By Lee Buchsbaum, Associate Editor and Photographer

The dominant theme for the 2012 Coaltrans Conference in Miami was the continued movement of coal away from domestic markets and into the export sphere. Once again, the two big drivers for these shifts are the potential markets in China and India as well as other developing nations. Though China, which has tremendous coal reserves of its own, will continue to be served by Australia, Indonesia and South Africa, as well as new mines coming online in Russia and Mongolia, those Asian and foreign markets are becoming crucial for the success of U.S. coal suppliers.

With low natural gas prices and draconian environmental regulations squeezing domestic coal markets, it is now clear that the entire coal industry will have to adjust to a new economic paradigm. In this new world, railroads will be focusing on moving coal not from a particular production region to one of hundreds of power plants, but from coal field to tidewater. How successful a producer is at gaining efficiencies of scale through high volume long-haul moves from mine to port may be the key to success. Or, the recipe for failure.

Anywhere but Here
Going forward, between China and India, coal demand may exceed more than 500 million tons. And, while over the next 20 years, Asia will be served primarily by other producers, “beginning around 2016 and 2017, the U.S. will really start ramping up exports off the West Coast. New port capacity will allow western coal to go over to the Asian market in large numbers, perhaps 10 to 15 million tons of additional supply over the next five to 10 years,” said John Eaves, president and COO, Arch Coal.

Observing that in 2011 the U.S. exported about 108 million tons—the most since 1992—Eaves sees this as part of a longer-term trend. While Arch has an established position on the East Coast through an ownership stake in the DTA Terminal in Hampton Roads, Va., and now along the Gulf Coast, in the near-term as a series of large new western ports open up, export tonnage will become much higher. “We’re forecasting that by 2015-2016, the U.S. will have the capacity to export roughly 250 million tons. Right now, every port operator in the west is looking at expansion opportunities. When we think about the West, we’re thinking Cherry Point and Millennium,” said Eaves, referring to the planned ports on the Columbia River near Longview and on the Pacific coast near Bellingham, Wash. “It could be three to five years but at the end of the day, we will really unlock the opportunity for Powder River Basin coal and western coal going into the international markets. However, there will not be a whole lot of growth until we open up those ports,” said Eaves.

Eaves also believes western bituminous coal will have a much larger role to play in the international markets as well. Though Arch is now shipping limited amounts through Long Beach, Calif., the company’s 38% equity stake in the Millennium Bulk Terminals and Arch’s agreement with Ridley Terminal in Prince Rupert, B.C., will allow increasing amounts of PRB and western bituminous to reach larger markets. “During this time, the U.S. will grow from being a swing supplier to being a base supplier of high quality coal into the international market for years to come,” said Eaves.

Bob Pusateri, executive vice president-energy sales and transportation, CONSOL Energy, echoed much of what Eaves discussed confidently discussing the future of metallurgical and pulverized coal injection (PCI) blends. While the future of these coals overseas is bright, little will be able to reverse the decline of central Appalachian production and the displacements caused by low natural gas prices. “No one knows for sure how many tons have been displaced by natural gas, roughly 40 million tons or more by our calculations. But it’s becoming clear that nearly every plant that has the ability to burn gas has or is shifting over to it now,” Pusateri said.

For producers like CONSOL Energy that are able to sell into the lucrative coal export markets, a robust future awaits. “Last year was a very good year for exports and CONSOL Energy enjoyed a record year. Exports will continue to be a major part of the U.S. coal market for the rest of the decade,” Pusateri said.

Though most industry observers are familiar with the Chinese and Indian growth stories, he also mentioned that CONSOL Energy is looking at much larger market base. “We’re also talking about the coal fired power plants in Turkey, Chile, Vietnam and Indonesia, and beyond. Coal will continue to provide a means of energy for the whole world,” said Pusateri. However, China has developed into a huge player in the international met coal trade and “we don’t think there’s any reason to believe this will change. China is built on steel.”

The blend of Pittsburgh No. 8 coal that CONSOL Energy produces has historically been a metallurgical stalwart. “A lot of people refer to it as crossover met coal. But it is responsible for the growth of America’s great steel industry,” Pusateri said. In the U.S., metallurgical demand continues to be driven by domestic auto production and sales. Following a rough 2008-2009, “auto sales were very strong in November and December of 2011. In fact it was the best December since 2007,” Pusateri said. And while he hopes the U.S. economy’s resurgence is right around the corner, like most coal operators, CONSOL Energy is betting that “exports are a long-term story. And, to that end, it is expanding to serve those markets,” Pusateri said.

CAPP Production Diminishes
As markets change and Central Appalachia (CAPP) goes into decline, where will the new coal growth come from? That was the subject of venerable analyst John Hanou of Hanou Energy Consulting. The answer—in large part—is the Illinois Basin.

“Historically, coal supply meets coal demand. Even though production maturity is reached after the peak supply for a particular region has passed, historically there continues to be increasing demand for the product. That, in turn, is mainly determined by cost and certain uncontrollable factors,” Hanou said. “In the coal business, some basins will run out of their economic supply. But demand keeps increasing, so we end up having a Btu deficit. The supply in a particular basin may be decreasing, but the demand has to be met somewhere else.”

Looking at the history of coal production in the U.S., as one region’s low cost reserves are exhausted, production shifts to another region. Pennsylvania anthra-cite saw its peak around World War I. After World War II, it went into steep decline—just as CAPP product began to flood the market. “Then, between 1985 and 1995, CAPP met its peak—now 20 to 30 years ago. Further west, though the Illinois Basin has a tremendous reserve base, coal quality is poorer in general than CAPP, with higher sulfur and lower Btu coals predominating,” said Hanou. Though the Illinois Basin (ILB) has been mined extensively for well over a century, it has not yet reached that exhaustion peak.

Further west, the PRB has impacted the demand for both ILB and CAPP coal because of the very low cost and very low sulfur production coming from that region. “I don’t know where the demand is going to go, but I have no doubt that the demand is there. PRB production will expand—but because of all the scrubbers that are being built and the high demand for export, we’re seeing a resurgence in the Illinois Basin,” said Hanou. In 2010, over 107 million tons were produced out of the that region. Last year, that figure climbed to about 115 million. In 2012, we’ll see roughly 129 to 141 million tons of production from there. We’re still on a tremendous upslope. And if the demand is there, it can even expand beyond that.”

Production from the Western Bituminous fields in Colorado and Utah could also increase, particularly because that coal is relatively high in Btus, and very low in sulfur. “It should do pretty well in the export market. Production in Utah can expand, there are enough reserves out there and enough mines. They have had some infrastructure issues, and they can’t expand as fast as say the Illinois basin, but it still has potential,” Hanou said. And with new terminals coming on line, that coal can be more economically shipped in large quantities.

The real competition to the expanding Illinois Basin coal is going to come from the Pittsburgh No. 8 seam. In 2011, producers mined more than 80 million tons of Pittsburgh No. 8 and a lot of new production is coming online. “CONSOL Energy, Murray Energy, Alpha Natural Resources and Alliance Resource Partners all have expansion plans. If they all work out like they want to, Pittsburgh No. 8 production could easily grow in the next five years or so by 30, 40, or maybe 50 million tons,” said Hanou.

Most of this new production will come from highly efficient longwall mines extracting out of virgin reserves. This is particularly true in the ILB. “What’s planned by these companies is 190 million tons of production. That’s not going to happen. I don’t think the market can stand that. However, 45% to 50% of that expansion, about 87 million tons, has already been capitalized. So you figure another 40 million tons is going to be mined either way,” said Hanou.

“As a result of all the new, low cost production, CAPP will not recover going forward, but it’s not going to go away either. However, it will never be the basin that it used to,” said Hanou.

 

New Rail Corridors & Strategies
With all the changing and shifting production and markets, what is required of the rail industry to keep U.S. coal moving? What sort of infrastructure and logistics will need to be created to keep the new production flowing to the export markets? Jamie Heller, president, Hellerworx, a rail consultancy group, tried to answer those questions.

No single commodity is more important to the railroad industry than coal. 44% of all tonnage moved by the railroads in 2010 was coal and it generally accounts for one quarter of the industry’s revenue. Even with the downturn, the railroads are still moving tremendous tonnage. “Our railroads are in really good shape. Remarkably during the recession, they continued to invest in infrastructure and facility expansion, although not necessarily in the coal area. Because of that, the railroads’ capacity to handle traffic has remained strong,” said Heller.

“Way back in 2008, when we were talking about coal traffic growth, you would have heard about the 70 to 100 new coal-fired power plants on the drawing boards along with new coal-to-liquids, coal-to-gas, and coal to everything plants. That is a world we are not currently in or contemplating. It is permanently dead. The combination of low economic growth, low natural gas prices, and very stringent environmental regulations makes it pretty grim for the expansion of new coal projects,” said Heller. “That paradigm will not change until something in terms of real carbon capture and sequestration gets put in place. So all of the growth in coal traffic will have to come from exports.”

The problem is that the U.S. rail network, outside of central and parts of northern Appalachia, was not built to take coal to tidewater. Instead, in the post-World War II era, the rail infrastructure has been reconfigured to haul steam coal from mines to power plants. “If you look at the routes over which steam coal moves in the U.S, they’re pretty spread out,” said Heller. Only CAPP coal enjoys a straight shot to Norfolk or Hamptons Road export facilities in Virignia. To a lesser extent, Alabama coal can easily be shipped to the Gulf as can a lot of Illinois Basin coal. But the reality is very different for western Bituminous and PRB coal, and, to a great degree, Northern Appalachia. While capacity has appeared in the rail network, that capacity is different in location than the export routes.”

So what happens to the network now? They evolve. NS and CSX have both been realigning traditional routes to take more ILB steam coal into areas previously served by CAPP products. However, much of the new capacity has come in areas—much of which is on CSX—in CAPP, because of a decline in market share. “But when you consider that this is a relatively small group of lines that previously provided much of the coal to the steam and export market, now that capacity has freed up other coal spots for the export market,” said Heller.

But as one reviews railroad earnings reports, it reveals that they have found a way to recoup what would otherwise be tremendous losses. “For NS, there’s virtually no increase in coal traffic, but yet there’s been a 26% increase in revenue. This reflects the growth in export traffic. This traffic is extremely profitable. Which in turn means there will be an increased Wall Street focus on and anticipation about eastern carriers handling more export coal,” said Heller.

Focusing on a handful of corridors is a challenge. There are 105 domestic utility power plants that CSX serves and 81 domestic industrial plants. Conversely, in 2011 there were only five export locations. “They’ve had to reposition locomotives and cars. It also means that the traffic is obviously spread over a smaller section of the system which means congestion problems can arise and they have. But these have actually helped their collective bottom lines. I know that if I were a western railroad, I too would be focusing real hard on exports and creating export opportunities, and that’s what BNSF has been doing,” said Heller.

Whichever way the markets settle, coal is going to continue to dominate railroad profits. But this may not take the form of the kind of rapid growth Wall Street wants. The railroads have never been particularly interested in cutting rates anywhere, at anytime. But when one considers the domestic utility picture, export growth is becoming much more important to the industry. “However, railroads competing with railroads is really something Wall Street doesn’t appreciate. So you’re looking at pushing traffic by cutting prices. I think that is going to be a while. The railroads have been pretty good at shaking rail rates to meet what they need to in order to match profitability,” said Heller.

Once You Get to Tidewater, What Happens Next?
Getting that coal to market, however, is going to be a bit tricky, said Robin Masters, vice president of shipping at Simpson Spence and Young in New York. Faced with a glut of new ships entering the market and virtually no back haul for them returning from China and India, “it’s quite a dangerous time for one side of the coin and for those who are actually aboard ships. For those of you who charter vessels, forward freight agreements (FFA) will be challenging and, for ship owners, expectations are meager. Today most ships are trading at low operating costs,” Masters said.

Predicting a “bumpy ride ahead,” for both ship owners and those who charter vessels, Masters warned that for many routes, ships may not be available. “If you’re looking at freight when you had a fair chance of picking up a vessel in the Gulf or the Caribbean, these vessels may not be available today. The major long-haul trade route is actually from Brazil to China. There was a time when freight was counted coming from Rotterdam. Today there’s not enough ships in Rotterdam. That count base is dead and when somebody prices that freight, it’s priced in the ship, in China,” said Masters, lamenting that the traditional ways of pricing ships and freight rates that have changed drastically following the economic crash of 2008 and the rise of China and other Asian markets. Currently many ships are going all the way past South Africa, to Brazil, and back without stopping. “In fact, it’s so bad, that if you have cargo today from Australia to Europe, the ship owner would often pay you to haul it,” he said.

As shipping patterns change, older vessels are getting scrapped at higher rates as newer, larger, more efficient cargo ships come into service. At the same time, shipping companies are delaying the production of new vessels since they are having a tough time maximizing existing inventories. “Owners are saying ‘I’ll take the delivery in 2011 rather than December of 2010.’ While scrapping is on the increase, the game is high stakes poker. A lot of what should never have been built was. And there are ships still being built, and still being financed and supported for a market that no longer exists. Things are pretty miserable for many ship owners. Some are getting rather desperate. My advice: Watch your back!” Masters warned.