By Steve Fiscor, Editor-in-Chief

Leaving a prosperous 2008 behind, U.S. coal operators, similar to most businesses, face a high level of uncertainty in 2009. The global economic crisis has already led to an economic slowdown. The U.S. coal industry may see first hand the economic impacts on coal consumption. While they are puzzled and pessimistic, they are still buying new equipment and investing in their operations because they believe the long-term market fundamentals favor coal, and they do. What coal operators know for sure is that they will see no relief in regulation in the form of both inspections and permitting. This and other interesting facts are revealed in the 2009 Coal Age Forecast.

The coal industry is somewhat unique compared to other mining markets. Globally, the coal supply-demand balance remains tight. Because it’s a baseload fuel for electricity generation, coal consumption will not suffer the same price/demand cycles of other mined commodities, such as copper or iron ore, during an economic slowdown. It is somewhat insulated from market swings. No matter what, the U.S. will still burn more than 1 billion tons of coal in 2009. But, how much more?

In last year’s Annual Forecast, Coal Age predicted that U.S. coal production would grow 2.9% to 1.180 billion tons from 1.147 billion tons. Total U.S. coal production for 2008 should grow 25 million tons to reach at least 1.172 billion tons. As of December 27, 2008, the Energy Information Administration (EIA) had total U.S. production pegged at a near record level of 1.162 billion tons (See News, p. 5) and the mines should have produced another 3.2 million tons per day for at least three more days. Last year’s Annual Forecast overshot the mark by less than 8 million tons (0.7%). Three states accounted for a large portion of this growth: West Virginia (3.3%), Wyoming (2.9%), and Kentucky (2.5%). While both eastern and western Kentucky were up 2.2% and 3.7% respectively, the same can’t be said for West Virginia where southern West Virginia was up 3.7% and northern West Virginia declined 4.1%.

For the most part, utility coal consumption during 2008 was tracking along the same lines as 2007 and, at 1.046 billion tons, 2007 was a record year. During the third quarter, latest figures available, year-to-date, coal consumption stood at 791 million tons compared to 789 million tons in 2007. At the end of the 2008 summer burn, utility stocks stood at 145 million tons.

The U.S. had not had any significant swings in total stocks since utilities rebuilt stocks to more than 140 million tons in the fourth quarter of 2006. Utility stockpiles ranged from 143 million tons to 151 million tons during 2007.

Part of the 2008 growth explanation, and one of the most prominent market factors, was the continued growth in export coal. High quality metallurgical coal exports increased dramatically this year. Projecting EIA quarterly figures, exports could easily exceed 80 million tons. In 2007, coal exports climbed to 59 million tons after languishing at around 50 million tons from 2004-2006. Looking ahead, steady coal exports in 2009 may help counter the impacts of the economic slowdown.

Prices for high quality metallurgical coals reached $300/ton fob during 2008 and supplies remain tight. Steam coal export volumes also grew rapidly as Asian energy demands reoriented the supply-demand dynamic in the Atlantic Basin. In Alpha Natural Resources, third quarter earnings report, the company’s chairman and CEO, Mike Quillen said, “International demand for metallurgical coal was impressive in the third quarter—as it has been all year—resulting in a new high-water mark of $130 per ton realized, on average, for our met coal.” Metallurgical coal sales accounted for 43% of Alpha’s total sales volumes during the quarter, Quillen explained, which produced a high cash flow for Alpha during the quarter. Having a strong cash position will not only help coal companies survive the financial crisis, it will allow them to capitalize were others falter.

Constrained Production Keeps Prices High

Of the 646 executives Coal Age contacted in December 2008, a  total of 69 responded to this year’s Forecast Survey. The majority of them (87%) produced bituminous coal. More than one-half (51%) said that their company produces more than 5 million tons, 34% produce 1 to 5 million tons, while 15% produce less than 1 million tons. A total of 20 respondents said that they surface mine coal exclusively, while 21 said that they were purely underground coal miners. The rest had a mixed production portfolio, which leaned more toward surface mining.

U.S. coal operators are not looking forward to 2009. Many of them (63%) said they feel less optimistic about 2009, while a lot less (22%) said they felt more optimistic. Last year, those numbers were 60% and 17% respectively—a complete reversal. Of the executives surveyed, 41% thought production in 2009 would increase from 2008 levels. Last year that figure was 71%, a dramatic swing. Knowing that many large coal companies already have a large portion of 2009 production sold, the survey asked about 2010 production. A larger contingent (55%) said that they thought production would climb higher in 2010. Even though they feel uneasy about next year, many of them believe that production will increase.

The uncertainty in the survey correlates to what publicly held coal companies are telling stockholders. In Massey Energy’s third quarter earnings statement, the company’s Chairman and CEO Don Blankenship said, “We are unable to forecast with any level of certainty the impact the financial crisis and any recession might have on coal prices going forward.” He does believe the demand for Central Appalachian coal is more stable than the supply for the foreseeable future and cited several factors, including production constraints due to increasing regulatory requirements and activity, depletion of reserves, a tight labor market, and high capital costs for equipment and development.

Speaking at the Raymond James First Annual Coal Investors Conference, Deck Slone, vice president-government, investor & public affairs, Arch Coal, discussed the financial crisis and the increasing difficult regulatory environment. Slone explained that a lack of credit could cause financial distress among smaller coal operators, which could lead to more industry consolidation. “Recent court challenges are already constraining the issuance of new permits,” Slone said. “The new administration could impose further restrictions. The net effect would likely be increased operating costs and a further curtailment of supplies.”

Taking a similar stance, in the company’s third quarter earning statement, James F. Roberts, Foundation Coal’s chairman and CEO, explained that three pervasive factors should continue to constrain supply growth in the eastern United States. “First, labor markets are extremely tight, raising costs and reducing production,” Roberts said. “Second, intensified regulatory activity has been cited by several producers as reducing coal production in the East. Third, the inability to secure permits has and will continue to limit the ability to open new mines and longer-term could threaten the approximately 87 million tons of Central Appalachian surface mine production. Given these systemic constraints, Eastern production can reasonably be expected to remain in structural deficit.”

In contrast to the tight market for Eastern coals, Roberts explained, the Powder River Basin (PRB) appears to be in a condition of near-term oversupply. “Inventories at utilities served by PRB coals remain high with over 60 days of inventory on average, and year-to-date production is up nearly 3% in the PRB,” Roberts said. That market analysis from earlier in 2008 foreshadowed recent announcements by both Arch Coal and Peabody Energy (See Transportation, p. 49) regarding production cutbacks in the PRB.

Tight supplies often translate to high spot prices. At the end of 2008, spot prices remained very high (See Figure 2). Illinois Basin coal was selling at $78/ton. Northern Appalachian (NAPP) coals were trading above $100/ton.  In its third quarter earnings report, CONSOL Energy, the largest NAPP producer, said it had realized a 26.8% increase in the average price for coal. “The strength of coal and gas markets over the last 12 months has allowed us to continually and systematically lock in higher prices that drive the average realized price up as older contracts are replaced with newer, higher priced ones,” said Brett Harvey, president and CEO, CONSOL Energy.

Investing for the Future Upside
As far as capital budgets are concerned, 44% of the respondents said that they are budgeted for more than $20 million. More than one-half (56%) of the respondants said that their capital budgets for 2009 had increased. When asked how they planned to spend the money, they said new equipment (84%), mine development (69%), equipment upgrades (75%), permitting and bonding (57%), and new mine start-up (31%). Those numbers are not significantly different from last year, but the new mine start-up did drop from 44% last year, but did not reach the level of 13% recorded in 2007. This year the respondents said that on average 42% of the budget would be allocated to new equipment.

The survey also asked about the single most expensive item the executives planned to purchase this year and its price in round figures. The answer (Figure 5) ranged from $20,000 for new computer equipment to $500 million for a new mine installation. In fact, two respondents mentioned new mine start-ups. Three mentioned that they intend to purchase new longwall mining units. Three said they intend to purchase a new electric shovel.

Many coal operators are investing in future production and most say that, during the near term, they will be able to operate at or near full capacity. When asked about productive capacity, 79% said that they would operate at 90% of design capacity or better. Last year, which was much more optimistic, only 63% of the survey respondents believed they would achieve 90% capacity. In light of the fact that they face an uphill battle from regulators, they believe they can cut and load coal at or near full capacity.

Coal operators did express a lot of concerns in the survey. As usual, prices were foremost among their thoughts, but they are also concerned about politics and the economy, which reflects the sentiments of the American public in general.

It’s safe to assume that total year-end production for 2008 would amount to at least 1.172 billion tons. Utility burn rates will probably decline along with a shrinking economy, maybe as much as 2%, which would be 20 millions. Industrial coal burners would be affected to an even greater degree. As has been demonstrated earlier, eastern markets are constrained. Wyoming’s production numbers will probably decline as more capacity is idled. Hopefully, exports will remain steady or grow, keeping eastern markets from falling into over supply, which should keep spot prices from falling. Taking these factors into consideration, Coal Age estimates a 2.3% decline in coal production in 2009. That would equate to a 27-million-ton decrease and pull total U.S. production down to 1.145 billion tons from 1.172 billion tons.