ANR Fair Value $20 On Met Coal Export Market & U.S. Thermal Coal Demand

by Trefis Team
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Alpha Natural Resources
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Alpha Natural Resources‘ (NYSE:ANR) stock price has plummeted sharply, shedding nearly 80% value in last one year. The dismal performance can be attributed to decade low prices of natural gas and environmental issues relating to carbon emissions in coal operations. In addition, an unusually favorable winter aggravated the situation as the coal demand for electricity generation was significantly lower than anticipated. However, we believe that the stock has potential for upside as met coal shipments, primarily in export markets, are expected to be upbeat in coming years. Moreover, the U.S. coal demand from utility companies will revive when coal prices reach an equilibrium with natural gas prices.

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China and India drive met coal demand

ANR shipped nearly 19 million tons of metallurgical coal in 2011 (including output from Massey since June 1, 2011), out of which more than 70% was exported. Europe receives the majority of met coal exports by ANR, followed by Asia. The economic downturn in Europe is expected to pull down met coal demand in the region which is expected to offset by demand from Asia.

India and China are expected to drive met coal exports. Met coal is typically used for steel manufacturing. As steel is a vital input for infrastructure development, it plays a critical role in the growth of an emerging country. We expect demand for met coal, which sells at a premium to utility coal, to increase in the future driven by infrastructure growth in China and India. However, our estimates could see a downside if the European downturn undermines ANR’s operations in the continent.

U.S. thermal coal demand to revive

The majority of thermal coal produced by ANR is used in electricity generation in the U.S. while very little is exported. The thermal coal demand in the U.S. is declining as natural gas is apparently sweeping its market. Coal, which was considered an absolutely essential commodity for power generation in the U.S. a decade ago, is grappling for its existence because of utility companies’ preference for cleaner and cheaper natural gas. Declining natural gas prices has dragged down the coal prices and shipments.

This is evident as ANR recently announced plans to stall mining operations in some of its Kentucky mines as fuel switching from coal to gas by many utility companies and low coal prices have rendered the operations in those mines economically nonviable. [1] However, the slide in coal demand will be arrested as gas prices start rising.

Gas and coal are traditionally considered the closest substitutes for electricity generation. An interesting analysis was presented by Marin Katusa from Casey Research. According to the analysis, if we consider the present price level of Central Appalachian coal of $61 per ton, with each ton generating 12,500 BTU of energy, it works out to $2.4 per million BTU for coal. [2] According to the latest natural gas spot henry hub, gas spot price is around $2.2 per million BTU. Hence, coal is not too far away from natural gas and energy producers only care about the production price. Once the prices catch up, we believe the coal demand will revive and drive revenues for ANR. However, if the environmental restrictions are too stiff, energy producers may choose to go ahead with natural gas as their preferred fuel, in which case there can be downside to our estimates for thermal coal shipments.

Our price estimate for ANR stands at $20, nearly 140% above the current market price, which is depressed due to subdued coal demand across the U.S.

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Notes:
  1. Alpha Natural Resources to Reduce Coal Production from Kentucky Mines, marketwatch.com, June 8, 2012 []
  2. Coal and Shale Gas: American’s Energy Siblings Are Locked in Rivalry, goldseek.com, May 30, 2012 []
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