Four of the largest U.S. coal producers made $20 billion of acquisitions last year to reduce their dependence on the domestic power industry. Instead those deals have added to the companies’ pain.
Alpha Natural Resources Inc. (ANR:US), Peabody Energy Corp. (BTU:US), Arch Coal Inc. (ACI:US) and Walter Energy Inc. (WLT:US) completed takeovers that boosted sales of metallurgical coal used in steelmaking. The companies bet that the coal, which sells for a higher price than the thermal variety burned to generate electricity, would benefit from booming Asian demand and counter threats from falling natural-gas prices and extra environmental regulation.
That strategy isn’t working out as planned. Prices for metallurgical coal, which were forecast by JPMorgan Chase & Co. in November to jump 50 percent in 2012, have fallen 16 percent so far this year amid slowing steel output in China and Europe. That may mean the U.S. coal industry, which has already seen the bankruptcy of Patriot Coal Corp. (PCXCQ:US) in July, will continue to burn through free cash for another year.
“There was some belief that there was countercyclicality between met and thermal,” said David Gagliano, an analyst at Barclays Plc in New York. “What we’ve learned is that they aren’t that different.”
U.S. coal producers have been closing mines and firing workers this year as some power plants switch from coal to gas, which is trading close to a decade-low amid booming output from shale rock.
Alpha’s 70 percent drop in 2012 makes it the worst performer on the 29-member Stowe Global Coal Index (COAL), which lost 31 percent in the period. Arch is down 57 percent, and Peabody has declined 34 percent in the period.
Domestic coal output in 2012 will fall 7.4 percent, or by 81 million tons, according to data from the U.S. Energy Information Administration.
Prices for Central Appalachian thermal coal, the U.S. benchmark, have declined 16 percent in the past year to $58.12 a ton on the New York Mercantile Exchange.
“It’s hard for us to imagine them getting much worse,” Mark Levin, an analyst at BB&T Capital Markets in Richmond, Virginia, said in an Aug. 21 note.
Low-volatility metallurgical-coal prices are down 34 percent over the last 12 months to $192.50 a ton, according to data published weekly by Energy Publishing Inc. China, the second-largest economy and biggest steelmaker, expanded 7.6 percent in the second quarter, the slowest pace in three years. Its daily steel output fell in July from the previous month and domestic steel prices are at their lowest in more than two years.
Also adding to the gloom is the recession in Europe, the destination for about half of U.S. metallurgical-coal exports. Luxembourg-based ArcelorMittal (MT), the world’s largest steelmaker, was cut to junk by Standard & Poor’s on Aug. 2.
“Clearly we’ve seen issues in the near term with a weak U.S. economy, recession in Europe and deceleration in China,” Vic Svec, a Peabody spokesman, said in an interview. “It’s an unusual confluence of weakness.”
Metallurgical coal won’t rebound in 2013, according to BB&T’s Levin, Prices will average $210 next year, up 9 percent from yesterday’s price, while thermal coal will be $70, a 20 percent increase from current prices, he said in an Aug. 14 note.
If metallurgical coal averages less than $200 next year and thermal doesn’t “explode to the upside,” then producers including Alpha, Peabody, Arch and Walter won’t generate positive free cash flow, Levin said.
Peabody, Alpha and Arch all reported negative free cash flow in the second quarter, meaning they didn’t generate enough cash to run their businesses, according to data compiled by Bloomberg. The data is calculated by subtracting capital expenditures including property additions from cash from operating activities.
This year has been unprecedented, according to Peabody’s Svec, who also said the company’s year-to-date free cash flow is $153 million. The St. Louis-based company expects coal burned for power in the U.S. to be down by as much as 120 million tons, as utilities use more gas instead. That’s something that couldn’t have been predicted, he said.
Peabody, Alpha, Walter and Arch have lost a combined $9.4 billion in market value in 2012, according to data compiled by Bloomberg.
Alpha paid $7.5 billion including debt for Massey Energy Co. in July 2011. Bristol, Virginia-based Alpha paid 25 times Massey’s earnings before interest, taxes, depreciation and amortization, making it the most expensive and the largest U.S. coal takeover, according to data compiled by Bloomberg. Alpha has plunged 70 percent this year, the worst performer on the Standard and Poor’s 500 Index.
“Our fundamental conviction is that the world is structurally undersupplied of high-quality metallurgical coal for the foreseeable future,” Alpha Chairman and Chief Executive Officer Kevin Crutchfield told investors on a January, 2011, conference call when Alpha announced the deal.
“We continue to believe that the Massey acquisition makes great strategic sense for Alpha,” Ted Pile, an Alpha spokesman, said Aug. 27. “What we’re seeing right now is a speed bump.”
Peabody acquired Australia’s MacArthur Coal Ltd. in December for A$3.8 billion ($3.9 billion) to expand its sales of metallurgical coal to Asia.
“Macarthur gives us a tremendous met coal resource and pipeline of projects in the world’s largest met-coal exporting nation, serving the fastest growing countries in the world,” Svec said.
Arch bought International Coal Group in May last year for $3.1 billion and Walter completed its takeover of Canada’s Western Coal Corp. for C$5.3 billion ($5.4 billion) in April of 2011.
“With the acquisition of ICG, Arch obtained some of the highest-quality metallurgical coal reserves in the world,” said Deck Slone, an Arch spokesman. “The market potential for these coals will only grow in the years ahead.”
Paul Blalock, a spokesman for Walter, declined to comment.
Not all producers made similar decisions on metallurgical coal. Consol Energy Inc. (CNX:US) opted to expand into gas, paying $3.5 billion for assets of Dominion Resources Inc. Canonsburg, Pennsylvania-based Consol overtook Peabody in May as the biggest U.S. coal miner by market value. It’s trading at about 17 times estimated 2012 net income, a higher ratio than Peabody and Walter, according to data compiled by Bloomberg.
“Consol Energy is developing its metallurgical coal assets organically at a cost per ton well below competitors’ recent acquisition rates,” said Lynn Seay, a Consol spokeswoman.
“Consol made a big bet on natural gas, Peabody made a big bet on Australia,” said Lucas Pipes, an analyst at Brean Murray Carret & Co. in New York. “Investors in my opinion are more comfortable about natural-gas prices bottoming than about the outlook for seaborne coal prices.”
Most metallurgical coal that’s seaborne -- the industry term for coal exported by oceangoing ship -- is priced each quarter based on a benchmark established by the largest exporters and users.
U.S. coal producers have been affected by unusually warm winter weather, which helped to curb demand for thermal coal. The industry is also facing regulations from the Environmental Protection Agency restricting the burning of coal to produce power, limiting new mining permits and enacting tighter water- quality limits.
The increasing regulatory burden combined with competition from cheaper gas has put U.S. coal producers’ “backs to the wall,” and metallurgical-coal hasn’t helped, Brean Murray’s Pipes said.
“There was generally an expectation met coal was going to hold up better,” he said.
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