ANR Has A Big Opportunity In Thermal Coal Exports

The share of coal-fired electricity generation in the United States has been on the decline over the last few years. Recent reports estimate that over 9 GW of coal-fired power capacity retired in 2012, which is likely to be the single largest annual retirement of coal capacity in U.S. history. Additionally, as much as 60 GW or nearly 20% of coal-fired generation capacity could be shut down across the country over the next few years. ^[1]

This decline in coal-fired generation is likely to dent thermal coal demand in the U.S. in the coming years and could impact Alpha Natural Resources (NYSE: ANR), one of the largest coal producers in the country. Here we explore the firm’s exposure to the thermal coal market and look at its opportunities in the export market.

See our full analysis and $9.50 price estimate

Why Is There A Decline In Coal-Fired Capacity?

Environmental regulations for power plants have become more stringent, stipulating the reduction of heavy metals and acidic gas emissions.  To comply with these standards requires coal-fired power plants to install expensive equipment like selective catalytic reduction (SCR) technologies and scrubbers, which could significantly drive up costs of generation.

On the other hand, the shale gas boom in the U.S. has driven natural gas prices down sharply with prices reaching their 10-year lows in early 2012. This has driven down fuel costs for gas-fired plants sharply, giving them an edge over coal power plants. Average generation costs per kilowatt hour from natural gas plants are around 7 cents, compared to around 9.5 cents for coal. Capital costs are also much lower. Coal-fired power plants can cost as much as $3,200 per kilowatt of generation capacity while a modern natural gas-fired power plant costs about $1,000 per kilowatt.((CNBC)) Given that natural gas is also a relatively cleaner fuel, utilities are choosing to phase out their aging coal-fired power plants, replacing them with natural gas rather than retrofitting them with expensive pollution control equipment.

Where Do The Firm’s Thermal Coal Exports Stand?

ANR’s thermal coal is used by utility firms and the industrial sector as a fuel for electricity generation. This division accounted for more than 80% of the firm’s shipment volume and around 45% of revenues in 2011. Unlike the metallurgical coal division, which is heavily geared towards the export market, most of ANR’s thermal coal is still sold in the U.S. market.

Over the past two years the firm’s thermal coal division’s revenues have been relatively flat; however, we believe that the firm’s ability to sustain and grow these revenues will hinge on exports. The firm exported around 4.5 million metric tonne of thermal coal (around 6% of production) in the first three quarters of 2012, up from almost nothing a few years ago. In contrast, the firm’s met coal division exported more than 75% of its production. Export markets included China, India and Europe.

The firm is well positioned to grow its thermal coal exports with significant shipping terminal capacity in the East Coast, primarily in Virginia and Maryland as well as in the Gulf Coast, giving the firm good access to the European, Asian, Latin American and African markets. The firm’s total port capacity presently stands at between 25 to 30 million tonne annually. The firm also owns a 41% stake in Dominion Terminal Associates in Virginia.

Export Markets That Show Promise

China remains the world’s largest market of coal, accounting for almost half of global coal consumption. Relatively high coal prices and logistical issues have turned the country into a net coal importer. As of Q3 2012, thermal coal prices in the country were around $100 which represents a near 50% premium over U.S. prices. ^[2] India is another promising market, thanks to its growing economy and an acute shortage of electricity which are likely to drive demand. The country’s thermal coal imports are expected to be around 80 million tonne in FY2012-13.

By tapping these markets, ANR should be able to drive volumes and profitability growth. However, the seaborne coal market is quite volatile and demand patterns fluctuate significantly over time. Additionally the firm could face competition from suppliers in Indonesia and Australia, which have a logistical advantage in serving the Asian markets.

Other attractive markets include Europe and Japan. Europe is seeing strong demand for thermal coal due to high natural gas prices (gas prices in Europe as as much a thrice those in the U.S.). In Japan, coal-fired power stations are operating at near their peak capacities as the country strives to meet the deficit caused by suspension of some nuclear capacity following the 2011 tsunami and earthquake. In Japan, the prices of powder river basin coal ( a low sulfur variety of thermal coal) are as high as $100 per tonne compared to just around $13 per tonne in the U.S.

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1. U.S. coal-fired power plant retirements top 9,000 MW in 2012, Reuters [↩]
2. China Suspends Coal Mines for Congress, Boosting Prices, Bloomberg [↩]