Bleak Market Conditions For Coal To Negatively Impact Union Pacific’s Coal Shipment Business

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Coal is one of the major commodities transported by Union Pacific (NYSE:UNP), with coal shipments accounting for roughly 18% of the company’s freight revenues in 2014. [1] Though coal shipments remain an important source of freight revenues for Union Pacific, the company’s revenues from coal shipments have declined sharply, falling roughly 18% year-over-year in the first half of 2015. [2] The decline in coal revenues has primarily been due to a sharp decline in coal shipments, which fell around 16% year-over-year in the first half of 2015. [2] Union Pacific’s declining coal shipments are an indicator of the prevailing weakness in the demand for the commodity. In this article, we will take a look at the prevailing state of the demand for coal in the U.S. and the implications for Union Pacific going forward.

Weak Prospects For Coal

A combination of an adverse regulatory environment and low gas prices has undermined the demand for coal, specifically thermal coal, which is used in the generation of electricity.

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The coal industry has become a major casualty of the federal government’s plans to reduce carbon dioxide emissions. Coal-fired power plants are a major source of carbon dioxide emissions, accounting for around three-fourths of the total emissions from electricity generation in the U.S., as indicated by the table shown below.

Carbon Dioxide Emissions From Electricity Generation, Source: EIA

Electricity generation accounts for around 38% of the nation’s total carbon dioxide emissions. [3] A recently announced emissions reduction regulation envisions a 32% reduction in power plant carbon dioxide emissions from 2005 levels by 2030. [4] In addition, new rules target an increase in the proportion of renewable sources of electricity generation in overall U.S. electricity generation to 28% by 2030, as compared to 13% last year. [4] Given that coal-fired power plants are the major sources of carbon dioxide emissions from electricity generation, the regulatory environment going forward is certainly unfavorable for these plants. On the other hand, electricity generation from natural gas based power plants, which now matches electricity generation from coal based power plants, accounts for only 22% of the carbon dioxide emissions from power plants in the U.S. [3] Given the relatively low emissions intensity of natural gas, the regulatory environment certainly supports greater natural gas based power generation going forward.

Besides the favorable regulatory environment for natural gas, low natural gas prices have also accelerated the pace of adoption of natural gas as the preferred fuel for electricity generation. As per Energy Information Administration (EIA) estimates, natural gas prices are expected to average less than $3 per million British Thermal Units (MMBtu) in 2015. [5] These levels favor increasing adoption of natural gas as the preferred fuel for electricity generation. [5] Though natural gas prices are expected to rise next year, they will still remain at levels which favor increasing adoption of gas based electricity generation, particularly given the prevailing regulatory environment.

Implications For Union Pacific

The bleak prospects for coal as a fuel in power generation have taken a toll on the coal mining industry. Alpha Natural Resources, one of the largest coal miners in the U.S., recently filed for Chapter 11 bankruptcy protection. [6] Given these adverse recent developments for the coal mining industry, it is not very surprising that Union Pacific’s coal shipments have declined sharply in the first half of the year. With an unfavorable regulatory environment, the company’s coal shipments are likely to decline significantly in the long term. The share of coal shipments in the company’s freight revenues is set to decline from the 18% reported last year. The pace of this decline is likely to be determined by the level of natural gas prices and any additional regulatory changes. Thus, though coal shipments are an important part of Union Pacific’s business at present, the company must certainly look towards other areas for future growth.

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Notes:
  1. Union Pacific Corporation 2014 10-K, SEC []
  2. Union Pacific Corporation Q2 2015 10-Q, SEC [] []
  3. Frequently Asked Questions, Energy Information Administration [] []
  4. Obama’s New Climate-Change Regulations to Alter, Challenge Industry, Wall Street Journal [] []
  5. Short Term Energy Outlook, EIA [] []
  6. Alpha Natural Resources Restructuring Information, Alpha Natural Resources Website []