Industry Trend Analysis - Peabody Bankruptcy To Add Pressure To Struggling US Coal - MAY 2016

BMI View: Peabody Energy ' s bankruptcy highlights the extent of the industry ' s rout, giving way to further consolidation. The announcement comes on the back of industry-wide challenges, namely high debt levels, low energy prices and increasingly stringent environmental regulations.

On April 13, US coal mining giant Peabody Energy filed for chapter 11 bankruptcy, citing a high debt load amid a challenging industry environment. The firm intends to use the process to improve liquidity and reduce debt, with operations set to continue in the US, and Australian entities excluded from the filings. In 2015, Peabody posted a steep net loss of USD2.0bn, the firm's fourth consecutive year in the red. The firm's USD10.1bn debt load (USD6.0bn net debt) stems largely from the USD5.1bn purchase of Macarthur Coal in 2011. Furthermore, Peabody faces a USD75.0mn settlement owed to the United Mine Workers of America in 2016 over healthcare payments for retired workers and USD1.5bn due in environmental liabilities.

While the firm has made strides reducing costs and divesting from non-core assets, given the weak price environment, management underestimated the price rout, relying on stronger demand growth from China and India and stable demand growth from the US as recently as September 2014.

Overextension In A Tough Market To Spell Trouble
Peabody Energy - Net Income (LHC, USDmn) & Total Debt/EBITDA (RHC, ratio)
Source: Bloomberg

Peabody's announcement illustrates the effects of the two key trends in the US coal industry: namely, persistently weak prices and the rising costs from tightening environmental regulations. The latest, and largest, bankruptcy yet signals a growing acceptance within the coal industry of its rapid decline in the US, and highlights the shift across mining sectors to pare down portfolios and focus on core assets ( see: 'Anglo's Plan, Only The Next Stage', February 17). The US coal industry will see further bankruptcies and consolidation, as evidenced by Fitch Ratings' announcement that the US institutional leveraged loan default rate in the metals/mining sector jumped to 29% from 25%, with the coal subsector default rate approaching 70%.

US Coal Bankruptcies
Company Date Debt (USDmn) Net Profit/Loss (USDmn) Production (mnt)
na = not available. Financial/production data from latest available year. Source: Bloomberg, Company announcements
Peabody Energy Apr-16 10,100 -1,996 208
Arch Coal Jan-16 5,138 -2,913 114
Walter Energy Jul-15 3,316 -2,822 9.3
Alpha Natural Resources Aug-15 1,343 -5,785 18.6
James River Coal Apr-14 425 -139 na
Patriot Coal Oct-15 390 -730 6.2

Lower For Longer Prices To Thin The Herd

We expect to continue to see bankruptcies, restructuring, divestment and consolidation in the US coal industry as structurally lower coal prices and elevated operating costs weigh on miners' profit margins. Both thermal and metallurgical coal prices will remain subdued, as declining coal use in electricity generation and declining steel production keep respective global markets oversupplied.

We expect thermal coal prices to average only USD51.0/tonne and USD52.0/tonne in 2016 and 2017, respectively. Our 2020 average price forecast of USD54.0/tonne is still 12.9% below the 2015 average of USD62.1/tonne. In the US, where over 90% of the coal produced and consumed is thermal, competitively low natural gas prices - underpinned by the country's shale revolution - will usurp coal as the dominant energy in the electricity mix ( see: ' Decline In Coal Power Forecast To Acce lerate ' , March 18).

Gas Power Will First Surpass Coal In 2016
US - Power Generation By Gas & Coal (TWh)
e/f = BMI estimate/forecast. Source: EIA, BMI

Lower prices will drive consolidation and divestment, with a dwindling number of firms well-positioned to purchase assets. Larger firms, such as Peabody, will prioritise deleveraging and firms across the sector will target slimmer and low-cost asset portfolios. The deteriorating credit market for miners will impede deals, making asset divestment an unreliable strategy for raising cash. For instance, in April, Peabody's USD358mn sale of three mines in New Mexico and Nevada to Bowie Resources collapsed, with the latter citing lack of funding. In February 2016, Coronado Coal purchased the Buchanan metallurgical coal mine from Consol Energy for USD420mn, with the strategic backing of financial partner Energy and Minerals Group. Consol will divest coal assets from its portfolio to focus on its natural gas business segment.

Lower For Longer To Take Its Toll
Global - Average Thermal Coal Price (USD/tonne)
f = BMI forecast. Source: BMI

Coal mines in the Illinois Basin and Powder River Basin will garner the most interest, due to low operating costs, while those in the Appalachian Basin and the western US will remain on the market longer and more likely to be idled ( see: 'Illinois Basin To Maintain Competitive Edge In Tough Market', March 29). For instance, in 2015, coal cash costs averaged USD25.2/tonne and USD30.4/tonne in the Powder River Basin and Illinois Basin, respectively, compared to USD39.7/tonne in Appalachia.

Illinois, Powder River Basin To Remain Most Cost-Competitive
US - Coal Cash Costs By Region (USD/tonne)
Source: Bloomberg

Tightening Regulations To Seal Bleak Fate

On top of plummeting profits from weak thermal and metallurgical coal prices, the US coal industry will come under rising pressure from environmental regulations. The momentum of the green movement in the US will raise costs significantly for coal miners. While the 2016 presidential race harbours the possibility of a Republican win providing aid for the coal industry, we do not expect the grassroots support for environmental regulations to fade. Over the course of 2015, the Obama administration passed substantial legislation aimed at reducing carbon dioxide emissions and increasing environmental accountability in the extractive sectors ( see: ' Clean Power Plan: Another Nail In The Coffin ' , August 6, 2015).

  • The Clean Power Plan will reduce carbon dioxide (CO 2) emissions by 32% by 2030 (compared to 2005 levels), with each state submitting a unique emissions reductions strategy by 2018 and comply with it by 2022. Coal-fired power plants will be a key target of the plan, expediting closures and shifting the country's electricity generation away from coal to natural gas.

  • The Mercury and Air Toxics Standards, implemented in April 2015, will require power plants to limit their emissions of toxic air pollutants such as mercury, arsenic and metals.

  • The proposed Stream Protection Rule, aimed at increasing the accountability of coal miners for environmental degradation, would, according to private US coal miner Murray Energy end longwall mining, 'sterilise' underground mining and cause 'dramatic' layoffs.

  • On January 15, the Obama administration announced that the Interior Department will freeze new coal leases on public lands (approximately 40% of existing coal mines are located on public lands).

  • In December 2015, President Obama signed the UN 2015 Paris Climate Change Conference agreement, signalling a long-term commitment to reducing green-house gases in the US ( see: ' UNCOP21: Assessing Implications For Industries ' , December 18 2015).

Green Movement To Hasten Coal's Decline
US - Coal Production, Weekly (short tonnes)
Source: Bloomberg
Largest Listed US Coal Companies
Company Market Cap (USDmn) Employees Revenue (USDmn) Net Income (USDmn) Capex (USDmn) Profit Margin (%) Net Debt/EBITDA
na = not available. Note: Accurate as of April 15. Source: Bloomberg
CONSOL Energy Inc 2,993 3,114 2,843 -375 1,023 -13.2 24.1
Alliance Holdings GP LP 1,010 4,243 2,273 211 213 9.3 1.3
Alliance Resource Partners LP 980 4,343 2,274 306 213 13.5 1.3
Foresight Energy 207 na 985 -39.5 85.0 -4.0 5.9
Hallador Energy Co 142 740 342 20.1 31.2 5.9 2.6
Westmoreland Coal Co 132 3248 1,411 -203 77.9 -14.4 na
Cloud Peak Energy Inc 127 1500 1,124 -205 37.7 -18.2 na
Natural Resource Partners LP 126 225 489 -572 50.9 -117 na
Westmoreland Resource Partners LP 125 658 385 -33.7 20.1 -8.8 6.2
Rhino Resource Partners LP 29.5 715 207 -55.2 63.0 -26.7 6.9