By Lee Buchsbaum
By the end of the second and third quarters of 2008, coal executives were nearly giddy. They had never experienced such profits, especially for metallurgical coal producers. Australia’s mines in Queensland were flooded. The South Africans rationed power to the mines and the coal that made its way to port was diverted away from traditional European markets. The suddenness of the Bust of 2008 may be remembered because it happened as met coal prices peaked above $300/ton, driving a rise in prices of all coal qualities.
“Prices have never climbed that fast, and then contracted so quickly,” said Jeff Watkins, an international coal analyst with Hill & Associates. “Settlements for metallurgical coal in 2007 were moving over $120, then $150, $200, and finally $305.” Producers eager to ride the wave were exploring ways to increase met production, develop untapped met reserves, and sell every ton of cross-over coal they could bring out of the ground.
In the market’s run-up, global steel makers were also actively scoping out met properties and reserves, determined to lock in premium coking product and cut their component costs. Massey Energy, Foundation Coal, Jim Walters Resources, and others, revved up expansion plans. International met producers like Anglo-American moved aggressively. Canadian met miner Teck bought out Fording Coal Trust in a highly leveraged deal, becoming the largest met miner in Canada as a result. The Czech Republic’s New World Resources, one of Europe’s largest met coal suppliers, after going public, doubled down on a huge and successful investment in their deep mines and moved forward with plans to mine in Poland. In the U.S., large met coal producers such as Alpha Natural Resources and Cleveland Cliffs, both experiencing profits beyond their dreams, decided to merge into one of the largest international met miners and steel component suppliers.
The boom was beautiful until the bottom fell out.
With the possible exception of California, coal is still the engine of the developing and developed world. It is used to create the majority of our electricity, and coal is a vital component in steel manufacturing. Whatever the causes of the recent crash, at some point after the collapse of Lehman Brothers, the world’s market economies seized up like an automobile engine out of oil. The rod thrown through the crank case shot right into the steel sector, pierced the metallurgical market bubble, burst the coal boom, and sank the fortunes of many stakeholders and investors. If steel production is the beating heart of world industry, than big steel had a massive heart attack and today is fighting to stay out of a coma. Steel’s pain immediately swept through all of those who supply its components, especially northern and central Appalachia, and Alabama coal producers.
After surging in 2007 and most of 2008, both the demand and the pricing for coal collapsed in 2008’s final quarter. During a six-week period, from December 19 through February 6, the spot price for Northern Appalachian coal fell from $101.50/ton to $66/ton, a drop of more than one-third. In the same way that escalating met prices were the rising tide that lifted all boats, today the tide is moving the other way.
As the wheels came off, and almost 50% of all of the world’s blast furnaces went offline, the handful of international integrated steel producers who dominate the industry worldwide, stated, almost in unison, “Contracts are no longer contracts. We’re no longer buying. Stop sending us, charging us, and mining coal for us, at any price, until further notice.” Those messages, which reverberated throughout the seaborne shipping lanes, tidewater ports, and railroads resulted in a shock wave of mine shutdowns, work stoppages, and shutting of met coal. Today, coal producers continue to measure the strength of the contraction. The situation remains critical as the largest banks in the world have largely turned into zombies, unable to shore up their bad investments, unable to extend credit, immobilized by the morass they’re wallowing through.
Today hopeful eyes in the steel and coking industry are casting a skeptical look toward a raft of international stimulus packages designed to re-boot the world’s staggering economy. If successful, the many large capital intensive infrastructure projects contained within these plans will generate more jobs and new orders for the steel industry, new met coal contracts and the world’s engine will sputter back to life.
But when all of this happens, how quickly will U.S. met coal producers rebound? And when they do, where will their markets be? Will they be able to re-connect with the Asian steel giants despite improvements in Australian, South African, and new met coal production? The ifs, however, are less concerning than the reality of the situation today, which is nothing short of dire.
Tales of Woe, Fears for Tomorrow
For many reasons, coal buying came to a virtual halt as the recession deepened at the end of 2008. “We were negotiating for 2009, and customers just said ‘Call it off,’” said Steven F. Leer, chairman and CEO, Arch Coal, during the recent CERAWeek energy conference. “It’s going to be some period of time. When we’re ready, we’ll call you.”
During Coaltrans in Miami, analysts, coal brokers, and industry insiders tried to find reasons to be hopeful, while telling tales of their woe. “We’re seeing orders up for February, but January has been one of the bleakest times I can recall,” said Ernie Thrasher, president, XCoal Energy & Resources LLC. “There is a glimmer of a recovery. At least the freefall has ended.” In 2008, XCoal calculated that steel production in three of the four largest economies, the U.S., Japan, and Germany was down 6.8%, 1.2%, and 5.6% respectively. Including Russia, all four of the five largest steel producers saw contraction. Only world steel production leader China saw their output grow at a reduced 2.6% pace.
Ken Kisko, president, CoalUSA, after predicting that world wide met coal production would temporarily contract by 40 to 50 million tons, stated that demand from China and India would rebound, though nobody could really state with certainty when, though it likely would not be through 2009. However, met coal fundamentals remain strong “because the developing world still needs coal to grow,” and also, since “China soaked up so much metallurgical coal, the world outside China has added enough coke-making capacity to boost world met coal demand by 52 million metric tons a year. Nearly three-fifths of that new coke-making capacity—and resulting met coal demand—is located in the Atlantic basin, which is served by U.S. met producers,” said Kisko.
Also, on the whole, merchant Chinese coke supplies a large portion of the seaborne market, “something like 50% or more. Chinese export coke prices have remained relatively high around $400-$450/mt as a result of production cutbacks and increased demand early this year,” said Kisko. World iron output also showed a modest increase in January 2009, mainly the result of increased Chinese production, but “China is importing some metallurgical coal presently.”
Domestically, several coal and coke producers also have new coking construction planned or underway. AK Steel of Middletown, Ohio, is planning a unit and US Steel has scheduled construction of a new facility in Granite City, Ill. Nucor Steel has also announced plans to increase blast furnace production, and a supporting coke plant and is pursuing permits for a site in Louisiana with an option to build off shore.
However, with current demand flat or worse, Thrasher called new contract talks “the 800-lb gorilla in the room” and said metallurgical coal prices would certainly fall throughout 2009, but dismissed forecasts they would sink to $85/ton to $125/ton. Last year buyers were still signing $300/ton contracts with XCoal through mid-October. Then the worm turned, hard. “The week before Christmas last year saw the lowest level of (steel) production since the early 1990s. The fourth quarter was a train wreck waiting to happen, and we had the track pulled out from under us,” said Thrasher.
In a sign of the severity of the situation, huge, powerful, and formerly reliable customers started tearing up contracts, demanding they be renegotiated. “For the first time in my life, tier-one, class-A customers suddenly said a contract wasn’t a contract,” Thrasher said. “I don’t even know what a contract means any more. The steel industry used to be very respectful of contracts, but now that’s all out the window. Producers will be very cautious of the wording in a contract.”
Evidently, unlike domestic utilities which make their contractual agreements under U.S. law, many of the international steel companies, even those with U.S. subsidiaries—faced with impossible realizations—chose to move in a different direction and enjoy the nebulous contract protections afforded under, say, Ukrainian laws. Coal producers were forced to either attempt a costly, lengthy court battle, or play ball while hoping that the promised ships still showed up.
Shuddering and Shutting in as the Markets Tremble
Ground Zero is central and southern Appalachia where several underground mines, already struggling from high costs, tough conditions, tight margins, and increased regulatory enforcement have closed. With prices down this far, if they are no longer capable of selling met coal for more than $100/ton, “many producers—especially if they have high quality coal—have just decided to shut in. They know they’re losing money long term,” said Watkins. “In this market, $140/ton to $150/ton is not such a bad deal for low cost Canadian producers. For the U.S. guys, it’s a bit different. Europeans will pay a premium for U.S. coal, and Alpha Natural Resources and Massey Energy could make money at $150/ton. However overseas, many Australian producers can turn a profit for much less. The fear, for everyone, is that pricing could drop even further, below $100/ton.” And at that point, what’s the point?
“Right now the market is awful,” said an Alabama coal broker that works with many small and independent mines. “You’ve got all of these coke makers that have cut their production back 50%. You can see all the met coal producers taking coal off the markets. There’s just nowhere to sell it right now. Coke producers are taking the coal they have under contact, but no more. Steel producers are trying to renegotiate their contracts, and delaying certain shipments. Some that were due in December have been pushed back to February, or later.”
According to another experienced trader who asked to remain anonymous, many met producers are saying they think they’ve gotten to the bottom of the barrel, but the problem is the bottom is where the market will stay through 2009. “What’s killing everyone is volume,” he said. “Truth is, there is none.” What business exists is coming from overseas, primarily Europe. The best coals are selling for $200/ton, but most are going for less. “If you can get $150/ton loaded in a seaborne vessel, that works back to $100 at the mine. But the small volume the Europeans are taking means your margin hardly makes the effort worth it.” Even worse, many of the steel makers have put their met producing suppliers on notice: “if you miss any contracted tonnage, you can’t make it up. And at any time, the steel makers can curtail their contracted coal orders.”
Last year, Jim Walters Resources had planned on expanding their No. 7 mine, but that has been delayed. In their recent earnings call they would only give an estimate on what they expect to sell, but only for the first quarter. Chairman Michael T. Tokarz cited growth in the core natural resources businesses despite global difficulties in the steel industry. Walters, who reportedly once sold coal at $305/ton to a Japanese steel maker, said their fourth-quarter average selling price of $167.19 compared to $85.73/ton in the year-ago period. Revenues in 2008 were $1.5 billion, up 19.9% from 2007. The increase was primarily attributed to higher metallurgical coal and coke pricing. “But according to another coal broker, when the bust came, several producers had orders for shiploads of prime met coal on the ground at the Port of Mobile that were suddenly cancelled. It happened so rapidly that the ships showed up and were sitting there in the port. They couldn’t even give it away,” said the source.
Further north, Patriot Coal Corp., which recently merged with Magnum Coal to become one of Central Appalachia’s largest met coal providers, reacted quickly to the slowdown by announcing the closure of their Black Oak metallurgical coal mine until market conditions improved. Patriot had planned on 900,000 tons of coal from the mine in 2009. Patriot sees Black Oak as a follow-on operation to replace metallurgical production from the Harris mine, which is reaching the end of its mine life. By not moving forward with Black Oak, coal from both operations will be pulled from the market.
Cliffs Natural Resources announced that it was idling its Pinnacle Complex in West Virginia for the month of February. Affecting about 360 employees, the closure will chop roughly 85,000 tons of met production from projected 2009 totals.
Alpha Natural Resources, which has become the largest U.S. supplier of met coal, saw export shipments rise by more than 1 million tons in 2008 over 2007 figures as the company reached a new high for metallurgical sales of 11.9 million tons in 2008 compared with 11 million tons the year before. Though steel production worldwide slipped 24% in the final quarter of 2008, the company is cautiously optimistic. “There have been no less than 80 separate production cuts announced by steel companies since October, a development that dramatically reduced their raw material requirements at the end of 2008,” said Kevin Crutchfield, president, Alpha Natural Resources. “Such draconian actions create a lot of short-term pain, but also hopefully accelerate the eventual recovery in iron and steel production as apparent demand outgrows available supply. Still, there’s no denying that our expectations are tempered and outlook cautious as we enter 2009.”
Continued uncertainty looms over international contracts for Alpha’s remaining planned metallurgical coal production in 2009. “Currently, there’s no precise indication where prices will settle out for the various coking coal qualities,” according to the company. Coal sales volumes of 6.4 million tons for the fourth quarter of 2008 were 14% lower than the prior year and represented the lowest sales level since the first quarter of 2005. One of the primary reasons for the decline were sharply lower domestic metallurgical sales, down 325,000 tons or 30%. In early December, Alpha also announced that customers were asking the company to defer scheduled fourth quarter shipments of metallurgical coal. Although December 2008 metallurgical shipments dropped 37%, or more than 350,000 tons, from the prior December, metallurgical coal revenues for the full quarter were nearly 50% above last year’s levels due to higher price realizations. At one point, Alpha estimated that fourth-quarter shipments of met coal would be reduced by approximately 500,000 tons due to deferments initiated by customers as the overall deterioration of the steel markets has in one instance led a customer to seek to reopen 2009 contract negotiations.
Going forward, Alpha is scaling back some of their met sales this year through a combination of reduced production and less third party purchases. But, after taking their Kingwood mine off line, which removed about 700,000 met tons from the market place, they do not have any further planned closings in the works. “We acted early and made appropriate reductions,” said Ted Pile, vice president of corporate communications, Alpha Natural Resources.
Foundation Coal produces approximately 1.5 million tons of met coal a year from their Pax and Kingston mines in West Virginia.
Foundation declined to discuss its present metallurgical operations nor how the downturn affected them due to an on-going litigation with a steel producer. According to the company’s fourth quarter earnings call, Jim Roberts, chairman of the board of directors and CEO, Foundation Coal, said the company’s Central Appalachian affiliate, Kingston Resources, filed a complaint in U.S. District Court for the Western District of Pennsylvania against ArcelorMittal USA seeking enforcement of an existing coal supply agreement.
International Coal Group (ICG) announced that it had been forced to re-negotiate some of its loans because the company may have to violate their terms in late 2009 due to falling prices and continued weak demand. While the company has locked in much of its 2009 steam production, ICG is concerned about “contracted” sales of met coal. The company’s recent quarterly losses were exacerbated by lower shipments and deferrals of some met coal to steelmakers who suddenly refused to take what they had previously ordered. In response, ICG is idling some high-cost production mines, delaying expansion and cutting its 2009 capital expenditure. “The global economic crisis came to bear heavily on the coal industry in the fourth quarter, as many steel companies suspended metallurgical coal shipments across the board and utilities responded to sagging electricity demand by halting spot coal purchases,” said Ben Hatfield, CEO, ICG.
Though several big steel customers did request deferments instead of outright cancellations—choosing instead to re-open and renegotiate settled business, this provided an opportunity to squeeze out some benefits for both parties. “Maybe you agree to talk about price adjustments, but in exchange for additional tonnage commitments in the out years,” said Pile. “If our longer-standing customers are facing distress like they are in today’s dismal market, we usually will work with them individually, on a customer by customer basis, and try to reach an agreement that benefits both parties.” Not all steel producers are in a hurry to create a new contract, or to settle. The steel industry really “doesn’t know where their end use demand levels are going to be near term. So for them, it’s really difficult to ascertain what direction to take on their raw material needs,” said Pile.
CONSOL Energy Dodges the Bullet
With well over a century of experience, CONSOL Energy has experienced market busts before, and they’ve learned how to take evasive action. In their recent earnings call, the company announced that they’ve reduced their overall mining plans for 2009 to 65 million tons, or about what they produced in 2008. A good portion of that planned reduction is in their met sector, especially Mine 84 in southwestern Pennsylvania—which produces primarily cross over coal—and their Buchanan mine in Virginia, one of the premier met mines in the nation.
“We had initially thought in 2008 that we could run Mine 84 as a cross over met mine, producing about 600,000 tons a year with several CM sections,” said Tom Hoffman, senior vice president, external affairs, CONSOL Energy. But with high mining costs and almost no market for even premium coking coals, CONSOL decided to idle Mine 84 beginning in mid-March of 2009. “We’ve given 60 days notice to our 275 person workforce that we are going to put it on a long term idle. It’s not a closing, but we expect to idle the mine for at least six months. We believe that unless there is a dramatic turnaround in global economies, cross over tons are going to be hard to place.” Without the premium CONSOL receives for met cross over, Hoffman explained, it’s hard to profitably operate in that situation. “We went from having a market where you could get $150/ton for cross over coal, to not being idle to get anything for it. There really isn’t a market today.”
Located 1,800 ft deep in southwestern Virginia, Buchanan is CONSOL’s principal low vol met mine, it has the capacity, if run all year, to produce about 4.5 million tons of all premium grade product. The company is going to target 3.1 million tons, about three-fourths its total capacity. Through a strategy of cutting back production shifts from three to two per day, and idling the mine from time to time to make sure that the production schedule is keeping up with demand, CONSOL will prevent a lot of coal from being put on the ground. “We want to make sure that we’re only bringing up what’s needed. We have contracts in place for all 3.1 million tons and we expect customers will take that coal, so we are planning to proceed. But we’ll manage the timing of that production very closely,” said Hoffman. (As this issue went to press, CONSOL announced it was shutting the mine for the month of March.)
If the market picks up, CONSOL is poised to move rapidly to take advantage of any opportunities. “We could respond quickly if needed, and pick up the pace of mining if a need arises. We worry first and foremost about stockpiles growing at our mines,” said Hoffman. At the end of the day, he believes CONSOL will sell about 3.6 million tons of met coals of various qualities in 2009, “that’s down about 5 million tons from last year, maybe 30% to 40% overall.”
Shots Felt All Around the World
In Canada, Teck, currently dealing with a debt load taken on through their $14 billion purchase of Fording Coal Trust in 2008, has been forced into drastic action, cutting more than 1,400 jobs and putting many of their assets up for sale. Now the world’s second largest producer of met coal, Teck, is trying to sell assets to pay down its debt. As a diversified resources firm focused on copper, zinc, oil sands, and gold, as well as met coal, Teck has options, and is expected to sell as much as 49% of its Elk Valley met mine and several gold properties. Japanese trading house Mitsui & Co. is among potential bidders for their Elk Valley mine in a deal that could be worth roughly $2.5 billion for the troubled company. Like all met miners, Teck found itself looking into an abyss by the third quarter of 2008. Of the US$5.2 billion profit the company earned last year, $4.3 billion came in the first half of the year.
Likewise, world met coal production leader, AngloAmerican, said in late February that it has curtailed its metallurgical coal production forecast for 2009 in the face of the fragile markets. “The outlook for 2009 for both metallurgical and thermal coal remains uncertain in a testing macro-economic environment where global energy prices are expected to be highly volatile,” the company said. Already, the company has shelved plans to increase metallurgical coal production by 10% through the year. It now expects annual met production to be marginally below the 14.7 million mt produced in 2008, about 15% of its total production of 99.5 million mt in 2008.
But there are signs that even profitable Czech met producer, New World Resources, chaired by ex-BHP Billiton Executive Mike Salamon, was giving serious ground by agreeing with customers such as ArcelorMittal to a 33% reduction in average coking coal prices this year, to €91.50 or $117.368/ton on falling volumes. In a late February earnings call, the company said that this year it expects to cut production at least 5% to 12.1 million mt in response to shrinking Central European demand. “Let’s be realistic—the steel industry is in grave stress,” Salamon said, adding that some Czech steel mills had already shut down. However, New World plans to increase its market share in central and eastern Europe this year as the shrinking customer base looks for a reliable supplier.
Predictions, Dire and Otherwise
At a recent meeting of the West Virginia Coal Association, Hal Quinn, president of the National Mining Association, predicted that overall U.S. coal production will decline 4% this year, while coking coal will fall 11% due to plunging demand for steel.
Though the economic news hasn’t improved through February 2009, Watkins “is still bullish long term. The U.S. is still the world’s engine and China and India are still coming along after. The markets will be there for met coal.” But when, for what price, and from where will that demand come?
The recent run up in prices was largely fueled by what was then seen as China’s insatiable demand. When Australia couldn’t fulfill their needs, the U.S. stepped up. Watkins admitted that the recent competitive holiday U.S. producers enjoyed in Asia is likely over. “Production problems overseas have greatly been solved,” said Watkins. “We see Australia opening up, though we’re not calling for big production increases soon. But they are expanding ports and rail capacity.” It’s likely that when the market bounces back, Australia will no longer be constrained. At that point, U.S. opportunities in Asia will evaporate as the Aussies will again dominate there. When that happens, “it’s back to Brazil, Europe, and Canada,” said Watkins.
“Things will get better,” said Hoffman. “Australia can set a very low marker if they want as a result of increased efficiencies in both production and shipment to vessels, not to mention the impact of the U.S. dollar against the Australian dollar,” said Kisko. Some sources are reporting that new prices at the negotiating tables are hovering around $140-$150, with some spot deals even lower. “But I suspect part of the equation will include settlement of unshipped contract tons now on the books,” said Kisko. “Australia and Canada will set the market, effecting the selection and amount of U.S. coking coal to be shipped. My guess is that the benchmark will be more like US$130. Keep in mind there are premiums and discounts to be made for individual coals based on value in use analysis by buyers and buyer options. Ocean freight has been on the rise and that will affect delivered costs comparing Australian, Canadian, and U.S. sources.” The stimulus packages announced in the U.S., China, and Europe each “have a lot of money for infrastructure projects which will use steel. So we should see some improvements, though we don’t have a great feel for when that will occur. You have to believe in the long run we’re going to get through this.” While that may be true, for companies that are heavily leveraged and dependent on high cost met mining, there could easily be some shakeout, Hoffman explained, especially with the tight credit markets.
Looking back on the collapse, Hoffman commented that CONSOL never felt like it was a good strategy to chase the met market. “The cyclicality of it has been pretty well demonstrated,” he said. “Even when prices were about $300/ton, we didn’t have a plan to double our met production. We felt strongly that the cyclicality hadn’t been squeezed out yet. Though we also didn’t predict that the market would just drop off a cliff. The rate of slowdown just took everybody’s breath away.”
At their February 4 earnings call, Crutchfield gave reasons to be hopeful. “We’re seeing some positive signs that maybe, just maybe, conditions are beginning to turn, or are at least stabilize. Steel service center inventories in the U.S. declined five consecutive months through December, and at year end stood at a 15 year low. This de-stocking is vitally important for the steel manufacturers to return to more normalized capacity utilization levels. As of about two weeks ago, steel capacity utilization levels were mired in the 42% to 43% range. While that’s not good, it’s better than late December or early January when capacity utilization bottomed in the mid-30% range. Meanwhile, in January, momentum seemed to pick up on steel orders. Positive signals are coming out of China in terms of lower coal exports and higher steel prices, and in Brazil where steel sales began to recover in January.”
“2009 isn’t going to be a bad year, even at some the rumored numbers we’re hearing about in the marketplace. It could be the second best price realization ever for U.S. met producers as a whole,” said Pile. “Also people forget that most of Alpha’s business is thermal and we have a nice pop in our steam pricing for the tons we’ve committed going out. Everyone is caught in this hang wringing but most of the other large coal companies did lock up their thermal books at decent prices too. It’s not as if we’re all facing a calamitous drop.”
Buchsbaum is a Denver-based freelance writer and photographer specializing in industrial subjects. He can be reached through his Web site at www.lmbphotography.com or by phone at 303-746-8172.