Union Pacific Corporation (NYSE:UNP) is one of the leading railroad companies in the United States. Coal represents a key commodity group for Union Pacific as it accounts for around 20% of its total freight revenues. Its revenue ton-miles of energy commodities freight (which primarily consists of coal), decreased from 239 billion in 2011 to 207 billion in 2012. Increased substitution of coal with cheaper natural gas for electricity generation is the main factor responsible for the decline. Higher stockpiles of coal at utilities and lower electricity generation further contributed to this drop.
According to the Association of American Railroads, the overall coal railcar loadings in the U.S. were down by 11% in 2012.  While, the share of coal in U.S. electricity generation has decreased from 45% in 2010 to 37% in 2012, the contribution of natural gas increased from 24% to 30% in the same period, according to the US Energy Information Administration. 
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We think Union Pacific’s revenue ton-miles of energy commodities freight will further drop to 187 billion in 2013, owing to declining coal production, the closure of coal plants and higher coal inventory levels at utilities. An increase in natural gas prices coupled and a decline in coal prices will bode well for the coal demand. However, we think natural gas prices should exceed $3.50-4 for coal to regain some market share in U.S. electricity generation. While U.S. exports of coal are rising, we think they will only partially offset the decline in domestic coal consumption.
In this article, we evaluate the key trends in the coal market that are expected to impact Union Pacific coal freight in 2013.
Factors That Could Lead To Higher Coal Freight Traffic In 2013
Increase In Natural Gas Prices
While the average natural gas spot price ($ per million BTU) was recorded at $4.40 and $4 in 2010 and 2011 respectively, this figure dropped to $2.80 in 2012, supporting the substitution of coal with natural gas for electricity generation. However, this figure started treading higher towards the end of 2012, and reached close to $3.30 in February 2013. 
According to Union Pacific, if natural gas prices go upwards of $3.50-4, then coal will become a more competitive fuel to natural gas for electricity generation. 
Decrease in coal prices
Prices of Central Appalachian coal have been declining recently, and they were recorded at around $2.5 per mmBtu in March 2012, bringing the price difference between Central Appalachian coal and gas prices to around $1 per mmBtu. 
While these factors bode well for electricity generation with coal, coal-powered plants still remain comparatively more expensive as compared to gas-powered plants according to some reports on account of two reasons – gas-based plants are around 25% more efficient as compared to coal-based plants, and the rail transportation of coal from the mine to the power plant costs around $1 per mmBtu, but this figure stands at a few cents for gas transportation by pipeline. 
Higher demand for U.S. coal exports
While the domestic demand for coal continues to fall, U.S. exports of coal are rising. In the first nine months of 2012, the U.S. exported around 98 million tons of coal, which was 23% higher than last year. Exports to Europe, China and India rose by 29%, 108% and 52% respectively during the period.  We expect increasing U.S. coal exports to partially offset the decline in domestic coal usage in 2013.
Factors That Could Lead To Lower Freight Traffic In 2013
Increased inventory levels
According to the U.S. Energy Information Administration, coal stockpiles at electric power plants throughout January-November 2012, were above the levels recorded in 2011 as well as the five-year average. Stockpiles in November 2012 were recorded at 11% higher as compared to the previous year.  The substitution of coal with natural gas and lower electricity generation contributed to the rise in stockpiles. This indicates that if the utilities prefer to use coal for electricity generation in 2013, they still have significant coal reserves and can defer coal purchases.
Lower coal production
Reflecting the lower demand for coal, its production in the U.S. dropped by 6% annually in the first nine months of 2012.  We believe coal production could continue to suffer in 2013, owing to lower domestic demand and higher stockpiles.
Closure of coal plants due to stringent emission standards
Stringent federal emission standards have led utilities to close their older coal plants as they are finding it uneconomical to invest in emission control equipment in the wake of cheaper natural gas prices and lower power prices.
Our $141 price estimate for Union Pacific is in line with the current market price.Notes:
- Rail traffic reflects more oil production, less coal-fired electricity generation, U.S Energy Information Administration, February 5, 2013 [↩]
- Electric Power Monthly, US Energy Information Administration, February 25, 2013 [↩]
- Natural Gas Spot and Futures Prices (NYMEX), U.S Energy Information Administration, February 27, 2013 [↩]
- Union Pacific Management Discusses Q4 2012 Results – Earnings Call Transcript, Seeking Alpha, January 24, 2013 [↩]
- US utilities seen burning more coal as prices decline, Creamer Media, March 06, 2013 [↩] [↩]
- U.S. Coal Exports, U.S. Energy Information Administration, December 20, 2012 [↩]
- Coal stockpiles at electric power plants were above average throughout 2012, US Energy Information Administration, January 25, 2013 [↩]
- U.S. Coal Production, 2006-2012, US Energy Information Administration, December 20, 2012 [↩]