Record low demand for thermal and coking coal is driving American coal producers to the edge of solvency as St. Louis-based Patriot Coal (OTC Pink:PCXCQ) was the first to file for Chapter 11 bankruptcy reorganization last week.
Patriot’s bankruptcy is the fallout from the continued glut of US “fracking” natural gas which has pushed US thermal coal miners down 41 percent this year. Declining sales and revenues forced Patriot to reorganize its finances with US $3.07 billion in debt and US $3.57 billion in assets on the books.
“The coal industry is undergoing a major transformation and Patriot’s existing capital structure prevents it from making the necessary adjustments to achieve long-term success,” Patriot CEO Irl Engelhardt said in a statement after accepting US $802 million in debt financing last week.
Rising operational costs and stagnant demand have also been considerable factors in Patriot’s reorganization. In a recent interview with the Globe and Mail, BMO Nesbitt Burns analyst Meredith Bandy noted that companies operating in the Appalachian Basin have long been at risk to what is unfolding right now.
“The Appalachian Basin is an aging basin facing rising strip ratios, deeper and thinner seam mines and a rising cost structure,” Bandy said.
Coal companies carrying heavy debt burdens from merger and acquisition activity last year have also been stressed by the lowest US coal demand in 24 years. Significant restructuring within the industry could follow. Brean Murray analyst Lucas Pipes told Platt’s that PeabodyEnergy (NYSE:BTU) and Arch Coal (NYSE:ACI) are also now facing financial fallout from Patriot’s bankruptcy filing.
Problem is global, not local
Coal stocks are suffering globally as China’s industrial output has slowed and gross domestic product growth has fallen to a three-year low of 7.6 percent. Despite reports that Chinese Premier Wen Jiabao hinted that a second-half stimulus packages could be on the way in China, Chinese coal production continued to suffer over the past month.
Thermal prices at China’s main coal port Quinhuangdao have fallen steeply over the past two weeks as buyers in the Chinese port have become increasingly scarce. Standard Chartered analyst Serene Lim said that a convergence in Quinhuangdao and Newcastle thermal spot prices may be an indication of a second round of cuts to thermal prices.
“This may lead to a slowdown in China’s coal imports and trigger another wave of distressed thermal coal prices, particularly when the global seaborne thermal coal market remains well supplied,” Lim was quoted in a Platt’s article.
Coking coal production in China has also been significantly impacted over the past month, with prices at Quinhuangdao dropping 12 percent to 650 yuan (US $102) per metric tonne by July 11. The China Daily reported low coal prices have forced several coal producers to stop or reduce production.
Meanwhile, Australian coal producer Rio Tinto (NYSE:RIO) announced this week that lagging Chinese growth was one of the reasons it was laying off an unspecified number of miners at its Clermont coal mine in central Queensland.
In a statement published by Reuters, Rio also noted pressures from rising wages, equipment and fuel bills, new taxes, and growing coal exports from the United States, all of which have sent thermal coal prices down nearly 25 percent this year.
Despite the trough-like position coal producers have found themselves in globally, there is some optimism around the prospects of a number of US thermal producers.
Citigroup’s Brian Yu believes there are some enticing investment opportunities in many of the US coal equities as much of the gloom caused by natural gas prices below US $3 per million BTU has likely already been priced into US coal equities.
In a note earlier this month in a Barron’s, Yu felt that “in the short run, coal equities lack identifiable catalysts with lower oil prices, low natural gas prices and generator inventories sitting at elevated levels.”
However over the long run, Yu argues that gas prices will come back up, reducing the current coal inventories and putting select coal producers back into the competitive positions they held before.
Yu said that there is a “case to be made here that a number of names are undervalued so long as they can survive the trough.” Deutsche Bank’s David Martin agreed with the undervaluation of premium US coal stocks like Peabody and Walter Energy (NYSE:WLT) in the same Barron’s article.
BMO’s Meredith Bandy identified the Powder River Basin in southeast Montana and northeast Wyoming as one region where the economies of scale to compete with natural gas below $3 per million BTU.
Securities Disclosure: I, James Wellstead, hold no direct investment interest in any company mentioned in this article.