A few months ago, one of my readers asked about metallurgical coal producer Walter Energy (NYSE:WLT). The company’s share price fell from a high of $136 in 2012 to less than $5 per share at the time. I wrote a blog post about it, and came to the conclusion that it had too much debt, was bleeding too much cash, and should probably be avoided.
Turns out I’ve been right, at least so far. The company’s stock currently sits under $3.
It continues to be a rough go for North American coal companies. Both thermal (used in power plants) and metallurgical coal (used for making steel) prices are terrible. Thermal coal prices are around $65 per ton, while metallurgical prices hover around $120. These aren’t great prices, so producers have been sending a bunch of coal over to a certain Asian country that’s been growing like a weed.
But there’s a problem. China isn’t growing so fast anymore. It’s real estate market is slowing, and therefore so is its demand for metallurgical coal. Rumors are also flying that it’s recently told exporting countries that it will reject imports of poor quality coal. Gone are the days when China would burn anything it could get its hands on.
There’s also speculation that the government’s next five-year plan is going to feature a huge push into green energy, almost to the point where it’s not going to build any additional coal plants. In fact, experts are even predicting that China might be close to peak coal. That’s also pretty bearish for thermal coal, which we’ll mostly be focusing on.
Okay, no big deal. If China gets to peak coal, that’s still a huge amount of coal they’ll still have to import.
In 2010-11, when China’s demand single-handedly pushed up the price of the mineral. coal producers made the same mistake gold producers did. They started developing a lot of mines. Not so much in North America, but certainly in China, Australia, Indonesia, Botswana, Mozambique, South Africa, Russia, and Colombia. Between these countries, there’s a lot of new coal supplies coming online.
Take a look at this map, from the Carbon Tracker Institute:
There’s a lot going on there, so allow me to explain. CTI looks at two scenarios. It figures that demand for thermal coal will likely start to fall over the next decade, as countries (especially Europe) replace their coal power plants with other sources, China gets away from burning so much coal, and renewable energy sources start making up a bigger percentage of our power needs. I would tend to agree with these statements.
Therefore, CTI thinks the price of thermal coal is unlikely to hit anything over $75 per ton. Remember, thermal coal currently sits at $65 per ton.
The map shows the cost of coal production planning on coming online in the next decade. Everything in the purple represents coal with a cost of less than $75/ton, and everything in the green circles represents coal with a production cost of north of $75 per ton.
Assuming coal usage stays flat over the next decade, there’s nearly $40 billion being spent on coal production that’ll be profitable at less than $75/ton. And that’s not even including present production.
I’m not even going to bother adding up the green circles, because I don’t think any of that coal will ever hit the market. And even if it does, do you really think China is going to be a net importer of thermal coal in that scenario?
Besides, a big chunk of worldwide coal production is controlled by four huge mining conglomerates. If they want, they can subsidize coal losses with profits from other divisions. Considering the amount of capital already sunk into some of these new mines, they might make a go at it, at least for a little while.
Add it all up, and what do we have? Demand that looks all but certain to either level off or more likely decline, huge amounts of new product that will hit the market even if prices remain low, and the biggest consumer of coal is likely to see both less demand and increased internal production.
This doesn’t look good for coal.
Now, which companies to short?
Walter Energy is the obvious one. Yes, I know they’re a metallurgical coal producer and not thermal, but it’s still a mess. The company has about 5 quarters of cash left, but I doubt the company will wait that long. They should see the writing on the wall in about nine months. The bond market is pricing in the risk of a bankruptcy too, sending the company’s bonds down to something like 50 cents on the dollar.
Alpha Natural Resources is also losing a lot of money, but the majority of that came from write-offs. It just recently raised $500 million. Only the last two quarters have been cash flow negative, now that I look a little closer. It’s not in terrible shape.
Peabody Energy is only sitting on $500 million in cash (compared to nearly $6 billion in debt). But it’s still managing to only lose a little money each quarter. It still pays a $0.09 quarterly dividend for some reason, but other than that doesn’t look too terrible.
Based on my five minute analysis, I’d short Walter Energy. Keep in mind that it isn’t an extensively researched call. I’m super bearish on coal, but I’m not exactly sure what the best way to play the trend is. One thing is for certain though — don’t try to play the recovery in coal. It’s not going to happen anytime soon.