Published in May 2005 American Longwall Magazine

While Appalachian coal has enjoyed soaring spot and contract prices over the past few years, Wyoming coal has experienced several years of dormancy. Of late, however, there has been a paradigm shift in favor of Powder River Basin (PRB) coal. That shift is a result of a number of factors, none more important than an improved performance by Western Rail services this year.

According to the Energy Information Administration (EIA), rising PRB prices are a result of improved coal haulage capacity – partly a consequence of the certainty associated with higher percentages of PRB coal shipments being handled under term-contracts.

“Firm coal contracts give the rail carriers reliable base volumes to plan on and allow carriers the flexibility to schedule spot shipments. That option became untenable in 2004 as most large customers had deferred coal shipments early in the year only to reverse strategy and demand maximum shipment tonnages later,” EIA said.

EIA coal distribution statistics for 2003 show at least 96% of PRB coal is dependent on commercial rail transportation out of the region. It now appears that western rail industry improvements in tracks, equipment, and personnel in 2004, and continuing in 2005, are helping increase coal haul volumes and turnaround time, EIA said.

Consultants John T Boyd agreed much of the cause for “somewhat muted” PRB prices in the past could be attributed to rail capacity. “Eastern utilities not already using PRB coal viewed the ongoing rail situation as a detriment. Consequently PRB coal may not have received sufficient consideration as a viable fuel alternative. Announced efforts by the railroads to relieve these problems, combined with the dramatic increase in the price of SO2 [sulfur dioxide] allowances, will provide incentive to utilities to consider trial shipments of PRB coal,” Boyd said.

EIA said as many as 24 generators tested Wyoming coal in 2004, many of which are now switching to PRB coal. The switch, according to Doyle Trading Consultants’ Steve Doyle, has come as benefits surface at the boiler’s burner tip.

Burner tip price factors are influenced by any increased operations and maintenance related to additional handling, blending, grinding and milling; transportation costs; emissions benefits from lower SO2 and Nox (nitrogen oxide); the capex associated with any boiler reconfiguration; and the cost of the coal.

“Compare the cost at the burner tip of PRB coal with many eastern coals at current price levels, and you will see the scale tip very much in favor of PRB coal. If you look at the increased demand in terms of organic growth from the current PRB consumers, the new demand from the switchers and blenders and the medium-term demand from the plethora of new power plants coming on-line, I believe you would come to the conclusion that paying a few dollars extra to lock in term contracts for PRB coal is a very worthwhile exercise for a utility,” Doyle said.

“Is the price more likely to go from $9/ton to $3/ton or from $9/ton to $15/ton? Now extrapolate that reasoning across the entire utility sector and the end result is what we are seeing: rapid increase in the price of PRB throughout the curve. There is a good reason why Arch and Peabody have so much unsold coal in 2007 and beyond - they did their homework,” he said.

While improved rail performance has increased PRB demand, EIA said the single greatest restraint on PRB prices may be the rising rail transportation rates. “Apparently transportation costs for many are increasing faster than coal prices. Sources at coal-fired power plants report that the greater portion of their cost increases for PRB coal is in railroad costs,” EIA said.

“Some instances of doubling of rates are claimed, but rate increases of 20-25%, on average, are said to be common. In addition, coal buyers are also paying fuel cost adjustments on all new contracts and much stricter limits on unloading time before demurrage charges kick in.”

The other factor playing a major role in the PRB price swing is emissions trading. Western coal burns cleaner because it contains less sulfur – a costly liability to power plants. When using PRB coal, less SO2 allowances need to be purchased, a very attractive factor to utilities. Recent figures show SO2 trading at $880 per ton, a 26% increase since the start of 2005. This increase has helped to raise the price of Basin coal by about 40c per ton since January, Doyle estimated.

The Clean Air Mercury Rule issued in March by the Environmental Protection Agency also calls for lower mercury emissions for all coal. The reductions required for bituminous coal are stricter than for lignite and sub-bituminous coal - such as that found in the PRB. This rule is sure to play its part in price increases.

So who are biggest winners? Certainly US coal giants Arch Coal and Peabody Energy will benefit. A rally in PRB spot prices in March helped Arch Coal’s first quarter figures. With rail service improving, spot prices for PRB coal increased 20-30% since the beginning of January, with much of that movement occurring recently. The spot price for Arch's ultra-low sulfur PRB production increased even more, buoyed by the climbing price of SO2 emissions allowances.

Since the first quarter began, the price of SO2 emissions allowances has climbed an additional 20%, to approximately $850/t. Such allowances were trading at just $130/t in January 2003. The increased price of SO2 allowances has boosted the value of compliance and low-sulfur coals.

"The PRB is already the fastest growing US coal supply basin, and it appears poised for more accelerated growth in the years ahead," Arch chief Steven Leer said. "In recent weeks, power generators in Pennsylvania, North Carolina and other eastern states have announced plans to increase the amount of PRB coal they use in the future. Furthermore, recent improvements in Western rail service are finally allowing this increased level of interest to translate into higher shipments out of the basin."

Peabody has also cemented its faith in the Powder River Basin, acquiring 327Mt of coal reserves during the first quarter and has purchased about 950Mt of ultra-low sulfur PRB coal reserves in the past year.

This year Peabody has facilitated test burns and increased blending and conversions for a number of its customers, some of which it was unable to do in 2004 due to transportation constraints.

So when will the bubble burst? John T Boyd argues it is not so much about when the bubble will burst, but more...click here to read on.