Andrew Moore, Platts: Coal Supply: Will We Overcorrect?
This article was originally published in Issue 1, 2016 of American Coal magazine – read the full issue (and past issues) on the ACC website by Clicking Here
Coal Supply: Will We Overcorrect?
By: Andrew Moore, Platts
According to recent forecasts from the Energy Information Administration, US coal production could dip to 784 million st in 2016, the lowest annual total since 1983.
Should the forecast prove correct, US coal production will have dropped 21.4% since 2014. In percentage terms, it would be largest two year decline since the EIA began tracking coal production in 1949.
It’s a similar story for power sector coal demand. The EIA projects 710.7 million st will be consumed in 2016, which would be a 3.9% drop from 2015 . But in 2015, power sector consumption dropped 13.1% from the prior year, the largest year-over-year decline going back to 1949.
Some market watchers have suggested 2016’s power sector demand could drop even further, as low natural gas prices continue to sap consumption.
Coal producers have reacted with production cuts. And while it’s clear a structural shift is underway in the US power market, coal remains a cyclical commodity, which begs the question: Is an overcorrection at risk?
“The market goes in cycles,” said John Hanou, of Hanou Energy Consulting. “Production cuts and stockpile depletion will inevitably cause another shortage, which will allow prices to increase. The question is when will it happen again.”
In December 2015, utility stockpiles averaged 197.1 million st, per the EIA. The monthly figure was 15.4% higher than the five-year average for the month, but just slightly below the all-time record of 203.8 million st set in November 2009.
A big reason for the increase in December was the ongoing impact of cheap natural gas on utilities that burned subbituminous (Powder River Basin) coal. With Henry Hub natural gas futures prices averaging below $2.50/MMBtu in the fourth quarter, many PRB-burning utilities switched to gas.
As a result, subbituminous stockpiles grew to an all-time high in December of 109.4 million st, nearly 27% higher than the monthly five-year average.
Since then, subbituminous prices have tracked lower. The monthly average of the Platts assessment for the over-the-counter PRB 8,800 Btu/lb futures contract totaled $9.82/st in February, a nearly three-year low.
“Those stockpiles need to drop to 50 million st,” said Hanou. “The only way to do that is to produce less and ship less.”
PRB production totaled 99.5 million st in the fourth quarter of 2015, according to the Mine Safety and Health Administration. The total was down 8.7% from the prior quarter and down 12.9% from the year-ago quarter.
For 2016, at least two PRB producers, Peabody Energy and Cloud Peak Energy, have said they plan to further cut production. The other two major PRB producers, Alpha Natural Resources and Arch Coal, both of whom have filed for bankruptcy protection, haven’t publicly discussed 2016 production but each showed quarter-over-quarter and year-over-year declines in the fourth quarter, perhaps signaling the two will continue to scale back.
In addition, EIA estimates for the first quarter of 2016 show PRB coal production tracking roughly 27% below last year’s levels.
As PRB producers adjust to falling demand, there’s the risk that too much capacity could come out of the market, said Matt Preston, the research director for North American coal markets at Wood Mackenzie.
“In the short term, demand can be made up but in the long run, they start to park equipment and it makes it very difficult to recover,” said Preston. “If you’ve stolen all the tires off the big trucks you can’t go back and turn them on again.”
In addition, the railroads will also cut capacity to meet demand. Should PRB demand increase, it will be take several months for the logistics to catch up, which could add additional tightness to the market.
“If [natural gas] gets well above $3[/MMBtu], I think we would find ourselves overcorrected but there are two parts to that,” said Preston. “Coal production might be a little overcorrected, but the rails might be a lot overcorrected, so just like in the polar vortex, there was plenty of coal demand to go around, but nobody could deliver.”
“I think we’ll see a combo of that same thig, everyone scrambling to produce tons if they possibly can but the ability to get it delivered might be the problem,” Preston said.
Since 2005, the lowest that subbituminous stockpiles have dropped was 43.8 million st in September 2005. That month, the OTC price for the PRB 8,800 futures contract averaged $8.90/st.
The contract quickly shot up in the following months to reach an all-time high in January 2006 of $21.95/st, though the price was also pushed higher by an increase in natural gas prices.
Subbituminous stockpiles climbed from that 2005 low to reach a peak of 100.2 million st in November 2009. Two months prior, in September 2009, the OTC price for the PRB 8,800 futures contract dropped to its all-time low of $6.47/st.
Subbituminous stockpiles then dropped in August 2011 to 67.8 million st, and the futures price that month climbed to an average of $14.08/st.
In May 2012, after a record warm winter, subbituminous stockpiles reached what was then an all-time high of 103.9 million st, and the OTC PRB 8,800 futures price dropped to $7.30/st in July.
Prices then climbed as stockpiles fell, and the May 2014 OTC PRB 8,800 contract averaged $13.15/st. The contract has largely been in decline ever since.
Hanou said prices typically spike roughly every three years, “so if you believe in that three-year cycle, it will be early 2017 but it’s likely going to be longer than that.”
For some, this time is different. The current pull back might not lead to an upswing.
“Coal is cyclical, but in the past, we knew what the base was,” said a market participant who wished not to be identified.
In the short term, this summer will be an important variable for coal demand. A hot summer could lead to increased power burn and burn down coal stockpiles and push up prices for natural gas.
Should the weather not cooperate, many see increased demand for natural gas from LNG exports, growing exports to Mexico and higher power and industrial demand strengthening gas prices in the next two years.
“If natural gas prices increase to $3.50/MMBtu, all of a sudden those coal plants start burning that coal, and those stockpiles will quickly deplete.”
Such a situation implies PRB prices will increase. But the timing is uncertain and not likely to be orderly.
–Andrew Moore, firstname.lastname@example.org