Published in American Longwall Magazine

On the one hand coal companies have one of the most robust coal markets on record backed by increased demand for electricity, low coal stockpiles, high prices and supply constraints for competing fuels. On the other hand - higher fuel, power and steel prices, as well as transport and labor shortages are biting hard. However, despite the costs coal companies are raking in record profits.

Obvious through all the third quarter results of the major coal companies was an unconstrained optimism for the future – right up until 2006. An ongoing theme of confidence, which included robust markets, tight supplies and high prices, was a feature of every chief executive’s comment.

And why not be positive? Global coal demand posted the highest growth rate of any energy source in 2002-03 and continues to grow in 2004. Coal use for electricity generation and steel manufacturing is particularly strong in the Pacific Rim countries of India and China due to their surging economies. Global coal supplies remain tight in most markets due to transportation and production infrastructure limitations in the majority of exporting countries.

According to many, China’s growth has only just begun, with consumer demand -particularly for cars and real estate - continuing to fuel growth. Car ownership is still as low as 5%, allowing plenty of room for growth which will drive demand for steel (coking coal and coke), cement and energy (thermal coal).

China’s steel demand has grown at more than 20% per annum since 2000. Currently, consumption sits at about 225 million tons per annum, more than twice the size of either Japan or the US. Steel demand has been forecast to eclipse 400Mtpa by 2010, making China the largest steel producer, consumer and importer.

According to minerals and energy market consultants Barlow Jonker, world pig iron production was 648Mt in 2003 and is expected to rise to 823Mt by 2015. China will be the major growth driver, with 140Mt capacity to be added and India is expected to add 10Mt overtaking US output by 2015.

“The global steel industry is expected to remain focused on the potential for shortfalls of coal supply and consequent steel production losses. In such a market, prices are expected to significantly reflect the customer’s ability to pay, and absorb or pass on the increased cost of coal,” investment group Wilson HTM said.

In the US, customer inventories remain at their lowest seasonal levels in more than five years, and 10-15% below average levels. These low levels remain despite a third quarter which was 8% cooler than normal, and 15% cooler than the prior year, in regions that rely heavily on electricity from coal.

Despite a very mild summer across much of the US, spot prices for many US coal products remained at or near their highest levels in decades. Pricing was particularly strong in Central Appalachia, where coal producers have struggled to maintain production levels in the face of reserve degradation, an increasingly challenging permitting and regulatory environment, and a continuing labor shortage.

Meanwhile, US power producers’ coal stockpiles remain under significant pressure. Arch Coal recently estimated consumption would outstrip production by about 35Mt in 2004, following a supply deficit of an estimated 40Mt in 2003. "We expect power plant stockpiles to fall to record low levels by the end of 2004, which should support continued strength in US coal markets," Arch chief Steven Leer said.

The tight supply picture in the east should also benefit Powder River Basin producers over time, with a number of eastern power producers indicating their intent to use an increasing percentage of Powder River Basin coal in fuel mixes.

For thermal coal Wilson HTM said an oversupply in the Pacific region in 2005 would lead to downward pricing pressure in Atlantic markets as surplus Pacific market coal is re-directed. Supply in the Pacific in 2005 is expected to grow from a historical 30Mt to 50Mt by 2006. Trade from the Pacific to Atlantic will increase in response to the oversupply in the Pacific.

While demand for coal has strengthened across all regions, the outlook for low-sulfur coal is also bright. In October, sulfur dioxide emissions allowances were trading at levels well above $500, translating into a significant premium for the lowest sulfur coal products.

The forward price of natural gas for 2005-06 is about $6-8.50 per million Btu, which should stimulate strong coal demand for the generation of electricity. The world’s largest private-sector coal company Peabody Energy said it expected the high costs and scarce supplies of oil and natural gas to remain for the foreseeable future. Significant improvements in oil and gas infrastructure are unlikely for at least several years, due to the declining output of existing wells and the long lead times required for development. These factors all bode well for coal industry fundamentals.

While restricted infrastructure, including insufficient port and rail capacity, is impeding companies from taking full advantage of the robust market, it is also adding to the constrained supply, and consequent high prices. "Current estimates are that Central Appalachia coal stockpiles at the end of September represented approximately 29 days of burn, almost one-third lower than the norm at this time of year of nearly 42 days and 28% lower than one year ago," Massey chief Don Blankenship said.

Rail related challenges exacerbated by the aftermath of hurricanes during the third quarter resulted in missed shipments totaling about 200,000t for Arch Coal. “We believe the railroads are working with an appropriate degree of urgency to restore rail service to acceptable levels. Unfortunately, these problems cannot be rectified overnight. While we expect some improvement as the year progresses, we anticipate continued challenges in the fourth quarter,” Leer said.

While Arch need only face transport issues in North America, Peabody Energy has been hit by a double whammy of rail and port problems in both its home country and its Australian operations. In the face of these issues, it still posted a net income of $43.4 million for the third quarter.

During the third quarter Peabody experienced an 18% quarterly improvement in Eastern US per-ton margins reflecting increases in metallurgical coal volumes and prices, which more than offset the higher costs to process metallurgical quality products and increased diesel fuel, steel, contract miner and sales-related costs. The 9% improvement in Western US unit margins was led by increased volumes and pricing in the Powder River Basin and South-west, and strong contributions from the Twentymile Mine in Colorado.

Peabody is targeting a 2004 sales volume of 225-230Mt, with production of about 200Mt.

Meanwhile, profit margins and a great outlook have given Arch Coal the confidence to...click here to read on.