A sharp deterioration in the demand and pricing environment for both metallurgical and thermal coal over the course of the last year has taken its toll on the business prospects of Alpha Natural Resources (NYSE:ANR). The company’s profitability and liquidity have been negatively impacted by the adverse business conditions that it is currently facing. This has resulted in the company’s stock price falling nearly 80% over the course of the last year or so. 
Though prospects look quite bleak for the company, in this article we will look at a couple of scenarios that could significantly boost Alpha Natural’s stock price.
Sharp Recovery in Natural Gas Prices
- Alpha Natural Resources’ Earnings Review: Weak Coal Demand And Pricing Weigh On Q1 Results
- Alpha Natural Resources’ Earnings Preview: Weak Coal Demand And Pricing To Weigh On Q1 Results
- Trends Driving Our $1 Price Estimate For Alpha Natural Resources
- Alpha Natural Resources’ Earnings Review: Weak Coal Demand And Pricing Weighs On Q4 Results
- Alpha Natural Resources’ Earnings Preview: Weak Coal Demand And Pricing To Weigh On Q4 Results
- Trends Driving Our $1 Price Estimate For Alpha Natural Resources
Demand and pricing for thermal coal has been weak over the course of the last year, primarily as a result of the weakness in natural gas prices. Due to the weakness in natural gas prices, and increasingly strict EPA regulations pertaining to coal-fired thermal power plants, utilities have been shifting to natural gas as their preferred fuel, undermining the demand for coal. Soft natural gas prices and weak demand conditions for thermal coal are expected to result in weak demand and pricing for thermal coal in 2015 as well. We expect natural gas prices to increase gradually over the next couple of years, primarily in response to rising demand.
However, there is a possibility of a much sharper increase in gas prices. This scenario involves a sharp increase in U.S. Liquefied Natural Gas (LNG) exports to Europe. Currently, imports from Russia account for around 167 billion cubic meters (bcm) or close to 60% of overall European gas imports.  With an adverse ongoing geopolitical situation in Ukraine, the sustainability of the status quo pertaining to Russia’s gas exports is in question. In the event of the worsening of the geopolitical situation in Ukraine, international sanctions may severely limit Russian gas exports to Europe. In such a situation, the displacement of Russian exports is likely to be compensated for by a sharp increase in LNG exports from a gas surplus U.S.
A sharp increase in demand for U.S. gas exports would boost benchmark Henry Hub gas prices that currently stand at $2.64 per mmBtu.  If prices recover to levels of around $5 per mmBtu, seen around a year ago, and remain at these levels for sustained periods of time, it could positively impact the prospects of Alpha Natural Resources. Such an increase in natural gas prices would retard the shift of coal-fired thermal power plants towards natural gas as their preferred fuel. Such a scenario would result in an upward revision to our shipments and margin forecasts for the company’s Utility & Industrial Coal division. In order to model this scenario, we factor in realized thermal coal shipments rising to 72 million tons by the end of our forecast period, as against 66 million tons in our base case scenario. In addition, there would be a corresponding increase in margins. If we factor in the impact of a rise in gas prices upon the relevant drivers in our price estimate for Alpha Natural Resources, it boosts our price estimate by around 68% from $1.11 to $1.87. Thus, in the event of a sharp recovery in gas prices, an upward adjustment in valuation could potentially follow for Alpha Natural Resources.
Recovery in International Metallurgical Coal Demand
Metallurgical coal is a major input in steelmaking. Thus, demand for metallurgical coal by the steel industry plays a major role in determining its prices. The prices for Alpha Natural’s metallurgical coal sales are benchmarked to international metallurgical coal prices. International metallurgical coal prices are largely determined by Chinese demand, since China is the largest consumer of metallurgical coal in the world. Demand for the commodity by the Chinese steelmaking industry has been weak, adding to subdued demand from other major consumers such as Japan and the EU. Chinese steel demand growth is expected to slow to 2.7% in 2015, down from 6.1% and 3% in 2013 and 2014, respectively.  Weak Chinese demand for steel has translated into weak demand for metallurgical coal.
Weak demand coupled with an oversupply situation, due to expansion in production by major mining companies, has resulted in a decline in international met coal prices, which has negatively impacted price realizations for Alpha Natural’s metallurgical coal business. Realized prices for Alpha Natural’s metallurgical coal mining business stood at $85.42 per ton in 2014, as compared to $99.01 per ton in 2013.  Given the prevailing weak demand and oversupply situation, Alpha Natural is expected to face a weak demand and pricing environment for metallurgical coal in 2015 as well.
However, there is a slim possibility of a slight recovery in met coal prices over the next couple of years. The drivers for this scenario are two-fold. Firstly, the current levels of met coal prices are insufficient to support a significant proportion of global met coal production. Benchmark met coal prices currently stand at around a third of their peak values in 2011.  This has resulted in the closure of several high-cost coal mines globally, which is likely to result in a more favorable global demand-supply equation. In addition, if Chinese economic growth recovers faster than expected, it would also provide a fillip to met coal prices. A combination of these two factors may bring the oversupplied global met coal markets into balance much faster than expected and push up realized prices and shipments for the company. In order to model this scenario, we factor in realized met coal prices rising to $100 per ton by the end of our forecast period, as against $94 per ton in our base case scenario. In addition, we have factored in a corresponding increase in shipments and margins. If we factor in the impact of a faster than expected recovery in met coal prices upon the relevant drivers in our stock price model for Alpha Natural Resources, it boosts our price estimate by around 53% from $1.11 to $1.70. Thus, in the event of a recovery in met coal prices, an upward adjustment in valuation could potentially follow for Alpha Natural Resources.
- Alpha Natural Resources Stock Price, Google Finance [↩]
- Ukraine Russia Europe Gas Oil Factsheet, International Energy Agency [↩]
- Henry Hub Natural Gas Spot Price, EIA [↩]
- Short Range Outlook for Apparent Steel Use 2013-2015, World Steel Association [↩]
- Alpha Natural Resources’ 2014 10-K, SEC [↩]
- Metallurgical Coal at 6-Year Low as Chinese Demand Slows, Bloomberg [↩]