Coal and Fuel Could Temper CSX’s Growth

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Prices of coal and fuel have been fluctuating for quite some time now. For railroad operator CSX (NYSE:CSX), the price movements of these commodities have a significant impact on its income statement. Coal is the single largest revenue generating commodity for CSX, while fuel is one the most important operating expenses. In this article, we take a look at how CSX’s business has been impacted by the change in prices of these commodities and what might be in store in the near term.

See our complete analysis of CSX here

Coal Woes Likely To Continue

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CSX has been suffering from weak domestic and export coal volumes since late 2012 due to a drop in natural gas prices in the U.S. and a decline in coal prices in global markets. As a result, coal’s contribution towards CSX’s revenues declined from 32% in 2011 to 22.5% in 2014. [1] Given the current scenario, it seems that the railroad’s coal woes will likely continue through 2015.

Domestic Coal

CSX’s domestic coal volumes have been under pressure due to low natural gas prices. In 2012, the price of natural gas declined by almost 50% due to high shale gas output, which encouraged electric utilities to shift to natural gas for generating electricity. [2] Natural gas was also a preferable source of power generation due to its low emissions, which at that time was an important requirement as the U.S. Environmental Protection Agency had introduced stricter emissions standards for coal fired power plants. As a result, the demand for coal slumped and CSX’s coal tonnage for domestic consumption declined 7% year-on-year in 2013. [3] The weak demand for coal led to a pile up of inventory, which then led to a decline in coal prices in the U.S., making it somewhat competitive to natural gas prices.

In February 2014, natural gas spot prices shot up to $8.1 per million btu as consumption at electric utilities increased due to a spike in demand for heating driven by the harsh winter weather. [2] Prices remained significantly above $3 per million btu through the year, a level at which utilities generally start moving away from natural gas to coal. As a result, the demand for coal increased, leading to a 15% year-on-year rise in CSX’s coal tonnage for domestic consumption in 2014. [4]

The demand for coal at electric utilities has again begun to decline, as the spot price for natural gas has remained lower than $3 per million btu in the past few months. This is also evident from the rise in natural gas consumption at electric utilities, which grew 30% year-on-year in March, [5] while coal consumption declined 17% year-on-year, leading to a 25% rise in coal stock piles. [6] [7] If the present conditions persist, CSX’s domestic coal volumes could tank in 2015. At a recent conference, CSX announced that it was expecting a minimum decline of 5% in its domestic coal volumes. [8]

Export Coal

CSX’s export coal tonnage declined 8% in 2013 and 11% in 2014, as a result of weak U.S. coal exports due to competition from low priced Australian coal and a decline in demand from Europe and China. [3] [4] A stronger U.S. dollar also made coal imports from the U.S. unattractive. On top of the weak export coal volumes, CSX had to undertake price cuts in order to support the weak U.S. export coal market. As a result, its coal revenue per carload declined 2% in 2013 and 7% in 2014.

Metallurgical coal is currently trading at around $111.50 per ton, as a result of Australian coal producers having agreed to sell metallurgical coal at around $109.50 per metric ton, a six year low price, to Japanese steel mills. [9] [10] Thermal coal is also trading at lows of $50 per ton, compared to its peak of $338.75 per ton in 2011. According to Citi, the low price environment will likely persist. [9] This should keep the pressure on U.S. metallurgical and thermal coal producers and temper exports, which will likely lead to a decline in CSX’s export coal volumes in the future, as well as its coal revenue per carload. CSX expects its export coal tonnage to decline from 39 million tons in 2014 to 30 million tons in 2015. [8]

CSX May Soon Lose Out On Fuel Price Decline Benefits

CSX’s fuel surcharge revenues have been suffering due to the sharp decline in fuel prices. Despite a 2% increase in its first quarter 2015 pricing, CSX reported flat revenue per carload due to an $89 million decline in fuel surcharge. [11] In the fourth quarter of 2014 as well, CSX reported an $8 million decline in fuel surcharge revenue. [4]

However, the declining fuel prices led to a net positive benefit for CSX. This is because fuel surcharge is based on two month lagged values of highway diesel prices, while fuel expenses are based on spot prices. Since fuel prices have declined continuously, spot prices are lower than prices two months back, leading to lower fuel expenses than fuel surcharge revenues.

The average price of the U.S. on-highway diesel fuel declined 26% year-on-year in the first quarter. [12] This led to a $176 million decline in CSX’s fuel expense. The lower fuel bill helped reduce CSX’s operating expense, which declined $89 million, leading to a 3% improvement in the railroad’s operating ratio (operating expense expressed as a percentage of revenue) and 11% increase in net profits.

Presently, it seems that the price of U.S. on-highway diesel fuel has bottomed out as crude oil prices have surged from its lows. In the first week of February, the average price of U.S. on-highway diesel fuel declined to a low of $2.83. However, it climbed to $2.94 by the second week of March before falling to $2.75 in the second week of April. Since then, the U.S. on-highway diesel fuel price has continued to climb, ending the fourth week of May with an average price of $2.91.

This situation does not bode well for CSX, since fuel expense will be higher than fuel surcharge revenues due to the upwards movement of fuel prices. As a result, CSX might have to suffer a net negative impact from the increase in fuel price in the next few quarters, which would cut into its operating ratio.

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Notes:
  1. CSX’s 2014 10-K SEC Filing, SEC’s Website []
  2. Henry Hub Natural Gas Spot Price, U.S. Energy Information Administration [] []
  3. CSX 2013 Fourth Quarter Financial Report, January 2014, CSX’s Website [] []
  4. CSX 2014 Fourth Quarter Financial Report, January 2015, CSX’s Website [] [] []
  5. Table 2.4.A. Natural Gas: Consumption for Electricity Generation, May 26, 2015, www.eia.gov []
  6. Table 2.1.A. Coal: Consumption for Electricity Generation, April 27, 2015, www.eia.gov []
  7. Electric Power Sector Coal Stocks: January 2015, March 27, 2015, www.eia.gov []
  8. CSX Corporation at Bank of America-Merrill Lynch 2015 Transportation Conference, May 14, 2015, CSX’s Website [] []
  9. Coal headwinds tipped to drive down prices, May 28, 2015, The Sydney Morning Herald [] []
  10. Met Coal Tumbles to New Six-Year Low Amid Slumping Demand, March 17, 2015, www.bloomberg.com []
  11. CSX’s Q1 2015 Financial Report, CSX’s Website []
  12. U.S. On-Highway Diesel Fuel Prices (dollars per gallon), www.eia.gov []