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Coal supply backs up further as spring shoulder season looms

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Coal supply backs up further as spring shoulder season looms

Closing out the first quarter of 2016, March coal markets tradedflat to slightly lower. While natural gas pricing to finish winter provides no supportto coal, producers simply cannot discount further to preserve market share. Theongoing result is a substantial weakness in demand going into the shoulder seasonthat could exceed year-over-year tonnage losses seen at this time in 2015. Weeklycoal shipments during the month averaged 12 million tons, 34% below the same timelast year. The NYMEX CAPP prompt-month benchmark traded flat, while NYMEX PRB gained3 cents/ton, or 0.3%, on the month. The Illinois Basin OTC mark gained 13 cents/ton,or 0.5%. Physical markers were flat for the month, with Northern Appalachian andUinta Basin benchmarks slightly down.

The surplus of natural gas in storage grew to 843 Bcf by theend of March, with season-ending inventories well above 2.4 Tcf. While support fromweather-related demand was only sporadic, power-sector demand pushed Henry Hub spotnatural gas from a low of $1.57/MMBtu at the start of the month back to $1.87/MMBtuto close out the month. Henry Hub natural gas has now traded below $2/MMBtu forsix weeks straight, with prospects to remain there for at least the next eight weeks.

In response, coal producers are maintaining low levels of productionto balance the coal market during the first half of 2016. S&P Global MarketIntelligence estimates that 45 million tons of surplus coal inventories exist inthe market today, and it is unlikely to shrink meaningfully over the shoulder season.

The chart below shows the current price forecast of S&P GlobalMarket Intelligence for the PRB 8800 and 8400 markers.

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The near-term forward strip for PRB remains relatively depressed,as low demand keeps prices in check. PRB 8800 forwards now sell below $11/ton through2018, with only modest growth from today's pricing. A combination of additional2016 coal retirements, low natural gas prices, and the surplus of coal from lowwinter demand is expected to suppress production severely this year, with modestroom for production growth through 2019. The inventory overhang and surplus productioncapacity will limit price growth during this period. The 2018-2019 strip is expectedto come under additional pressure as coal fleet determinations are made under RegionalHaze Rule settlements. NYMEX indications for PRB 8800 are available through 2018,with the long-term forecast picking up in 2019.

NYMEX CAPP and NAPP physical pricing has held relatively firmthrough the first quarter of 2016, even as natural gas prices fell below the $2/MMBtumark. ILB markers have discounted to a greater degree so far to compete with emergentnatural gas competition in the Midwest. Export markets for high-btu steam coal andmetallurgical coal opened weak for 2016, and export demand is expected to continuetrending lower. S&P Global Market Intelligence estimates 2015 exports at 75million tons, with 60 million tons projected for 2016.

While S&P Global Market Intelligence expects bituminous coaldiscounts to ease by 2017, further price growth will be limited by intra-basin competitionfor flat-to-declining steam generation volumes through 2019.

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The above chart indicates price discounting in bituminous marketsover the near term, with upward movement to 2017 as supply and prices begin to realign.S&P Global Market Intelligence expects that price growth across most basinswill be limited after 2017 as generation demand declines by more than 100 milliontons from 2015 levels.

Coal production and demand

As noted above, production in February averaged 12 million tonsper week, as utility demand for coal, already at low levels, take a further stepdown in anticipation of low spring demand. S&P Global Market Intelligence forecastsCAPP and NAPP will lose 41 million tons of annual production in 2016 from 2015 levels,while the Southern PRB's market will shrink by 69 million tons. Electric-sectordemand as a whole is projected to fall to 626 million tons in 2016, 147 milliontons lower than 2015. Part of this demand decline reflects deferred purchases dueto buildup of inventory during this past winter.

The chart below compares the production forecast with recenthistory. As noted above, electric-sector coal demand will fall by 147 million tonsfrom 2015 to the end of 2016, before making a modest recovery. The low price regimeimposed by natural gas is projected to cause most of its coal market loss throughthe end of this year, with demand stabilizing a bit through 2019. Overall, the coalmarket is projected to shrink by an additional 93 million tons from 2015-2020, includingboth domestic demand and exports.

Production outlook PowderRiver Basin

The 2016 forecast of S&P Global Market Intelligence projects80 million tons will be lost compared to 2015, as natural gas competition gougesthe market. PRB production (Northern and Southern) for 2016 is projected at 325million tons. Ongoing pressure on electric-sector demand is expected to keep productionessentially flat through 2019, before more favorable spreads and electricity demandgrowth start to move in favor of higher coal burn. Absent a push from seasonal demand(both summer and winter) over the next few years, surplus inventory in the coalmarket may linger for several years.

Production outlook Illinois Basin

S&P Global Market Intelligence estimates that 2015 ILB productionfinished at 124 million tons. With no recovery in sight for export markets and greatergas competition in ILB's core Midwest markets, forecast production is expected tofall by 16 million tons in 2016. As with the PRB, ILB producers have some abilityto maintain low prices and preserve coal burn, which will keep production flat atthese levels through 2017. Similar to the forecast for PRB, ILB producers wouldneed a push from seasonal demand to clear the markets sooner and begin to grow production.

Production outlook Appalachian basins

Appalachian basins face rapidly declining production, particularlyin Central Appalachia, against weak metallurgical markets, and further loss of marketdue to Midwest coal retirements in 2016. Regional natural gas prices remain thelowest in the country, and prospects for higher coal plant demand appear delayeduntil summer 2016 at the earliest. S&P Global Market Intelligence currentlyexpects 2016 production will total 179 million tons, or 19.4% less than estimated2015 levels. Ongoing market loss is expected to drive 2019 production down to 171million tons. While metallurgical coal production has generallybeen firmer than production for domestic steam markets, Central Appalachia is expectedto reach a point where consolidation of production reduces met coal production capacityalong with the reduction in steam coal production capacity.

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Coal forecast methodologyoverview

Market-indicative coal forecasts produced by S&PGlobal Market Intelligence represent forward curves for spot-traded instruments,analogous to a strip of contracts, with the shorter tenors (current year, promptyear, plus additional years if available) driven by the observed/assessed marketand the longer tenors (years 3-20 for physically assessed markers, and years 5-20for markers with NYMEX futures) driven by fundamental estimates of cash costs ofproduction, accepted returns to capital, regional productive capacity, and forecastsupply and demand. For the long-tenored portion of the curve, S&P Global MarketIntelligence forecasts prices for specific coal markers, and defines the remainingmarkers via historical spreads.