Industry Trend Analysis - Clean Power Plan: Another Nail In The Coffin - SEPT 2015

BMI View: On top of continued coal price weakness, US coal producers will face significant headwinds from stricter EPA environmental regulations a nd declining coal demand growth.

Globally, we expect continued coal price weakness to create significant headwinds for coal producers. In our view, a coal oversupply will remain, but gradually erode over our forecast period to 2019. We forecast coal prices to average USD61.0/tonne over 2015-2019, significantly lower than USD94.1/tonne over 2010-2014.

We have revised down our 2015 US coal production growth forecast from -4.8% to -7.5%. In our view, US coal production will decline from 906 million tonnes (mnt) in 2014 to 838mnt in 2015. Over the long term, output will decline to 780mnt by 2019. We forecast US coal output growth to average -2.9% y-o-y over 2015-2019, down from -1.4% y-o-y over 2010-2014. High-frequency data from the Energy Information Administration (EIA) shows that US coal production fell by 9.8% y-o-y over H115.

US coal production growth will be constrained due to continued coal price weakness and slowing demand growth. On August 4, 2015, Alpha Natural Resources, the third-largest US coal producer, filed for bankruptcy, citing weak coal prices and high debt. Alpha's debt soared after the firm's USD7.1bn acquisition of Massey Energy in 2011. Alpha acquired Massey to strengthen the firm's dominance in the US coking coal sector. HoHowever, as of August 4, 2015, the firm holds USD2.0bn in secured debt as well as USD2.1bn in outstanding unsecured bonds.

Weak Prices To Force Output Cuts
United States - Coal Production (tonnes) & Consumption (tonnes), Monthly
Source: EIA, BMI

Stringent environmental regulations will constrict domestic coal demand growth. Introduced by the Environmental Protection Agency (EPA) on August 3, the Clean Power Plan aims to reduce carbon dioxide (CO2) emissions by 32% by 2030 (compared to 2005 levels), with each state to put forward its own emissions reductions strategy by 2018 and comply with it by 2022. Regulations will further tighten on account of the Mercury and Air Toxics Standards (MATs), which is expected to come into effect during 2015/2016 as well as regulations on carbon emissions from existing power plants introduced by the EPA. Over 90% of the coal produced and consumed in the US is thermal coal. As such, one of the main challenges facing coal miners is the trend towards natural gas rather than coal as the main source of US electricity generation. This transition has become more and more apparent in recent months as energy producers find themselves constrained by increasingly stringent environmental legislation.

Foreign demand for US coal will not be able to make up for weaker domestic demand and reverse the industry's decline. Over the last couple of years coal demand from US power and industrial sectors has declined due to a secular shift towards natural gas. According to the EIA, US coal consumption fell by 13.1% y-o-y over H115. In addition, since 2012, US coal exports contracted significantly, primarily due to decreasing electricity demand from continental Europe on the back of slowing economic growth. Infrastructure limitations in the Pacific Northwest will also cap total export volumes, as significant local protests are likely to hold up development of new rail and port capacity for years. Producers operating in the Powder River Basin (PRB) will be best positioned to increase exports of both thermal and metallurgical coal to Asia owing to the basin's coal quality and cost competitiveness. Peabody Energy, which is a major producer of PRB coal, has secured export capacity from three terminals operated by Kinder Morgan in the Gulf of Mexico to avoid bottlenecks in the Pacific Northwest. The deal should enable Peabody to export an estimated 7mnt. However, exporting coal to Asia from the Gulf of Mexico as opposed to the Pacific Northwest will present added costs, even though the eventual expansion of the Panama Canal, set to be completed in 2016, should mitigate this.

Significant Contraction For Both Production And Consumption
United States - Average Annual Production & Consumption Growth (%)
Note: 2015 = January 1 - June 30 2015. Source: EIA, BMI