COVID-19 to Further Weaken US Coal Demand in an Already Diminishing Market
By Marleny Arnoldi
March 30, 2020 - US domestic demand for thermal coal will fall during the second quarter of the year as individual states shut down much of the industrial economy to try and stem the spread of Covid-19.
This is according to Moody’s Investors Service, which states that, in broader terms, the global economy will experience an "unprecedented shock" in the first half of 2020 as a result of the coronavirus impacts.
Coal-fired power plants are US thermal coal producers' most significant customers, but their purchases have dropped off significantly over the last decade, even before Covid-19.
Before the intensification of the pandemic in the US, Moody’s expected that coal production would fall by between 15% and 20% this year to between 550-million and 600-million tons.
The agency now expects that industry conditions will worsen beyond this forecast – driven by the weakened electricity demand in commercial and industrial operations.
“This will impact market share across the coal industry, which may improve for some rated producers, and the ability to reduce debt – particularly for those producers that rely on US thermal coal for a substantial portion of earnings,” Moody’s says.
For example, Alliance Resource Operating Partners has certain advantages in competitive cash costs, modest debt leverage, and enough free cash flow generation to cushion the blow of lower prices. By contrast, Consol Energy, which has reduced debt aggressively since becoming an independent company in 2017, is more leveraged financially with less anticipated cash flow to reduce debt.
Where coal-fired power plants are usually at an advantageous position through winter, compared with gas-fired power plants, the past winter has seen gas prices staying low owing to an oversupply, while the winter of 2019/20 was also the second-warmest on record.
By March, much of the Northeast’s demand for electricity had reduced by about 10%, while the speculative-grade debt market seized up at the same time.
“The combination of weak power fundamentals, challenging capital market conditions, and increasing concern about environmental, social and governance-related (ESG) issues will likely push a significant amount of coal capacity into bankruptcies and lead to new closure announcements over the next year or two,” Moody’s notes.
The agency adds that ESG issues related to the coal industry have increasingly eroded access to capital for US coal companies.
A few of the stronger coal companies have obtained new financing in 2020, including equipment financing for Arch Coal, which Moody’s believes remains widely available, and a new revolving credit facility for Alliance. But, in general, the industry’s access to capital remains tight, and the coronavirus outbreak adds to the uncertainty.
This, while prospective government assistance for the coal industry remains highly uncertain, though the National Mining Association has reportedly requested relief for the coal industry.
Coal companies have also struggled with recent adverse political developments, including a revised approach to black-lung liabilities that would require them to post more collateral during a weakening market environment, and a recent US Federal Trade Commission ruling against Arch and Peabody’s joint venture in the Powder River Basin – which would have helped these compete against alternative fuels.
Moody's argues that the domestic coal industry cannot be saved by exports either, since export thermal coal markets will continue to fall this year.
The agency says that coal pricing in Europe will not support a continuation of US exports at 2019 levels, which were themselves down 20% from 2018's level.
While thermal coal prices continue to decline, demand for metallurgical coal (met coal) used in steelmaking remains uncertain, with clear downside risk, Moody's says.
The US exports most of the met coal it produces, especially to European steelmakers. Moody’s points out that met coal prices have held up better than most commodities in 2020, which the agency says reflects a combination of weather-related issues in Australia and anticipation of a major stimulus programme in China.
“However, demand in Europe has softened, particularly with the auto-related shutdowns, and, to the extent that US steel producers idle capacity at blast furnaces on declining end market demand, met coal producers serving the US market would be hurt.
“US met coal producers have very different costs and levels of business diversification. Warrior Met Coal, which produces benchmark-quality met coal from two longwall mines in Alabama, will remain durable amid unfavourable pricing. Contura Energy, which operates smaller mines with higher cash costs, is the most exposed to met coal pricing, and will burn through its cash in 2020,” Moody’s states.
The agency adds that Arch Coal will also spend much of its cash to help fund the development of the Leer South high-vol A mine in 2020, but Arch also has significant cash reserves and very little net debt.
Some unrated producers have idled met coal mines within the past few weeks.
About three-quarters of rated US coal companies have negative outlooks as at March 27 – indicating weakly-positioned ratings.
“We took negative actions on more than three-quarters of the sector between mid-February and mid-March 2020, based on our expectation for weak industry conditions in 2020 and a decline in industry-level earnings before interest, taxes, depreciation and amortisation by at least one-third in 2020.
“While the coal industry generated significant free cash flow in 2017 and 2018, credit quality did not improve meaningfully because producers returned much of that cash to shareholders through dividends, special dividends, and share repurchases,” the agency states.
Moody’s confirms it will monitor the anticipated supply/demand balances for the various grades of coal and within key coal-producing regions to determine its view on prospective cash flow generation, which will be overlaid against the sufficiency of rated producers' liquidity arrangements.
The agency will also consider any prospective government, though it is unlikely.