Light at the end of the tunnel?

Jonathan Rowland

It is no understatement to say that the US coal industry has been through a pretty horrible few years. From around 907.2 million t (1 billion short t) in 2014, output contracted to 812.8 million t (895.9 million short t) in 2015, according to the US Energy Information Administration’s (EIA) ?Quarterly Coal Report January – March 2016'.¹

But worse was to come: 1Q16 production slipped to just 157 million t (173 million short t) – a 34.9% fall on 1Q15. Meanwhile, in April, Peabody Energy became the last of the top-three producers to enter bankruptcy, following rivals Alpha Natural Resources and Arch Coal.

Bouncing back?

There are signs however that the industry may be through the nadir. At the end of July, the EIA reported weekly coal production down just 11% on the same week in 2015 at a 2016 peak of 14.6 million t (16.1 million short t).² Meanwhile, year-to-date production had pulled back to 353.7 million t (389.9 million short t) – a year-on-year fall of ‘only’ 25.8%. And in the latest round of quarterly reports, some US coal companies were sounding almost positive.

“There is a growing chorus coming from US coal producers that there are things to look forward to in the back half of the year,” Taylor Kuykendall of S&P Global Market Intelligence told World Coal. Take Cloud Peak Energy, a pure-play Power River Basin (PRB) producer and the only one of the major coal producers to stay out of bankruptcy court, as an example: it wrapped up 2Q16 with some good news.

“June started off hot, which increased our customers’ nominations,” said Cloud Peak’s CEO Colin Marshall. “We currently believe that shipments are being limited by rail capacity due to the delay in bringing crews and train sets back into service. If the summer remains hot, we would expect to see a meaningful reduction in stockpiles as burn exceeds shipments and then a steady monthly increase to give us a strong second half to the year.”

Cloud Peak’s comments have been echoed by other coal companies, said Kuykendall: “We’ve heard similar news from CONSOL Energy’s CNX Resources, where the CEO essentially called May the bottom of this battered coal market cycle. Alliance Resource Partners pointed to a hot summer, depleting stockpiles and higher natural gas prices as points of optimism for the coming half. Westmoreland Coal’s executives went so far as to say they were ‘excited’ to report earnings in the second half: that’s difficult to imagine coming out of a coal executive’s mouth only a few months ago.”

There are also some big hopes for Contura Energy, the “phoenix rising from the ashes of Alpha Natural Resources” – the only one of the big three so far to leave Chapter 11 protection. “While it may be debatable how the [bankruptcy] deal will shake out for what’s left of Alpha, its employees and the states where it operates, I think it’s easy to imagine [that] Contura could find some success now that it can focus on Alpha’s premier assets,” said Kuykendall.

Alpha’s Chapter 11 deal saw Contura – a new company owned by group of Alpha’s first lien lenders – buy the best of Alpha’s operations and reserves, including the Cumberland mine complex in Northern Appalachia, Alpha’s PRB operations and three Central Appalachian mining complexes. Contura also purchased Alpha’s interest in the Dominion Terminal Associates coal export terminal in eastern Virginia – and got Alpha’s CEO, Kevin Crutchfield.

Yet despite a more positive attitude in the industry, coal production will finish the year significantly below last year’s level. Based on the EIA’s weekly forecasts to the end of July and extrapolating forward, US coal output could fall to around 594 million t (654.8 million short t) this year – a 26.9% fall. Mitchell Hugers of BMI Research is slightly more optimistic, putting US production at 653 million t (719.8 million short t) by the end of the year – but that would still see the US slip to third in the coal production rankings, behind India.

According to Hugers, India will achieve coal production of 753 million t (830 million short t) this year on the back of significant government pressure to increase output.³ And the gap will only widen over the next few years with Hugers forecasting US production falling to 590 million t (650 million short t) to 2020, while Indian production will reach almost twice that at 1.014 billion t (1.11 billion short t).

A regional picture

Behind the national figures, there are significant regional stories centred on the three major coal basins: Appalachia, the Illinois Basin and the PRB. While Appalachia has been hit hardest over the downturn as a whole, this year the pain has been pretty evenly spread – with the largest production cuts in terms of volume coming in the PRB, according to S&P’s Kuykendall.

Looking at EIA production estimates by region paints the picture. Appalachia is down 28.7%, while the Illinois Basin (Illinois, Indiana and western Kentucky) is down 29%. At the heart of the PRB, Wyoming output is down 27.2%, while Montana production (also in the PRB) is down 28%.

A caveat to the regional production picture comes in Appalachia, however, where Northern Appalachia (NAPP) is faring much better than Central Appalachia (CAPP), where production costs are at the highest. Consider the state of West Virginia: production in the north of the state (NAPP) was down just 20.4%, while that in the south of the state (CAPP) is down a much steeper 35.7%. Similarly, production in eastern Kentucky (CAPP) is down 38.3%, while that in western Kentucky (which mines in the Illinois Basin) is down only 27.5%.

CAPP “is increasingly unprofitable to mine and non-competitive,” explained Kuykendall, who expects mining there to level off at production comprising “mostly higher-quality metallurgical coals or perhaps some speciality or strategically placed coal mines.”

In comparison, “NAPP has some marked transportation advantages and some highly productive longwall mines,” Kuykendall continued. “To the extent that the big producers there, like Murray Energy and CONSOL Energy, continue to actively capture new markets and continue to serve large baseload power plants with transportation advantages, I think you may see some small growth or stabilisation there, particularly if gas prices continue to rise.”

Looking ahead and competition between the basins is likely to heat up as coal companies scrap for presence in a smaller market. While the PRB enjoys a cost advantage over both the Illinois Basin and NAPP, geography counts against it – although Kuykendall still rates it as the better bet: “The region is super low cost and the most easily competitive with natural gas,” explained Kuykendall. “Even with some significant transportation hurdles, when natural gas prices start edging up, that region is likely to grab the most demand.”

Similarly, Molly Shutt, a New-York-based Commodities Analyst at BMI Research, expects the industry to “prioritise low-cost, large-scale mines with significant reserves in the PRB and the Illinois Basin”, noting the significant cost advantages enjoyed in these regions.⁴ Continuing her forecast, Shutt expects low-cost producers in the PRB and Illinois Basin to “experience some relief by 2017 as rising natural gas prices return some domestic demand for cheaper thermal coal.”

The EIA, however, presents a slightly different forecast, noting that “almost all” of its predicted rise in production next year will come from Appalachia and the Interior region (which includes the Illinois Basin).⁵ It adds: “coal in these two regions has the advantage of lower transportation costs and a higher heat content compared with Western [i.e. PRB] region coal.”

In any case, the coal industry is going to have to adapt to large demand swings from quarter to quarter, with fortune favouring the most flexible producers. “Shipments [of coal] are going to be much more variable than we have experienced in the past,” Cloud Peak’s Marshall said. “In the future, the amount of coal burn in any particular year is going to depend on the weather and natural gas prices much more than it did previously, particularly if natural gas stays below about US$3 per million Btu.”

A result of this changing market is likely to be fewer long-term contracts, said Marshall, and more spot buying, as customers “seem confident that coal and gas will remain cheap and readily available should they need them on short notice.”

“I would like to think that before long they will be caught out by a cold winter or hot summer and declining natural gas production. This would remind them why they used to make sure they knew where their coal was coming from,” Marshall continued. Yet while this might boost coal prices in the short term, it would not roll back the fundamental shift going on in the coal market, Cloud Peak’s CEO continued.

The changing face of US power

All of this hints at the huge changes that have reshaped the US power market over the past few years. As Marshall neatly summarised: “coal now competes for marginal rather than baseload electricity production”, a state of affairs that would have been unthinkable only five or so years ago. Three principal trends have brought the industry to this point: competition, regulation and demand. And these three will continue to impact the industry going forward.

Competition

According to the EIA’s ?Electricity Monthly Update' for May,⁶ coal-fired generating capacity in the US has fallen 15% over the past six years, dropping from 317 GW at the end of 2010 to 276 GW in April 2016. Overall, coal is expected to generate just 30.3% of electricity this year, compared to the 34.3% that will be generated from natural gas. Although coal’s share will grow slightly in 2017, the EIA said, it is a far cry from coal’s recent heyday when it accounted for around half of US electricity generation.

“The problem for coal is that, for a long time, it enjoyed the benefits of being the cheapest fuel source around,” said S&P’s Kuykendall. “Now though, natural gas has become so abundant and accessible, it will likely be a long-term contender for market share.”

Adding to the competition facing coal is the roll-out of renewable generation, Kuykendall continued. “Renewables are still a small part of the US electricity portfolio, but I think the policy and societal opinion arc we find ourselves on will drive continual growth in those areas. The sector is already growing rapidly and I would predict more enthusiasm generally for both operational and research development in the space.”

Regulation

Also weighing down coal’s attraction as a fuel are a mix of regulations that have made it more expensive to mine and burn coal. “While competition from other fuel sources should be part of normal business, the onslaught of regulations, both promoting and subsidising renewables and those curtailing and increasing the cost of coal generation, are not good for the future of the US economy,” said Cloud Peak’s Marshall. “The regulatory actions being taken at state and federal levels are causing the closure of many coal plants that will not be available to provide low-cost electricity that would allow the economy to grow in future.”

The most controversial of these regulations is the Clean Power Plan (CPP). Although currently held up by legal challenges, the CPP and its tight emissions standards for coal-fired plants is the “biggest wildcard” facing the US coal and power sectors, said Kuykendall. According to the EIA’s ?Annual Energy Outlook' (AEO2016), if implemented, the CPP would see coal-fired generation drop below that of renewables in the US energy mix by 2030.⁷ Without it, coal stays ahead of renewables out until 2040.

Yet even though the Supreme Court has stayed its implementation pending a ruling on the CPP’s legality in a lower court, there are signs that it is already affecting the way that utilities and states are thinking about their fleets, said Kuykendall. “The risk of a rule that would be so restrictive on coal, probably has a lot of generators finding it easier to justify bigger spends on natural gas or other fuel systems, even if that means less coal – which has historically been more price stable – in their portfolios.”

The impact of the CPP on coal production would be severe with the EIA forecasting coal production that is 214.1 million t (234 million short t) lower by 2040 than would otherwise be the case were the rule not to come into effect. Within this, the Appalachian and Western Region share of production would fall; Interior Region share of production strengthens, however.

Demand

The final challenge facing coal power in the US receives less attention than the increase in competition and regulation. But it is significant nonetheless: a slowdown in US electricity demand growth.

“The link between economic growth and power consumption in the US – as in most developed economies – is likely to increasingly weaken over coming years” said BMI Research in its latest US power industry forecast, as growing demand for electricity services (on the back of population growth, rising disposable income and population shifts to warmer regions with greater cooling requirements) is offset by efficiency gains and growing investment in energy-efficient equipment and distributed energy solutions.

According to the AEO2016, US electricity use will grow at an average of just 0.9% per year between 2016 and 2040. This leaves less space in the electricity generation sector to absorb new generation from natural gas and renewables, amplifying the impact of those factors – such as regulation and low-cost gas – that reduce coal’s competitiveness.

A worrisome trend

Although green groups have lauded coal’s decline, a recent market survey from Black & Veatch, shows a more ambivalent view from the power sector.⁸ According to the survey, which received input from 672 qualified respondents from utility, municipality, commercial and community stakeholders, 83% of responders said early coal retirements would have a negative impact on system reliability. Reliability also topped the survey’s list of issues impacting the electric power industry, scoring an average of 4.56 out of five (five being “very important”), just ahead of cybersecurity and environmental regulation, both of which scored 4.37.

“Can anything stop the momentum towards decreasing or removing coal entirely from the US power mix? Many would say the answer is no. But at the same time, the country has yet to experience a widespread, prolonged issue with reliability,” the report said. “The country’s previous coal generation backbone has provided high reliability in the past. As coal and nuclear power disappear from the baseload realm and only gas and renewables remain, many utilities see this as a worrisome scenario.”

This is leading some utilities to commit to coal, despite the regulatory risk, as part of a diverse portfolio, as Scott Brooks, a spokesperson for Tennessee Valley Authority (TVA) told World Coal. “Coal is still an important part of TVA’s generation mix for the foreseeable future,” said Brooks. “We are working towards a diverse portfolio, which includes about 30 – 35% coal production.” To this end, TVA is investing more than US$1 billion to add environmental controls to its coal units at the Gellatin and Shawnee power plants to allow the plants to keep running. “We believe a diverse generation mix is essential to providing low-cost, reliable power to our 9 million consumers,” added Brooks.

Some in the coal industry also see a potential opportunity in the development of cleaner-coal technologies – and particularly carbon capture, utilisation and storage (CCUS).

“Cloud Peak believes that concerns about climate change and CO₂ should be addressed in a meaningful way through technology development, specifically the commercialisation and deployment of CCUS,” said Marshall. “In this, we are in full agreement with the Intergovernmental Panel on Climate Change, which has stated that achieving goals of climate stabilisation will be 138% more expensive – and may not be possible at all – without widespread deployment of CCUS.”

Development of carbon capture technologies has so far had a difficult history and may not happen at all without government support. Yet here there may be reason to be positive, points out Marshall. Legislation has been introduced in the US Senate with cross party support that would support the development of commercial-scale CCUS. Similar legislation has also been introduced in to the House of Representatives – also with cross party support.

“These bills are the latest indication of a growing bipartisan consensus that CCUS can help reduce CO₂ emissions, protect the jobs and communities of people who depend on coal and natural gas and avoid sharp energy price increases for those least able to afford them,” Marshall said.

The new world

What then is the future for US coal? It is certainly facing a number of significant challenges. That is not to argue that coal is about to disappear, however: even under the CPP, the EIA expects coal to contribute significant amounts of power to 2040, the end of its forecast period. But the industry will need to be flexible and innovative in order to make the most of its opportunities – leveraging technology and new markets in order to prosper.

Take Cloud Peak, which has achieved significant operational advances in production, safety and reclamation in recent years to help offset some of the impact of the downturn. Its commitment to preventative maintenance and in-house rebuilds are an example of this, CEO Marshall explained. These “help control costs and ensure the quality of repairs on heavy equipment used throughout the company.”

“Condition monitoring and planned maintenance programmes help extend equipment life and reduce monitoring costs without compromising equipment integrity,” Marshall explained. “The Cloud Peak Energy Rebuild Centre was started over ten years ago and continues to increase our in-house capabilities. We believe that the rebuild centre producers higher-quality work at significantly lower costs than is available from external rebuild facilities.”

The Wyoming-based mining company is also not ruling out exporting its coal again in future. “While international thermal coal markets continue to be oversupplied, they are showing signs of coming into balance as supply is reduced and demand grows,” continued Marshall. “We are optimistic that this trend will continue and will look to resume exports when they are once again economic.”

Marshall was also positive that the company could overcome opposition to the coal terminal development required to grow coal exports significantly, “so the US can benefit from the jobs, taxes and export revenues additional coal exports will bring.”

Trump to the rescue?

Others see opportunity in the presidential election coming up in November. Yet while many portray this as a clear-cut choice between an anti-coal candidate in the form of Democrat Hilary Clinton and a pro-coal choice in the form of Republican Donald Trump, the reality is less clear, said Kuykendall.

“If we are talking thermal coal markets, I would guess Clinton would do little more than continuing like-minded policies to those we’ve seen under President Barack Obama. That is to say, she may put caps and limits on the coal market in an effort to slow CO₂ emissions – but probably not at a pace much worse than what natural gas competition did in recent quarters. She has also expressed an interest in carbon capture technologies and, if one assumes we are on a path, as a country, toward lowering our CO₂ footprint, that may prove crucial. In other words, I don’t think she’s going to shut the industry down overnight as her opponents would like to believe, even if she is planning to support policies that will ultimately mean less coal burn.”

Despite this, however, Trump may not offer anything better – although he has courted the coal vote. “He’s not shown us a plan for reversing current secular trends aside from vague promises to undo many of Obama’s policies,” continued Kuykendall. “Notably he’s spent a lot of time talking about increasing natural gas production and coal production. It’d be difficult to do both without creating some massive increase in electrical demand – something that just isn’t being widely forecast. Trump, at best, could make it cheaper to mine coal but I don’t think there’s much he’s going to be able to do on the demand side at this point without massively tweaking the business models and plans of electric generators.”

BMI Research offers a similar conclusion, noting that Trump would not have the authority or Congressional support to achieve some of his pro-coal pronouncements (e.g. abolishing the Environmental Protection Agency), while global markets make his other pledges (e.g. the return of coal jobs) “unviable”.⁹

Conclusion

Ultimately, the presidential election may not have too much impact on coal’s destiny: it is certainly no panacea to the pain endured by the industry in recent times. And while there are some brighter spots on coal’s horizon, the future will be much more volatile than the past as competition, regulation and slowing electricity demand growth continue to reshape the US energy landscape.

References

1. ‘Quarterly Coal Report (Abbreviated) January – March 2016’ (US Energy Information Administration; June 2016), p. 2.
2. Production figures taken from the Energy Information Administration’s Weekly Coal Production estimate for the week ending 31 July (released: 4 August 2016).
3. For more on the Indian coal industry, see: HUGERS, M., “Good Intentions”, World Coal, Vol. 25, Issue 1, (January 2016) pp. 14 – 19.
4. See also: ‘Industry Trend Analysis – Steep Cuts in 2016 Before Hints of Relief’ (BMI Research; 25 May 2016).
5. ‘Short-Term Energy Outlook: Coal’ (US Energy Information Administration; August 2016), p. 8.
6. ‘Electricity Monthly Update: May 2016’ (US Energy Information Administration; July 2016). 
7. 'Annual Energy Outlook 2016: Rollout Presentation’ (US Energy Information Administration; June 2016). 
8. ‘2016 Strategic Directions: Electric Industry Report’ (Black & Veatch; August 2016).
9. ‘Industry Trend Analysis – US Presidential Election: Mining Industry Implications’, (BMI Research; 3 August 2016).

Acknowledgments

For sharing their insights into the US coal sector, my thanks to: Scott Brooks, Tennessee Valley Authority; Mitchell Hugers, BMI Research; Taylor Kuykendall, S&P Global Market Intelligence; and Colin Marshall, Cloud Peak Energy.

About the author: Jonathan Rowland is the editor of World Coal.

Read the article online at: https://www.worldcoal.com/special-reports/13092016/light-at-the-end-of-the-tunnel-2016-2413/