Must-know: Why coal producers' stocks are declining (Part 4 of 10)
Shale gas revolution challenges U.S. coal industry
Porter’s five forces model, coined by Michael Porter in 1980, is widely used by analysts and academics across the globe for the simplicity and analytical value attached to it. In this section, we’ll analyze the coal industry in the U.S. using the Porter’s five forces model.
Threat of new entrants
In case of the coal industry in U.S., the treat of new entrants is minimal. The reason for this is two-fold. First, coal mining is a capital intensive business. It involves a lot of upfront costs such as license fees, purchase of mining equipment, and removal of overburden in the mine. There are costs even before the mine starts producing coal and the company starts generating revenue. Second, mining companies often require technical expertise and experience. The two reasons keep new entrants at bay. This protects the interests of existing players such as Peabody Energy (BTU), Arch coal (ACI), Alpha Natural Resources (ANR), Cloud Peak Energy, and Consol Energy (CNX).
Since the U.S. is a coal surplus country, competition exists between players operating in the industry, especially while securing long-term coal supply agreements. However, scope for price competition is minimal. Coal prices are generally market driven because they’re a commodity. Companies generally try to gain an advantage by cutting costs and streamlining operations.
Buyers of coal are typically the electricity generators and steel makers. Recently, there has been a shift from coal to gas due to the shale gas revolution. This has resulted in conversion of some coal fired plants to gas based plants, typically in the Midwest. Some coal fired plants are being retired too. This has resulted in higher negotiation power for the buyers of coal.
Suppliers of coal companies include mining equipment manufacturers such as Caterpillar (CAT) and JCB. There are a number of suppliers available in the market that sell mostly standardized mining equipment. As a result, the suppliers don’t exert great power over miners. The most crucial supplier for the coal miners is the labor force. Since a large part of labor involved in mining is unskilled, the extent of negotiating power available with the labor depends on the state of the economy and the opportunities in other sectors. While new technologies have made mining safer, it remains riskier than a lot of other sectors which prompts labor to seek risk premium.
Threat of substitutes
The most prominent threat that the coal industry is facing in recent years is from the drop in gas prices. The drop in prices was cause by new drilling techniques used to recover gas trapped in shale formations. The new discoveries coupled with subdued demand for energy have resulted in natural gas price for electric power generation to drop to $2.81 per thousand cubic feet in April, 2012, from $12.41 per thousand cubic feet in June, 2008, at its peak. The prices have started increasing since April, 2012, as many power producers and petrochemical companies are flocking to the natural gas market to take advantage of lower natural gas prices. The natural gas prices as of May, 2014, remain at $6.28 per thousand cubic feet.
In the next section of the series, we’ll elaborate on the shale gas revolution before moving on to other threats looming over the coal industry.
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