Amid Doubters, What Are the Positives for Coal?

Stringent regulatory measures to control emissions are curbing the unrestricted use of thermal coal for electric power generation. But notwithstanding the many hurdles in coal’s way at present, this fuel source still holds an advantageous position thanks to its wide availability and lower cost compared to other fossil fuels and renewable sources of energy.

Per a report from World Coal Association, we currently have 861 billion tons of proven coal reserves worldwide. This means that there is enough coal to last nearly 112 years at current rates of production. In comparison to this, proven oil and gas reserves are equivalent to around 46 and 54 years, respectively, at current production levels. Proven reserves are considered economically recoverable at any given time, taking into account available mining technology and costs.

As you can see, the current availability of coal even outpaces the combined proven reserves of oil and gas.

However, the Clean Power Plan will add to the mounting challenges that have been adversely impacting the demand for coal in the U.S. The crucial question is what’s keeping the coal industry afloat amid rising competition from other fuel sources and a hostile regulatory climate. Let’s dig a little deeper into the factors driving this industry going forward.

Coal Dominates U.S. Power Generation: Coal as a major source of generating fuel dominates the utility industry. Per the Energy Information Administration (EIA), coal was the generating fuel for nearly 34% of the electricity consumed in the U.S. in 2015. Moreover, electricity generation absorbs more than 83% of the total U.S. coal consumption. The reason is quite simple: coal is by far the least expensive and most abundant fossil fuel in the country.

Long-term Supply Agreements: Most of the coal companies in the business have existing long-term coal supply agreements with their customers. Coal producers are also prompt about renewing contracts on expiry as these provide earnings visibility into the future.

Peabody Energy (BTU) derives in excess of 20% of its revenues from five large customers. There are 41 coal supply agreements in place, expiring at various times from 2015 to 2026, to cater to these customers. These long-term supply agreement provide visibility to future earnings stream.

Not Just Electric Generation: Electricity generation is just one use of coal in the U.S. Manufacturing plants and industries use coal to make chemicals, cement, paper, ceramics and metal products, to name a few. Methanol and ethylene, which can be made from coal gas, are used to make products such as plastics, medicines, fertilizers and tar.

Certain industries consume large amounts of coal. For example, concrete and paper companies burn coal, and the steel industry uses coke and coal by-products to make steel for bridges, buildings and automobiles.

Coal as Input for Steel Industry: Due to its heat-producing feature, hard coal (metallurgical or coking coal) forms a key ingredient in the production of steel. Nearly 70% of global steel production depends on coal. Since met coal is an essential ingredient for the production of steel, U.S. met coal producers could benefit from the increase in steel consumption.

Demand Upsurge in Asian Countries: The increase in coal demand in Asian economies like China and India has been a key price driver since the end of the recession in 2009. We expect this trend to continue in the future mainly due to rising energy needs in India, China and South Korea. The current decline in demand in China will hurt, but the markets are going to improve gradually, if we go by the report from the International Energy Agency.

The two Asian countries also produce coal, but not enough to meet the growing demand in the region, resulting in a continuous need to import. These two countries also rely heavily on coal for electricity generation.

Japan is also importing large volumes of coal following the deactivation of its nuclear power plants. Given the rising demand from the fast-growing Asian economies, U.S. miners will find it attractive to export coal to these regions.

We expect Peabody Energy with its Australian platform to leverage the demand for coal in the Asian markets. Peabody through its trading and business office in India will cater to the rising need for met and thermal coal in the country.

The MLP Way: Coal-based MLPs might stem some of the rot in the coal industry. SunCoke Energy Partners, L.P. (SXCP) was formed from SunCoke Energy Inc. (SXC) in 2013. SunCoke Energy Partners delivered positive earnings surprises in the last two quarters of 2015. CONSOL Energy (CNX) followed the same path to form CNX Coal Resources LP (CNXC). The crucial question is whether the coal-based MLPs will help the industry to survive. We will have to wait and see what the future holds.

To Sum Up

Among the coal miners, Cloud Peak Energy (CLD) stands out with an unblemished earnings surprise record over the last four quarters. Its performance is particularly noteworthy when most of the big names are fighting for survival.

The importance of coal in the fuel source chain is far from over. For the aggressively growing and energy-hungry Asian economies, coal seems to be the most popular source of power generation in spite of inroads being made by renewables.

Large sections of the population in the developing nations of Asia and Africa have yet to access electricity. The lower cost of coal compared to other fuel sources and the stability coal-fired units provide to the grid’s performance make it a preferred choice in the emerging countries.

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