By Lee Buchsbaum
Faced with the potential of a long term negative domestic growth scenario, both metallurgical and increasingly steam coal producers are rapidly shifting their assets to produce into a robust export market. As Wall Street plunks its money down, NAPP and CAPP producers CONSOL Energy, Patriot Coal and a host of other companies are responding. While railroads and port owners ramp up to handle the extra volume, they are also debating how sustainable the export market will be long term—and how much of their fixed assets and capital they need to support it.
As U.S. utilities reduce their dependence on coal-fired generation, to sustain themselves—let alone grow—coal producers are racing to tap into overseas markets and invest in finding ways to move more of their coal off-shore. Few companies are expanding their thermal production, though many are replacing existing mined out tonnage. Lately it seems that any producer that can is shifting capital into whatever metallurgical or PCI coal reserves they can access. Though exports may be only 8% of U.S. coal demand, it is the most profitable market for producers. While metallurgical coal enjoys the largest profit margins, exports of high Btu Illinois Basin and increasingly Western Bituminous coals are also bringing in impressive yields. As a result, “the seaborne markets have become the tail that wags the dog for investors and capital markets,” said Paul Forward, managing director at Stifel Nicolaus, in his presentation U.S. Coal: Is a Strong Export Market Enough?
Worldwide metallurgical supplies are already tight due to Australian flooding and other problems that together have taken as much as 30 million metric tons (mt) of total coal off the international market creating a scramble for customers in need. Available supplies were further impacted by labor issues at Teck Coal’s Elkview mine in British Columbia which shut in another 600,000 mt. With almost 30% of the world’s known coal reserves, buyers worldwide are increasingly turning to U.S. producers to fill their needs.
Investors are also betting on the tightening international met market as well as the seaborne thermal space to generate large returns. Wall Street analysts have projected the net incomes of the largest seven U.S. producers over the next two years to be almost $10 billion. “That is greater than the total accumulated net income generated over the past decade,” said Forward. Wall Street apparently is going all in on the strength of the export market “because really what’s working now is the export markets,” Forward said.
“Our expectations are for the U.S. export totals are to increase by roughly 12-14 million tons over 2010 figures, meaning the U.S. will export somewhere between 93 to 95 million tons,” said Brian Gamble, vice president of coal and alternative energy equity research, Simmons & Co. Int’l at the March conference. “We are forecasting 2011 U.S. coal demand (consumption plus exports) to exceed supply (production plus imports) by 20 million tons, resulting in an equivalent drop in total U.S. stockpiles.”
In late April, just a month after the Platts conference, Arch Coal and other producers began predicting U.S. exports may rise even further to 100-105 million tons this year—and more in 2012. However, Gamble and other analysts continue to estimate that spare export capacity in North America is only 20-25 million tons. How well producers, railroads, ports and shippers respond to the logistical challenges created by this fundamental market shift may well reshape the industry throughout the next decade.
Speaking for Xcoal, now the largest exporter of U.S. metallurgical coals, Jack Porco, president and COO, Xcoal, discussed the company’s outlook for 2011. Xcoal exported 10.5 million mt in 2010 out of Baltimore, the company’s primary facility. Almost all of this tonnage was produced by various CONSOL Energy mines. Xcoal projects sustained worldwide economic growth, particularly within Asia, will sustain and grow metallurgical markets for U.S. coals. “Steel demand in the Asian Pacific region is going to increase by 60 million tons in 2011, and the U.S. will play a significant role as we are once again seen as long-term sustainable supply source,” said Porco.
The met coal industry recovered in 2010, largely due to increased Chinese imports. “In 2009, China singlehandedly changed the perception of the met coal market, and more importantly, it changed the role that the U.S. industry is going to play going forward,” he said. Largely because of China, 2010 was the best year for U.S. met exports since 1992.
Another factor that’s impacting the met markets is new pricing schemes. Last year, BHP Billiton and many of the Australian and Canadian producers switched from annually negotiated pricing to quarterly pricing. U.S. suppliers, however, continued to maintain the traditional one-year pricing concept. “That really benefited the U.S. We have many buyers in Europe and Asia who wanted to diversify their portfolio, not only by coal source, but by pricing as well,” said Porco.
Increasing amounts of NAPP PCI coal will be part of the export surge. According to its research, Xcoal sees 20 million mt of high vol met coal being produced in this region, with over 16 million mt going into the export market. What’s really driving this particular train is the definition of met coal. In part driving by tight supplies, tolerances by end users have expanded in the last few years. “In 2004, NAPP coal just couldn’t participate in the met market. Today it can.” Though high in sodium, the mainly Pittsburgh No. 8 coal produced by CONSOL Energy is generally considered of good quality. “What we found is that other people have been able to accommodate that higher salt amount,” said Porco.
One of the other major developments is where this U.S. produced coal is now travelling. In 2010, four of the top 10 met export destinations were in Asia: China, Japan, South Korea and India. In 2009, only India was on that list. In 2010, the U.S. exported over 11 million mt from east coast ports to Asia. “That represented 28% of the total exports of met coal out of the U.S. east coast. Our forecast for how many tons of met coal we think are going to go into the Asian market in 2011 is 20 million mt or more. Demand in Europe and South America will be increasing as well,” said Porco. With so much attention being paid to growing Asian markets, Porco reminded the Platts audience that “as a trading block, Europe is still the largest destination for U.S. met coal, with Asia number two ahead of South America and Canada.”
And right behind them is India. “India imported 35 million tons of met coal last year. On a seaborne basis they imported more met coal than China did, by a couple million tons,” said Porco. Over the next few years, Porco predicts India will become the second largest importer of coking coal after Japan. “By 2015 their imports will double to 70 million tons. India’s the future,” said Porco.
In his presentation, Richard Whiting, president and CEO, Patriot Coal, described “increased demand coupled with constrained supply are expected to lead to sustained strength in met markets, driving met coal prices even higher. We believe the U.S. met coal supply totaled about 75 million tons in 2010 including the crossover met.” Producers, including Patriot “are reacting as rapidly as possible to the higher met pricing by selling more crossover coal in the short term and then expanding met production any way that we can in the longer term,” he said.
Currently, Patriot ships most of its “met coal into Europe and Brazil. About one-third of our business is now going to the U.S. steel industry though last year our exports increased about 75%.” Customers, “are using lower quality met coal in some cases, changing their blends, and redirecting in some cases some of the higher quality met coal to the process to make higher quality and higher priced steel,” said Whiting.
Armed with a stronger balance sheet and cash position, Patriot plans to further grow its production base. “We’re going to use existing high quality coal reserves that we already have in our portfolio. We also intend to be on the lookout for future coal acquisitions, including larger transformational transactions, like the deal we did with Magnum.”
Internally, Patriot has detailed plans to increase their met production from 6.9 million mt in 2010 to about 11 million mt by 2013. “We have quite a bit of tonnage coming along in kind of a modular fashion. We’re planning to open seven new met mines in the next two years,” said Whiting. Termed “organic projects,” most of the new mines will be add-ons to existing operations. Most of these will produce between 200,000 and 750,000 tons per year (tpy) with the exception of new Peerless mine which will run more than 1 million tpy. Coal qualities from the new operations will range from “A+ to B- by global standards,” said Whiting.
Though expansion may trigger further environmental and regulatory reviews, Whiting feels attracting available experienced “labor will be one of the biggest challenges to our industry going forward.”
Moving Coal to Market
For the railroads to be able to keep up with the surging export demand not only will they have to gear up and invest in their coal networks, but their port owner supply chain partners will have to expand their terminals, dust off improvement plans and re-tool for a sustained market run.
In many ways the market we’re seeing today is the same thing we saw in 2008, explained Han Luetkemeier, commercial director for the Lower and Mid-River Mississippi Regions, Kinder Morgan. In 2010, Kinder Morgan handled a little more than 31.6 million tons of coal through its terminal network. However, today both producers and buyers are willing to invest capital in long-term improvements. “Global power generation, led by China and India, coupled with the met markets, is telling us that there’s going to be more ocean transportation of coal throughout the world than there is today, and the projections into the future show that that number could be fairly high,” Luetkemeier said.
“If you look at the tonnage that’s going out on the ocean side, 65 million tons, or 80% of the total tonnage is handled through four primary port districts of the United States. Baltimore shipped just under 14 million tons, Hampton Roads shipped 32 million tons, ports in the Lower Mississippi River shipped 9.3 million tons and just under 10 million tons were shipped from the Mobile,” said Luetkemeier.
Though there were about 3.5 million tons direct transfers out of the lower Mississippi river in 2010—a figure KM expects to more than double by 2011—as more tonnage goes out to the Gulf and Lower Mississippi, thermal and met coal volumes are starting to compete against each other for space. Oil refinery created petcoke is also fighting for its place in the mix. Southeastern utilities, accustomed to receiving coastwise tonnage as an alternative to railroad service are having to adjust their delivery strategies as well.
The two dominant eastern railroads, Norfolk Southern and CSX, have been widely criticized this year for their lack of ability to adjust to moving more coal through their systems to export terminals. Lack of available cars, locomotives, crews, very challenging weather conditions and poor economic forecasting are all to blame—along with a tidal wave of demand for high quality met coal.
In his presentation, Mark Bower, group vice president of export, metallurgical and industrial coal marketing, Norfolk Southern, allowed an increasingly rare but very honest mea culpa. “How was our performance? Not good. There were signs of things coming last year, but we started to prepare too late.” In truth, few saw the huge amount of sudden demand that came on in late 2010.
The surge in export demand that began last year was so great that by January 15 NS’s Lambert’s Point coal port in Norfolk “was completely out of load dates through March.” Operating at full speed ahead, Lambert’s March run rate was the best in a decade. “Earlier this month, we dumped a remarkable 500,000 tons in six days” as the facility’s run rate was approaching 2.2 million ton per month, or an annualized rate of 26.4 million tons.
With the largest east coast terminals at DTA, Kinder Morgan’s Pier IX, Chesapeake Bay and CNX all sold out. “Our assumption is that if you don’t already have space, you’re not going to get it,” said Bower. Though a few ports may be able to be re-configured in the relative short term, according to Bower the only major terminal with relatively large amounts of extra capacity is NS’s Lambert’s Point Pier 6 terminal in Norfolk.
The current terminal, ironically largely built in the 1960s to serve the Japanese met market, 50 years later is serving an ever-growing amount of Asian customers. During that time, Lambert’s all time through-put high was 40 million tons, its low was down around 10 million tons. In 2010, the facility dumped 16.5 million tons. Bower believes today its “realistic capacity” with improvements is slightly more than 30 million tons. In its recent first quarter earnings call, NS announced it was going to move forward with plans to ramp up Lambert’s Point, albeit cautiously.
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.