Market Analysis
Overview of U.S. Coal Production
U.S. coal production over the last 10 years has hovered around 1.1 billion tons. Most U.S. coal moves to the domestic power industry which traditional produces about half of its generation from coal. (Exhibit 1)
Exhibit 1. U.S. Coal Consumption (Million Tons)
The origin of U.S. coal production has been shifting. As shown in Exhibit 2, western coals have become increasingly important. In 2009, western coal accounted for almost 60 percent of total U.S. coal production. Western coal growth is primarily attributed to the Powder River Basin which because of its cost and quality not only captured a substantial market in new generation but was also able to displace design coals in many eastern power plants.
Exhibit 2. U.S. Coal Production (Million Tons)
Coal production in the eastern U.S. continues to be significant. (Exhibit 3) The largest eastern U.S. coal supply region is Central Appalachia which includes coal production from eastern Kentucky, southern West Virginia, Virginia and Tennessee. This is the principal source of low sulfur bituminous coal in the United States and is used for power generation, metallurgical coke production and industrial boilers. This region has been mined very heavily for decades and much of the remaining reserves are below drainage (underground) and high ratio (surface) which increases their costs. This combined with new safety regulations pursuant to the 2007 MINER Act and permitting difficulties has caused costs in Central Appalachia to increase disproportionately which has reduced the competitiveness of Central Appalachian coals within the U.S. With periodic up-ticks due to unusual market conditions (such as what occurred in 2001, 2005 and 2007/2008), this region has been on the decline since the late 1990s.
Exhibit 3. Eastern U.S. Coal Production (Million Tons)
Second largest is Northern Appalachia which includes all bituminous coal production in the states of Pennsylvania, Ohio and Maryland and production in the northern part of West Virginia. Production in Northern Appalachia is currently dominated by the Pittsburgh seam, a large reserve of thick coal which lies in a basin that runs through southwest Pennsylvania, northern West Virginia, and eastern Ohio. (Exhibit 4) The Pittsburgh seam extended into central Pennsylvania and western Maryland but has been mined out in these areas. The current dominance of the Pittsburgh seam is attributed to longwall mining technology which is ideal for the consistent five to eight foot seam height and good roof and floor of the Pittsburgh seam. About 60 percent of Northern Appalachia coal comes from 11 longwall mines, the largest of which produce over 11 million tons per year. Expansion of the longwall mines is limited due to permitting difficulties, particularly in Pennsylvania, and limited reserves. In theory, Pittsburgh seam mining capacity could be expanded to 100 million tons per year; in reality this is unlikely to happen due to permitting issues, the high costs associated with developing new mine capacity, and a general recognition that limitations on supply offer advantages to the current producers. The non-Pittsburgh seam production is mixed in quality. Some can be developed at competitive prices. Generally the mining conditions are not as favorable as the Pittsburgh seam and the mines operate at much higher costs.
Exhibit 4. NORTHERN APPALACHIA COAL PRODUCTION (Million Tons)
The third largest region in the east is the Illinois Basin which consists of the coal producing areas in Illinois, Indiana and West Kentucky. (Exhibit 5) The coals in this region are produced from the same geological formation. The coal is bituminous with 10,000 to 12,500 Btu per pound and mostly over two percent sulfur. There are pockets of low sulfur coals in Indiana and Illinois but virtually no low sulfur coal in West Kentucky. Much of the low sulfur coal in Illinois has already been mined. The Illinois Basin today is radically different from the one that existed in the 1990’s. UMWA production has dropped to under 10 percent. Indiana is now the largest producer, surpassing West Kentucky in 2000 and Illinois in 2001. The Illinois Basin is the only major coal supply region to experience an increase in 2009.
Exhibit 5. ILLINOIS BASIN COAL PRODUCTION (Million Tons)
West Kentucky Coal Production
.Production in west Kentucky has been on the rise largely due to expanded production by Alliance and the start-up Armstrong Coal. Production by company for the last seven years is summarized in Exhibit 6.
Exhibit 6. WEST KENTUCKY COAL PRODUCTION BY COMPANY (1,000 Tons)
The largest producer is Alliance which was formed from the old MAPCO mines. Alliance has made several strategic acquisitions which have increased its dominance. Alliance’s new River View mine is coming on line in 2009 and will ultimately produce over six million tons per year. The second largest producer is Patriot which was formed when Peabody elected to spin off a number of older mines in 2007. Armstrong Coal, the third largest producer, is bringing coal from reserves it bought from Peabody into the market. The next three producers are Phoenix, Green River and Murray Energy. Phoenix, which was an aggregation of several smaller producers, was sold in 2009 to Oxford Mining. Green River reopened the old Pittsburg & Midway mines. Murray Energy operates the KenAmerican/Paradise mine. The remaining producers are relatively small.
Production by mine is provided on Exhibit 7. The major deep mines in West Kentucky are continuous miner operations operating in the #9 seam. Generally, the reserves are too shallow for longwalls and faults are not uncommon. The surface production is generally in smaller blocks. Many of the operating mines have limited reserves and are believed to be near depletion.
Exhibit 7. WEST KENTUCKY PRODUCTION BY MINE (1,000 Tons)
New mines under development in west Kentucky in addition to the River View mine include the Gryphon deep mine project which was part of Phoenix but has been alleged to have been sold, the Thoroughbred mine which was tied to the development by Peabody of a power plant of the same name and now is tied to a coal-to-gas project, and the Carbonado project. The Peabody mine is only likely to be developed in conjunction with a dedicated market. Some new mines are needed to meet demand requirements given the expected reserve depletion.
Carbonado Market
The primary market for West Kentucky coal is the utility market. Shipments of West Kentucky coal to electric utilities in 2008 are summarized on Exhibit 8. Five customers (TVA, LG&E/KU, Big Rivers, Duke, and Seminole) account for almost 90 percent of sales.
Exhibit 8. UTILITY PURCHASES OF WEST KENTUCKY COAL
This market has been and is expected to continue to grow as a result of (1) the retrofitting of pollution control equipment for sulfur dioxide (SO2) control which will allow the use of higher sulfur coals and (2) the addition of at least one new power plant on the river (Trimble County) which is designed for Illinois Basin coals. In addition to the 46 GW of scrubbers already retrofit on eastern power plants, an addition 20 GW are under construction and another 30 GW are either required or projected to be built.
The market for West Kentucky coal can be divided into three categories: local truck and rail markets, Ohio River barge markets, and southeast rail and barge markets. Given its quality and location, Carbonado coal could compete in all of these markets.
The plants included in each of the three categories along with 2008 purchases and burn are listed in Exhibit 9. As noted in Exhibit 8, additional utility plants have purchased coal from West Kentucky and could potentially be a source of demand. They are not included below as they are not deemed to be a primary market at this time.
Not surprisingly, West Kentucky’s share of the local market is relatively high. This is the market to which West Kentucky coal has a transportation advantage.
Some of the best growth opportunities for West Kentucky coal lie with the Ohio River market. The retrofitting of scrubbers on Ghent, Miami Fort, Spurlock 1 and 2, Stuart, and Killen will increase the market for higher sulfur coals, largely at the expense of Central Appalachia coal. In addition, the new Trimble County unit which is expected on line in 2010 will add about 2.5 million tons of new demand.
Exhibit 9. MARKET FOR WEST KENTUCKY COAL BY CATEGORY
Carbonado Pricing
Long-term coal prices are set by the full cost of production (including cash operating costs and return of and on capital investment) within a producing region. Prices can vary around the long-term “equilibrium” price based on market conditions. In the short term, the floor on coal prices is the cash operating cost for the marginal producer, which
forces a decline in production. The short-term ceiling on coal prices is the price at which demand declines, generally through customers switching to a different coal, but possibly switching to a different fuel (pet coke) or a different generation source (natural gas combined cycle priced on the grid). Because it takes time for the market to respond to coal price changes (including capital), disequilibrium pricing can last for an extended period (two to three years) before markets correct.
Prices are loosely connected between supply regions. If costs and prices are rising in one region, customers may switch to coal from another region if they can use the quality and the transportation differentials do not consume the basis differential. The extent of the ability to switch among regions creates the connections between regional coal prices. In some cases, the switching can occur as quickly as the logistics allow. In other cases, most notably when plants not designed for sub-bituminous coals are switched to Powder River Basin coals, the switching requires planning and capital investments.
As described above, West Kentucky coal as part of the Illinois Basin competes primarily with other Illinois Basin coals. To a limited extent, it competes with Northern Appalachia, Central Appalachia and even the Powder River Basin. Within the Illinois Basin, the price setting mines are expected to be the cost of a new continuous miner deep mine in southwest Illinois. These mines, rather than new longwalls in southeast Illinois, are setting the price, because of the market constraints related to chlorine.
The West Kentucky price is then adjusted for quality and transportation differences. West Kentucky producers have a transportation cost advantage to the barge market as the rail/dock charge for Illinois coals is typically $6 to $7 per ton.
The prompt price forecast the Carbonado coal West Kentucky coal is provided in Exhibit 10. Prompt prices are the price today for delivery in 90 days. Prices for longer term contracts are typically higher than prompt prices when the market is backwardated (as it is currently) and lower than prompt prices when the market is in contango. The forecast represents pricing in an equilibrium market. Pricing can be significantly higher during periods of market imbalance. In 2008, the price approached $70 per ton.
Exhibit 10. PROMPT PRICE FORECAST ($/Ton FOB Barge)
