By Robert W. Steyer
September 11, 2018 - You know the coal industry is nervous when an analyst refers to the summer of 2008 as the "halcyon days."
"With U.S. electricity generation demand and global & U.S. steel production growth rates dropping sharply since the end of September, we believe the surplus that started in October will build as we move through the first half of 2009," says a recent report by Credit Suisse.
Electricity accounts for 88 percent of U.S. coal shipments, says the investment banking firm Jefferies & Co. Steel and other industrial uses represent 7 percent; exports make up 5 percent.
Earlier this month, the Dahlman Rose firm warned clients that "a pricing collapse in 2009 (is) all but certain" for producers of metallurgical coal.
Declining demand from steelmakers could push this coal's price back to 2007 levels. "Any near-term optimism supporting pricing is unwarranted," said Dahlman Rose, noting that steel prices began dropping in July.
Despite the jolt to the industry, Wall Street analysts keep reminding clients that somebody has to keep the lights burning during an economic collapse. They say coal will remain the biggest fuel source for electricity-generation for quite some time.
Even Dahlman Rose, with its gloomy forecast, has "buy" ratings on eight of the nine coal producers that it follows, including the three St. Louis-based companies.
For Peabody, the world's largest coal producer, Wall Street "buy" ratings easily surpass the number of neutral ratings, according to Thomson Reuters.
Arch, second in the U.S., has a majority of favorable ratings on Wall Street. For Patriot, "buys" barely beat the "holds." No analyst has a sell rating on the St. Louis companies.
Part of Wall Street's response is based on the significant gains by coal companies in comparison to other energy companies and the S&P-500 stock index between mid-2003 and mid-2008. So, when a stock goes down after a big gain, analysts often shrug it off as a "correction."
However, they'll need another word to describe the sharp declines by St. Louis companies -- Peabody by 69 percent, Arch by 79 percent and Patriot by 90 percent -- in the past six months.
Part of analysts' reasoning is based on expectations of an economic recovery, although calculations of the speed and scope of the comeback are being adjusted constantly.
The worldwide economic slump caused Morningstar's Michael Tian, the author of the "halcyon days" remark, to revise his industry economic model in October and November.
And part of analysts' optimism about coal is tied to the belief that tougher industrial emissions laws, predicted for a Barack Obama administration, won't come as quickly or as dramatically as some had expected.
"As the economy turns south, I don't think it will be palatable to introduce another tax," says Tian, referring to the prospects of an attempt to reduce power-plant and industrial-plant emissions of carbon dioxide. "What politician will introduce a carbon tax in this economic environment? I think this relieves some of the political pressure."
More Energy, More Coal
The underlying belief in coal's future is tied to greater worldwide energy needs.
"There's an unarguable assumption that demand for coal will increase in the near term and that other fuels do not appear to be able to pick up the slack," says Luke Popovich, a not-so-neutral observer as a spokesman for the National Mining Association.
Industry members, energy consultants and Wall Street analysts do their own calculations; but they often use economic projections by the federal government as a foundation.
The federal Energy Information Administration (EIA) predicts worldwide coal consumption will increase by 65 percent between 2005 and 2030. Emerging markets -- especially China, India and other Asian countries -- will lead the growth.
The agency forecasts coal will account for 29 percent of world energy consumption in 2030, up from 27 percent in 2005.
Electricity generation is expected to spur the growth, with coal predicted to account for 46 percent in 2030 (versus 42 percent in 2005). China's consumption of coal for electricity is expected to triple, and its coal use for industrial purposes will nearly double.
The federal analysis makes assumptions based on population growth, industrialization, changes in technology and changes in government policies at home and abroad.
In the U.S., the EIA says coal's share of the electricity-generating market could slip to 49 percent in 2015 from 50 percent in 2005, then climb to 54 percent in 2030. The rebound will be propelled by new coal-fired generating plants coming on line. Until 2015, natural gas will be the "top choice for new generating capacity," the report says.
"The projections could change significantly, however, if changes were made in U.S. laws and policies, particularly those regarding greenhouse gas emissions," it adds.
The EIA report was issued in June, so it doesn't take into account the deepest dive in the U.S. and world economies and the strangling of credit markets that could delay construction -- or raise the price -- of new coal plants.
A Changing Environment
Given the inherent uncertainties in the coal market, many analysts believe Peabody is best able to cope, thanks to its size and diversity. Its mines range from Illinois to Wyoming to Australia, giving it access to different types of coal as well as catering to markets in Asia's emerging economies.
Major risks to Peabody include "a softening of global coal supply demand fundamentals, especially in the Asia Pacific Basin," said Jefferies analyst Michael Dudas, in a recent report to clients. Although he cut earnings projections for 2009 and 2010, he maintained a buy rating. Peabody "will be able to withstand the powerful near-term forces" affecting energy and commodity prices, he added.
However, he told long-term investors to watch how low the stock price falls. "The time to buy is when the market is oversupplied" and when pricing is suppressed, he added.
Stifel's Paul Forward praises Arch for having a diversified portfolio of coal properties stretching over seven states and three geological regions. In a late October analysis, he kept his "hold" rating due to the "extremely volatile environment" for coal prices and stock prices.
Patriot's production is confined to West Virginia and Kentucky, thanks to a spin-off by Peabody in November 2007. Patriot's near-term task is integrating operations of a mining company acquired in July.
Earnings have been weak since the spin-off, but this was caused by "low-priced legacy contracts confounded by operating difficulties at a few key mines," said the report by analyst Mark Liinamaa, who has an equal-weight, or neutral, rating. "Longer term, we think the company is well positioned."
"Longer-term" is the key word for a commodity business, in which a company's performance can be affected by a competing producer, a competing fuel, an event in another continent or a production problem in a single mine.
Despite the short-term deflating of coal stocks, investors who stayed with Peabody between December 2003 and June 2008 would have enjoyed about a nine-fold stock gain when adjusted for stock splits.
Arch investors would have secured a five-fold gain on a split-adjusted basis. And in its short life, Patriot produced a four-fold gain, when adjusted for a stock split, before the stock fell sharply.
The occasionally dramatic turns in a stock's value or a company's profit are linked to a motto that Morningstar's Michael Tian says should be memorized by anyone who follows the coal industry. "It's not the tons," he says. "It's the price."