Editorial comment
Moody’s expects a modest recovery in demand will not be sufficient enough to alleviate pressure on the beleaguered coal industry in 2021. Increasingly evident financial distress in major coal basins following a meaningful decline in export prices in 2019 worsened considerably in 2020. Global outbreaks of COVID-19 exerted pressure on demand for electricity and steel around the world, including the US power generation market where coal took the brunt of the hit compared to other fuel sources (e.g. natural gas and renewables).
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Ongoing financial distress is evident in several key bankruptcies in 2020. Continued focus on environmental, social, and governance (ESG) factors has limited consolidation necessary to facilitate an orderly decline of the thermal coal industry. We expect modest recovery in domestic demand for thermal coal, continued pressure on domestic pricing from an increasingly competitive environment for dwindling demand, and modest improvement in export prices that will allow a partial recovery in export volumes – particularly for thermal coal sold to Asia Pacific and metallurgical coal. However, we expect earnings and cash flow generation in 2021 will remain well below pre-pandemic levels experienced in 2017 – 2019.
The coal industry remains vulnerable to retrenchment in public health and economic activity. In the early days of the emerging pandemic, Moody’s identified the coal industry as likely to suffer disproportionate financial damage but a poor candidate for an industry-specific rescue package. Characteristics, such as secular decline in demand for thermal coal and aggressive use of cash to fund shareholder returns in 2017 – 2019, make an industry-specific rescue a tough sell – and that would remain the case in a second wave scenario. Most major coal producers have burned cash to fund operating losses and eroded liquidity positions. Every Moody’s-rated thermal coal producer and some metallurgical coal producers in the US coal portfolio have experienced negative rating actions (including outlook and liquidity ratings) and the rating outlook for many remains negative despite a positive inflection in demand. Any meaningful retrenchment in economic activity that undercuts demand for electricity and steel could magnify challenges for these weakened producers that have already exhausted many options to shore up liquidity.
ESG risks are significant for the coal mining industry, including very high environmental risks, high social risks, and emerging governance-related risks associated with growing challenges related to access to capital. Environmental risks, highlighted in a study that Moody’s published in 2015 and updated in 2018, limit and contribute to downward pressure on the credit ratings of coal companies. Social risks, while less acute for the coal industry compared to environmental risks, are still significant enough to be material to producers’ credit quality, leaving the industry vulnerable to socially-driven policy agenda with respect to climate change and decarbonisation. While low natural gas prices are the most significant factor influencing the reduction in domestic demand for thermal coal, ESG-related factors play a meaningful role in our analytical process. Moody’s also believes that these risks make it difficult to achieve the pace and magnitude of industry consolidation compared to other industries that experienced secular decline, such as the paper industry.
ESG risks intensified in 2020 – especially issues related to reclamation and access to capital. A faster pace of decline in demand for thermal coal highlights environmental and social risks associated with reclamation of closed coal mines, accelerating the timeline for cash spending by coal producers and heightening concerns by third parties involved with these liabilities – including providers of surety bonds. While a significant reduction in sector-level market capitalisation has reduced equity currency for publicly-traded producers and trading prices for the companies’ debt weakened further in 2020, a growing number of equity investors, debt investors, and lenders have simply decided to stop investing in thermal coal or the entire coal industry. While we observed significant debt issuance in the broader category of industrial companies in 2020, we saw very little issuance in the coal industry. We believe the experience of COVID-19 and examples observed in recent months highlights investors’ limited appetite for coal-related investments.
The Powder River Basin (PRB) is in a particularly tough spot with a consolidation attempt blocked by the Federal Trade Commission (FTC) and export opportunities blocked by ESG-related concerns. An appeals court upheld the FTC’s ruling related to a proposed joint venture between Arch Resources and Peabody Energy that would have helped the combined entity compete with low-cost natural gas. Arch thus signalled an intention to divest these assets. The PRB faces more significant challenges related to the shift toward renewable energy, which is more pronounced in the western US, and social opposition to exports in the Pacific Northwest that have made it more difficult to develop export markets to alleviate the pressures associated with falling demand for thermal coal in the US. Producers exported only a very small percentage of production to Asian coal-fired power plants where the demand for thermal coal is still growing.
