expects coal relief from cyclical recovery in domestic thermal market

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Analyst expects coal relief from cyclical recovery in domestic thermal market

A new report from FBR & Co. predicts that if currentcoal production rates and natural gas prices hold roughly level, theprice-crushing oversupply of utility coal stockpiles could to normal levels by the summer of2017.

Analyst Lucas Pipes wrote in a July 12 note that as long asnatural gas prices remain above $2.50/MMBtu, a further reduction in is likely despite a recentrebound in coal production over the past four weeks. If inventory levelsdecline, U.S. coal producers could benefit from an improvement in prices.

"With higher natural gas prices and beneficial to greater coal burn,we expect coal consumption to regain some market share in the second half ofthe year," Pipes wrote. "While the increase in domestic coalproduction does not help the speed of a recovery, we believe that domestic utility inventoriesare still likely to decline in the current natural gas price environment, evenon the more recently increased coal production levels."

FBR is assuming that 2016 coal production will be roughly22% lower year over year.Pipes wrote that based on a review of employment levels, miner productivity andmine labor utilization rates, the estimated thermal coal production capacity inthe U.S. is near 700 million tons.

Because employment at U.S. coal mines has fallen so steeply— roughly 37% from a peak in 2011 to the first quarter of 2016 — bringing backcoal production to higher levels could be difficult.

"This is not to mean that 700 million tons representsmaximum U.S. coal output, but that beyond this level, we believe that newminers would probably have to be hired, which would likely take time andrequire higher prices," Pipes wrote. "We think that the current coalsupply capacity level would meet demand up to approximately $3.50/MMBtu."

FBR wrote that investors looking for upside in the spaceshould consider CONSOL EnergyInc. The coal and natural gas producer could unlock value throughasset sales and de-lever its balance sheet without issuing equity shouldcommodity prices rise.

"Importantly, we believe the company's exposure in bothcoal and gas makes it a highly preferred name to capture greater cash flow onour expected market evolution," Pipes wrote. "We also believe thecompany's Utica assets remain well undervalued by the market and provideadditional fundamental upside potential to the name."

FBR ranked U.S. thermal coal producers it expects tooutperform in the following order AllianceResource Partners LP, HalladorEnergy Co., and WestmorelandCoal Co. In the report, they also highlight , rated at marketperform, and Cloud Peak EnergyInc., rated at market underperform.