Company overview: Arch Coal Inc. (Part 5 of 9)
The tougher coal market conditions
In the recent years, the demand for coal has declined due to the increased competitiveness of natural gas, especially in the United States where major utility and other high-volume coal users have shifted to other alternatives. Within the United States, coal accounted for 37% of the United States electricity generation in 2012. This was down by approximately 5% in comparison to 2011.
The lower demand for coal has led to an oversupply condition in the coal market, negatively affecting coal prices. These factors have affected Arch’s business and have forced them to cut back on their non-core assets. However, going forward if there is an increase in natural gas prices; it might prompt a shift of demand towards coal electricity generation, which would benefit the major players in this industry. If such a shift were to occur, Arch Coal will be in an advantageous position as they have been slowly adjusting their strategic position in order to capitalize on such an opportunity.
As metallurgical coal is required for the production of steel, it is important to note that an increase in demand in the steel industry will have a positive impact on Arch Coal as they control a large amount of metallurgical coal. One area to note for the demand for steel is the development of emerging economies. Infrastructure development and electricity generation in such economies will prove advantageous for a major player in this industry like Arch Coal. A more detailed report on the industry’s business overview will be published at a later date.
While coal prices are currently low due to an oversupply and lower natural gas prices, the demand for coal is still present. As metallurgical coal is essential in the production of steel, there might an increase in demand if there are expansions and development of infrastructure globally. The company’s acquisition of Leer Mine in the Appalachia Region has recently begun production in December 2013. This mine is expected to produce more than 3 million tons of high volatile metallurgical coal which is more efficient in steel production. Arch Coal has invested over $400mm into this operation to date and is expected to see a significant return on their investment over the next five years. It is crucial for Arch Coal to invest into infrastructures of their core assets should there be a recovery in the coal market in the near future.
Browse this series on Market Realist:
- Part 1 - A handy investor guide to Arch Coal (ACI)
- Part 2 - Where does Arch Coal mine and what are the implications?
- Part 3 - How does Arch Coal earn revenue and free cash flow?
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